The Energy Review - Contraction and Convergence … E XECUTIVE S UMMARY EXECUTIVE SUMMARY Key points...

A PERFORMANCE AND INNOVATION UNIT REPORT – FEBRUARY 2002

The Energy Review

Performance and Innovation UnitCabinet OfficeFourth FloorAdmiralty ArchThe MailLondon SW1A 2WHTelephone 020 7276 1416Fax 020 7276 1407E-mail [email protected]

© Crown copyright 2002

Publication date February 2002

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Th

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CONTENTS

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CONTENTS

Draft Foreword by the Prime Minister 3

Executive Summary 5

Chapter 1: Introduction 15

Chapter 2: The Challenge Ahead 19

Chapter 3: Framework 32

Chapter 4: Security in the Energy System 53

Chapter 5: Lessons from Scenarios 81

Chapter 6: Options for a Low Carbon Economy 93

Chapter 7: A Programme for a Low Carbon Future 109

Appendix to Chapter 7: Institutional Barriers 136

Chapter 8: Institutions 141

Chapter 9: Concluding Themes 155

Chapter 10: Implementing the Recommendations 161

Annexes

Annex 1: The Role of the Performance and Innovation Unit 168

Annex 2: Project Team, Sponsor Minister and Advisory Group 169

Annex 3: Organisations Consulted and Submissions Received 171

Annex 4: Impact of Energy Review Recommendations on Fuel Poverty 180

Annex 5: Energy Efficiency: The Basis for Intervention 182

Annex 6: The Potential for Cost Reductions and Technological Progress inLow Carbon Technologies 188

Annex 7: Timelines Affecting Decisions 200

Annex 8: Chief Scientific Adviser’s Energy Research Review:

Summary and Recommendations 206

Annex 9: Glossary 209

Annex 10: References 213

FOREWORD BY THE PRIME MINISTER

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FOREWORD

Energy underpins our daily lives: it lights our streets, heats our homes,powers our industry, and fuels our vehicles. That’s why securing cheap,reliable and sustainable sources of energy supply has long been a majorconcern for governments.

However, the energy sector is constantly changing.

The last few decades have witnessed the development of North Sea oiland gas reserves; privatisation and liberalisation in the energy sector; ashift towards gas for electricity generation; and the emergence of newrenewable technologies. Electricity prices are now cheaper, and carbondioxide emissions are lower, than 10 years ago.

There is no reason to expect that the pace of change will slow. And thereare added challenges – climate change and, for the UK, resourcedepletion in particular – to which our energy policy needs to respond.That is why I asked the Performance and Innovation Unit to examine thelong-term challenges for energy policy in the UK, and to set out howenergy policy can ensure competitiveness, security and affordability in thefuture.

Their report looks to 2020 and beyond to 2050, sets out the key trends,and explains the choices that we face. It is difficult to predict thetechnological, economic and geopolitical changes that will take placeduring that time – and the report does not try to do so. But it makes clearhow important it is to keep our options open, so that we can respondpositively to changing circumstances.

Three issues stand out from the analysis:

● Diversity and security of supply are no longer only a matter of ensuringa balance of energy sources within the UK. Increased reliance onimports from Europe and elsewhere underlines the need to integrateour energy concerns into our foreign policy.

● Alongside low prices and secure supplies, climate change has become acentral aspect of energy policy. Achieving global emission reductionswill need major technological innovation, and I am convinced that theUK would benefit from being ahead of the game in moving to cleanand low carbon technologies and in sharply improving ourperformance on energy efficiency.

● It is striking that both security of supply and climate change issues aretruly international. The UK cannot therefore only act through domesticpolicies, but must address these issues via international policies and

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agreement, particularly through EU market liberalisation and the Kyotoagreements.

This report is being published as a report to government, and as such isnot a statement of government policy. However, I believe the report raisesmany of the issues we need to discuss as we develop our energy policy.

I hope that this report will launch a thorough debate. The Governmentwill consult shortly on the issues raised in the report and will set out itsdetailed response in an Energy White Paper later in the year.

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EXECUTIVE SUMMARY

Key pointsTrends in energy markets have been comparatively benign over the past 10–15 years: the UKhas been self-sufficient in energy; commercial decisions have resulted in changes in the fuel mixthat have reduced UK emissions of greenhouse gases; and trends in world markets anddomestic liberalisation have reduced most fuel prices.

The future context for energy policy will be different. The UK will be increasingly dependent onimported oil and gas. The Californian crisis has highlighted the importance of putting in placethe right incentives for investment in energy infrastructure. And the UK is likely to faceincreasingly demanding greenhouse gas reduction targets as a result of international action,which will not be achieved through commercial decisions alone.

The introduction of liberalised and competitive energy markets in the UK has been a success,and this should provide a cornerstone of future policy.

But new challenges require new policies. The policy framework should address all threeobjectives of sustainable development – economic, environmental and social – as well as energysecurity. Climate change objectives must largely be achieved through the energy system. Whereenergy policy decisions involve trade-offs between environmental and other objectives, thenenvironmental objectives will tend to take preference.

Key policy principles should be: to create and to keep open options to meet future challenges;to avoid locking prematurely into options that may prove costly; and to maintain flexibility inthe face of uncertainty. Increasingly policy towards energy security, technological innovationand climate change will be pursued in a global arena, as part of an international effort.

Within the UK, the overall aim should be the pursuit of secure and competitively priced meansof meeting our energy needs, subject to the achievement of an environmentally sustainableenergy system.

The UK’s future energy strategy should have the following elements:

(i) energy security should be addressed by a variety of means, including enhancedinternational activity and continued monitoring. However, there appear to be no pressingproblems connected with increased dependence on gas, including gas imported fromoverseas. The liberalisation of European gas markets will make an important contributionto security;

(ii) continued attention to long-term incentives is needed, though recent levels of investmentin the energy industries have been healthy;

(iii) there is a strong likelihood that the UK will need to make very large carbon emissionreductions over the next century. However, it would make no sense for the UK to incurlarge abatement costs, harming its international competitiveness, if other countries werenot doing the same;

Recent trends in energymarkets have been benign forpolicyIn recent decades, the context for energy policyin the UK has been remarkably benign. The UKis currently one of just two G7 countries whichis self-sufficient in energy. Energy prices havegenerally been falling in real terms, partlybecause world oil prices have fallen and partlybecause of the successful liberalisation of UKgas and electricity markets. UK industry andconsumers, including the fuel poor, havegained. And the UK has found it easier thanmany other countries to achieve greenhousegas reductions – the “dash for gas” in particular(which was driven by commercial decisions)reduced carbon emissions from electricitygeneration.

But the future context will bemuch more challengingThe future for energy policy seems likely to bemuch less benign for two reasons:

● issues of energy security are likely to becomemore important. The UK will becomeincreasingly dependent on imported oil andgas. And the Californian energy crisis hashighlighted the importance of gettingincentives for new investment in energyright;

● the UK is likely to face increasinglydemanding carbon reduction targets. A lowcarbon future, if it were to be adopted, couldnot be achieved on the basis of spontaneouschanges within the energy system, especiallywhen at present, one low carbon source,

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(iv) keeping options open will require support and encouragement for innovation in a broadrange of energy technologies. The focus of UK policy should be to establish new sources ofenergy which are, or can be, low cost and low carbon;

(v) the immediate priorities of energy policy are likely to be most cost-effectively served bypromoting energy efficiency and expanding the role of renewables. However, the optionsof new investment in nuclear power and in clean coal (through carbon sequestration) needto be kept open, and practical measures taken to do this;

(vi) the Government should use economic instruments to bring home the cost of carbonemissions to all energy users and enable UK firms to participate in international carbontrading. Achieving deep cuts in carbon would require action well beyond the electricitysector where cuts have been concentrated in recent years;

(vii) step changes in energy efficiency and vehicle efficiency are needed, with new targets forboth. In the domestic sector, the Government should target a 20% improvement in energyefficiency by 2010 and a further 20% in the following decade;

(viii) the target for the proportion of electricity generated from renewable sources should beincreased to 20% by 2020;

(ix) institutional barriers to renewable and combined heat and power investments should beaddressed urgently; and

(x) the Government should create a new cross-cutting Sustainable Energy Policy Unit to drawtogether all dimensions of energy policy in the UK.

In the light of this review, the Government should initiate a national public debate aboutsustainable energy, including the roles of nuclear power and renewables.

nuclear power, faces a progressive run-downas existing plant reach the end of their livesand are decommissioned.

In addition, although good progress is beingmade towards the elimination of fuel poverty,many people continue to spend a substantialproportion of their income on fuel, largely as aresult of the age and energy inefficiency of thehousing stock.

New challenges require newpoliciesThe introduction of liberalised and competitiveenergy markets in the UK has been a success,and competitive markets should continue toform the cornerstone of energy policy. But newchallenges require new approaches. The futureframework for energy policy needs to addressall three objectives of sustainable development– environmental, economic and social – as wellas energy security. But climate changeobjectives must largely be achieved through theenergy system.

Consistent with this, the future aim of energypolicy should be the pursuit of secure andcompetitively priced means of meeting the UK’senergy needs, subject to the achievement of anenvironmentally sustainable energy system.

The strategy articulated in this review thus hasthree main dimensions:

● measures to address the security of theenergy system;

● measures to ensure the energy system isenvironmentally sustainable – these areintended in particular to create options toput the UK on a path to a low carboneconomy; and

● approaches which take full account of thepotential costs of achieving the objectives ofpolicy, in terms of higher energy bills.

Concerns about security needto be addressedThere are a number of reasons why security ison the agenda. These include:

● the Californian experience of electricityblackouts;

● concerns resulting from the terrorist attacksin the USA of September 11; and

● the sensitivity to the UK’s future need toimport gas, possibly across long pipelinesand from trading partners who seem to offerless security than we are used to.

There is general agreement that a diverseenergy system – both in terms of types ofenergy and their sources – can benefit security.Some people argue that self-sufficiency isneeded for security. But this is not necessarilyso. As in other markets, imports can be avaluable means of increasing diversity andreducing risks – most other G7 countriesalready rely substantially on imported energy.Some submissions to the review have suggestedthat the Government should decide the fuelmix to be used for electricity generation. Thisreview has rejected these proposals on thegrounds that they would seriously distort theefficient functioning of energy markets.

Instead, the approach taken is to view issues ofsecurity in risk management terms. Some risksare essentially international, others domestic.

There are three main ways to safeguard security:

● to make maximum use of competitivemarkets to meet customers’ needs. A keyconclusion of the review is that theliberalisation of EU gas and electricity marketsis important for energy security. Liberalisationwould add flexibility and depth to Europeanenergy markets, increasing substantially theresilience of the energy system;

● to create a more resilient and flexible energysystem. The review considers various optionsfor enhancing the resilience of the UK energy

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system, including increased gas storage;greater use of liquid natural gas (LNG); andgreater ability to use coal than wouldotherwise be the case. In the first instance,these are matters for market participants toaddress. The role of government should beto monitor the actions of market participants;to remove any barriers due to policies, suchas the planning system; and to intervenedirectly, as a last resort, where there is clearevidence of market failure and where thebenefits of intervention are likely to outweighthe costs; and

● to use international action to address globalthreats to energy security. On just about anyscenario the UK will become moredependent on imports both for both its gasand its oil. There is little risk of there beinginsufficient gas available internationally: thereis plenty, and 70% of the world supplies canbe accessed from Europe. But the UK cannotbe sanguine about the path that the gas willtake from its source to the European marketand the risks it may encounter en route.Particular concerns are:

● the level of investment in the exportingcountries;

● investment in the transit countries; and

● facility failure overseas.

These risks need to be monitored. They areoutside the direct control of UK purchasers orthe UK Government. The key is to developstrong links with trading partners, so that theUK can ensure that the benefits associated withtrade are mutually recognised and delivered.

Making sure suppliers face theright investment incentives isessential The other main area of risk to energy security isthe set of issues which arise as a result of theCalifornian experience. Supplies of electricity

were interrupted because insufficientinvestment had been made both in the networkand in electricity generation. The Californianproblems were very specific to that state andwere due in considerable measure to failures inregulation, which have no parallels in the UK.

Present levels of capacity in the UK in bothelectricity and gas networks and in electricitygeneration are healthy. The processes ofprivatisation and liberalisation seem to havesucceeded well. Even so, the situation needs tobe monitored since future investment might beconstrained if the wrong signals and incentivescome through the regulatory structures. Butthere is no reason for immediate concern. Careis also needed to ensure that the anticipation ofpublic intervention does not lead the privatesector to hold back its own investment plans.

Moving to a low carboneconomy poses a majorpotential challengeLooking to the longer-term, the centralquestion for energy policy is the weight to begiven to environmental and other objectives.The strong likelihood of a stringent greenhousegas target being adopted in the future issufficient to justify giving the environmentalobjective a strong priority within future energypolicy – especially since the energy system isthe source of 80% of UK greenhouse gases and95% of CO2. Low carbon options also have themerit that, particularly where they are local anddispersed, they generally contribute to thesecurity of the energy system.

This review has not considered the scientificcase for carbon reductions – this was the task ofthe Royal Commission on EnvironmentalPollution (RCEP), and of bodies such as theIntergovernmental Panel on Climate Change(IPCC). Neither has the review conducted acost-benefit analysis of the different ways ofresponding to the challenge: this is a matter for

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the international community as a whole. Thereis a lot of work on the possible overall costs tothe economy of meeting a substantial carbonreduction target. Most estimates suggest thatthe impacts on GDP are likely to be small –though precise costs will depend on themethods chosen to reduce carbon, the rate oftechnical progress, and the scope for tradingreductions elsewhere in the world.

Possible future energy worlds in 2020 and 2050have been analysed using scenarios. Crediblescenarios for 2050 can deliver a 60% cut in CO2

emissions, but large changes would be neededboth in the energy system and in society. Twoopportunities stand out. Substantialimprovements in domestic and business energyefficiency could be made, and there areprospects for significant improvements inenergy efficiency in the transport system. Yeteven if these improvements can be achieved,and even if the electricity system was toproduce no carbon whatsoever, a 60% cut inCO2 emissions could only be met if we werealso to go on to make very large reductions inthe use of fossil fuels as the main means ofpowering future vehicles. This shows the scaleof the challenge.

The Government will need to make decisionsabout its longer-term approach to carbonreducing policies in the light of the UK’sinternational commitments. The RCEP hasproposed that the UK should adopt a strategywhich puts the UK on a path to reducing CO2

emissions by 60% from current levels by 2050.This would be in line with a global agreementwhich set an upper limit for the CO2

concentration in the atmosphere of some 550ppmv. It would be unwise for the UK now totake a unilateral decision to meet the RCEPtarget, in advance of international negotiationson longer term targets. Greenhouse gases areglobal pollutants, and it would make no senseto incur abatement costs in the UK and therebyharm our international competitiveness, ifothers were not contributing.

Given the strong chance that future, legallybinding, international targets will become morestringent beyond 2012, a precautionaryapproach suggests that the UK should besetting about creating a range of future optionsby which low carbon futures could bedelivered, as, and when, the time comes. Thefocus of this review is on ways of creating newoptions, and building upon the options wealready have. Attention has been given to thecost-effectiveness of different options, bothimmediately and in the longer term.

There is a central role formarket-based instruments andfor support for innovation andR&DA centrepiece of any long-term carbon-reducingpolicy should be the use of market-basedinstruments to put a price on carbon emissionsand to help determine the most cost-effectiveopportunities. This need not happenimmediately, but decisions about long-termapproaches are needed soon, since earlycommitment will start to influence decisions inmany markets. A central aim should be toenable the UK to participate in internationalcarbon trading.

A vital means of increasing the range of optionsfor the future is innovation. This is a theme thatneeds to pervade all areas of energy policy anda range of policies should be directed towardsit. The encouragement of renewables is onemeans of increasing innovation and newtechnologies.

Central to that process will be a strongerresearch and development (R&D) base. A groupconvened by the Government’s Chief ScientificAdviser (CSA) has undertaken a review ofenergy research to inform this review. Thefindings of this group suggest there is a needfor much greater investment in R&D if thecutting-edge technologies for a low carbon

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future are to be developed. R&D will not onlyfacilitate the achievement of environmentalgoals but should create valuable exportopportunities for British industry. A healthy R&Dbase is also necessary to attract and foster thescientific expertise needed by the newindustries which will arise from the innovation itstimulates. The CSA’s group suggested that anational Energy Research Centre should beestablished to provide the focus for suchscientific activity.

A step change in energyefficiency is neededIncreased energy efficiency is obviouslyworthwhile if it saves money. There is no pointin wasting energy that can easily be saved. Thescope for cost-effective energy efficiencyimprovement is large and new potential willcontinue to be created by innovation. Majorenergy users have the incentive to save energy,but where energy is a small part of anindividual’s or firm’s budget the opportunitiesare often ignored, partly because there are risksand bother involved in making the necessaryinvestments.

This review puts forward a programme toproduce a step change in the nation’s energyefficiency. At the centre would be a new target – to ensure that domestic consumers’energy efficiency improves by 20% betweennow and 2010, and again by a further 20%between 2010 and 2020. This wouldapproximately double the existing rate ofimprovement. It is a challenging proposition.The gains in terms of energy savings in a yearcould reach about 0.25% of GDP by 2020, overand above the cost of the investment needed tounlock these savings.

Combined Heat and Power (CHP) – which issometimes viewed as a form of energyefficiency – is a low cost option for carbonabatement, but not zero carbon. In the long

term, it will benefit from policies that put aprice on carbon. Industrial CHP is a maturetechnology. It does not need support toencourage “learning by doing” cost reduction,in the same way as new renewable technologiesdo. Yet it is important that current market andinstitutional barriers to CHP are removed –many of these barriers are similar to the onesconfronting renewable investments. The scopefor CHP will be increased substantially by micro-CHP suitable for use in homes.

An expanded role forrenewables should be a keyplank of future strategyRenewables are not just a single technology buta highly flexible set of options. Some of theseoptions will be developed under the existingRenewables Obligation. At the moment, the useof renewables nearly always costs more thanthe use of fossil fuels. Government support isjustified for two reasons:

● use of renewables will help the UK to obtaincarbon savings in the short term which helpsin meeting international obligations; and

● support for renewables will induceinnovation and “learning”, bringing downthe longer-term unit costs of the varioustechnologies as volumes increase andexperience is gained. In this way, today’sinvestment buys the option of a muchcheaper technology tomorrow. Althoughlearning will be international, some of thenew technologies – notably the marinetechnologies – may have particularly Britishapplications and require UK basedtechnological development.

In order to bring down the cost of newrenewables and to establish new options, anexpanded renewables target of 20% ofelectricity supplied should be set for 2020. Thereview estimates that meeting the whole of this20% target could produce domestic electricity

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prices in 2020 around 5-6% higher thanotherwise. The longer-term assurance which anextended target would give to the industrycould, however, help to bring down the costs ofsupporting renewables over the next decade.The review has not come to a conclusion aboutthe means by which the 2020 target should bedelivered. This should wait upon the review ofthe working of the Renewables Obligation in2006/07.

Achieving the existing target that 10% ofelectricity should be supplied by renewableenergy by 2010 is by no means guaranteed.The renewables industry faces three institutionalbarriers that must be removed if it is tosucceed. These are:

● the excessive discount which, following theintroduction of the New Electricity TradingArrangements, is currently imposed on theprices paid to small and intermittentgenerators;

● the urgent need to change the way in whichlocal distribution networks are organised andfinanced; and

● the working of the planning system, which atpresent fails to place local concerns within awider framework of national and regionalneed.

Recommendations are made to address all ofthese barriers.

Measures are needed to keepthe nuclear option open . . .Nuclear power offers a zero carbon source ofelectricity on a scale, which, for each plant, islarger than that of any other option. If existingapproaches both to low carbon electricitygeneration and energy security prove difficult topursue cheaply, then the case for using nuclearwould be strengthened.

Nuclear power seems likely to remain moreexpensive than fossil fuelled generation, thoughcurrent development work could produce anew generation of reactors in 15–20 years thatare more competitive than those availabletoday. Because nuclear is a mature technologywithin a well established global industry, thereis no current case for further governmentsupport.

The decision whether to bring forwardproposals for new nuclear build is a matter forthe private sector. Nowhere in the world havenew nuclear stations yet been financed within aliberalised electricity market. But, given that theGovernment sets the framework within whichcommercial choices are made, it could, as withrenewables, make it more likely that a privatesector scheme would succeed.

The desire for flexibility points to a preferencefor supporting a range of possibilities, and not alarge and relatively inflexible programme ofinvestment such as would be implied by the10GW programme currently proposed by thenuclear industry. If the UK does not supportnuclear power today, the option will still beopen in later years, since the nuclear industry isan international one, using designs that havebeen developed to meet circumstances in manycountries. The desire for new options points tothe need to develop new, low waste, modulardesigns of nuclear reactors, and the UK shouldcontinue to participate in international researchaimed in this direction.

The nuclear skill base needs to be kept up-to-date. In particular the Government shouldensure that the regulators are adequatelystaffed to assess any new investment proposals.Action is also required to allow a shorter lead-time to commissioning, should new nuclearpower be chosen in future. Finally, within a newframework for encouraging a low carboneconomy, the Government should ensure that,as methods to value carbon in the market aredeveloped, additional nuclear output is able tobenefit from them.

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The main focus of public concern about nuclearpower is on the unsolved problem of long-termnuclear waste disposal, coupled withperceptions about the vulnerability of nuclearpower plants to accidents and attack. Any moveby government to advance the use of nuclearpower as a means of providing a low carbonand indigenous source of electricity would needto carry widespread public acceptance, whichwould be more likely if progress could be madein dealing with the problem of waste.

. . . and to create futureoptions for coal by carbonsequestrationIn the medium-term, coal has a continuing roleto play in the energy mix. Its longer-termcontribution depends on there being a practicalway of handling the CO2 that it produces. CO2

capture and sequestration – whereby carbon istaken out of fossil fuels and stored:

● could be a means to preserve diversity of fuelsources, while meeting the need for deepcuts in CO2 emissions;

● has the potential to allow fossil fuels to be asource of hydrogen for transport and otherapplications without large-scale carbonrelease into the atmosphere; and

● seems to be well suited to UK circumstances,since the UK has potential repositories in theContinental Shelf, and the carbon couldpossibly be used to get more oil fromexisting wells.

At the moment uncertainties surrounding costs,safety, environmental impacts and public andinvestor acceptability are large. Steps should betaken to reduce these uncertainties – asdiscussed more fully in the DTI Clean CoalReview. As part of this work, the legal status ofdisposing of CO2 in sub-sea strata needs to beclarified, in the light of possible conflicts withthe London and OSPAR Conventions.

Increased vehicle efficiencyand investment in newoptions for transport fuels isrequired in the longer-termThe transport sector is likely to remain primarilyoil-based until at least 2020. Access to oilsupplies is not a current concern. Nevertheless,the economy’s dependence on transport,coupled with increased imports as UKCSproduction declines, reinforces the need toimprove the energy efficiency of oil-drivenvehicles. Prospective advances in vehicletechnology hold out the possibility of significantreductions in fuel use.

The potential long-term requirement forsignificant CO2 emissions reductions from thetransport sector combined with the possibilitythat oil will become scarcer, raise the need todevelop alternative fuels. There is the long-termprospect that the technology for poweringvehicles by fuel cells fed on hydrogen will fulfilits current promise, and so ultimately provide asubstitute for oil. Other options, such as liquidbiofuels may also have a role. Internationalefforts are needed to develop thesetechnologies.

Handling the projected growth in aviationenergy use and CO2 emissions must become apriority. Taxation and other measures tomanage aviation demand should be prioritisedfor discussion in EU and other internationalforums.

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Institutional changes,including to the planningsystem, need to be made todeliver the strategy. The approach adopted in this review suggeststhat in the long-term the Government shouldbe aiming to bring together the threeinterlinked themes in this review – energypolicy, climate change policy and transportpolicy – in one department of state. In theshorter-term, consideration should be given tolocating responsibility for energy efficiency andCHP policy with other aspects of energy policy.

As an immediate response to the challenge, theGovernment should set up a Sustainable EnergyPolicy Unit. This would be a cross-cutting unitstaffed by civil servants from all thedepartments with an interest in sustainableenergy, as well as staff from the DevolvedAdministrations, external experts and peoplefrom the private sector. The Unit would focuson providing ministers with cross-cuttinganalytical capability to ensure that keydevelopments in energy use and supply weremonitored and assessed. It would lead on thedevelopment of strategic policy issues, adaptingquickly to changing circumstances.

The different responsibilities of the DTI and theregulators, most notably Ofgem, shouldcontinue. The DTI and DEFRA should do moreto set out their priorities in guidance to Ofgem,so that Ofgem can further consider the impactsof its proposals for non-economic objectives.But it is Ministers who should take responsibilityfor intervention in markets, if economicobjectives conflict with environmental andsocial goals.

In many parts of the energy industries, investorshave found that their projects have difficulty ingaining planning permission. The attitude oflocal communities to proposals for new energydevelopments is important. They must continueto have their say in the planning process, whichis one reason why it is important to engage the

public in the energy policy debate. But nationalplanning guidance needs to make it clear wherethere is a national case for new investment inenergy-related facilities by establishing therelevant national and regional context for eachtype of development.

Next steps: a national publicdebate is now neededThe review develops a radical agenda – toenable the UK to put itself on the path to a lowcarbon economy, while maintainingcompetitively priced and secure energy.Precautionary action is needed in advance offurther international agreement. Tasks thatshould be undertaken within the next five yearsinclude:

● Government should move towards a clearrationale for the balance of policyinstruments – taxes, permits and regulation –to create powerful incentives for long-termcarbon reduction; and

● immediate action is needed to assistinnovation and to create new options, andalso to manage risk.

But these are not matters for the UK alone.Increasingly, policy towards energy security,technological innovation and climate changewill be pursued in a global arena, as part of aninternational effort.

The implementation of an ambitious lowcarbon policy would be a demanding task.Change of this kind takes a long time. It wouldbe wrong to imagine that everything can be“win-win”: there will be some hard choices,and there will be losers as well as winners. Forthis reason the Government needs to take theissues to the public soon. During the review,proposals were made to the PIU for anextensive process of public involvement. Therewas insufficient time for this, but it shouldconstitute a central part of the implementationof the findings of the review.

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The nation must not be lulled into inaction bythe focus of much of the expert debate on longtimescales and on energy systems in a futurewhich will belong mainly to our grandchildren:the time for action is now and all players in theenergy system have a role to play. Given thatthere is considerable inertia in the system, andthat the low carbon technologies are not partof the conventional energy system, a change ofdirection will be difficult to achieve. It willrequire clarity of purpose in all parts ofGovernment.

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INTRODUCTION

Introduction1.1 Energy use is central to our lives, whetherto provide light or warmth, to drive our cars orto fuel our services and industries. Fortunately,the energy markets supplying UK consumersexhibit many signs of health and there is noenergy crisis in the UK. However, debate hasbeen increasing about the ways in whichenergy policy balances economic,environmental and social objectives. Blackoutsand price hikes in California in late 2000 andearly 2001 raised concerns about regulatoryframeworks and investment in energyinfrastructure. The fuel protests in October2000 illuminated how affordability andaccessibility of energy are vital to maintain asecure and equitable society. Human inducedclimate change is now being seen as a reality,with energy use being the major contributor,raising the question of how best to achieve asustainable future.

1.2 A number of countries and internationalorganisations have considered it timely toreview their approach to energy: for example,the USA1 and the European Commission2

published papers in 2001, and the Council ofAustralian Governments has set up a review toidentify strategic issues for Australian energymarkets.

1.3 A prudent government must be sure thatlong-term concerns have been addressed andvaried objectives are being balanced. In June2001 the Prime Minister, Tony Blair, asked thePerformance and Innovation Unit (PIU) to carry

out a review of the strategic issues surroundingenergy policy for Great Britain.

Review objectives and scope1.4 The review had three main objectives:

● to set out the objectives of energy policy,including the UK contribution to globalpolicy initiatives, to 2050;

● to develop a framework for reconciling thetrade-offs among the different objectives ofenergy policy; and

● to develop a vision and strategy for achievingthese objectives and to identify the practicalsteps that need to be taken in the short-andmedium-term, as well as the longer-term.

1.5 A further objective of the review was toinform the Government’s response to the RoyalCommission on Environmental Pollution’s(RCEP) report on Energy – The ChangingClimate3; and in particular the recommendationthat: “The Government should now adopt astrategy which puts the UK on a path toreducing carbon dioxide emission by some 60%from current levels by about 2050”.

1.6 The scope of the review was to coverenergy policy in Great Britain with a timehorizon of 2050. While the review analysed theimplications for fuel poverty of possible policychanges, the review did not cover policytowards fuel poverty. Fuel poverty has recentlybeen addressed by the consultation on, andfinal publication of, the UK Fuel PovertyStrategy.4 In addition, while the review covered

1. INTRODUCTION

1 US National Energy Policy Development Group (2001).2 Commission for the European Union (2001d). 3 Royal Commission on Environmental Pollution (2000).4 DTI, DEFRA (2001).

the role of the transport sector in futurescenarios and considered potential technicaldevelopments, the review did not covertransport policy instruments.

1.7 The review is being presented to theGovernment. It is a consultative document andnot a statement of Government policy.

1.8 Energy policy in England, Scotland andWales is the responsibility of UK Government,but responsibility is devolved in NorthernIreland. However, there are areas within energypolicy in Scotland and Wales that are devolved:these are detailed in Box 1.1 below. Thereview’s formal recommendations should beinterpreted as applying only to UK Governmentresponsibilities; it is for the devolvedadministrations to determine policy in relationto devolved matters. Given their range of

responsibilities, the Scottish Executive andNational Assembly for Wales must remain fullyinvolved in the development of energy policy.

Review process1.9 The review team, a multi-disciplinary mixof civil servants and secondees from outsideWhitehall, was assembled in June 2001. Annex2 lists the team members and their homeorganisations.

1.10 There were five phases to the review:

● posting scoping notes on various issues onthe PIU website to stimulate discussion;

● taking evidence from interested parties.Around 400 submissions were received, andmany were placed on the PIU website;

16


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Box 1.1 Devolved powers and energy

While responsibility for energy policy in Great Britain is reserved to the DTI, anumber of areas relating to energy policy are devolved to Scotland and Wales.Listed below are the key areas that impact on energy policy that are devolved inScotland and Wales.

Devolved in Devolved inArea Scotland Wales

Environment policy ✓ ✓

Promotion of renewable energy ✓ ✘

Promotion of energy efficiency ✓ ✘ *

Support for innovation ✓ ✓

Housing ✓ ✓

Building Regulations ✓ ✘

Planning (apart from the energy consents listed below) ✓ ✓

Power station consents (over 50MW) ✓ ✘

Overhead electricity line and gas pipeline consents ✓ ✘

The National Assembly for Wales also has a cross-cutting duty under theGovernment of Wales Act to promote sustainable development across all of itsactivities. The Scottish Executive’s Ministerial Group on Sustainable Scotlandundertakes a similar role in Scotland.* The NAW controls the budget and/or funds certain energy efficiency schemes in Wales, e.g. the Home Energy Efficiency Scheme,the Energy Efficiency Best Practice Programme, and part of the activities of the Carbon Trust Wales.

● establishing important times and dateswithin the energy industry, and creatingscenarios for possible energy systems in 2020and 2050. These three sources of informationhighlight key issues for energy policy in theshort-, medium- and long-term;

● formulating a framework for Government onhow to make choices among differentpolicies and how to reconcile competingobjectives; and

● setting out key Government actions in theshort-term while exposing fundamentalpolicy decisions for the medium- and long-term.

1.11 In carrying out the review, the PIU teamhas drawn on the expertise of the review’sAdvisory Group, made up of representativesand stakeholders inside and outsideGovernment. (Annex 2 lists the membership ofthe Advisory Group.) Brian Wilson, the Ministerof State (Industry and Energy), Department ofTrade and Industry, acted as the review’sSponsor Minister and chair to the AdvisoryGroup. The input and assistance of the AdvisoryGroup was a crucial part of the review. Thegroup was, however, advisory; the report doesnot necessarily represent the views of all groupmembers.

1.12 In keeping with other PIU projects, thereview team adopted an open and consultativeapproach, involving discussions with a widerange of outside stakeholders. Severalworkshops were held in England, Scotland andWales and the team participated in severalconferences and undertook numerous bilateralmeetings. In addition, Whitehall departmentsprovided invaluable support and assistance. Weare grateful to all those who have spent timetalking to us, organising and taking part inworkshops, and referring us to relevantliterature and research findings.

Review outline1.13 The rest of the review is structured asfollows:

● Chapter 2 briefly describes the current stateof play in the energy system and challengesfaced;

● Chapter 3 sets out the objectives for energypolicy, a framework for future decisionmaking and a discussion of different policyinstruments;

● Chapter 4 considers the issue of security inthe energy system;

● Chapter 5 presents the lessons from fourscenarios created for 2050 and 2020;

● Chapter 6 discusses low carbon options;

● Chapter 7 presents policies and aprogramme for a low carbon future;

● Chapter 8 considers the institutional changesrequired to achieve a secure, low carbonfuture;

● Chapter 9 summarises the review’s mainconclusions and policy recommendations;and

● Chapter 10 looks at implementation of therecommendations.

1.14 Annexes then follow:

● Annex 1 sets out the role of the Performanceand Innovation Unit;

● Annex 2 gives details of the Project Team,Sponsor Minister and Advisory Group;

● Annex 3 lists the organisations consulted andsubmissions received;

● Annex 4 presents an analysis of the potentialimpact of recommendations on fuel poverty;

● Annex 5 presents the basis for governmentintervention in the improvement of energyefficiency;

● Annex 6 provides details of low carbontechnologies discussed in Chapter 6;

1

INTRODUCTION

● Annex 7 discusses key future events and setsout timelines affecting decisions;

● Annex 8 presents a summary andrecommendations from the Chief ScientificAdviser’s Energy Research Review;

● Annex 9 is a glossary; and

● Annex 10 lists references.

1.15 A series of working papers wascommissioned or prepared by the review teamto underpin the review’s analysis andconclusions. These are referred to in the textand listed in Annex 10.

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19

THECHALLENGEAHEAD

Introduction2.1 The energy system would face a seriouschallenge if the UK were to try to achieve largecarbon reductions, while maintaining energysecurity and affordable and competitive energy

prices. The purpose of this chapter is tointroduce and explain those challenges, largelyby showing how the energy system hasdeveloped. Since this review has the task oflooking ahead for 50 years, this chapter takes

2. THE CHALLENGE AHEAD

Summary

The energy system would face a serious challenge if the UK were to try toachieve large carbon reductions, while maintaining energy security andaffordable and competitive energy prices.

● The UK is currently one of only two G7 countries that are netexporters of energy, but it will almost certainly be increasingly relianton imported energy over the next 10-20 years.

● Energy prices in the UK seem to be at, or even slightly below, theOECD average.

● There is the prospect of rapid technological change in the energyindustries. Substantial change may be in prospect, but it would needto be accommodated.

● UK carbon emissions have been falling steadily over the last 30 years.Future emission reductions will be harder to achieve than pastreductions.

● Energy use and emissions from transport have been growing broadlyin line with GDP, until recently.

● There is a continued need to protect the fuel poor from the impactof higher energy costs. Similarly concerns relating to industrialcompetitiveness need to be addressed.

some glances back over the past 50 or moreyears, but most of the information relates to thelast 30 years. After a brief historical review, thechapter gathers together some facts relating tothe major themes of this review: energysecurity, energy prices, fuel poverty, UKcompetitiveness and trends in carbon emissions.It finishes by looking at some of the optionsopened by recent change in energytechnologies.

2.2 An examination of past trends demonstratesthat huge changes in energy systems can bemade. The energy system is made up of a seriesof physical assets, for example power plants,gas and electricity network infrastructure, andoil refineries. These take time to build and, oncein place, last for years, often decades, into thefuture. It is therefore difficult to transfer out ofan energy system quickly without creatingstranded assets, and efficient policy should tryto minimise this waste. Annex 7 gives details ofsome of these “timelines”, whose importance isone of the themes of this review.

2.3 These long time horizons create a need totry to look into the future. Yet the history of

energy reviews is littered with failed attempts toproject or forecast the production and/or use ofenergy resources. This review is unlikely toprove an exception. The important thing is toreflect this uncertainty in policy-making, so thatit is flexible in the face of new information. Itwould be wrong to try to plan the energysystem, but equally, given the often long leadtimes within the energy system, a long-termvision is sometimes needed if we are to avoidcommitments which may be found wanting aspolicy needs change.

The UK Energy System in theTwentieth Century 2.4 The UK’s energy system has changeddramatically over the last century. Similarchanges in technologies, fuel supplies,infrastructure, management and operation ofthe industry and customer relationships can beexpected over the next century. In 1950, asFigure 2.1 shows, the energy system for bothindustry and domestic demand was fuelled bycoal. Fifty years later that energy system looks

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Figure 2.1: Change in the UK primary fuel mix from 1950 to 2000 (%)

Source: Darmstadt et al (1971) and DTI (2001a).

1950 2000

Hydro0.1%Crude oil

10.4%

Coal89.5%

Renewables1%Nuclear

9%

Gas43%

Oil32%

Coal15%

very different. In 1965, it was not clear whetherthe UK would find natural gas in the NorthSea.1 Today domestic natural gas is our largestsource of energy.

2.5 A thumbnail sketch of the history is asfollows:

2.6 Before World War 2:

● coal was the dominant fuel in industry andelectricity power plants, and in houses andbusinesses;

● town-gas networks existed in larger towns,with the gas derived from coal; and

● vertically integrated, independent companiesdistributed electricity to customers viadistribution networks with limitedinterconnection between them.

2.7 The structure of the energy system and thediversity of energy supplies altered considerablyin the second half of the twentiethcentury:

● coal continued to be of central importancefor electricity generation, although itsimportance elsewhere fell substantially;

● nuclear power plants began to becommissioned from the mid-1950s;

● the electricity industry was combined intostate-owned monopolies, during the 1950s;

● the high voltage electricity transmissionnetwork was created in order to transportelectricity over long distances from bigpower plants;

● electricity distribution networks shrank inimportance and activity;

● during the 1960s and 1970s there was amove to an extensive natural gas network forheating (industry, commerce and domestic);

● demand for transport fuel increaseddramatically;

● gas fired central heating largely replacedopen coal fires in homes; and

● the use of electrical appliances in commerceand the domestic sector increased hugely.

2.8 During the 1990s, the GB energy sectorwas transformed by market liberalisation. Theprivatisation of the gas and electricity supplyindustries, combined with the introduction ofcompetitive markets, gave consumers choicebetween alternative providers of gas andelectricity. These changes, which were largelypioneered in GB, are now being adopted inmany other countries.

2.9 A longer-term shift from coal to gas wasalready underway but liberalisation acceleratedit, with beneficial environmental effects. Theswitch from coal to gas in electricity generationwas the result of:

● the availability of cheap gas;

● pressure on coal generators to reduce acidrain emissions;

● the wholesale electricity market; and

● the availability of combined cycle gas turbinetechnology.

2.10 The changes during the 1990s in theenergy system had a number of beneficialimpacts, both economic and environmental.Some of the environmental improvements inrespect of carbon were incidental, althoughthere were direct policy measures intended toimprove efficiency. The beneficial impacts were:

● privatisation and liberalisation helped toreduce the costs of production andtransportation;

● reductions in costs, partly also due to fallingworld fossil fuel prices, have been translatedinto retail fuel price reductions;

● falling real prices have helped to reduce fuelpoverty while maintaining thecompetitiveness of UK industry;

21

THECHALLENGEAHEAD

1 Ministry of Fuel and Power (1965) said that “… gas may be found under the British part of the Continental shelf”.

● the switch from coal to gas reducedenvironmental emissions, not only of acidgases, but also of greenhouse gases; and

● the switch from coal to gas increased thediversity and security of electricity generation– at the start of the 1990s, coal accountedfor about two-thirds of the fuel used forelectricity generation, but it now accountsfor only one-third.

Security2.11 Security of the energy system is a centralconcern and is examined in detail in Chapter 4.One facet of security has always been taken tobe the diversity of fuels in use in the energysystem. Countries vary widely in their energysupply mix. Figure 2.2 shows the different mixof primary fuels in the G7 countries. There areconsiderable differences among countries,especially in the shares of nuclear and coal. All

countries use roughly the same proportion ofoil, reflecting its dominance in transport usesand its phasing out in most other markets. Thedifferences in each country’s fuel mix largelyreflect historical circumstances, resourceendowments and different political and marketchoices. A variety of very different approacheshave been adopted.

2.12 In the UK, one aspect of security concernhas been the imminent peaking of oil and gasproduction from the UKCS. As Figure 2.3shows, the UK is one of only two G7 countriesthat is a net total exporter of energy. Table 2.1shows that the UK is projected still to be a netexporter of oil in 2010. But then total netexports are projected to fall rapidly, so that theUK becomes a net importer shortly after 2010.

2.13 The UK is expected to become a netimporter of gas sooner than for oil, indeed theUK already imports natural gas during periods

22


ANDINNOVATIONUNIT

0

10

20

30

40

50

60

70

80

90

100

Other Nuclear Gas Oil Coal

Figure 2.2: Primary energy use in G7 countries and in the EU and OECD, 2000

Note: “Other” includes renewables and net imports of electricity. Electricity trade is less than 1% of total energy in all cases except France, which exports 2% and Italy, which imports 2%

Source: IEA (2001a).

UK Canada France Germany Italy Japan USA EUAverage

OECDAverage

of peak demand. Based on the current level ofreserves and prices, the Department of Tradeand Industry (DTI) forecasts that the UK willbecome a net importer of gas on an annualbasis from 2005.

2.14 Other changes which may impact onenergy security are expected by 2020:

● many of the existing nuclear power stationswill have ceased production; and

● coal is likely to play a smaller role in theenergy mix, and at least some UK coal mineswill have exhausted their reserves.

2.15 This means that the UK is heading towardsa situation where it becomes a net importer ofoil and gas and where the two leadingelectricity generating technologies of the pastcentury – nuclear and coal – are, on currentplans, running down. Whether this muchincreased import requirement represents aproblem is discussed in Chapter 4.

2.16 In the 1970s the energy problem waslargely defined in terms of potential world-wideshortages of resources. Energy policy was seenby some people as a process of finding newoptions to replace depleting reserves. Since the

23

THECHALLENGEAHEAD

Figure 2.3: Energy self-sufficiency in G7 countries and in the EU and OECD, 1999



OECDAverage

0

20

40

60

80

100

120

140

160

% o

f en

erg

y us

e m

et f

rom

loca

l res

our

ces*

self-sufficient

*nuclear is treated as local

Table 2.1: UK oil production and trade, 1973-2010 (mtoe)

1973 1990 1998 2005 2010

Production 0.6 95.3 138.9 150.0 126.0

Exports 20.9 76.5 113.1 123.3 95.5

Imports 136.9 65.4 61.3 70.0 70.0

Bunker use 5.4 2.5 3.1 2.0 2.0

Net imports 110.6 –13.6 –54.9 –55.3 –27.5


1970s, views have changed and there is nolonger a sense of urgency about future world-wide energy resources. In large measure this isbecause there has been a more systematicsearch for major energy resources, and manyhave been found. While in the 1970s the worldreserve to production ratio for gas was around40 years; it is now close to 60 years, despitesubstantial and rising gas use in the meantime.2

World coal reserves now stand at 200 years ormore.3 The position for oil is slightly different.While world reserves have remained roughlyconstant at around 35 years, oil has beensearched for intensively for many years, and fewlarge new discoveries have been made for sometime.4 This means that for the 50-year period ofthe current energy review, it is possible to beconfident about world-wide coal reserves, andreasonably confident about gas availability, butoil might become scarcer by mid-century.

Energy Prices2.17 Table 2.2 shows that industrial energyprices have been on a downward trend sincethe early 1980s. The exception is the price ofheavy fuel oil which has fluctuated, and wherethe price in 2000 was above the price in 1990(and indeed 1970). This is a reflection ofchanges in oil prices. Table 2.3 shows that, withthe exception of petrol prices, domestic energyprices have fallen over the last decade: the fallsin gas and electricity prices have beenparticularly marked.

2.18 Figure 2.4 shows that if UK averageindustrial and domestic electricity prices arecompared with prices in other European andG7 countries, the UK is slightly below average.But average industrial prices conceal a widerange of terms, and it can be misleading toapply them to particular sectors. Figure 2.5

24


ANDINNOVATIONUNIT

Table 2.2: Trends in real industrial energy prices by fuel, UK, 1970–2000

1970 1980 1990 2000

Coal 108.1 154.5 100.0 60.27

Heavy fuel oil 91.1 245.4 100.0 122.99

Gas 158.9 166.8 100.0 58.76

Electricity 117.1 127.0 100.0 67.95

Source: DTI (2001a).

Table 2.3: Trends in real domestic energy prices by fuel, UK, 1970–2000

1970 1980 1990 2000

Coal and smokeless fuels 89.2 109.0 100.0 94.9

Electricity 84.9 104.0 100.0 78.3

Gas 129.0 86.4 100.0 77.4

Petrol and oil 97.1 107.3 100.0 116.7


2 BP (2001).3 UNDP and WEC (2000).4 BP (2001).

shows that in 1999, UK gas prices seemedsimilarly to be somewhat below the average.The prices shown in Figures 2.4 and 2.5 includetaxes: in the UK, domestic energy taxes are low,relative to other European and G7 countries.5

Carbon emissions2.19 An objective of the review was to informthe Government’s response to the RoyalCommission on Environmental Pollution 2000

25

THECHALLENGEAHEAD

Figure 2.4: The price of electricity in G7 countries, 1999

Source: DTI (2001f).

UK Canada France Germany Italy Japan USA0.00

0.05

0.10

0.15

0.20

0.25

0.30

Electricity for households Electricity for industry

$ p

er k

Wh

Figure 2.5: The price of gas in G7 countries, 1999

Source: DTI (2001f).

UK Canada France Germany Italy Japan USA0

200

400

600

800

1000

1200

1400

1600

$ p

er G

ross

Cal

ori

fic

Val

ue

Natural Gas for industry Natural Gas for households

5 DTI (2001).

report on Energy – The Changing Climate.6 Andin particular, the recommendation that: “TheGovernment should now adopt a strategywhich puts the UK on a path to reducingcarbon dioxide emission by some 60% fromcurrent levels by about 2050”.

2.20 Because 95%7 of UK carbon dioxideemissions result directly from fuel combustion,the energy system will be key to any action toreduce carbon emissions. Yet the UK contributesonly around 2%8 to global carbon dioxideemissions. Any major move to reduce carbondioxide emissions would have to be in thecontext of widespread international action.Figure 2.6 shows energy consumption andcarbon emissions per unit of GDP for the UKand other OECD countries. The UK carbonemissions per unit GDP are roughly equal to theOECD average, though some countries, such as

France and Japan, have much lower carbonemissions per unit of GDP. Figures for emissionsper capita show broadly the same picture.

2.21 Figure 2.7 shows UK fossil fuel use bysector, and the resulting carbon emissions. Themain sources of carbon dioxide emissions arepower stations (28%), industry and business9

(32%), transport (25%), and the domesticheating sector (17%).10

2.22 Figure 2.8 illustrates the links betweenGDP, energy use and carbon emissions since1970. Despite rising energy consumption,carbon emissions have fallen. The main reasonsare that the energy ratio has fallen due toimprovements in energy efficiency, changes inindustrial structure and saturation in demandfor some important energy needs; and that thecarbon ratio has fallen because of switching tolower carbon fuels.

26


ANDINNOVATIONUNIT

6 RCEP (2000).7 DEFRA (2001b).8 DETR (2000).9 Includes all business and public sector activity and oil refineries.10 DTI (2001).

Figure 2.6: Energy consumption and CO2 emissions in the EU and OECD, 1999



OECDAverage

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

toe/

tCO

2 p

er U

S$10

00

Energy (toe) Carbon (tCO2)

2.23 Figure 2.9 illustrates how transportgrowth, measured in terms of both passengerkilometres and freight tonnes travelled, hasnearly doubled over the last thirty years. Unlike

Figure 2.8, which shows that GDP and carbondioxide emissions from energy use arediverging, Figure 2.9 shows that carbon dioxideemissions, transport growth and GDP continue

27

THECHALLENGEAHEAD

Figure 2.7: UK fossil use and CO2 emissions by sector, 2000(%)

Source: DTI (2001d).

Transport Domestic Industry* Electricity Non-energy**0

5

10

15

20

25

30

35

Fossil fuel CO2 emissions

Perc

enta

ge

shar

e

*Includes commerce, public sector and refineries**emissions from land use changes

Figure 2.8: UK GDP, energy consumption and CO2 emissions,1970-2000

Source: DTI (2001a), ONS (2001), DEFRA (2001b).

0

20

40

60

80

100

120

140

160

180

200

1970 1980 1985 1990 1995 20001975

CO2 emissions

GDP

Energy consumption

The carbon ratio (carbon output

divided by energy use) The energy ratio (energy use divided by GDP)

Inde

x (1

970

= 10

0)

to be in step with one another, except veryrecently when CO2 seems to have stabilised.

2.24 Figure 2.10 illustrates the variation amongthe amounts of carbon dioxide that are releasedthrough the use of different fuels. Natural gas

has lower emissions than coal or oil, whilenuclear and renewable energy have almost zeroemissions.

2.25 Different parts of the economy usedifferent types of energy: for example, the

28


ANDINNOVATIONUNIT

Figure 2.9: UK GDP, transport growth and CO2 emissions, 1970-1999

Source: DTLR (2000), DEFRA (2001b).

1970

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1972

1994

1996

1998

40

60

80

100

120

140

160

180

200

Total passenger km Total freight tonne-km Real GDP Total CO2

Figure 2.10: The carbon content of fuels


0

5

10

15

20

25

30

CoalOilGasRenewablesNuclear

Kilo

gra

mm

es o

f ca

rbo

n p

er G

J

transport sector primarily uses oil, while thedomestic heating sector primarily uses naturalgas. There are obvious technological constraintson the extent to which each sector is able toswitch to a lower carbon fuel supply, in theshort term. The implication is that it is harder tomove those sectors towards a lower carbonratio than the sectors which use a lot ofelectricity.

2.26 Past trends in the carbon ratio should notlead us to be complacent about futureemissions from the energy system. As shown inFigure 2.8, between 1970 and 2000 theaverage rate of reduction in the carbon ratiowas 0.75% a year. To deliver 60% CO2 cuts, asenvisaged by the Royal Commission onEnvironmental Pollution, would require anaverage rate of reduction of 2% between 2000and 2050.

2.27 Moreover, the combination of favourablecircumstances that arose in the 1990s is unlikelyto be repeated:

● opportunities for carbon emissions reductionsthrough fossil fuel-switching by end-users arealmost over, with most heat demand alreadybeing met by gas; and

● the output from existing nuclear powerstations will start to decline as they reach theend of their commercial lives, puttingupward pressure on greenhouse gasemissions.

Fuel Poverty2.28 Any move towards a low-carbon futurewould need to take account of the impacts ofany changes in prices on those in fuel poverty.The most widely accepted definition of a fuel-poor household is that it is one which needs tospend more than 10% of its income on fuel useand to heat its home to an adequate standardof warmth. The number of households in fuelpoverty in the UK has fallen over the lastdecade (see Figure 2.11). The improvement has

29

THECHALLENGEAHEAD

Figure 2.11: Number of households in fuel poverty in the UK, 1996-2000

Source: DEFRA, DTI (2001).Note: chart based on definition of fuel poverty including housing benefit and income support for mortgage interest as income.

0

1

2

3

4

5

6

Northern IrelandWalesScotlandEngland

2000199919981996

Num

bers

(m

illio

ns)

largely been a result of reduced fuel prices,improved energy efficiency and increasedincomes. In more recent years, the new HomeEnergy Efficiency Scheme (HEES) and winterfuel payments, now standing at £200 perannum, have helped. Annex 4 gives moredetails.

New Opportunities2.29 The energy system in 2050 will be verydifferent from that in place today. It would bewrong to try to design a policy that appliedunchanged over the long term. Theuncertainties – both technological andcommercial – are too great. The guidingprinciple should be to design policy in such away that it allows maximum flexibility, if andwhen circumstances change.

2.30 Legislative requirements impose animportant set of boundaries or constraints. TheUK is bound by the provisions of relevant

European Directives11 and international treaties,for example the Kyoto Protocol, which establishcertain required outcomes by certain times.While the means of achieving those outcomesare left to individual governments, theoutcomes are legally binding.

2.31 The 1990s saw a number of developmentswhich opened up new options for future energysystems:

● a number of new renewable energytechnologies emerged on the world energyscene for the first time (some renewabletechnologies such as large-scale hydro havebeen established for many years). The UK isvery well endowed with renewable resources,yet it uses less renewable energy than mostEU countries (though many countries achievetheir higher ranking by extensive use of largehydro and conventional biomass plants,rather than by using new renewables).Looking at different countries’ plans for newinvestment in renewables to meet the EU

30


ANDINNOVATIONUNIT

Figure 2.12: Increase in the share of renewable electricity required by 2010 to meet EU target

Source: Official Journal of the European Communities (2001).

0

5

10

15

20

25

UnitedKingdom

SwedenFinlandPortugalAustriaNetherlandsLuxembourgItalyIrelandFranceSpainGreeceGermanyDenmarkBelgium

Perc

enta

ge o

f ele

ctric

ity g

ener

ated

from

ren

ewab

le fu

els

11 For example, the Common Rules for the Internal Market in Electricity; the Common Rules for the Internal Market in Gas; thePromotion of Electricity Produced from Renewable Energy Sources in the Internal Electricity Market; a Community Strategy to LimitCarbon Dioxide Emissions by Improving Energy Efficiency; see http://europa.eu.int/eur.lex for full list.

renewable energy target, the increase towhich the UK is committed is broadly similarto that in many other countries (Figure 2.12);

● network information and controltechnologies, as well as meteringtechnologies, have opened up the possibilityof designing and operating energy networksin new ways;

● new demands, for example from Internetserver farms for high quality power secureagainst network disruptions, are drivingchanges to the energy system. As a resultthere will perhaps be more on-site power,different service offers or new networkquality standards;

● new technologies, such as fuel cells, microturbines, and new market structures haveopened up the possibility of energy systemsbased on clean and efficient, decentralisedunits;

● the major car makers have made progress inthe production of low emissions vehicles,such as hybrid electric engines. There havealso been major advances in research intogenuinely zero emission vehicles, based uponfuel cells.

Conclusions2.32 This brief survey suggests the followingthree main conclusions:

● UK carbon emissions have been fallingsteadily over the last 30 years, mainly as aresult of commercial decisions in the light ofgovernment policy. Future emissionreductions will be harder to achieve thanpast reductions. Until recently, emissionsfrom transport have been growing broadly inline with GDP;

● the UK is currently only one of two G7countries that are net exporters of energy,but it will be increasingly reliant on importedenergy over the next 10-20 years; and

● if instruments which raise energy prices areused to reduce carbon emissions, therewould be a continued need to protect thefuel poor from the impact. Similarly concernsrelating to industrial competitiveness willneed to be addressed.

31

THECHALLENGEAHEAD

32


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3. FRAMEWORK

Summary

This Chapter looks at the justification for government involvement inenergy markets and proposes a framework on which future energy policyshould be based.

● Government intervention in energy markets may be justified wherethere are market failures or equity-related objectives, such as fuelpoverty, that market outcomes may not serve. But competitive energymarkets should continue to be encouraged.

● The guiding principle should be sustainable development, requiringachievement of economic, environmental and social objectives. It isalso vital to maintain adequate levels of energy security at all points intime.

There will be trade-offs and synergies between these objectives.

● Because greenhouse gas abatement can only be delivered through theenergy system, energy policy is likely to give preference to thisobjective.

● An overarching statement of energy policy could be “the pursuit ofsecure and competitively priced means of meeting our energy needs,subject to the achievement of an environnmentally sustainable energysystem”.

● We should prepare for the greater use of economic instruments thatenable the wider environmental costs of carbon to be incorporatedinto market prices. Such instruments are likely to be cost-effective andto be used in international carbon trading.

The rationale for having anenergy policy3.1 The general objective of Governmentenergy policy at present is “to ensure secure,diverse and sustainable supplies of energy atcompetitive prices”.1 The UK energy market isnow almost wholly in private ownership; thereis more competition than ever before and anindependent economic regulator is in place tocontrol the activities of the natural monopoliesin the energy sector – the gas pipelines andelectricity wires – and to police competition.Why then have a Government energy policy?

3.2 Government intervention in private marketsmay be justified on the following grounds

● market failures which lead to economicinefficiencies;

● equity issues, so that even where marketswork well, the outcomes are consideredsocially undesirable; and

● other reasons including strategic andpolitical ones.

It does not follow that the existence of potentialgrounds for government intervention meansthat actual intervention is necessarily justified.Governments do not have perfect knowledge,and interventions may be poorly structured andhave unanticipated consequences. Governmentintervention may sometimes make mattersworse.

33

FRAMEWORK

● This will tend to raise energy prices. If energy is used more efficientlyenergy bills will not necessarily rise. And action to reduce fuelpoverty will also help to remove constraints.

● Good policy will normally require a mix of different instrumentsincluding actions that directly tackle market failures. Targets can beuseful for signalling long-term Government intentions to the market,even if not backed up by specific measures from the outset.

● A unilateral commitment to large cuts in carbon emissions beyondthose already agreed would damage the competitiveness of UKindustry without corresponding global environmental gain.

● In the short- to medium-term, the key priorities of energy policy areto maintain energy security, to ensure compliance with existingcarbon abatement targets, and to develop a range of low carbonoptions to be used to meet possible post-Kyoto targets. The UKshould also be pursuing innovation to permit deep cuts in carbon inthe longer-term. The Government has an important role instimulating innovation.

1 DTI (2000c), page 4 paragraph 1.1.

Efficiency reasons3.3 There are four main market failuresassociated with the energy markets:

● there are market failures arising in part fromthe fact that electricity and gas networks arenatural monopolies. Even with regulationof those monopolies, their existence inhibitsthe ability of suppliers to tailor products tomeet the needs of individual consumers andfor consumers to communicate their wishesto suppliers. These issues are discussedfurther in Chapter 4;

● there are very large “environmentalexternalities” associated with energyproduction and use: the costs ofenvironmental damage are not visited onthose people who are responsible;externalities can be “internalised” bymeasures that enable the wider social costsof pollution to be factored into commercialdecision-making;

● there are information failures (or“asymmetries”), especially in the householdand small business sector, where consumershave much less information (for exampleabout energy saving possibilities) thansuppliers. Another way of looking at this is tosay that there are very substantial economiesof scale in making decisions about efficientenergy use; and

● there is the public good aspect ofinnovation which may result in the privatemarket tending to under-supply innovation,especially in a liberalised market, because itcannot privately capture all the benefits thatresult.

Equity reasons3.4 In the right conditions – such ascompetition among a large number of buyers

or sellers – markets will often provide the mostefficient outcome. But efficient markets are notnecessarily equitable. Governments andsocieties may have preferences for distributionsof incomes and products which are differentfrom those that markets produce, and in suchcases intervention for social reasons may bejustifiable.

3.5 Equity considerations are affected by thefact that energy is a necessity of life. Everyoneneeds warmth and light to survive. And in amodern society access to electricity is alsoessential in order to maintain a range ofhousehold needs. For example refrigerators andtelevisions and (increasingly) access to theInternet are no longer regarded as luxuries andtheir absence is liable to increase socialexclusion. The Government is concerned thatmany of the poorer and more vulnerablemembers of society cannot afford adequatesupplies of energy and for that reason has setout a strategy to tackle fuel poverty.2

3.6 It should also be recalled that equityconcerns can be addressed by means otherthan intervention in energy markets, forexample through special payments to thosethought to be in need through the socialsecurity system.

Other reasons3.7 But there are other reasons whygovernments tend to intervene in energymarkets which are essentially strategic andpolitical. Energy is essential, not only tohouseholds but also to businesses. The non-transport part of our energy system placesheavy reliance on two fuels, gas and electricity,for which energy storage is very difficult.Electricity cannot currently be stored insignificant quantities3 and gas is also difficultand costly to store except in large specialised

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2 DTI, DEFRA (2001).3 Consumer could meet small needs using batteries and fuel-cell technologies are becoming developed for larger applications.

facilities.4 The difficulties with storing these fuelsmean that security of supply is extremelyimportant. Significant supply interruptions canvery quickly become a matter of major politicalconcern. This is reinforced historically: untilrecently Government owned the UK gas andelectricity industries. Consumers have becomeaccustomed to seeing Government playing amajor role in energy markets. The continuedexistence of “emergency arrangements” formost forms of energy, under whichGovernment can suspend market operations, isalso evidence of this continuingpolitical/strategic concern.

3.8 These are the reasons why Governmentmay choose to intervene, but what principlesshould govern its intervention? These must beestablished in relation to the Government’sobjectives.

Objectives of energy policy 3.9 Sustainable development is an overarchinggoal of Government policy. The notion ofsustainability originally stems fromenvironmental concerns, but sustainabledevelopment is now defined in terms of tryingto balance progress in high level economic,environmental and social objectives, rather thanjust environmental goals:

● Economic objectives: Economic policy isconcerned mainly with promoting economicgrowth and efficiency via trade liberalisationand competitive markets. Within energypolicy, this translates into the promotion ofefficiency, both in the sense of achieving thelowest possible costs, and of allocatingresources to where they are of greatest socialbenefit. Greater economic efficiency orgrowth releases or creates resources whichcan then be devoted to other goals, such asenvironmental protection. The economic

implications of a country pursuing aunilateral carbon abatement policy,particularly in terms of its competitiveposition in international trade, are consideredlater in this chapter.

● Environmental objectives: Effectiveprotection of the environment is a majorhigh-level Government objective. Tacklingclimate change is currently the mostprominent, but there are many othersincluding safeguarding individuals againstpoor air quality and toxic chemicals,improving water quality and providingsolutions to nuclear waste problems. Theenvironmental impact of the energy system isprobably greater than that of any otherindustrial activity.

● Social objectives: The key social issuesspecific to the provision and use of energyare: tackling fuel poverty; maximising accessto services that need electricity (e.g. theInternet); maximising access to transport,particularly in rural communities; minimisingtransitional employment shocks due tochanges in the energy industry; and ensuringfair siting of energy infrastructure throughthe planning system.

Security: a cross-cuttingobjective3.10 Energy security does not fit easily into anyof the categories of economic, environmental orsocial objectives of policy, but the importanceof achieving adequate levels of energy securityhas already been noted and is discussed morefully in Chapter 4 which focuses on energysecurity issues. Achievement of adequate levelsof energy security can be thought of in riskterms: the objective of policy is to achieve anappropriately low level of the various risks ofinterruption and stress that face the energy

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4 The capacity of the gas holders found in most towns is very limited – they are used mainly to help smooth the difference betweendaytime and night-time gas use.

system and to develop means of managing theresidual risk. The risk analogy suggests thatsecurity policy will often involve the payment ofa premium as an insurance against an adverseoutcome. A more secure system is likely to be amore costly one.

3.11 The energy system faces a range of (oftenlinked) risks in relation to the continuity ofenergy supply:

● there are risks to both the quantity of energysupplied and the price of energy;

● the risks may be long-term: for exampleincreasing use of imported fossil fuels mayexpose the UK to greater risks of supplyinterruption or high prices due to eitherpolitical difficulties or the exercise of marketpower;

● risks could equally be medium-term: forexample inadequate network investmentnow could lead to a shortage of capacity inthe network in a few years’ time; and

● risks may be very short-term: for example if alarge power station suddenly fails, othergenerating capacity needs to be ready tomake up the shortfall in a matter of minutes.5

3.12 The achievement of adequate levels ofsecurity can therefore be seen as an objectivethat has to be satisfied at all points in time ifother objectives are to be satisfied. RecentGovernment statements on energy policy havelaid particular stress on security, and ondiversity as one means of promoting security.Whatever the relative priorities given toeconomic, environmental and social objectives,security needs to be maintained. However, theneed for Government intervention to establishan adequate level of security is likely to varyover time as circumstances in world energymarkets change. This could be characterised asthe price of security (the “insurance premium”)varying over time.

3.13 A secure energy system is also likely tohave elements of both diversity and flexibility.Both these characteristics will enable it torespond more easily to changing circumstanceswithout undue problems for final energyconsumers and are discussed further in Chapter 4.

3.14 One of the problems with security as anobjective is the difficulty of quantifying it. Bycontrast, carbon emissions are relatively simpleto measure. It is fairly easy to look at out-turnsecurity in terms of actual interruptions andprice volatility. However, because of the timelags in the energy system, current policy isconcerned with future security. Estimates offuture interruptions depend on a huge range ofjudgements about the likelihood of variousevents, ranging from the relatively frequent andpredictable (e.g. how often a coal-fired plantmight break down) to the very infrequent andhighly unpredictable (e.g. an explosion at amajor gas terminal).

3.15 The importance of energy security isemphasised by the fact that both Ofgem andthe Secretary of State for Trade and Industryhave legal duties in relation to the provision ofsecure supplies of gas and electricity.

The energy system3.16 Consideration of energy security drawsattention to the links between different energymarkets of which one of the most obvious is theuse of gas for electricity generation. But thereare other good reasons for thinking in terms ofenergy systems. In particular, carbon emissionscome from all aspects of energy use and theremay be little value in driving down emissionsfrom one part of the energy system (e.g. powergeneration) if that is being offset by risingemissions elsewhere (e.g. transport).Alternatively, if carbon emissions are very costlyto abate in one sector, there may be good

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5 The shortfall could also be managed if some consumers were ready, at a price, to lose their supplies at very short notice.

grounds for strong abatement measureselsewhere.

3.17 An aspect of the approach taken to thisreview has been to try to consider the energysystem as a whole, rather than focussing onindividual fuels or sub-markets. The structure ofthis review reflects that approach and it isrecommended that future analysis of energyissues also tries to consider the implications ofparticular measures for the energy system as awhole.

Trade-offs, synergies andconstraints3.18 In some circumstances, actions thatpromote one objective will also promoteanother. Reducing energy consumption, forexample, should both enhance energy securityand reduce environmental impacts. It will beimportant in future to maximise suchsynergies. But there will also be trade-offsand these may be more frequent than thesynergies. Security considerations are anecessary underpinning, but how should trade-offs between the three constituent objectives ofsustainable development – economic,environmental and social – be assessed?

3.19 Government intervention to addressmarket failures or internalise externalities would,if successful, increase efficiency and should thusenable at least one objective to be improvedwithout harm to others. However, theseimprovements may not always be readilyapparent, especially when they lead to changesin income distribution, as most individualinterventions do. For example, governmentintervention to address environmentalexternalities could take the form of energytaxes, leading to higher energy prices andreduced pollution. This may at first appear toconflict with the economic objective of costminimisation, but if a wider view is taken of

“costs” so as to include environmental costs, ordamage, then this intervention can be viewedas in accordance with economic objectives.However, unless otherwise addressed, thehigher prices would adversely affect those infuel poverty. If the environmental issue wasglobal but was being tackled unilaterally, therewould also be adverse economic impacts on acountry’s international competitiveness.

3.20 Some of the strongest synergies mightcome about where measures to promoteenvironmental objectives (such as morerenewable energy, less energy use, higherenergy prices) also have beneficial effects onsecurity (such as less need for imported energyand less reliance on fossil fuels). But it is mostunlikely that synergy will ever be completebetween two sets of objectives. For example, ifgreater use of coal were thought to increasesecurity, there would be adverse environmentaleffects. In fact, the greater need for trade-offs infuture is a general theme of this report. It isunlikely that the cheapest energy options willalways be best for the environment, securityand wider social objectives.

3.21 Where potential trade-offs exist it isimportant to establish whether one or more ofthe objectives constitutes a “constraint”, that isan objective where there is no scope forcompromise or trade-off within the UK politicalprocess.6 If all the objectives are seen asconstraints in this sense then the only way toproceed is to use additional measures outsideenergy policy to offset adverse impacts.However, this may just be shifting the trade-offsfrom one policy domain to another.

3.22 Security has some of the characteristicsof a constraint – something that should be metat all times. However, because security isinherently hard to quantify, it may be difficultto identify the degree to which it is damagedby a particular policy and thus the extent ofcompensating action required. It is also likely

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6 In practice, almost all “constraints” will be flexible in some circumstances – like “force majeure” provisions in contracts.

that small changes to the level of security couldbe tolerated if the alternative was theintroduction of completely new measures toachieve just a small impact.

3.23 Aside from security, the main constraintson UK energy policy are likely to come frominternational agreements of one sort oranother.

3.24 The main area in which internationalagreements constrain UK energy policy is in theenvironmental field. The main areas ofagreement at present cover emissions of thegases that cause acid rain (mainly oxides ofsulphur and nitrogen) and emissions ofgreenhouse gases. Current commitments forgreenhouse gases, under the Kyoto Protocolcover the period 2008-2012. The constraint ongreenhouse gases, under the Kyoto Protocol,currently operates only until 2012. The partieshave agreed to establish additionalcommitments beyond 2012, but the timing andscale of these remains very uncertain.

3.25 Of course, international agreements arenot simply imposed on countries, but arise froma process of negotiation. At the negotiationstage, each country is likely to emphasise thedifficulties it would face in meeting particulartargets. To the extent that such difficulties areaccepted as real, or well presented, the draft ofthe agreement may be adjusted accordingly.However, future agreements on climate changewill involve many countries, and the ability ofany one country to influence the agreement toits advantage will be correspondingly small.

3.26 International agreements on carbonabatement are expected to permit trading ofemissions among participants. The KyotoProtocol already makes provision for suchtrading through the Kyoto flexibilitymechanisms.7 If the UK is able to meet futureinternational targets by trading rather thandomestic action, it could be argued that

environmental considerations no longerrepresent a constraint on energy policy. To alimited degree, this may be true. Were theGovernment to reach the view that domesticcompliance with emission limits would haveunacceptable implications for energy security(in practice, this seems unlikely) thencompliance could be achieved by buyingpermits from abroad whilst keeping domesticemissions higher in order to safeguard security.In this sense, the potential for trade-offsbetween environmental and security objectivesremains. However, the permits purchasedwould have a cost for the nation and it seemsvery probable that this cost would be placed onenergy consumers by one means or another.This means that the potential for sacrificingenvironmental objectives in favour of economicor social ones would remain constrained.

3.27 International constraints also exist in theareas of other policy objectives. However, theseare generally of a partial nature or areconstraints on instruments, rather thanobjectives. An example of a partial constraint isthe UK’s obligation, as a member of theInternational Energy Agency, to hold specifiedlevels of oil stocks. These contribute to energysecurity but the IEA does not attempt to placegeneral constraints on the energy security ofmembers – indeed, in view of the difficulties ofmeasuring security as a whole, it is hard to seehow it could do so. An example of a constrainton instruments is the EU limit on the minimumrate of VAT (5%) on domestic energy.8

3.28 In broad terms, international agreementsplace some restrictions on UK energy policy butdo not prevent UK ministers making decisionsabout the trade-offs among the economic,social and security objectives of energy policy.International agreements are more likely toconstrain UK ministers’ ability to tradeenvironmental benefits for benefits in otherareas.

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7 DETR (2000), page 18.8 European Commission 6th VAT Directive 77/388 Articles 12(3)(a) and 28(2)(b).

What can energy policyachieve?3.29 In seeking principles to guide theresolution of trade-offs, it is useful to look atwhat energy policy can realistically deliveracross economic, environmental and socialobjectives. This recognises that policy in a widerange of other areas (such as education, thegeneral tax and benefits system, employmentand trade) can have a significant impact onthese objectives.

3.30 Starting from environmental policyobjectives, the expectations about what energypolicy can deliver are necessarily large. Takingfirst the issue of climate change, some 80% ofall greenhouse gases are directly the result ofenergy use (including energy use in transport).Reducing these emissions by significantamounts will therefore inevitably require actionwithin the energy system. There are otherpolicy areas (e.g. building regulations) whichinfluence levels of greenhouse gas emissions.9

But the level of emissions finally depends onenergy use, and energy use is squarely withinthe domain of energy policy. If reduction ofgreenhouse gas emissions is important, energypolicy must be the main delivery vehicle.

3.31 Energy policy is also crucial to otherelements of environmental objectives. Forexample, almost all emissions of oxides ofsulphur and nitrogen and (non-military) arisingsof radioactive waste come from the energysystem.

3.32 Turning to economic objectives, theenergy system again plays a crucial role – thecontinuing need which businesses andhouseholds alike have for secure and efficientlyprovided energy supplies has already beendiscussed. Energy accounts for about 4% of UKGDP.10 Total expenditure on energy by

households is about 5% of total consumerspending, with about half of this beingspending on motor fuels. For most companies,energy costs amount to only 1-2% of totalcosts, but some industries have a much greaterdependence on energy than this. Theinternalisation of environmental externalities inenergy prices (as discussed in Paragraph 3.19)can be viewed as serving broad economicobjectives, but would inevitably worsen theeconomic prospects of energy-intensiveproducers of traded goods.

3.33 The extent to which energy policy candeliver social objectives is quite limited. Ifpolicies to promote security or environmentalprotection led to higher energy prices, therecould be a significant effect on those sufferingfuel poverty. Here, however, there is a very highdegree of policy substitutability – increased fuelpoverty can be addressed quite directly eitherby income supplements (outside energy policy)or by improved energy efficiency measureswithin the homes of those who experience fuelpoverty. In the area of citizen involvement withlocal decision-making – where, say, animplication of environmental objectives was theexpansion of certain kinds of decentralisedenergy – the degree of policy substitution is lessclear cut. However, it is still reasonable tosuppose that some accommodation betweenenvironmentally motivated local energydevelopment and citizen participation might bereached without sacrificing environmentalobjectives to any great extent.

3.34 The most important starting point for aframework to resolve trade-offs betweenobjectives in energy policy-making is thereforethat Government must use the energy system todeliver most environmental objectives,especially climate change objectives. And theenvironmental objectives which energy policy is

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9 It is also the case that adaptation approaches to climate change involve a much wider policy-making arena. At present emissionreduction is at the heart of international approaches to climate change although individual governments, including that of the UK,are also considering ways of adapting, not least because some measure of climate change now appears unavoidable.

10 DTI (2000d), page 16.

best placed to deliver are the ones most likelyto be subject to binding internationalconstraints.

3.35 As the achievement of environmentalobjectives, especially climate change, can onlybe achieved through the energy system, andsince some environmental objectives mayeffectively be constraints, this suggests thatwhere energy policy decisions involvetrade-offs between environmental andother objectives, then environmentalobjectives will tend to take preferenceover economic and social objectives. Theactual balance will, of course, depend on costs:a minor environmental improvement would notbe worth having at the expense of majoreconomic cost. But given the unavoidable needto take action in the energy system forenvironmental ends, there is a strong likelihoodthat, where major actions are needed, the valueof the environmental gains will outweigh thecosts in other areas. The wider impacts ofenvironmentally-motivated decisions mustalways be carefully monitored, so that policieswhich can mitigate the more serious impacts onfuel poverty and competitiveness can beconsidered.

3.36 There is a constant need to check theextent to which given policy approaches affectsecurity objectives – in extreme cases thepursuit of security may, over short periods oftime, need to over-ride environmentalconsiderations.11

3.37 Recommendation: The DTI shouldre-define its general energy policyobjective. The new objective could be“the pursuit of secure and competitivelypriced means of meeting our energyneeds, subject to the achievement of anenvironmentally sustainable energysystem”.

Resolving trade-offs3.38 The previous analysis suggests that in thelonger-term a good deal of energy policy maybe devoted to resolution of environmentalissues where the scope for trade-off againstother objectives is very limited. Nonetheless,trade-offs between other objectives will remainand there may be some scope for trade-off withenvironmental objectives.

3.39 There is no easy way to make these trade-offs. Each will need to be considered separatelyin the context of its particular circumstances. Inthe last resort, such trade-offs are politicaldecisions and political priorities can, and do,alter.

3.40 There are tools that can assist with thesedecisions. Two examples that are widely usedare cost-benefit analysis (CBA) and multi-criteriaanalysis (MCA). A key aspect of CBA is that itattempts to reduce all aspects of the decision tomonetary values. This can involve placing valueson things that are not traded and hence do nothave a market value that can be observed. Andit can also involve deliberately reducing orincreasing certain market values in an attemptto allow for equity concerns. This process isknown as “shadow pricing”. In order to assistpolicy evaluation, Government shoulddetermine shadow prices for any importantenvironmental externalities as well as for thevalue of a reduction in fuel poverty and thevalue of more or less energy security. It isaccepted that there are no easy means toestablish appropriate values for these shadowprices and that uncertainties associated withthem are likely to be large. This is a goodreason for keeping them under regular reviewand may also justify using a range of shadowprices to assess the robustness of a policy touncertainty. The shadow prices could then beused in policy analysis by Governmentdepartments and by independent regulatory

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11 For example, if the impact of temporary shortage of gas on the electricity sector could only be offset by a higher level of coal use,then exceeding emission targets or limits might be the only way to maintain supplies.

bodies. In the longer-term, the need for someshadow prices could fall away, for example ifenvironmental externalities were internalisedthrough economic instruments and thus cameto be reflected in market prices.

3.41 MCA does not try to reduce all aspects ofa decision to monetary values, but ranksalternatives according to a range of criteria ofwhich monetary value is just one. Others mightinclude public acceptability, environmentalimpact or transparency. Different weights canbe placed on the criteria to determine anoverall ranking.

3.42 A key element in any evaluation of trade-offs is to consider them against a range offuture scenarios. Options that appear relativelyattractive in some global scenarios will be lessso in other, perhaps equally likely, scenarios. Anobjective of any assessment would therefore beto seek policies or choose options that arerobust against a wide range of future scenariosand may also be flexible enough to adapt tochanging circumstances.

3.43 In Chapters 6 and 7 a simplified form ofMCA is used to assess the relative attractions forthe UK of a range of low carbon options. Theanalysis is then translated into broad policyrecommendations in relation to each option.The form of the analysis reflects the purpose forwhich it is intended – i.e. to recommend broadstrategic guidance and directions for moredetailed analysis rather than to make firmdecisions between clear-cut alternatives.

3.44 There is no simple way to resolveresidual trade-offs. Each case willdemand separate analysis. It isrecommended that to assist this processHM Treasury should establish, and keepunder regular review, shadow prices forkey environmental externalities andother non-economic policy objectives.

When should Governmentintervene?3.45 Compared to the era when Governmentowned large swathes of the energy industries,Government now has fewer policy levers orinstruments than it had, and there is muchgreater recognition of the effectiveness ofmarkets in choosing between energy optionsand allocating energy resources.

3.46 The existence of Government policyobjectives, and of considerations that might inprinciple justify intervention in pursuit of thoseobjectives, does not in itself mean that thereneeds, at any particular time, to be active ormajor policy intervention. If an existing system,based on market operations, producesoutcomes that deliver policy objectives, activepolicy intervention will not be needed. Forexample, from the mid-1980s to the late-1990s,UK policies mainly aimed at promoting energymarkets and at curtailing acid gas emissions, inconjunction with developments in internationalenergy markets, kept energy security atacceptable levels and also led to reductions incarbon emissions, without the need for majornew policy intervention on either account.Establishing the importance of a policyobjective does not therefore always requirepolicy activity. And it must always beremembered that Government may lackdetailed knowledge of market conditions orbetter foresight than the market, and thatGovernment intervention, particularly in theform of “picking winners”, may be misjudged.Only when events threaten the boundariessurrounding the achievement of an objectivewill it be necessary to intervene. The corollary isthat achievement of energy policy objectivesneeds to be kept under continuous review.

3.47 Government intervention needs, so far aspossible, to provide transparent, consistent andlong lasting signals to all participants in energymarkets. The provision of long-lasting signals isof particular importance since many energy

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investments are capital intensive, of longduration, and once built are relatively inflexible.Without long-term signals, these investmentswill not be influenced in the directions desiredand changes that may need to happen overmany years will not come about. Short-runinterventions in pursuit of immediate political oreconomic gains should be avoided. Someelements in the preferred energy policy mixmay take time to establish – there may need tobe a transitional period, allowing for existingcommitments to be met. If long-term objectivesneed to be sacrificed for the sake of protectingexisting commitments, then this should beclearly recognised.

3.48 The converse of providing long-lastingsignals is that when, for whatever reason,Government feels unable to provide clearindications of its longer-term policies, it shouldattempt to ensure that the absence of suchsignals, or of instruments supporting them,does not lead to investment being made inlong-lived energy assets which are very likely tobe incompatible with those policies. This wouldlimit resources being wasted on stranded assetsdue to lack of clarity over Government policy,and also reduce the risk of energy systemsbeing “locked-into” inappropriate assets.Sometimes it is easier to say what is not wantedthan what is wanted.

3.49 Where possible, Government shouldadopt long-lasting energy policy signalsin order to affect energy investmentsand ensure long-term change. Whereshort-term policy adjustments arerequired, in response to particularevents, these should be recognised assuch and should not undermine the long-term signals.

How should Governmentintervene? 3.50 There are three main types of instrumentavailable for Government intervention:

● direct regulation, in which Government orregulators can set the physical or economicrules under which energy system participantscan act. This can take the form, for example,of licensing firms to supply retail energy,controlling the emissions from an industrialplant, or setting building regulations toensure a minimum level of energy efficiency;

● economic (or market-based)instruments, where Government orregulators can encourage particularoutcomes without in any way specifying howthose outcomes might be delivered. Anexample might be a tax on a particular formof energy, which encourages all consumersto reduce its use, but does not attempt tosay by how much or which sort of consumersshould make the reductions; and

● policies of other kinds. This is a catch-allcategory that includes direct governmentspending (for example on energy R&D),decisions on how Government will procureenergy services and energy-using equipmentfor its own use, and voluntary agreementsbetween Government and groups of marketparticipants.

3.51 Whatever instruments are used, and inwhatever combination, their use should meettwo broad criteria: they should be efficient orcost-effective and they should promote equity.

3.52 The criterion of efficiency coverseffectiveness – in other words, it needs to helpmove the energy system clearly towards thedesired goal – and costs, not only togovernment (public sector costs) but to theeconomy as a whole (resource costs). Thecomparison of effectiveness and resource costsgives a cost-benefit or cost-effectiveness

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criterion that is fundamental to the assessmentof policy instruments.

3.53 The two most important considerations interms of equity are distribution – how theinstrument affects the distribution of goodsbetween different members of society, andtransparency – how clear and comprehensible isthe instrument.

3.54 The relative merits of the differentapproaches are explored in the followingparagraphs using carbon abatement as anexample of the final objective.

Direct regulation

3.55 Regulation is of particular importance forthe natural monopolies where competitioncannot be relied upon to set appropriate pricesor levels of output. However, regulation is oftenused in competitive markets as well. Forexample, producers of a particular energy-usingproduct might be required to ensure that itmeets specified criteria for energy use per unitof output in order to reduce the carbonemissions associated with its use. Regulation hasthe advantage of considerable flexibility and,depending on the detail, it can deliver a highdegree of cost-effectiveness, especially incircumstances where a wide range of marketparticipants face very similar costs (e.g. costs offinding information) or have similar preferences.But there are risks of regulation not being cost-effective if, through ignorance on the part ofthe regulator, market participants are compelledto specified actions when other, less costlyactions could deliver the same results. Ingeneral, such distortions will be minimisedwhen regulation specifies the result to beachieved, rather than the means of achieving it.

3.56 In most circumstances direct regulation istransparent to those immediately affected and itcan be structured in such a way as to avoidsome adverse distributional outcomes. On the

other hand, the costs (e.g. raised productprices) or benefits (e.g. reduced energyconsumption) are not always obvious to thebuyer.

Economic instruments

3.57 The key property of an economicinstrument is that it is designed to achieve oneparticular objective, usually by placing a valueon a cost or benefit that, for whatever reason, isnot valued by the market. By doing so, theseinstruments affect market prices – for example,a tax on carbon emissions would increase theprices of fossil fuels. Another example is asystem of tradable carbon permits for thecontrol of carbon emissions. Such permits couldbe traded between all participants in the marketto ensure that the overall emission target(which would fix the number of permits) wasmet in the most cost-effective manner. Thosewho could reduce emissions most cheaplywould sell permits to those whose emissionreduction costs were higher. There would alsobe good incentives to find new and innovativeways of reducing emissions in ways thatregulators may not have considered at theoutset. Such instruments can be particularlyuseful in addressing environmental externalitiesbut can also be applied to other objectives.

3.58 For economic instruments to be efficient,market participants need to know well inadvance how many permits, for example, are tobe issued for any particular period. It is alsoimportant to ensure that there are no othermarket or institutional failures that preventparticipants reacting to the incentive.12

Economic instruments are generally transparent,even to those not directly affected, but are notstructured to address distributional issuesbecause they affect market prices which in turnaffect all types of consumer or producer.However, distributional issues can be addressedby other, parallel, measures. A large majority of

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12 An example of such a failure might be the inability to obtain planning permission for a low carbon technology. Such failures wouldneed to be addressed directly.

those consulted in the course of the energyreview (of those who expressed opinions oninstruments) believed that economicinstruments have efficiency and transparencyadvantages over other instruments and shouldbe used more in the future.

3.59 The impact of tax instruments could beenhanced by agreements such as thosenegotiated in respect of the Climate ChangeLevy. In return for a lower tax rate, the taxpayeragrees to abate energy (or carbon) use morethan had it faced the full tax rate. This isprofitable for the taxpayer since the reductionin tax on residual energy (emissions) can morethan offset the extra abatement costs. Thisapproach is sometimes known as “conditionaltaxation”. Its disadvantages are greatercomplexity, the need for regulators to reachjudgements about the amount of abatementthat is reasonable in return for a given taxreduction, a potential distortion of incentivesbetween those with agreements and thosewithout, and the possibility of taxpayerssubsidising very high-cost carbon abatement atthe margin.

Other instruments

3.60 The general characteristic of this group ofinstruments is that they “pick winners” withGovernment giving support of one sort oranother to a particular technology or type ofactivity that it believes will be able to achieve itsobjectives efficiently. Because Governments maybe poorly informed of the relative carbonabatement costs of different options, they maypick winners that turn out to be losers.Instruments of this sort do have the advantage,however, of considerable flexibility and can beused in circumstances where, for whateverreason, it may not be appropriate to give long-term general incentives or introduce newregulations. These instruments can also be quitecarefully crafted to minimise adversedistributional consequences, although the pricemight be some lack of transparency.

Comparison of instruments

3.61 It is clear that different instruments havedifferent advantages and disadvantages. Mostpast policy approaches to environmental andother energy policy problems have used acombination of instruments – there has been apolicy package, rather than a single instrument.It is very likely that such an approach willcontinue to be needed in the future. Economicinstruments have very important potentialadvantages in terms of their ability to involve allmarket participants in addressing an issue andthereby delivering the most cost-effectivesolution, but unless or until certain marketfailures can be resolved, and internationalagreement reached on longer-term carbonabatement, economic instruments alone cannotbe relied on for the purpose of carbonabatement. The use of a range of instruments isalso more likely to deliver an overall policystance that is flexible to changes incircumstances and distributional considerations,while still giving significant messages aboutfuture policy to the markets. The overallconclusion is that in many instances deliveringenergy policy objectives will need an effectiveand pragmatic blend of instruments, althoughin the longer term a greater role for economicinstruments should be sought.

The role of targets

3.62 An important element of environmentaland energy policy-making has been theestablishment of targets for the achievement ofgiven outcomes by a specified dates. Targets donot, of course, determine means (which, if any,of the instruments discussed above might beused to deliver them), but they do give a clearindication of ends. How far should targetscontinue to be used?

3.63 The case for continuing to set targets isstrong. They provide an obvious means offocusing both policy makers’ and marketparticipants’ attention on areas where newpolicy measures may be required or existing

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ones adjusted. In doing so, they also provide afocus for innovation at a time when clearermarket support (perhaps in the form ofeconomic instruments) is premature, and theymay of themselves help to stimulate a modestamount of investment, especially in R&D, byfirms anxious to anticipate future developments.

3.64 At the same time, a target does not ofitself have much impact on market investmentpatterns, unless backed by instruments andmeasures to ensure its achievement (or unless itwould have been achieved anyway). It leavesroom for back-tracking in the event thatcircumstances turn out to be different fromwhat was expected, while still making back-tracking sufficiently sensitive politically so that itwould not be undertaken lightly. This sensitivitycontributes a lot to the confidence-enhancingquality of targets, which is necessary if they areto have any impact at all on behaviour.

The centrality of carbon andthe climate change issue3.65 The issue of climate change has beenidentified as a key challenge for our futureenergy system. Under the Kyoto Protocol theUK faces internationally agreed targets forcarbon emissions covering the period up to2012. The Government has set out a range ofpolicies to meet those targets in its ClimateChange Programme.13 This section considerswhat might come next against the backgroundof widespread agreement that the developedcountries will need to make very largereductions in carbon emissions in the longer-term if the climate is to be stabilised.14

3.66 In broad terms there are three possiblenational policy approaches to climate change:

● unilateral: proceeding with significant long-term reductions in carbon without any

guarantee that other countries will dolikewise. Since the benefits of carbonreductions are global, rather than accruing tothose reducing the emissions, it seems veryunlikely that individual countries, includingthe UK, would be prepared to accept therisks of this strategy. If a country movesahead unilaterally on abatement of pollutantswith global effect, its competitive position islikely to be undermined and economicgrowth restricted. Depending how the costsof that abatement are met, companies inthat country producing internationally tradedgoods with energy intensive processes (suchas steel) may be particularly threatened. Onthe other hand, if other countries thenfollow, the country starting the process couldhave gained “first-mover” advantages,perhaps by developing low carbontechnologies it can then export;

● reactive: only taking action to addresscarbon reduction once bound byinternationally agreed targets and not goingbeyond those targets. This approach carriesdifferent risks, including being unpreparedand ill-equipped, relative to other countries,to pursue emissions reduction. For thisreason it is also likely to be unattractive tothe UK; and

● leading: aiming to promote internationalagreement and taking precautions thatwould minimise the risks of failing to meetexisting targets, while also facilitatingachievement of possible future targets andpromoting a degree of first-moveradvantage. This is the approach alreadyadopted in the UK Climate ChangeProgramme15 and is well suited to framinglonger-term policy in this area.

3.67 A further important consideration is thatinternational agreements to reduce carbon arevery likely to feature international trade in

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13 DETR (2000).14 Further details can be found in PIU (2001g).15 DETR (2000), page 6, paragraph 8.

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Box 3.1: Carbon Valuation:There are two major alternatives for producing a market value of carbon (i.e. a generalincentive for carbon abatement). One is carbon taxes and the other is tradable carbonemission permits (TCEPs). There are two key differences between these approaches:

● taxes fix the value of carbon but leave the quantity undetermined whilst permits fix thequantum and leave the value to be determined; and

● the distributional consequences can vary depending how the permits are allocated.

In both cases, the mechanisms would need to be phased in over long future time periods inorder for future tax levels, or future permit availability, to affect current investment decisions.If introduced suddenly, either mechanism could produce very high taxes or permit prices,given the difficulties of substituting for energy in the short term.

Carbon taxes could be applied to producers of fossil fuels. The taxes would be passed on tobuyers in the form of higher prices, all the way down to the final purchaser. The tax would beset at the level thought necessary to deliver the total level of carbon abatement required.

TCEPs might be required for all sales of fossil fuel to final consumers. The total volume ofpermits issued would equal the quantity of emissions allowed and their value would bedetermined by trading between permit holders. For example, a petrol company might needto surrender a permit for each unit it sold to motorists and the cost of that permit would bereflected in the price paid by the motorist. Large consumers might buy their own permits tocover their energy needs and pass these to their energy supplier to surrender.

The key issue with permits is their initial allocation. One approach is to auction all permits tothe highest bidder. In this case, the distributional consequences would be similar to those of acarbon tax. But a range of other approaches is possible, including approaches under whichsome permits, or the revenue therefrom, are allocated to groups which the Governmentconsiders especially deserving, for example energy intensive industry or the fuel poor. Thetraded price of permits in the market, and hence the incentive to reduce emissions, isunaffected by the initial allocation.

As noted in Paragraph 3.59, the impact of carbon taxes or permits could be enhanced byagreements which make their impact conditional on achieving specified savings.

Using taxes to value carbon would not mean that taxes in the energy field could notsimultaneously be used for other purposes, including addressing other environmentalexternalities. In many cases, there may be synergies so that reductions in carbon might alsolead to reductions in, for example, acid gases. What matters for carbon valuation purposes isthat there is a “carbon element” in the tax which reflects differences between the carboncontent of different fuels. It is not impossible that in overall tax levels, carbon differentialscould be more than offset by differentials arising from other externalities or objectives. Forexample, taxes on motor fuel might be much higher than those on domestic coal use, eventhough coal was the more carbon-intensive fuel, on account of concerns about roadcongestion. In other cases, the uncertainties associated with combining a range of objectivesin energy taxes might mean that taxes on energy use might be preferred to different tax rateson individual fuels.

carbon emission rights. This in turn implies thatcarbon will be valued in the market-place (seeBox 3.1). It is possible that such trading will belimited to inter-governmental transfers, but it israther more likely that carbon permits willincreasingly be owned by individual firms whowill trade between themselves.

3.68 Another implication of internationalclimate change agreements is that the problemsof higher energy prices for energy-intensiveindustry can be dealt with. Clearly, there is nomerit in raising prices to meet a domesticemissions target if the result is to drive energy-intensive industry to move to another countrywith no carbon limit. Global emissions wouldnot be reduced but local jobs would be lost.The more countries participate in aninternational agreement, the lower the risk ofthe problem. And the countries taking actioncould well agree among themselves measuresto protect energy-intensive industry within theircollective borders.

3.69 A “leading” approach to climate changeimplies three separate policy timelines:

● measures to comply with agreed targets;

● measures to prepare for future targets notyet agreed but probably involving not allcountries and operating for limited time-periods; and

● measures to prepare for a world of long-termemission limits agreed between all countries,possibly based on the principles ofcontraction and convergence.16

3.70 There is no clear dividing line betweenthese phases. Post-Kyoto targets affecting theUK could be finalised by 2005 but agreementmight take longer, perhaps a lot longer, and thescale of the next targets is uncertain. Likewise, itis possible that we could be in a world of long-term universal targets by 2010. There is even a

remote possibility of moving directly to the finalphase from the current position.

3.71 In the same way, it is far from clear whatthe scale of future targets will be. The RCEPsuggested that a 60% reduction for the UK by2050 would be needed within a contractionand convergence agreement, but the exactfigure is very uncertain. All that is certain,whether we move to a contraction andconvergence world, as suggested by the RCEP,or follow the guidance produced by the IPCCabout global levels of emission reductions thatwill be needed to avoid dangerous climatechange, is that developed countries will need tomake very substantial cuts from currentemission levels over the century ahead.

3.72 There are risks that internationalagreements to abate carbon will not be reachedand that in such cases, many countries wouldnot move unilaterally. This should not detractfrom the argument that the scientific case forabatement is becoming increasingly strong andthat there will therefore be increasing pressureson governments to reach agreements and ahigh probability of agreements being reachedin due course.

Frameworks and trade-offs forpolicy timelines

Compliance with agreed carbontargets – to 2012

3.73 Measures to comply with the UK’s Kyototargets were set out in the UK Climate ChangeProgramme. The measures are actuallyexpected to deliver greater reductions thanrequired, in order to give a high degree ofconfidence that the targets will be met andbecause the Government has also set adomestic goal to reduce carbon dioxideemissions by 20% below 1990 levels by 2010.

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16 “Contraction and convergence” is a possible basis for long-term international agreement on carbon abatement. It would entaildeveloped countries reducing their per capita emissions (contraction) whilst developing countries’ emissions expanded until allcountries’ per capita emissions converged at a level considered to be sustainable.

3.74 However, there is no automaticmechanism in place to ensure the UK meets itsKyoto target if events do not turn out asexpected. For this reason it is crucial thatenergy sector developments continue to bemonitored and that the assessment of newpolicies takes account of any contribution theymight make to the target or the extent towhich they might make it harder to meet. Inthe latter case, it is particularly important tofactor in the cost of alternative measures to putthe UK back on track to meet what are bindingtargets. This could be done using a shadowprice for carbon.17

3.75 Energy policy trade-offs affectingthis period should generally give priorityto carbon reduction if there is a materialrisk of failing to meet internationally-agreed emissions targets. Failure to meetthe target would be inconsistent with a“leading” role for the UK in response to climatechange. This may require compensating policymeasures in other areas to achieve other policyobjectives.

3.76 Given the expected role of existingmeasures, the practical difficulties in moving towidespread carbon valuation (see Box 3.1) andthe limited time that carbon valuation measureswould have to affect the energy system before2012, there might seem little reason to movetowards carbon valuation in the short-term.

3.77 On the other hand, there are strongreasons for early progress towards carbonvaluation:

● carbon valuation is likely to be the singlemost effective low carbon delivery measurein the longer-term, and to delay movingtowards it would give a misleading signal;

● the Kyoto mechanisms (see Paragraph 3.26)allow for international carbon trading, whichin turn implies valuation, in the period 2008

– 2012 and a draft EU Directive18 proposes anEU wide trading scheme from 2005. It isimportant that the UK has the option ofmaking full use of these mechanisms as ameans of delivering its Kyoto commitments;

● there is a real possibility that by 2008,longer-term internationally-agreed emissiontargets will have been agreed which wouldenable greater reliance to be placed oncarbon valuation; and

● carbon valuation is not an “all-or-nothing”issue. Although the long-term aim might beto use carbon valuation as the major lowcarbon policy measure affecting the whole ofthe energy market, in the shorter-term itcould be limited to certain sectors andcombined with other instruments if morewidespread implementation would conflictwith energy security or social objectives.

3.78 The UK has already made a start oncarbon valuation through the Emissions TradingScheme, a tradable permit scheme being takenforward by DEFRA for launch in 2002. Thecoverage of the Scheme is effectively confinedto larger business energy users and participationis entirely voluntary.

3.79 Consequently, it is recommendedthat HM Treasury/DEFRA give earlyconsideration to expanding the use ofcarbon valuation through taxes ortradable permits to cover as much of theenergy market as possible. This couldinvolve expansion or modification of thecurrent Emissions Trading Scheme andshould ensure that UK companies couldparticipate in international carbontrading schemes, including the draft EUscheme, as soon as these are introduced.

3.80 It is also important to remove politicalbarriers to carbon valuation. In this context, themain objectives are to press ahead with the fuel

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17 Recent work by DEFRA indicates that a point estimate of £70 per tonne carbon, together with a sensitivity range of £35–£140 pertonne carbon, could be appropriate illustrative values to use for a shadow carbon price. This work should be available shortly as aGovernment Economic Service Working Paper.

18 Commission for the European Union (2001c).

poverty programme and to ensure thatinternational agreements deal with the concernsof energy-intensive industry.

3.81 It is particularly important to addressinstitutional or other barriers to the take-up ofthe technologies encouraged by the measuresalready in place. This should also lead toeconomic benefits and greater deployment of“no-regret options”, such as many energyefficiency measures. On the other hand, there islittle scope for innovation to play a significantrole in meeting targets for this period.

Preparation for future carbontargets – post 2012 – keepingoptions open

3.82 The size, duration and starting points forfuture targets remains uncertain. The firstconsequence is that preparation to meet suchtargets should not involve commitment of largesums of money. The second consequence isthat there is greater scope for trade-offsbetween environmental and other energy policyobjectives since there are no binding carbonconstraints at present.

3.83 With the scale and duration of futuretargets uncertain, it is not possible to put inplace carbon valuation schemes that would fullyreflect the longer-term cost of emissions. Forexample, if carbon taxes were to be used, itwould be far from clear at what level theyshould be set. It is even possible that if post-Kyoto targets had not been agreed by around2008, the UK might decide thatimplementation of any form of carbon valuationwould not be worthwhile.

3.84 The most important preparation for thisperiod is to establish19 a greater range of lowcarbon options, ready for deployment asnecessary. In some cases this will involve

measures to keep existing options open. In viewof the continuing uncertainties, we should notbe seeking to establish every possible option,regardless of cost, but rather to take forwardwork on a sufficiently large range of options sothat, allowing for the possibility that somemight turn out poorly, the UK would even sostill be able to make significant carbonreductions. Options that are robust to a rangeof future scenarios will be particularly attractive.Establishing these options will require a rangeof measures in addition to any possible role forcarbon valuation. The difficulty of relying to asignificant extent on carbon valuation, becauseof the uncertainty about the scale and durationof future targets, indicates that someGovernment judgements on which options tosupport will be needed.

3.85 Because policy relating to this timescale isinevitably more uncertain than when clearcarbon emission targets are in place, greateruse should be made of indicative policystatements, including targets not backed byinstruments, in order to provide someindication to the market of expected futuredirections. Such an approach would includesteps to discourage lock-in to technology likelyto be inappropriate in most future scenarios.

3.86 In general terms, the options that mightbe deployed to meet the next generation oftargets are likely to have been technicallydemonstrated to at least some degree.However, at least some will be at the stagewhere further process innovation will beimportant. Further public funding forinnovation, perhaps in an international contextfor options capable of deployment across awide range of countries, is likely to be anecessary condition for their establishment.

3.87 Although the creation of low carbonoptions and keeping existing options open is

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19 In this context, “establish” means that the technology should be technically proven; have been deployed at a commercial scale; bein at least its second phase of commercial-scale deployment, to allow for learning benefits from the first deployment and from pre-commercial deployment; and have been deployed to an extent which enables a significant part of any economies of scale to beexploited. With these criteria, the future costs of large-scale deployment should be reasonably predictable.

the main current activity relating to the post-2012 period, there is also a case for limitedcalling of options, even those which are not no-regret. This report recommends an expansion ofthe targets for renewables in the post-2010period (see Chapter 7). This is partly to enableadditional renewable technologies to becomeestablished as extra options and partly to deployextra volumes of some technologies that wouldhave become established anyway with currenttargets and measures. Aiming for this limitedextra deployment at this stage will help to keepthe UK on a long-term low carbon path and toensure necessary infrastructure changes takeplace. However, it is not considered necessarythat we plan at this stage for steadily decreasingcarbon emissions towards a possible long-termgoal. So long as a good range of low carbonoptions is established by 2020, the UK would bewell placed to meet large long-term reductions.

Preparation for long-term universalemission limits

3.88 If long-term universal emission limits areagreed, carbon emissions will become a bindingfeature of UK energy policy. At this stage, thefocus of policy choice will therefore have tofocus on means of delivering other objectives atthe same time as environmental ones, and ontrade-offs between those other objectives.

3.89 The nature and scale of long-term targetsis very uncertain and we do not know whenthis stage will be reached. The mainpreparatory measures are likely to fall into twoparts:

● ensuring that the UK is able to participatefully in international carbon trading; and

● supporting research into the morespeculative low carbon options and thosewhose deployment looks likely to be somedecades away.

3.90 There is a strong role for innovation inpreparing for these long-term limits. Innovationshould be understood to encompassinstitutional as well as technical innovation.Institutional innovations required for a low-carbon energy system, such as changes toelectricity distribution systems, are discussed inChapter 7. Here the focus is on technologicalinnovation, which is one of the primary meansof creating the long-term options that are sonecessary to an overall low carbon strategy.

3.91 Successful technological innovation is theproduct of a complex network of actors,stretching from basic university research todiffusion of commercial innovations in themarket. Policy needs to encourage the supplyside (the research and technology developmentsystem) and also encourage consumers andfirms to seek and adopt new technologies (thedemand side). The Renewable Obligation (seeChapters 6 and 7) is expected to encourageinnovation in renewable electricity generationand is an example of a demand side measure.

3.92 Both the DTI and the Chief ScientificAdviser (CSA) have recently given attention toenergy R&D.20 The CSA’s review of energyresearch stresses the importance of seeinginnovation in system-wide terms and not just asa matter of individual, stand-alone technologies.It is important to tackle issues such as gas andelectricity system operation. For future policy itwill be important to frame innovation policy notjust as part of industrial or competitivenesspolicy but also in relation to long-term lowcarbon objectives.21

3.93 Will UK promotion of innovation makemuch difference? Much technologydevelopment is now highly internationalisedand some technologies can be “bought off theshelf”. But not all technologies can be instantlyand automatically adapted to UK conditions.

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20 The Energy Group of the DTI has looked at long-term R&D and the CSA established a working group specifically to inform the PIUEnergy Review. A summary of its report is at Annex 8.

21 PIU (2001b) develops these arguments further, especially in Chapters 2 and 4.

This is especially true of energy efficiency andmany renewable technologies, where localconditions are critical to design. More generally,it is at least necessary to be an informed buyerof technology, and it is also important to beable to buy into wider technology developmentprogrammes by contributing to R&D directly.Nevertheless the domestic/overseas distinctionis important in deciding priorities for UK R&Deffort.

3.94 Should Government intervene and helpfinance innovation in energy? The classic casefor government support is that the public goodaspect of innovation – the results cannot befully appropriated by individuals or firms –tends to discourage private sector investment.However, this does not make a special case forGovernment support for energy innovation inparticular, or more support for energyinnovation in the future. The distinctivecharacteristics of energy as a candidate forparticular Government support are:

● until such time as carbon valuation is builtinto energy prices, the market does notprovide incentives for commercialdevelopment of low carbon technologies;

● many low carbon options need to bedeveloped for specific UK conditions; and

● the precautionary principle that is soimportant in preparing for the long-term lowcarbon future will not be fully reflected inprivate markets with their relatively short-term focus.

3.95 The CSA’s review and the RCEP bothmake strong cases for expansion in publiclyfunded energy R&D for low carbon reasons. Inthe context of a ten-fold fall in UK public sectorenergy R&D in the last 15 years and a muchlower spend on energy R&D than our maintrading partners, the case for expanded energyR&D support is strong (see Chapter 7). TheCSA’s review also puts forward four criteria toinform policy for energy R&D. The need for a

low carbon economy is at the top of the listand the other three are:

● achieving secure/sustainable energy supplies;

● dealing with long-term oil/gas depletion; and

● international competitiveness.

We endorse these principles. Further detail onthe review’s recommendations is in Chapter 7.

Conclusions: The principles ofgood energy policy3.96 In looking at any proposed energy-relatedpolicy, whether it is consistent with thefundamental goal of moving towards a lowcarbon system is the most crucial question. Itneeds to be followed by asking whichalternative policy instruments (or combinationof instruments) are available to meet therelevant policy objective.

3.97 For each policy instrument or package,there is the need to assess:

● what are the impacts on energy security?What are the means and costs of mitigatingany such adverse impacts? This is a keyquestion in view of the importance of energysecurity in all future circumstances and isdiscussed in detail in the next Chapter;

● what are the impacts on economic, otherenvironmental and social objectives? Again,what are possible adverse effects, how and atwhat cost can these impacts be mitigated?

● given that uncertainty means that manytypes of long-term future are possible, is thechosen policy robust to many differentpossible future states of the world – not justto those which seem currently most likely orwhich seem to be preferred? and

● does the proposed instrument or packagehelp maintain existing options, or create newones?

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3.98 Some elements in the preferred set ofobjectives may take time to achieve andtransitional periods may be needed in whichpre-existing commitments must be met. Wherethis occurs the aim should be to separate outthe desired long-term approach fromtransitional arrangements, and if long-termobjectives sometimes need to be sacrificed topreserve existing commitments this needs to beclearly and explicitly recognised.

Summary ofRecommendations

Main Recommendations

1. Where energy policy decisions involve trade-offs between environmental and otherobjectives, then environmental objectives willtend to take preference over economic andsocial objectives. The DTI should re-define itsgeneral energy policy objective. The newobjective could be “the pursuit of secure andcompetitively-priced means of meeting ourenergy needs, subject to the achievement of anenvironmentally sustainable energy system”.(3.35 and 3.37)

2. There is no simple way to resolve residualtrade-offs. Each case will demand separateanalysis. It is recommended that to assist thisprocess HM Treasury should establish, and keepunder regular review, shadow prices for keyenvironmental externalities and other non-economic policy objectives. (3.44)

3. It is recommended that HM Treasury/DEFRAgive early consideration to expanding the use ofcarbon valuation through taxes or tradablepermits to cover as much of the energy marketas possible. This could involve expansion ormodification of the current Emissions TradingScheme and should ensure that UK companiescould participate in international carbon tradingschemes, including the draft EU scheme, assoon as these are introduced. (3.79)

Other Recommendations

4. Where possible, Government should adoptlong lasting energy policy signals in order toaffect energy investments and ensure long-termchanges. Where short-term policy adjustmentsare required, in response to particular events,these should be recognised as such and shouldnot undermine long-term signals. (3.49)

5. Energy policy trade-offs affecting the periodto 2012 should generally give priority to carbonreduction if there is a material risk of failing tomeet internationally-agreed emissions targets.(3.75)

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4. SECURITY IN THE ENERGY SYSTEM

Summary

Energy Security needs to be satisfied at all times – its importance derivesfrom the critical role that energy plays in all aspects of everyday andbusiness life. Without adequate energy security, the sustainabledevelopment objectives would be compromised.

There is a role for government in energy security given consumerexpectations and market imperfections. But, where intervention occurs,governments need to ensure that their judgements about appropriaterisk levels and methods of intervention are better founded than thoseexpressed in the market.

No immediate decisions are needed about the rising share of gas in theUK energy system and the risks involved do not justify significantinterference in energy markets at this time. However, there are a numberof measures that would help to mitigate against risks of a higher gasshare without major distortion of energy markets.

Imports can increase diversity in the energy system, however there arealso a number of risks involved. Over the longer term measures to reducethe risks associated with oil will focus on development of alternativetransport fuels and improvements in energy efficiency. There are also anumber of measures to reduce the risks associated with gas imports,mainly in the international arena. Particularly important will be progresstowards EU liberalisation.

The adequacy of the UK infrastructure is vital to energy security. Many ofthe energy markets in the UK have recently been liberalised, and theadequacy of incentives for investments in these new markets is currentlyunproven. However, the present situation is healthy and interventionwould be premature.

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Insecurity and risk4.1 The sustainable development objectives –economic, environmental and social – are themain focus for UK policy towards the energysystem. Cutting across these is the need forenergy security. It can be seen as anunderpinning objective that needs to besatisfied at all future points if other objectives,especially economic and social, are to beachieved. It is therefore, useful to discuss issuesof security before moving on to look at carbonand the energy system.

4.2 The importance of energy security derivesfrom the critical role that energy plays in allaspects of everyday and business life. Theeconomic and social implications ofbreakdowns in the energy delivery system arevery severe. There is a clear asymmetry betweenthe value of a unit of energy delivered to acustomer and the value of the same unit notdelivered because of unwanted interruption.1

Interruptions, or threats of interruption(including immediate network balancing issues)can quickly lead to widespread disruption giventhat it is difficult to store energy, especiallyelectricity. The resilience of energy systems toextreme events is a major issue.

4.3 The importance of security in the energysystem is highlighted by recent events:

● fluctuations in the price of oil;

● the Californian power crisis, which at its peaksaw rolling brown-outs, blackouts and highwholesale prices;

● the UK fuel protests of October 2000, whenfuel depots were blockaded;

● the expectation that the UK will become anet importer of gas within a few years and ofoil a few years later;

● recent escalation of terrorism in the USA andits worldwide consequences; and

● the prospect of more distributed andintermittent generation on the distributionnetwork.

4.4 By energy “insecurity” we mean asubstantial risk of a physical supply interruption.This need not necessarily lead to actualinterruptions in all cases. A market reaction toprospective interruptions will usually be suddenincreases in price over the period of theexpected shortfall. A prolonged period of highand unstable prices is, therefore, normally asymptom of high levels of insecurity.2

Interruptions to supply can also derive fromshocks to the energy system, which could inturn be the result of deliberate acts ofdisruption or unexpected generic faults inenergy supply technology. We can think of

Although some actions are needed in the short term, there is no crisis ofenergy security for the UK. However, a number of the risks described inthis chapter should be closely monitored, particularly as they changeover the next 20 years. Future security risks will be significantly less if theUK has in place a low-carbon strategy for the long term since this shouldreduce overall energy use and gas dependence beyond 2020.

1 Under the former trading arrangements for wholesale electricity in England and Wales (the Pool) the value of a unit of electricitysupply not delivered due to interruption was administratively set at about 100 times the sale price of electricity to reflect thisasymmetry.

2 As opposed to more occasional and short-term “spikes” especially in wholesale energy prices, which are generally market responsesto less serious risks.

supply interruption in terms of quantity risk,while the possibility of sustained high or spikyprices is price risk.

4.5 Different timescales are involved in energysecurity: ranging from the immediate – how toavoid a power station breakdown today frominterrupting electricity supply – to the verylong-term – what to do to avoid the risk in 30years time that world oil may start to havebecome scarce and expensive. A low carboneconomy, such as that considered in Chapter 5,would also have long term security benefits. Itwould have high energy efficiency, and so useless fuel and use a range of resources that arerenewable (and so are often local) or areplentiful, as in the case of uranium. Such anenergy economy offers some security benefitscompared to the high-use, fossil fuel dependantsystem we now have.

4.6 But a long-term move towards lowercarbon does not protect us against all risks.Energy efficiency, renewable energy and nuclearpower are good general hedges against fossilfuel dependence, but in the short-term theyoffer no immediate response to a crisis, becausetheir output will normally be at the maximum.Further, networks are still vulnerable in a varietyof ways, and for as long as oil and gas remainimportant their supply could be disrupted. Forthese reasons, it is necessary to considerpossible policy responses to a wide range ofsecurity risks, many of which are not connectedto the low carbon economy.

4.7 This chapter discusses the role ofGovernment in ensuring security in the energysystem and suggests a number of generalapproaches which might lead to better security.It then considers the various perceived risks toenergy security. The threat of disruption maycome at any point in the supply chain, withinthis Chapter the risks are considered under twoheadings, strategic and domestic:

● Strategic risks: often involving the risk ofinterruption to the supply of fuel from

overseas. The origin of the problem may bemarket power, political instability, or lack ofinvestment in overseas infrastructure. Theseproblems derive from outside the UK’sborders.

● Domestic system risks: where the riskderives from low or inappropriate investmentwithin the UK in energy equipment(production, transportation or storage); fromtechnical failure; from terrorism; or, as in thecase of oil supply in 2000, from fuel protests.

4.8 While these two kinds of risk usually haveseparate origins, policy to deal with the effectsof one may also be effective at dealing with theeffects of the other. For example, more gasstorage would help to deal with the loss of gassupplies either from abroad or from indigenoussources.

Why government?4.9 Because it is impossible to quantify theextent or cost of all of the risks to energysecurity judgements are needed, either byprivate markets or governments. Economictheory might suggest that the appropriate levelof security is that which would be delivered bya competitive market system, so that decisionsare based on a good knowledge of consumers’willingness to pay for different levels of security.Extra security would continue to be added untilthe cost of the last unit was just equal to theextra value consumers as a whole placed on it.In some cases, the value that companies inparticular put on security can be discerned byoffering different forms of contract. Theconditions needed to be sure that markets willprovide the “right” levels of security include:

● competitive domestic energy markets,without significant externalities;

● consumers being able to signal the valuethey place on interruption to their energysupply;

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● consumers at all levels being able to insureagainst system failures;

● stable and predictable regulation;

● the general absence of any divergencebetween public preferences and the sum ofprivate preferences; and

● the absence of cartels in world fossil fuelmarkets or of the possibilities of interferencein markets for geopolitical reasons.

4.10 Where these conditions cannot be met,the full impact of price or quantity risks maynot be borne by those who make decisionsabout security levels, and markets may under-provide security. Examples in the UK are:

● small consumers cannot signal theirvaluations of energy security;

● public and private risk aversion may differbecause many security failures, such as thoseon electricity wires, will result in interruptionof a whole area. However, individualvaluations of security may assume continuingsupply to neighbours in the event ofinterruption;

● the public valuations of gas and electricitynetworks will exceed the private valuationbecause these networks enable competitionto take place between producers andsuppliers and help to break down localmonopolies; and

● the short time horizon and/or limited liabilityof private investors may cause them todiscount excessively the possibility of lowprobability, high consequence events.3

4.11 Firms, consumers and politicians have alsogrown used to the expectation thatGovernment will intervene when energysupplies are tight.4 Because of this, consumersmay fail to provide adequately for their ownsecurity, even to the extent that they can.

Moreover, since Government will tend to beblamed for any failures, they will wish to avoidunwanted political consequences. Thecontinued existence of “emergencyarrangements” for most forms of energy, underwhich Government can suspend marketoperations, is evidence of this continuingpolitical concern. DTI and Ofgem have alsorecently established a Working Group onSecurity of Supply in order to monitor anumber of the risks to energy security.

4.12 The opinion of most of those consulted inour review as well as the evidence from pastand present behaviour of most governments, isthat despite the power of markets to deliver aconsiderable degree of security they will, tosome extent, under-provide given consumerexpectations and market imperfections. But,while there is a role for governments indelivering some aspects of security, governmentaction can worsen as well as improve matters.Where intervention is suggested, governmentsneed to be sure that their judgements aboutappropriate risk levels and methods ofintervention are better founded than those ofmarket participants, who have close knowledgeof markets and who have commercial interestsin security and stability. Sustained intervention(as opposed to monitoring) may only beneeded in particular circumstances.

Achieving better security4.13 A number of approaches, all of whichmight lead to better security, can be proposed:

● Competitive markets. As discussed above,in competitive conditions individualproducers are encouraged to pay attentionto consumers’ needs. Consumers (especiallylarge consumers) are also encouraged tothink of how they might meet some of theirown security needs.

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3 Federal Energy Regulatory Commission (2001).4 Because of the severe economic and social consequences of energy supply interruption it is generally believed that governments will

“step in” if things go wrong. It is also very difficult in many cases for customers to easily or safely store their own energy.

● Resilience. A basic need is to ensure thatenergy systems are resilient to shocks. Thisserves to reduce both physical and economicvulnerability, where possible and subject tocosts. Resilience is itself the product ofdiversity and flexibility. The basicprinciple of diversity is straightforward – notputting all one’s eggs in one basket. Diversitymay be seen as a general hedge against allkinds of risk and uncertainty. It is a propertyof a whole system rather than a particularoption or technology, so that the same trend(for example more use of gas in theelectricity system) may lead to greaterdiversity in one period, and less in another. Itis less clear what exactly should be diversifiedand how much diversity is enough. Theextent to which diversity is to be pursueddepends on the balance between the extracosts and the degree of risk reductionachieved. Flexibility, the ability to adaptquickly at low cost, is also important;examples in the energy system could includethe installation of dual-firing capacity in fossilfuel plants, the stockpiling of fuels to copewith supply interruptions, and the deliberatemaintenance of excess capacity.

● Self-sufficiency. Many submissions to thereview take it as self evident that domesticsupply of energy is preferable, on securitygrounds, to imports. One possible reason forthis preference is a conviction that the worldwill soon run short of fossil fuels. Chapter 2explains why this view is exaggerated. Asecond reason is that imports are regarded asinherently more unreliable than domesticsources. However, as in other markets,energy imports allow us to access morediverse, and cheaper, resources, than ifenergy sources were produced solely athome. Experience with coal in the 1970s and1980s, and the fuel protests of 2000suggests that the equation of “domestic”and “secure” does not always apply. Importsof energy are not necessarily less secure than

domestic sources. Where trade involvessubstantial market power on the part ofproducers, or there are good grounds forworrying about the political reliability ofsuppliers, then there maybe a case forgovernment intervention.

● International action. This will beparticularly important where risks arestrategic. There are clear limits to what canbe achieved by a relatively small player likethe UK. Much of what is necessary to reducestrategic risks needs to be carried forwardthrough the EU and the International EnergyAgency. The EU has importance for tworeasons. First, future gas security for the UKdepends in part on the liberalisation ofEuropean gas network industries, andsecondly, many of the wider issues of gasand oil security are handled through the EU.

● Consistency with other objectives.Wherever possible, security-enhancingpolicies should be consistent with, andpromote, the policy objective of achieving alow carbon economy. This may not in allcases be possible and security considerationsmay need to over-ride environmentalobjectives, usually temporarily. But wherethere are policy choices in promotingsecurity, those that promote the low carboneconomy will generally be preferred overthose that conflict with environmentalobjectives.

Resilience in the energysystem4.14 Both diversity and flexibility help to deliverresilience. Security is improved by having adiversity of different sorts of fuel in use withinthe energy system. Security will also beimproved if there is a diversity of sources of thesame fuel. Flexibility is important as it helps theenergy system to react to unexpected events.

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4.15 Concern about diversity has tended to beconfined to the electricity system. The marketfor heating, especially in homes, is dominatedby gas (and the share of gas in that market isgrowing). In transport, 98.5% of all energyused is oil-based.5 In neither case is there adiversity of fuels, though in the case of oil, thereis a diversity of sources. The prospects fordiversifying away from oil and otherhydrocarbon products in transport are limitedin the period to 2020. In the longer-term, thereare reasonable hopes that hydrogen maybecome an important transport fuel.

4.16 The immediate focus for diversity is in thepower system (illustrated in Figure 4.1). Whengas grew from a minuscule share of electricitygeneration in 1990 to some 40% today, itincreased diversity. Further growth in the share ofgas will represent a reduction in diversity.Forecasts based on “business as usual” suggestthat gas may account for 60% to 70% ofelectricity production in 2020. In the meantime,the share from existing nuclear will fall, as

probably will that of coal, while the share ofrenewables will rise. As gas is unlikely to bedisplaced in heating markets over the next 20years, the overall reliance on gas in the UKenergy system over that period is expected torise. But beyond 2020, increased use of lowcarbon options, including zero carbon electricityand hydrogen, seems likely to depress the gasmarket share. In the long-term, a large share forgas in the energy sector may not be consistentwith substantial cuts in carbon emissions unlesscarbon sequestration can be successfullydeveloped.

4.17 This trend exposes risks relating to:

● import dependence;

● failure in the UK gas system;

● adverse interactions between the UK gas andelectricity markets; and

● adverse interactions between the UK andcontinental European gas markets, making itdifficult for the UK to access sufficient gascheaply enough.

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5 DTI ( 2001a).

Figure 4.1: UK power sector fuel mix 1990-2020 (DTI projections)

Source: DTI (2000b) Central High Scenario

0

50

100

150

200

250

300

350

400

2020201520102005200019951990

Imports Renewables Nuclear Gas Oil Coal

Year

TWh

gene

rate

d

4.18 There is a wide range of possibilities opento Government to take counter measures inrespect of these risks. They range from actionsthat relate to the gas market, to interventions inthe electricity market, such as the imposition ofrestrictions on the approval of investment innew gas-fired generation, or the establishmentof obligations on electricity suppliers for thepurchase of coal-fired and nuclear electricity,analogous to the Renewables Obligation.

4.19 Restricting gas-fired generation and“carving out” market shares for other fuelswould constitute a significant interference inthe workings of the electricity market, andwould impose new costs on consumers. Itwould not help to create a flexible energysystem. The Renewables Obligation will alreadyincrease electricity bills. Other obligations mightbe cheaper, but any policy which stopscompanies from using the cheapesttechnologies has a cost which might beexpected to grow as the market becomes moreconstrained. Despite the offsetting gains fromenhanced security, the judgement taken here isthat the imposition of further obligations wouldjeopardise the establishment of an effectiveelectricity market. (The particular reasons forcontinuing to treat renewables differently areoutlined in Chapter 7.) The risks of growing gasdependence are real, but – as perceived now –they can be dealt with by a number ofmeasures that are likely to be relatively low costand which will not cause significant distortionto energy markets.

4.20 Over the longer term the measuresdiscussed in Chapter 7, in particular theincreased use of renewable generation, will bevaluable in contributing to diversity. They alsoprovide a number of flexible generatingoptions. Energy efficiency activities have a keyrole to play in reducing the overall level ofenergy required. Two other ways of increasingthe diversity of electricity supply options are tomake greater use of either coal-fired generationor nuclear power. Chapter 7 presents an

approach to nuclear power which, although putin the context of a programme for a low carbonenergy system, also takes account of thecontribution of nuclear power to diversity. Thenext section considers the future role of coal.

Coal-fired generation 4.21 The use of coal in the generation mix addsto diversity and contributes to security. Coal-fired generation uses a primary fuel which isreadily imported and freely available on worldmarkets. Coal continues to have a firm, long-term future in the world energy industry. In thelast year or so, coal has gained market share inthe UK, partly in reaction to high gas prices.Coal seems, therefore, to have a continuingmedium-term role in the UK energy mix.

4.22 Where the coal is mined in the UK there isthe added benefit that it is an indigenousenergy source. The UK coal industry hasadvantages in terms of its proximity to coal-fired generation sets, and the preference thatmany users have for UK supplies. The industry,particularly open-cast mining, currently suffersfrom problems relating to planning permission,and these are addressed in Chapter 8.

4.23 Coal suffers on account of its impacts onthe environment, either from its emissions ofthe gases that give rise to acid rain or from itsemissions of CO2. The tightening of controls onSO2 and NOx has been accompanied by hugechanges in the place of coal in the UK energymix. Further anticipated tightening of EUregulations will mean that it will be essential tofit Flue-Gas Desulphurisation (FGD) equipmentin order to run a coal-fired station, except on apeaking basis.

4.24 There are further possible obstacles in theway of future coal-burn arising from theprospect of controls on carbon emissions. Untilnow carbon constraints have not been imposedin the UK on coal-fired stations, yet theEuropean Commission’s draft trading directive

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would require mandatory carbon targets on allIPPC combustion plants from 2005.6 The timingof a step of this kind should be considered withgreat care, in the light of the security benefits ofcoal.

4.25 In the meantime, it could be useful if atleast some of the existing coal-fired generationstations can be retained, including some ofthose without FGD (it is generally agreed thatlife extensions can easily be engineered), toprovide either peak capacity or back-up (theneed for which will increase as the proportionof intermittent renewables grows). Theeconomics of operating coal-fired plant atlow load factors would be improved ifbusiness rates were charged pro rata toenergy delivered and not based onconventional assessment methods (i.e. valueof buildings). There is no overwhelmingjustification for assessing business rates forgenerating stations on the basis of buildingvalue. Other measures of ability to pay may bemore appropriate. Any revision could apply toall generation plant.

4.26 It may be worth considering keepingsome coal plant as a strategic reserve to beoperated only if there was an imminentdanger of widespread power cuts. Such plantcould be solely contracted to NGC and thecosts covered through the NGC’s regulatedcharges – this would be in addition to NGC’snormal reserve arrangements.

Recommendations on diversity andflexibility

4.27 There is no case for restricting the shareof gas in the power sector at this time.However, the DTI/Ofgem Working Group onSecurity of Supply (WGSS) should monitorthis situation, in particular to assess themarket signals surrounding gas prices. Onereason for believing that no immediatedecisions are needed to stop further increases in

the use of gas in the electricity sector is that lowcarbon policies proposed elsewhere in thisreport should, to some extent, act as countermeasures. Increased energy efficiency, and agrowing share for low carbon options, provideno immediate contingency cover, but over timethey could have a significant effect. Moreover,by around 2020 the early gas-fired stations willbe nearing the end of their lifetimes. The needto replace them will ensure continuingopportunities to substitute away from gas if thisis then thought desirable. It may also be thecase that market participants will, to someextent, naturally hedge against exposure to therisks of over-dependence on a single fuel.

4.28 This does not mean that Governmentshould do nothing in the shorter-term to guardagainst the risks. There are several othermeasures that would help mitigate against therisks associated with a higher level ofdependence on gas. The Government shouldmaintain an interest in all these developmentssince they would add back-up and diversity. Itis recommended that the DTI undertake anassessment of the cost-effectiveness of policyresponses that could enhance security of thesystem and have in place contingency plansshould the market level of diversity seem atdivergence with the risks of futuredisruptions. A number of additional measureswhich could assist diversity and flexibility of theenergy system are listed below:

● energy storage is a key component in allenergy systems: it is a means of balancingsupply and demand and a buffer againstshocks that would otherwise interruptsupplies to consumers. Fossil fuels currentlyact as a cheap and convenient store. A majorconstraint on security is that it is, at themoment, costly to store energy for use inelectricity systems. At the grid scale onlypumped storage has, to date, been costcompetitive; off-grid, batteries can be used.

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6 Commission for the European Union (2001c).

Other options are becoming available,including a regenerable fuel cell basedtechnology. In the longer-term a substantialhydrogen sector could very much reducestorage costs;

● should conventional pipeline sources of gasbecome tight or subject to disruption, theavailability of gas storage and LiquidNatural Gas (LNG) facilities wouldsignificantly add to security. Departmentsshould look at the barriers to private sectorconstruction of either option, in particular athow these projects are represented inplanning guidance. LNG trade, which opensup a global resource base, is rising rapidlyunder normal commercial incentives inseveral parts of the world. It would providean important new source of diversity. Ifsufficient private sector investment is notforthcoming, then consideration may have tobe given to the imposition of mandatoryobligations on storage;

● the development of electricity and gasinterconnectors are discussed later in thischapter. It is an obvious way of increasingthe diversity of sources of supply and ofproviding greater resilience and security;

● possibilities for improving the prospects ofkeeping existing coal-fired capacity openhave already been discussed;

● one way to provide greater security is torequire the owners of some generation setsto have dual-fired capacity (most obviously,oil and gas). This must depend on the cost. Anumber of plant operators have alreadychosen to have this capacity; and

● the resilience of the electricity system willalso be improved by action on the demandside. This can be addressed by loadmanagement – the development ofmetering, signalling and control technologywill facilitate this – and through network lossreduction and end use efficiency.

4.29 DTI should monitor market developmentsin all these measures. Dependant on theoutputs of the monitoring recommendedabove and the DTI assessment of thesemeasures, the WGSS should then review theneed to develop policies to implement anumber of low cost measures that will aidsecurity without causing major distortions inenergy markets. It is also recommended thatgovernment should retain the lever of Section36 consents under the Electricity Act 1989, as ameans of allowing it to influence the fuel mix inelectricity, but no action under these powers isrecommended now (apart from thatrecommended specifically for CHP in Chapter 7).

Imports4.30 The UK currently engages in internationaltrade in energy fuels and products. We are inthe unusual position for a G7 country of beinga net exporter of energy.7 As discussed inChapter 2 this situation will almost certaintychange over the next 10–20 years, with theresult that by 2020 we could be a significantenergy importer.

4.31 The effects of higher levels of primary fuelimports have been seen by many of those whohave submitted evidence to the review as amajor potential source of future risk to the UKenergy system. However, our dependence willbe at least matched by the dependence ofexporters of oil and gas on the revenues theyreceive from the UK. Concerns on imports aredifferent from general concerns about diversitysince imports can be a means to increasediversity.

4.32 Of the main fuels available to the UK –coal, oil, gas and uranium and renewableenergy – only gas and oil raise major strategicrisks. Uranium is plentiful, widely distributedthroughout the world and currently cheap.Even more important, it is a very smallproportion of the cost of nuclear power

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7 Illustrated by Figure 2.3 in Chapter 2.

generation, so the economic impact of pricerisk is small. Storing future uranium needs isstraightforward in physical and economic terms.Proven world coal reserves are very large andwell spread geographically: some estimatessuggest that there are more than 200 yearsworth of world use at current production levels.Coal is currently available on world markets,and from domestic sources, either deep-minedor open cast. The world industry is generallycompetitive, though there have been someindications of market consolidation into a fewlarge companies, in efforts to reduce overcapacity, and possibly to increase prices. The UKhas a large indigenous renewable energyresource.

4.33 The main strategic risks of imports havetraditionally concerned oil and now,prospectively, gas. Location of known worldreserves of oil and gas are illustrated in Figure4.2. Concerns about imports focus on theexercise of market power, the politicalunreliability of possible suppliers or lack ofinvestment overseas. The UK is currently more

than self-sufficient in gas and oil, but over thenext decade it will become a net importer ofgas. Net oil imports are likely to follow in the2010s. The precise dates by which the UK willbecome a net importer are a matter of somedispute: progress in energy efficiency, andmarket and technology conditions will havesignificant effects on timing, and projects suchas PILOT are likely to yield extra exploitableUKCS resources.

Gas imports4.34 The prospect of future gas importdependency and the likely sources of supply hasbeen a major theme in submissions to thereview. Currently, the UK has sufficientindigenous supplies of gas to meet demand.However, on many projections, the UK willbecome increasingly reliant on non-indigenoussources, notably from Norway (with 2–3% ofproven world reserves), Russia (with 35–38% ofproven world reserves), the Middle East (with33–34% of proven world reserves) and Algeria

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Figure 4.2: Location of world reserves of oil and gas, 2000

Source: BP (2001)

Oil(Total: 1046.4 billion barrels)

15%8%

6%

8%

9%

11%

9%

25%

9%

18% 9%

35%

38%

Gas(Total: 150.2 trillion cubic metres)

OECD Former Soviet Union

Other non-OPEC Iran

OECD Middle East

Former Soviet Union Rest of World

Iraq Kuwait

Saudi Arabia UAE

Other OPEC

(with 2–3% of proven world reserves).8 The UKwill become dependent at some point over thenext decade on imports sourced from at leastsome of these countries, though it will stillcontinue to produce gas from the UKCS. Evennow the UK is importing gas at times of peakdemand, though mainly from nearerneighbours like the Netherlands and Norway.However, the real issue is the growingdependence of the European gas system as awhole on imports from further afield.

4.35 This raises a number of questions for thereview, namely:

● Are there enough global reserves to meet theUK’s demand?

● What are the changing risks to the UK as itbecomes increasingly trade dependent forgas? and

● What are the appropriate policy responsesfrom the UK government?

Are there enough reserves globally tomeet the UK’s potential demand?

4.36 Some two thirds of the world’s global gasreserves are already within economic distanceof the European gas market. These reserves are

equivalent to 100 years of current Europeanconsumption level.9 With technology advances,the potential for both the level of discoveredreserves and the area of economic captureimprove. Hence the actual level of reservesavailable to Europe is likely to be higher still.

4.37 The question of whether there are enoughreserves has therefore not been a major focalpoint of this review. The main emphasis of thework has been what risks are associated withthe UK accessing this gas.

The risks associated with the UKbecoming increasingly dependent ontrade

4.38 As the UK becomes increasinglydependent on traded gas, the question is not astraight forward: Is self-sufficiency preferable toimports? It should be: What are the new areasof risks that the UK faces from accessing gasfrom outside of the UKCS? And what, if any,actions should the UK Government be taking tomitigate these risks?

4.39 Figure 4.3 highlights the four main areasof the supply chain to the UK accessing the gasand the key risks associated at each stage.

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Figure 4.3: Key areas of risk for delivery of gas to the UK

8 IEA (2001b).9 Shell (2001).

Gas producingcountries

•Unreliable supply source(including investment inthe infrastructure)

•Market power

•Facility failure

European gas market

•Delayed liberalisation ofthe EU gas marketsresults in a fragmentedEuropean gas market

•Facility failure

Domesticissues

•Distorted investmentincentives

•Facility failure

Transit countries

•Under-investment in theinfrastructure

•Market power

•Facility failure

4.40 The risks in relation to the UK becomingincreasingly trade dependent can therefore besummarised as:

● unreliable supply source;

● lack of investment in infrastructure;

● facility failure;

● market power; and

● delayed European liberalisation.

Unreliable supply source

4.41 The concern that the gas producingcountries may prove unreliable trade partnersfocuses around the three main suppliers: Russia,North Africa and the Middle East. Would thegas producing countries cut supply to theEuropean market – either deliberately oraccidentally? This section looks at the potentialfor deliberate restrictions. Accidental restrictionsare discussed below in the failure to invest andfacility failure sections.

4.42 It is impossible to answer with any degreeof certainty the question of whether the gasproducing countries would deliberately restrictsupply. An assessment of the risks suggests thatRussia is unlikely to deliberately restrict suppliesfor two reasons. First, Russia has been a reliabletrade partner for more than 20 years, throughdramatic shifts in both its domestic politics andinternational relations. Further, there are clearmutual benefits from trade: 20% of Europeangas currently comes from Russia; andhydrocarbon exports, currently account for50% of Russia’s export revenue and 40% of itsgovernment revenue. Secondly, the disputeswith neighbouring countries that have resultedin Russia restricting supply have typicallyfocused around lack of payment for deliveredgas. It is unlikely that similar problems wouldhappen when trading with the EU.

4.43 The volatile nature of the economic andgeopolitical situation in North Africa and MiddleEast has led some respondents to express

concern that supplies may be deliberatelyrestricted. While the difficulties facing thesecountries are real, they are heavily reliant onexport revenues from fossil fuels for theireconomic stability, and they have a strongincentive to trade. Further, historical evidence -most notably the Gulf War - has shown thatthese countries have been reliable tradepartners.

4.44 There would therefore appear to be noimmediate threat of gas producing countriesdeliberately restricting supply to the Europeangas market. But, situations can change. Currentand recent past experiences of trade are not anabsolute guarantee of future supplies.

Lack of investment in infrastructure

4.45 Lack of investment in infrastructure canappear at any stage in the gas supply chain.The countries where this risk could be greatestare the gas producing countries, principallyRussia, and the transit countries.

4.46 Some respondents to the review havewondered whether Russia’s still-nascentcommercial and legal structures will act as abarrier to Russia being able to generate thelevel of investment required to ensure it is ableto meet future European supply requirements. Akey question for the review is whether Russia’scommercial and legal regimes will provide thestability which is necessary if frequent,involuntary, disruptions of supply to theEuropean gas market are to be avoided. It isimpossible to answer with certainty. Meetingswith industry representatives have suggested anoptimistic outlook for future Russian investment.A number of companies were consideringfuture Russian opportunities. Past experience ofBritish investment in Russia has not always beenencouraging, and figures for foreign directinvestment (FDI) are disappointing. FDI totalsare a small proportion of what is likely to berequired in the next 5-10 years in the energyindustry. This indicates that the commercial

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regime, as well as political uncertainty, has to acertain extent acted as a barrier in the past andthere is a still a challenge for the future.

4.47 Other responses to the review havefocused not on the infrastructure within thegas-producing countries, but on theinfrastructure which the gas-producingcountries rely upon to deliver their gas to theEuropean market. In particular, they have askedwhether there will there be sufficientinfrastructure to meet the demands of theEuropean gas market?

4.48 The main area of concern focused on thegas infrastructure in Ukraine. Currently, some90% of Russian gas flows through Ukraine. Intheory investment in capacity has been morethan sufficient to ensure supply. There is thepotential for the Ukraine system to increase gasthroughput by 50% with current capacity. Inpractice the actual capacity may well be muchlower, and is likely to require substantialinvestment over the coming decade if it is tomeet future demands. The Russian governmenthas already taken steps to diversify its supplyroutes in order to reduce the risks associatedwith accidental disruption to supplies, and thereview supports such actions. We shouldencourage Ukraine to implement reforms in itsenergy sector and gas-transit system so as toattract the investment required to increase thetransit system’s capacity.

Facility failure

4.49 Facility failure can occur at any point inthe supply chain, and a major disruption ofsupply at any point has the potential to pose asignificant risk to the UK. This review is not theplace to carry out a major assessment of therisks and impact of failure for each facility onwhich the UK relies. One issue that arosefrequently throughout the process of the reviewwas the question of domestic facility failure. Inparticular, how vulnerable would the UK be if itsuffered a significant facility failure?

4.50 The main concern in relation to domesticfacilities focuses around the terminals where gasenters the UK. There are seven main beachterminals that are capable of receiving gas tothe UK. Only two of these are capable ofprocessing gas from outside of the UKCS - StFergus and Bacton. As well as being connectedto overseas gas supplies, St Fergus and Bactonare the two most important domestic facilities;they process 38% and 22% of all gasrespectively.

4.51 There are plans for another interconnectorto mainland Europe, and at present it wouldappear the most likely site for this is next to theexisting Bacton-Zeebrugge pipe. The keyfacilities in terms of UK security are therefore StFergus and Bacton, and the correspondingterminals in Norway and Belgium (given thatany disruption at these would be just as seriousas a disruption at the UK end).

4.52 This has led a number of respondents toexpress concern that if either of these facilitiesfailed (either through natural or deliberatemeans) there would be a significant reductionin the volumes of gas available to the UK.Further, it could be many weeks before thissource of supply was re-established. In anexample of the effect of the disruption to aterminal, Easington was struck by lightning inDecember 1999: it took five days to return theterminal to full capacity and UK gas prices rosefrom around 15p/therm to a spike of75p/therm in the interim period, despite thefact that Easington accounts for less than 15%of the gas in the system.

Market power

4.53 Market power can appear anywhere in thesupply chain. Key areas of risk are the potential for a“Gas OPEC” and the market power in the transitpipelines.

4.54 By its very nature, it is almost impossible to beprecise about whether a successful cartel willemerge. The differing nature and incentives of the

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gas-producing countries would suggest that theprobability of a successful gas cartel operating overthe timescale covered by this review is low. But suchan event cannot be ruled out.

4.55 What would happen to supplies to theEuropean gas market if a cartel does develop? Thepast trading performance of the gas-producingcountries coupled with evidence from existingcartels, notably OPEC, would suggest that suppliesto the European market are unlikely to bedeliberately threatened since trade is mutuallybeneficial to both parties. However, the existence ofa cartel might well result in higher prices to theEuropean market.

4.56 The exercise of market power can occur at anypoint in the transit pipelines between the gas-producing countries and entrance into the UK. Thisreview is not the place to carry out a majorassessment of the potential for market power in thepipeline of every transit country to the UK. As ageneral principle, the less diversity in the routes thatgas can take in order to reach the end market, themore potential there is for market power toemerge. Whether the market power is abuseddepends on how access to the pipelines is allocated,and on the degree of transparency that exists. Inorder to minimise the potential for the abuse of

market power, there should be open andtransparent access for third parties to each of thepipelines; and a regulatory structure that is capableof enforcing open access. Without these conditions,there is a possibility that the price of gas to the UKwill be higher than if there were pipelinecompetition. In a liberalised market thesepossibilities would be much less serious since abroader range of supplies would be available.

Delays in the European liberalisationprocess

4.57 Liberalisation is a major issue in relation tothe long-term security of the European gasmarket. Box 4.1 sets out why liberalisation is soimportant.

4.58 Neither a fully liberalised market, nor onedominated by local monopolies and long-termcontracts will deliver cast-iron guarantees ofphysical deliverability in the face of exogenousshocks. The key difference is in the degree offlexibility that each offers. The existence of alarge, liquid and deep market allows moreflexibility. It does this by allowing the pricemechanism to signal the effect of a shock –something that does not happen in a marketcharacterised by a small number of players with

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Box 4.1: Why liberalisation mattersFull liberalisation of the European gas market will create a large, liquid and connected marketwhere gas can be freely traded, both within and between national borders, and where gas willbe available at cost-reflective prices.

Liberalisation achieves this by:

● enabling existing infrastructures to be used more efficiently;

● allowing gas to be moved more easily between networks, encouraging the creation oftrading hubs (such as Zeebrugge);

● separating network operators from network users, making transportation and storagecapacity readily available on the basis of common carriage arrangements;

● providing clearer price signals that facilitate investment in new infrastructure; and

● allowing a range of companies to contribute to market-based security by providing signalsfor companies to sell gas back to the market when required.

high market shares; and who have used thismarket power to impose inflexible long-termcontracts onto their customers. Responses toshocks are therefore likely to be more efficientin a fully liberalised market than in a marketdominated by long-term contracts. It is for thisreason that we encourage the UK governmentto continue its efforts in relation to full EU gasliberalisation.

Government response to risks

4.59 We do not at present see the risksassociated with the gas-producing countries asa major threat to UK security and hence do notsee an immediate need for significantgovernment intervention. But situations changeand an assessment of current risks is not aguarantee of future security. Hence, despitethere being no immediate major threat to theUK, there may be potential future risks. Therisks associated with gas imports should be keptunder constant review.

4.60 Our analysis suggests that the best way tosecure gas supplies is to encourage diversityboth in the sources of supply, and in thefacilities and infrastructure on which they rely.There are a number of steps that thegovernment can take now to improve securityand encourage diversity. These are measuresthat only Government can take, and by doingso, will assist private markets to achieve securityof supply. Recommendations include:

● Working Group on Security of Supply shoulddevelop a series of indicators on the risksassociated with gas imports;

● DTI should continuously monitor whetherthe measures taken by UK suppliers willensure continued supply in the case ofdisruption. Further, it should carry out a fullassessment of the options (including

mandatory obligations on storage and dual-fired power stations) and have contingencymeasure in place if the market level ofsecurity seems at divergence with the risks offuture disruptions;

● FCO should ensure that foreign policy ismore fully integrated into the energy policyprocess as the international dimension toenergy policy becomes more significant;

● DTI should continue to champion theliberalisation of European energy markets andsupport the European Commission inpressing forward with the relevant Directives;

● FCO/DTI, as part of the wider EU effort,should continue to develop close relationswith the gas-producing and transit countriesto ensure that the principles and benefitsassociated with trade are mutually agreedand shared;

● FCO/DTI, as part of the wider EU effort,should push for the liberalisation of pipelinesin the non-EU transit countries, and for openand transparent tariffs for third-party accessto these pipelines; and

● when the private sector submit proposals forlocating future gas (including LNGterminals), DTI should consider, with thedevelopers, the implications for futurediversity.

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Oil imports

Are there enough reserves globally tomeet the UK’s potential demand?

4.61 As argued in Chapter 2, future worldresources of oil are unlikely to be a majorconcern in the period to 2020, and probablyfor some time beyond. Availability of cheap oilis less certain after 2020-2025, but there arealready a number of technologies10 beingdeveloped that are designed to extractunconventional sources of oil. It is likely thatthese will be much more viable by 2020, whenthe costs of these technologies are likely to havefallen. In the worst case, in the medium-term oilprices might rise over a number of years,reflecting increasing scarcity and the need toexploit low-grade reserves. For the medium-and long-term, therefore, oil will remain animportant strategic security issue – but for theworld as a whole rather than the UK inisolation.

4.62 There are interests in diversifying awayfrom oil and other hydrocarbon products intransport. Prospects are limited in the period to2020, during which time reliance will mostly beplaced on improvements in transport fuelefficiency. After 2020 there are reasonablehopes that alternative fuels in transport, such ashydrogen, will become an important. Forreasons of long-term security, as well as carbonbenefits, early attention to energy efficiency andsubstitution for oil in the transport system isimportant. Much of this effort, both public andprivate, will necessarily take place in aninternational and EU context. Chapter 7outlines some immediate actions.

The risks associated with the UKbecoming increasingly dependent ontrade

4.63 Even though the UK is a net exporter ofcrude oil, we cannot insulate ourselves from anyupset in world oil markets. The fact of ourbecoming a net importer will not make muchdifference to this. While supplies of crude oilcould be disrupted, for example, during periodsof international conflict, the main impact ofproducer pressure has been on prices ratherthan quantities.

4.64 IEA figures suggest that the world as awhole will, in coming decades, become muchmore dependent on supplies of oil from theMiddle East. Inevitably this carries risks. On pastevidence, any physical disruption is likely to betemporary – perhaps a few months at most –since exporters depend on revenue from oilsales, just as we depend on their supplies.Additionally, exporters have little power toenforce a boycott of any destination for theirproduct. The IEA and EU have put in placerequirements for member countries to hold acertain level of oil stocks to guard againsttemporary shortages in supply.11 The EUrequirement is to hold 90 days’ worth of oilproducts in stocks (this requirement has beenreduced to 67.5 days for the UK, while weremain a net exporter). Recent experiencesuggests that when there is a major upheaval inworld oil markets, oil remains available oninternational markets, although at a high price.This reflects a world where supplies come froma range of different suppliers. The potential forthe oil market to disrupt the world economyremains. If supply becomes more concentratedin a few countries, these risks may grow.

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10 UNDP and WEC (2000).11 The IEA has put in place a number of co-ordinated emergency response measures, designed to help member states cope with short

term supply disruption and price spikes. Cuts of supply to individual members or major disruptions are managed through theInternational Emergency Programme and the sharing of available supplies. Over the last decade the membership of the IEA hasexpanded to include most major oil consumers.

4.65 In order to minimise strategic risk ofdisruption of oil supplies we recommend thatsimilar to gas:

● DTI/FCO should continue, together with theEU, its work on developing close relationswith the oil producing countries to ensurethe principles and benefits associated withtrade are mutually agreed and shared.

The integration of foreign and energy policyrecommended in 4.60 will also be important forminimising oil risks.

4.66 While there is no immediate strategic riskenvisaged for oil supplies to the UK, thesituation should be constantly monitored. If itbecame a more serious concern over the next20 years, further ways of mitigating the riskscould include: requirements for more oilstorage, measures to extend the life of theUKCS as an oil province, and more focus onmoves towards greater efficiency and alternativefuels (recommended in Chapter 7 as part of themove to a low carbon economy).

International action4.67 Much of policy towards strategic securitymust take place in an international context. TheEU will have an important role in taking someof these actions forward. The aim of the EC’s

recent Green Paper on energy security was to“sketch out the bare bones of a long-termenergy strategy” – following this paper thereshould be a summary of responses in the firsthalf of 2002, and then a White Paper.

Investment in UKinfrastructure4.68 The adequacy of the energy infrastructure inGreat Britain is an important issue for security. Theconcern here is not with the availability of fossilfuels, but with the capital stock whereby thosefuels and other energy sources12 are convertedinto energy and transported around the country.

4.69 The key areas of energy infrastructure are:

● the natural gas transmission and distributionnetworks – the pipelines that carry gas fromthe terminals at which UKCS gas is landed orpipelines from Europe reach the UK, toconsumers’ premises;

● the electricity transmission and distributionsystems – the wires that connect powerstations with consumers’ premises;

● power stations – that transform fossil fuel, orother forms of energy, into electricity;

● gas and electricity interconnectors – pipelinesor wires that link the UK to other countries;

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12 Other energy sources include nuclear power and the various forms of renewable energy.

Box 4.2: Main proposals in the EU Green Paper on Security of EnergySupply● The EU must rebalance its supply policy by clear action in favour of a demand-based policy.

● The EU must achieve a real change in consumer behaviour, highlighting the value oftaxation measures.

● There must be an increased focus on climate change in the supply sector, through adoubling of the share of new and renewable energy sources (including biofuels) by 2010.

● The contribution of nuclear energy in the medium term must be analysed.

● For oil and gas, stronger mechanisms are required to build strategic stocks and to foreseenew import routes.

● oil refineries – that transform crude oil into theoil products that consumers require; and

● oil networks – the network of pipelines androad and rail vehicles that carry oil productsfrom refineries to consumers’ premises or localdistribution points.

4.70 Before the liberalisation of the gas andelectricity industries, a process of public planningdetermined much energy investment. This tendedto ensure that there was always sufficient capacityavailable to meet demand, but there were fewincentives to ensure that capacity was providedefficiently. Indeed, public providers had a generalincentive to play safe and to provide too muchcapacity, raising costs unnecessarily.

4.71 Now, while regulators are closely involved ininvestment by monopoly gas and electricitynetworks, investment elsewhere is determined bymarket forces. Even in the case of the monopoliesthere is scope to base investment on marketsignals. In the absence of clear evidence thatmarkets cannot and do not deliver, only limitedintervention in these processes should becountenanced. Governments have far fromperfect information or foresight, and there is asignificant danger that any intervention by publicauthorities – the government or regulators – todetermine the level of investment, would lead usback to the old, less efficient, world. One dangeris that government intervention would lead towasteful over-investment. Governmentintervention could also undermine the securitythat the market would have provided: even thethreat of intervention may upset the processes ofprivate sector decision-making if investors start todoubt whether they will be allowed adequatereturns on investment, or to assume that publicsector decisions will be substituted for theirs.13

4.72 Nevertheless, given that experience withliberalised electricity and gas markets remains

limited, it is prudent to review the situation in thelight of the experience in California. There, forvarious reasons, an apparently liberalisedelectricity market does not seem to have broughtforward the right level of investment, though, infact, the main reasons for the supply failures inCalifornia seem to have been regulatory mistakes.Box 4.3 explains why the situation in the UK isvery different to the conditions that led up to theproblems in California.

4.73 The following section looks at twodifferent investments – in power stations and ingas and electricity networks – and examinessome reasons why some people suggest thatpublic intervention may be needed to ensuresecurity.

Investment in electricitygeneration4.74 Since privatisation of the electricity marketsome 25GW of new generating capacity hasbeen built.14 Since the lifting of the stricter gasconsents policy, in November 2000, consenthas been given for a number of new powerstations, but progress with their constructionhas generally been slow. Generation capacitycurrently exceeds peak demand by almost30%.15 It is this surplus of capacity that iscontributing to low prices in the short-termwholesale electricity market, discouraging newbuild. There is no evidence that liberalisation isfailing to bring forward sufficient newinvestment.

4.75 But circumstances could change. Failure tomeet any of the conditions outlined at theoutset of this Chapter (paragraph 4.9) couldprovide a case for government intervention. Inthe case of electricity markets some of theseconditions may not be met. In particular, the

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13 For example, Ofgem argued that “Any Government attempt, however well intentioned, to dampen the price effects (associatedwith peak demands or supply shocks) runs the risk of undermining the incentives and signals that competition creates and whichensure security of supply.” Ofgem (2001b).

14 OFGEM (2001b)15 DTI (2001a)

signals which suppliers receive concerning thevaluation which domestic customers put onsecurity are limited: large consumers may givesignals by signing interruptible contracts, butthis option is currently unavailable to smallconsumers. As a result there is alreadyintervention to set service standards fordomestic customers. This will continue to benecessary.

4.76 Whatever the theoretical arguments aboutthe capacity of markets to provide adequatesecurity, this must in the end be an empiricalquestion. A significant plant margin is alwaysneeded to provide the means of meeting theextremes of demand and risks of plant failure.The capacity margin now in place seemshealthy by historical standards (see Figure 4.4).The recommendations set out in Chapter 7 will

reduce the rate of peak demand growth andstimulate renewable generation, furtherimproving the situation. For this reason, thereseems no reason to worry today about the factthat there is little current investment incapacity. Investments will need to be monitored(see below), but at the moment there is nocause for concern.

4.77 Investment incentives for generation plantwill be affected by the new electricity tradingarrangements (NETA). With well-designedmarket rules, when signals of scarcity start toappear new investment will be made.16

Electricity forwards markets will be particularlyimportant in providing the right basis for newinvestment. Some respondents have voicedconcerns that, given the way in which NETA isworking, the right signals will not appear.

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16 Including investment to defer retirement of existing plant.

Box 4.3 The Californian problem

California UK

California still had regulatory controls on Electricity supply price controls in Great prices that electricity suppliers could Britain have been abolished for mostcharge consumers, and was unwilling to consumers and Ofgem propose to lift all adjust those controls in the face of forms of direct price control in April 2002 evidence of future shortfalls

Regulators prevented suppliers buying Under NETA, generators and suppliers are power on long-term contracts or encouraged to use hedging arrangementsotherwise hedging the volatile prices in and contracts and avoid exposure to thethe wholesale spot market volatile prices in the Balancing Mechanism

Local opposition prevented construction Generators have been able to manage of new generating plant local concerns and substantial amounts

of new generating capacity have beenbuilt in recent years

Electricity demand was growing very fast Demand growth has been modest - in the late 1990s around 1% per annum

Lack of transmission capacity in some areas Transmission constraints are not a meant that some plant was unusable serious problem

Low rainfall reduced the potential of hydro This risk is hardly applicable in UKplant in California and neighbouring states circumstances

4.78 One worry is that recent wholesaleelectricity prices are currently well below theprice that would be needed to justify new entry.As capacity margins tighten prices will rise - firstby way of price spikes seen on particular days ofshortage. But, given the times needed to makenew investments in different sorts of capacity(see Annex 7), once price spikes start to appear,will it be too late to make the investment intime? Another point of dispute is the extent ofpresent forward prices - with some peoplequestioning the depth of the market.

4.79 Another concern is that currentmechanisms will work only if there is anexpectation that price spikes will be allowed tocome through as necessary, so that a clearsignal is given to the market at the appropriatetime. Given Ofgem’s recognition of theproblem and the Government’s desire to allowmarket mechanisms to work, the concern maybe misplaced.

4.80 A final issue is that market participants willinevitably have limited experience of theworkings of NETA over the long term, so thelack of an historical trend may make the firstround of investment more risky than wouldotherwise be the case.

4.81 NETA is new, and given current sparecapacity, it would be premature to think of anyintervention on this account. The experience ofother commodity markets is that extra flexibilitywill be added over time, on both the demandand the supply sides, as new possibilities fortrading appear. The development of thecapacity margin will be monitored both byOfgem and NGC, and NGC will supplement theprice signals in spot and forward markets withits own statements. Consideration could begiven to possible means of intervention shouldinvestment not be forthcoming, but the mainfocus of attention should be on encouragingprivate investors to make the right choices.

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Figure 4.4: Electricity generation plant margin (England and Wales)17

Source: Data provided by NGC

1990/91 1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01 2001/020

5

10

15

20

25

30

35

Year

Mar

gin

(%

)

Actual ACS Plant Margin Forecast Based on Current Expectations

17 Figure 4.4 illustrates the electricity generation plant margin. This data has been normalised to an average cold spell (ACS) in orderto allow comparison year on year.

Regulation will enhance energy security if itprovides a stable background for investment inboth the natural monopolies and thecompetitive parts of the market.

Investment in electricity andgas networks4.82 There is a good record of recentinvestment in electricity and gas networks inthe UK. Ofgem pointed to a generally healthysystem, with lower levels of failure than in thepast and continuing investment.18

4.83 Where there is competition, the need forgovernment intervention can, in time, bereduced. Where there is a natural monopoly, asin the case of a significant proportion of the gasand electricity networks, there is a need for acontinued regulatory role. While, some networkinvestments are rightly seen as speculativecommercial ventures so the limits of the naturalmonopolies are not always clear-cut, most ofthe networks of the main electricity and gasinfrastructure providers are natural monopolies.They are essential facilities providing transportcapacity and the arena for competition betweencompetitive suppliers. But continued regulationof the monopoly networks will be needed –without regulation owners could either chargean artificially high price for security or underinvest in security relative to customers’expectations.

4.84 The best way to regulate investment andservice provision by natural monopolies is oneof the most difficult questions of regulatorypractice. It concerns regulators in manyjurisdictions. Submissions to the reviewquestioned the extent of the incentives to investin the natural monopolies contained in currentUK regulatory practice. This review has not

been the place for a thorough review of thebasis for regulating a natural monopoly, butsome general propositions about the likelybalance of incentives can be made:

● RPI-X regulation offers incentives to increaseprofits by cutting expenditure on investmentbelow the levels assumed in the initialsettlement;

● network companies always have an incentiveto claim that they need to be allowed moreinvestment than the regulator has allowed;

● a profit maximising unregulated monopolywould tend to under-invest to keep priceshigh and output, including the amount ofsecurity, low; and

● quality of service regulation constrains theability of companies to cut costs at theexpense of quality.

4.85 The conclusion is that:

● as is generally recognised, where RPI-Xregulation is used, the scheme must aim toremove possible distortions, so thatcompanies have broadly the same incentivesto invest in quality-enhancing investments atdifferent points in the regulatory cycle;

● Ofgem has started to refine and improve theRPI-X approach – although it still keeps afive-year review period; and

● it can be argued that a longer period ofcontrol is needed to provide the rightincentives for long-term investment, thougha longer-term settlement would tend to beaccompanied by more intermediatemonitoring of performance, and this wouldtend to accentuate the elements of “costplus an allowable profit margin” regulationwhich are already present, even in currentapproaches.

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18 “Since vesting, the average performance of electricity distribution networks with respect to security of supply has improvedmodestly and has been largely limited to the period after 1996. The electricity transmission systems’ annual unavailability has fallenfrom 9% in 1991/92 to around 4% for the years 1997/98 to 1999/00. Information on security of supply on Transco’s network ismore limited than that for the electricity transmission and distribution companies. However, as in electricity, there have been nowidespread security of supply problems due to transportation failures since privatisation.” Ofgem (2001b).

4.86 Regulators will, so far as possible, want touse market mechanisms to generate moreinformation about the value that marketparticipants place on different levels or types ofservice provision by the regulated monopoly.This is central to Ofgem’s approach. Regulatorsand network providers increasingly use market-based mechanisms – like auctions, within whichusers bid for the right to use network capacity –to provide information about the need for newinvestment capacity. These mechanisms willonly work well when there is a healthy level ofcompetition in all areas of the network, and thismay not always be the case. Energy markets arerarely completely competitive: there tend to besignificant pockets of market power, and thereare often relatively few competitors. In thesecircumstances, market signals may beincomplete and biased in favour of the interestsof the incumbents. It is inevitable that finaldecisions about network investments bynetwork operators will require some degree ofex-ante “approval” by the regulator and sosome regulatory judgement is inevitable.

4.87 Recent experience with the use of auctionsto allocate capacity in the gas networkdemonstrates some of the difficulties of usingmarket mechanisms in complex energy markets.Inevitably it takes time to develop a mechanismthat meets the particular circumstances. Wherethe mechanism creates a new source of funds,as with the short-term capacity auctions for gas,the merits of different ways of returning themoney to users should be assessed against thefull range of energy policy objectives –including the longer-run consumer interests insecurity and diversity of supplies. In the case ofgas auctions, the industry has suggested thatdifferent mechanisms carry differentimplications for offshore developments. The DTIshould maintain a continuing interest in theimplications of onshore gas marketdevelopments for offshore activity.

Conclusion in relation to electricityand gas investment

4.88 The review has not come to a finaljudgement concerning the different claimsabout current levels of investment in networksand capacity. This would require a much moredetailed process of investigation than has beenpossible. Two institutional conclusions are:

● the DTI, in collaboration with Ofgem, shouldcontinue to operate via the variousemergency arrangements, the securitystandards on grid operators, and theregulations applicable to various licenceholders;19 and

● the DTI and Ofgem, through the recentlyestablished joint Working Group on Securityof Supply, should maintain close contact withthe main system operators, NGC, theScottish electricity grid operators, theelectricity distribution grid operators andTransco, to monitor network performance,availability of generating plant and sources ofgas, including peak gas.

4.89 There are also a number of social concernssurrounding the regulation of UK networks,which must be balanced alongside securityconcerns. These are discussed in Box 4.4.

Gas and electricityinterconnectors4.90 As an island, Great Britain has relativelyfew interconnections, and those that exist arelarge and clearly identifiable pieces ofequipment. This suggests that for many years tocome these links can be treated separately fromthe natural monopoly networks that they link,and that different interconnectors could co-existin competition with each other. For both gasand electricity, interconnections will provide animportant source of diversity and of security.

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19 For example, the Gas Supply Regulations which require suppliers to have sufficient gas to meet a 1 in 20 winter.

4.91 A number of new interconnector projectsare currently under discussion, includingproposals for electricity interconnectors withNorway and the Netherlands, and theupgrading the gas interconnector with Belgium.These proposals are moving forward on amarket-led basis with the presumption thatregulation will be confined to ensuring that

access is not restricted, and that it will not seekto determine prices or allowed returns.

4.92 European Commission funding is availablefor studies on new interconnector projectsthrough the Trans-European Networks (TENS)fund. This helps to offset any inherent tendencyof markets towards under-provision. There havealso been proposals that the scope of TENS

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Box 4.4: Social aspects of gas and electricity networksSafety. An important social aspect of energy networks, and of gas in particular, is that theyoperate safely. Network safety is the responsibility of the Health and Safety Executive (HSE).There is a regular dialogue between HSE and Ofgem, regarding the levels of safety requiredand its implications for network operators’ costs. There is no evidence that this approach isfailing to provide appropriate levels of safety. The recommendation that economic regulatorsundertake analysis of significant proposals would help to point up any potential clashesbetween safety and cost reduction.

Extension of the gas network. The Government has set up a working group comprisingDTI, DEFRA and Ofgem officials, energywatch, NEA, EST and representatives of the industry toconsider the issues surrounding extension of the gas network.20 The working group’s initialreport concluded that, whilst the extension of the gas network across the whole country couldnot be justified on cost-benefit grounds, the extension in some communities could be justified.The report recommends further work is needed to test the effectiveness of extending the gasnetwork in addressing fuel poverty and further consideration should be given to assistingcommunities where gas and electricity are not the most appropriate fuels.

In addition to reducing fuel poverty, the replacement of oil or coal heating, or electric heatingbased on fossil fuelled electricity, with direct gas heating would reduce carbon emissions. Thisbenefit should be included in the consideration of network extension. Also, where it is found tobe worthwhile, Ofgem should allow some of the costs to be met by the generality of gasconsumers, so that new consumers do not face materially higher bills than existing ones.

Cross subsidies between smaller network consumers. Existing “flat rate” distributionprice controls may cause cross subsidy between different groups of consumers: rural consumersmay be subsidised by urban ones or vice versa. In pursuance of the Embedded GenerationWorking Group proposals, it may be found that there is a case for regional access pricing withindistribution networks. It would be sensible to give generators this price signal and further workis needed in order to assess whether there would be benefit in reflecting these charges in thetariffs applied to small consumers. Ofgem should investigate fully the possible distributionalimplications of any proposals, so that decisions can encompass Government and wider societalviews on distributional issues.

20 A material component of fuel poverty is associated with solid-walled homes in areas not connected to the gas network. Initialanalysis suggests that, for England alone, if gas central heating and appropriate insulation measures could be provided, then 0.6 to0.7 million out of the 0.9 million fuel poor households not currently using gas could be removed from fuel poverty. DTI, DEFRA(2001).

should be expanded to include support forinterconnector construction. There may be agood reason for public subsidy in the case ofinvestments in the peripheral member states,but there is less justification for subsidyelsewhere.

4.93 There appear to be no grounds at presentto think that there is insufficient interconnectorcapability or that markets will not provide newcapacity as needed. The DTI and Ofgem shouldadopt the following guidelines:

● the international regulation of large discreteinfrastructure projects should be confined torequirements for open access; and

● there should be no major new initiatives forpublic funding for new projects, given thatsuch proposals would be likely to underminemarket-driven proposals and could be costlyfor consumers.

4.94 There should be maximum co-operationbetween governments to ensure that market-driven proposals do not founder on political orplanning concerns.

Refinery and terminal capacity4.95 There are currently nine major oil refineriesin the UK with a capacity of producing 88million tonnes per annum. Despite the recentshut down of two oil refineries in the UK, levelsof throughput have not significantly decreased,since the remaining refineries have increasedtheir production rates in response. Over the last30 years, UK refinery production has fallen byaround 14%, yet the UK remains a net exporterof petroleum products. As the UK becomes anet importer of crude oil over the next decadeor so, some adjustment in the UK refinerysector may be needed: 90% of current inputsare North Sea crude (although some comes

from Norway). At the same time, consumerdemand in the UK may grow.

4.96 Would any reduction in UK refinerycapacity, or increase in imports of refineryproducts, impose significant risks for UKcustomers? Europe as a whole is currently onlya marginal importer of petroleum products, andthere is a strong regional market.21 Therefore, aslong as Europe as a whole has a strong refinerysector, it is likely that the UK will continue to beable to access the full range of petroleumproducts.

4.97 A further issue is the balance of demandfor different petroleum products. For example,in recent years the demand for diesel in Europehas risen unexpectedly. This has caused noserious problems. Over the longer term, themain issue may well be not so much overallvolumes of demand for petroleum products,but the balance of demand between differentproducts. Looking to the very long term, therewill be a problem if, as in some PIU scenarios,the only fuel that was still required in the UK iskerosene for air transport.

4.98 DTI should monitor both what ishappening to European refinery capacity, andthe balance of UK product demand.Consideration might need to be given to waysof incentivising investment, if either looked likebecoming a problem. But no immediate actionis needed.

Availability of skilled labour4.99 Although energy infrastructure is generallythought of as physical assets such as pipelines,wires and power stations, access to skilledlabour to operate and maintain these assets isalso essential. Skilled labour in the area ofenergy efficiency will also be important.

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21 Transport and Energy Statistics, Commission for the European Union website –http://www.europa.eu.int/comm/energy/index_en.html

4.100 The Government should encourage theenergy industry to look at manpower and skillsrequirements of the energy sector in order toestablish likely future shortages.

Exposure to terrorism,technology failure anddomestic protests4.101 The vulnerability of an energy system toterrorist attack is in part dependent on theimportance to that system of a few very largeitems of plant, or a few sites. Both gas andelectricity are inherently more vulnerable thanfuel sources such as oil and coal, which do notrely on integrated networks. The gas networkcould be particularly vulnerable to the loss ofone of two major terminals. This is not tosuggest that there are substantial risks atpresent. The energy industries, in cooperationwith Government and regulators, already makeconsiderable efforts to ensure that their plantand systems are robust against risks of this sort.

4.102 In the case of gas, where the systemrelies on fewer input points than is the casewith electricity, in order to guard againstsecurity threats, the government shouldconsider whether existing terminals are theright location for future developments.

4.103 There are also risks to individual plants.The particular risks to nuclear power plantshave recently been considered by theInternational Atomic Energy Agency.22

4.104 During the 1970s and 1980s coal wasthe main cause of energy insecurity, as strikesby coal miners created a temporary shortage insupply. Since then the UK coal industry hasdeclined substantially, and this is no longer apresent threat.

4.105 Following the fuel protests of September2000, the Government has carried out athorough examination of the arrangements for

storing and transporting oil and oil products.There is no need for this report to reviewfurther these arrangements, and there are norecommendations for this sector.

The impact of liberalisationand company failure onsecurity risks4.106 Liberalised and competitive marketsmanage a wide range of risks. But there aresome risks – especially those connected withextreme events – which competitive marketsmay not handle well. Hence the need for acontinuing public intervention, for example inthe form of emergency arrangements.

4.107 As in other markets, competitiveprovision exposes customers to the risk ofcompany failure, but experience shows thatthese new risks can be handled, whether withinthe market itself, or by regulatory intervention.Given the central role of networks in gas andelectricity markets, special arrangements areneeded to ensure that network operations arenot disturbed by any wider troubles of theoperator’s parent company. Ofgem havedeveloped financial ring-fencing arrangementsof this sort.

4.108 In the case of energy supply, whereconsumers would continue taking supplies fromthe system after their supplier had gone intoliquidation, regulation is needed to devise rulesfor switching those customers to othercompanies. The rules developed by Ofgem haveworked satisfactorily to date.

4.109 Recent failures, such as that of Enron,highlight the possibility that company failuremight impact on the supply of electricity to themarket. In practice, any problems relating tounfulfilled contracts within the balancing andsettlement code were covered by NGC withinthe balancing mechanism procedures which

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22 International Atomic Energy Agency (2001).

were already in place. Other energy companiesalso needed to obtain new cover for risks thatthey had hedged with Enron’s trading arm.There seem to have been no systemic problems.

Conclusions4.110 Security has moved up the politicalagenda rapidly in recent years. Many of theenergy markets in the UK have recently beenliberalised, and the extent to which there areincentives for adequate investments in thesenew markets is currently unknown.

4.111 Although some actions are needed in theshort term, there is no crisis of energy securityfor the UK. Future security risks will besignificantly less if the UK has in place a lowcarbon strategy for the long term since thisshould reduce gas dependence beyond 2020. Anumber of the risks described in this chaptershould be closely monitored, particularly asthey change over the next 20 years.

4.112 The recently established DTI/OfgemWorking Group on Security of Supply(WGSS) should expand its existingactivities to take on responsibility formonitoring all of the risks to energysecurity discussed in this Chapter. Inorder to do this effectively it will needto:

● expand its membership to includerepresentatives from the FCO, sincemany of the risks have an importantinternational element;

● build on the Group’s existingindicators to monitor all risks tosecurity of supply discussed in thischapter; one completely new area forthe group will be risks to oil supplies;and

● conduct ongoing monitoring of all ofthese indicators, in order to establishhow the risks alter over time.

4.113 Over the short term, the best responsesto security risks are measures that deal directlywith the risks in gas and (to a much lesserextent in the short-term) oil markets. Thealternatives, including early action to discouragegas use and encourage readily availablealternative fuels like coal and nuclear power,seem premature. They would conflict stronglywith economic objectives, and some actions,such as encouraging coal on a large scale,would conflict with environmental objectives.If it is found through monitoring work that therisks to security rise over time, more wide-ranging and costly intervention in later yearsmay be necessary. For the moment the primaryresponsibility for dealing with issues of securityshould rest with the private sector, backed upby judicious, but limited, intervention by thepublic sector.

Summary of recommendations

Main recommendations

6. The recently established DTI/Ofgem WorkingGroup on Security of Supply (WGSS) shouldexpand its existing activities to take onresponsibility for monitoring all of the risks tosecurity of energy supply discussed in thisChapter. In order to do this effectively it willneed to:

● expand its membership to includerepresentatives from the FCO, since many ofthe risks have an important internationalelement;

● build on the Group’s existing monitoringindicators to monitor all risks to security ofsupply discussed in this Chapter – onecompletely new area for the group will berisks to oil supplies; and

● conduct ongoing monitoring of all of theseindicators, in order to establish how the risksalter over time (4.112).

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7. FCO should ensure that foreign policy ismore fully integrated into the energy policyprocess (4.60 and 4.65).

8. DTI should continue to champion theliberalisation of European energy markets andsupport the European Commission in pressingforward with the relevant Directives (4.60).

9. There is no case for restricting the share ofgas in the power sector at this time. However,the WGSS should monitor this situation, inparticular to assess the market signalssurrounding gas prices (4.27).

10. DTI should carry out an assessment of thecost-effectiveness of policy responses that couldenhance security of the system. These resultsshould inform decisions on any contingencyaction taken in response to the monitoring(4.28 and 4.60). Key measures which should beconsidered include:

● increased availability of UK gas storage andLiquid Natural Gas (LNG):

◆ Departments should examine barriers toprivate sector construction of eitheroption, in particular at how these projectsare represented in planning guidance;

◆ if sufficient private sector investment is notforthcoming, then consideration may haveto be given to the imposition ofmandatory obligations on storage.

● the development of electricity and gasinterconnectors (see recommendation 11and 12).

● improving the prospects of keeping existingcoal-fired capacity open, possibly by:

◆ altering the basis on which business ratesare charged; or

◆ keeping some plant as a strategic reserve,to be operated only if there was animminent danger of widespread powercuts (4.25 and 4.26).

● requiring the owners of some generation setsto have dual-fired capacity (most obviously,oil and gas).

● action on the demand side.

Other recommendations

11. DTI should retain the lever of Section 36consents under the Electricity Act 1989, as ameans of allowing it to influence the fuel mix inelectricity, but no action under these powers isrecommended now (apart from thatrecommended for CHP in Chapter 7) (4.29).

12. FCO/DTI, as part of the wider EU effort,should continue to develop close relations withthe oil and gas-producing and transit countriesto ensure that the principles and benefitsassociated with trade are mutually agreed andshared (4.60 and 4.65).

13. FCO/DTI, as part of the wider EU effort,should push for the liberalisation of pipelines inthe non-EU transit countries, and for open andtransparent tariffs for third-party access to thesepipelines (4.60).

14. When the private sector submit proposalsfor locating future gas terminals (including LNGterminals), DTI should consider, with thedevelopers, the implications for future diversity(4.60).

15. DTI and Ofgem, through the recentlyestablished WGSS, should maintain closecontact with the main system operators, NGC,the Scottish electricity grid operators, theelectricity distribution grid operators andTransco, to monitor network performance,availability of generating plant and sources ofgas, including peak gas (4.88).

16. DTI and Ofgem should adopt the followingguidelines with relation to new interconnectorcapacity (4.93):

◆ the international regulation of largediscrete infrastructure projects should beconfined to requirements for open access;and

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◆ there should be no major new initiativesfor public funding for new projects, giventhat such proposals would be likely toundermine market-driven proposals andcould be costly for consumers.

17. There should be co-operation betweengovernments to ensure that market-drivenproposals for interconnectors do not founder onpolitical or planning concerns (4.94).

18. DTI should monitor both what is happeningto European refinery capacity, and the balanceof UK product demand. Consideration mightneed to be given to ways of incentivisinginvestment, if either looked like becoming aproblem. But no immediate action is needed(4.98).

Social aspects of networks

19. Ofgem/DTI should look at theenvironmental as well as social benefits ofinstalling direct gas heating when consideringgas network extension (Box 4.4).

20. Where it is found to be worthwhile, Ofgemshould allow some of the costs of extensionwork to the gas network to be met by thegenerality of gas consumers, so that newconsumers do not face materially higher billsthan existing ones (Box 4.4).

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5. LESSONS FROM SCENARIOS

Summary

This Chapter summarises the results from detailed scenario-basedprojections of supply and demand in the long (2050) and medium (2020)term. The challenge for 2050 is to deliver significantly more energyservices with substantially lower carbon emissions. In the medium termthe challenge is to keep this option open.

The 2050 analysis shows that it is possible to deliver reductions in carbonemissions of 60% provided sufficient energy efficiency measures areadopted, the electricity system has very low carbon emissions and majorprogress is made towards a low carbon transport system, probably basedon hydrogen. Such transitions are highly unlikely without strong policyattention to the development of low carbon options.

The 2020 analysis shows that significant carbon reductions are possibleprovided that energy efficiency is prioritised and the deployment of CHPand renewables is accelerated.

Other conclusions from the analyses are:

● significant carbon emission reductions are only achieved in scenarioswhere environmental objectives are prioritised;

● oil will remain the dominant road transport fuel to 2020 but by 2050low carbon options are required and expected to be available;

● gas will be dominant in heating markets and in power generation to2020;

● achieving a low carbon future requires a significant increase in therate of adoption of energy efficiency measures in all sectors of theeconomy; and

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5.1 No single part of the energy system candeliver all the Government’s objectives. For thisreason, our analyses focus on the whole system- the supply and conversion technologies, thedemand technologies, and the infrastructure ofnetworks and storage that links supply todemand. Equally important it includes themarkets and the institutional structures thatshape, and are shaped by, the technologies.

5.2 Some of the objectives of energy policy -notably a sustainable environment and energysecurity - require a long-term view. Yet thefurther into the future we look, the greater the

uncertainty. Many decisions can be put off untilthere is a greater level of certainty, but not all.One way to explore these uncertainties is theuse of scenario analysis - allowing considerationof a range of possible worlds, and the ways inwhich energy systems might evolve withinthem. The PIU approach has been to devise aninternally consistent set of demand and supplyassumptions based on the DTI Foresightscenarios, which include assumptions onbehavioural change and an assumed consistentpolicy environment. Conclusions can then bedrawn by comparing results across scenarios.

● in power generation, the lowest cost low carbon options for thefuture appear to be CHP and most renewable energy. This requiresaction very soon to accommodate changes to the nature of theenergy system.

Figure 5.1 Locating the five scenarios on the grid of governance andsocial values

Globalisation

Regionalisation

Consumerism Community

WorldMarkets(WM)

GlobalSustainability

(GS)

LocalStewardship

(LS)

ProvincialEnterprise

(PE)

Business As Usual(BAU)

5.3 Figure 5.1 indicates the way in which thescenarios cover a spectrum of possibilities.Scenarios have been constructed for twohorizons.

● 2050 – On this timescale major changes inenergy markets and technology are possible.Attention is focused on the implications ofthe development of new energy sources andcarriers, given the long lifetimes of someenergy infrastructure.

● 2020 – Although the existing energy systemhas substantial momentum, limiting theextent of change by 2020, a large fraction ofenergy capital equipment will need to bereplaced by then. The availability ofindigenous fuel supplies will have changedsignificantly. For this time horizon a “businessas usual” (BAU) scenario has also beenexamined. This is described more fully laterin this chapter.

5.4 The longer-term possibilities are consideredfirst and the conclusions used to judge whetherdevelopments to 2020 are on the trajectoryrequired to achieve longer-term carbonreductions. The same broad approach has beenused for both the 2050 and 2020 analyses.Demand for energy has been estimated byassuming the number of consuming units, theenergy service level required and the efficiencywith which that service is provided. Demand isaggregated into heating, power and transport.The supply options are then matched to thesedemands and the total primary fuel and carbonemissions derived.

5.5 Detailed descriptions of the scenarios andthe different energy systems have been set outin PIU working papers.1 This chapter identifiesthe implications for decisions in the near future.

The far future – 20505.6 The energy system in Great Britain couldalter very dramatically over half a century.Almost all energy supply and energy useequipment will be replaced at least once.Institutions and market structures couldundergo extensive change.

5.7 However, some similarities with the currentsystem are likely to remain. About half of thestock of buildings for 2050 has probably alreadybeen built. Although the energy infrastructureof pipes and wires will be largely renewed andincremental change is therefore certain, thenetworks form a huge sunk cost so thatcomplete transformation is unlikely.

Energy services: the driver of theenergy system

5.8 Under all scenarios, the services for whichenergy is needed remain the same: heatingbuildings and industrial processes, poweringmachines and electrical appliances, andtransporting people and goods. These servicedemands will grow, but in most cases moreslowly than the economy. Once they arecomfortable people will not want their homesto get any warmer, nor are they likely to wantto spend more time commuting.

5.9 Demand for energy services is scenariodependent. In a low growth, conservationistworld it might hardly change. At the otherextreme, in a high growth, consumerist worldthe demand for energy services might double,with associated implications for levels of wasteand traffic congestion. In intermediate scenariosenergy services demand grows by about 50%in the period 2000-2050.

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1 PIU (2001e) and PIU (2001f).

5.10 This sets the resource productivitychallenge for the energy system in 2050: to get50% more output (energy services) withsubstantially lower carbon emissions.

Getting more from less: improvingenergy efficiency

5.11 Levels of energy demand depend on thedemand for energy services and on theefficiency with which energy is used. Energyefficiency will certainly continue to improve, asit has done historically. The rate ofimprovement will depend on innovation,reactions to energy prices and policyinterventions to improve efficiency. Thescenarios suggest that energy efficiency couldimprove by between 35% and 100% (i.e.doubled) by 2050. Assuming an aim towardsthe top of the range, this implies annual rates ofimprovement in excess of 1%. In the last twodecades we achieved figures averaging about1% improvement in housing2, but less inindustry and transport.3

5.12 Putting changes in the demand for energyservices and in energy efficiency together, totalenergy use could either rise or fall, as shown inFigure 5.2. The sector with the strongesttendency for growth is transport, especiallyaviation. The use of electricity is also likely togrow. The demands for energy services thatdepend upon electricity – motors, electronicsand lighting – are further from demandsaturation than heat. Even with strong energyefficiency programmes the scenarios do notsuggest that these demands for electricity willfall by more than 10-20%. Overall the level ofenergy use in 2050 might be within the rangeof 60% and 140% of current levels. It falls onlyin scenarios where policy and social changesgive substantial weight to environmental goals.

5.13 Energy efficiency can make a bigcontribution towards delivering significantlylower carbon emissions, but this will needpolicy action. Even then energy efficiency alonewill not deliver carbon emissions reductions onthe scale expected to be necessary.

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2 DTI (1997),Table 7.4.3 DTI (2002).

Figure 5.2: Energy demand by scenario in 2050

Domestic Services Transport Industry Total0.0

0.5

1.0

1.5

2.0

2.5

WM PE GS LS

Rel

ativ

e to

200

0

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Energy supply: which fuels?

5.14 The change in the pattern of energysupply over 50 years is even more uncertain.Gas, coal, oil, nuclear and renewables sourcescould all make a major contribution. Theirfuture will depend upon costs, on supplyconstraints, and on environmentalconsiderations. Estimates of possible primaryfuel supply mixes in 2050 by scenario areshown in Figure 5.3 and details are given in Box5.1. The estimate shown for the GS scenarioassumes that, as expected, renewables costs fallsharply such that renewables become the mostcost-effective zero carbon form of electricitygeneration. If this were not to happen, or if thecosts of nuclear or carbon capture andsequestration were to be lower than expectedand other uncertainties with these sourcesresolved, then GS could show a significantnuclear or coal component.

5.15 Electricity is likely to remain a key form ofenergy in 2050. It has a rising share of energydemand under all scenarios and is clean andconvenient at the point of use. The growth in

use of renewable energy sources will haveimportant implications for the electricitynetwork. In all energy scenarios, the increaseduse of renewable energy and combined heatand power (CHP) implies major increases in theconnection of embedded generators (powerstations connected to the lower voltageregional distribution networks rather than thehigh voltage transmission grid). This has majorimplications for the construction, operation andregulation of the electricity distributionnetworks (see Chapter 7 and the Appendix tothat Chapter). Infrastructure investment in thetransmission system will also be required ifsignificant use is made of off-shore powersources (wind, wave, tidal) or if a strongerconnection with European systems is required(either for increased security or to add anelement of diversity).

5.16 The scale of power generationtechnologies is likely to continue to fall. Somelow carbon power options (nuclear and fossilfuels with sequestration) would necessarily belarge scale. But both renewable energytechnologies and (CHP) tend to be smaller scale

Figure 5.3: Primary fuel mix by scenario in 2050

2000 WM PE GS LS0

50

100

150

200

250

300

renewables nuclear coal oil gas

Prim

ary

fuel

(m

toe)

than conventional power generation. CHPprovides the most efficient way of using fossilfuels and biomass, so that by 2050 all lowtemperature heat could be provided from CHPunits of an appropriate size. The developmentof fuel cells and low cost solar photovoltaics

might allow micro-generation in buildings todeliver a substantial fraction of our power needsby 2050. Early action on grid investment,connection, regulation and pricing will beneeded if this option is to be available.

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Box 5.1: The use of different fuels in 2050Natural gas: likely to continue to play a big role. Convenience in use makes it attractive as aheating fuel, probably also has a continued role in power generation. Most people expect gasto remain available in Europe in large amounts, and at low cost, unless geopolitical concernsrestrict supplies. By 2050, the UK will, like most other countries, be predominantly dependenton imports. Strategic security is therefore a concern.

Oil: likely to retain a comparative cost advantage in road transport, and to remain essential inair transport. Demand critically dependent on transport use, vehicle efficiency and thedevelopment of alternatives. There are different assessments of world oil reserves, and someanalysts are more optimistic than others. Even so, the ready availability in 2050 of low cost oilsupplies cannot be assumed. Reduced reliance of road transport on oil could be achieved byusing liquid biofuels, electricity or hydrogen.

Biofuels: might be available from indigenous sources, but only in significant amounts if themanufacture of ethanol from woody fuels is successfully developed. Even then domestic supplyis likely to meet only a fraction of likely demand, and the development of a large biofuel importmarket would be required.

Hydrogen: the carrier most likely to displace fossil fuels for road transport. Whether it in factwill do so depends on the way fuel cell technology develops, and on the provision of aninfrastructure for hydrogen production and storage.

Coal: unless gas is very seriously constrained, only likely to find a significant market in powergeneration. Even there, a substantial role is only possible, consistent with carbon emissionsreduction, if engineered carbon capture and sequestration are successfully deployed.

Renewable electricity: wind, wave, tidal, biomass and solar may all play a major part inpower generation supply by 2050. Despite the uncertainties, the PIU’s assessment of long-termcosts (see Annex 6) suggests that, with continued support and development, renewables couldbe among the most cost-effective options for reducing carbon emissions, particularly under theassumptions of the GS scenario. In this case, they could, by 2050, produce very large quantitiesof electricity.

Nuclear power: a role that cannot yet be defined, since concerns about radioactive waste andlow probability but high consequence hazards may limit or preclude its use. Costs ofproduction could fall substantially if new modular designs are effective. Unlikely to competewith fossil fuels in power generation on cost alone, but might have significant role if lowcarbon emissions are required. If renewable costs do not fall as anticipated, and/or concernssurrounding waste and risks can be resolved, nuclear would be an obvious candidate fordelivering low carbon electricity in scenarios such as GS.

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Reducing carbon emissions: the keyrole of hydrogen

5.17 PIU estimates of carbon emissions in thedifferent scenarios for 2050 are shown in Figure5.4. Substantial reductions in carbon emissionsare not achieved in the two scenarios which donot place high value on sustainability. Theanalysis also shows that if the demand forenergy services grows broadly in line withcurrent trends, then even the completeconversion of the electricity system to zerocarbon fuels does not lead to carbon reductionsof 60%. Major energy efficiency improvementswill, of course, also help, but they are notenough. The RCEP’s analysis shows that largecuts in carbon emissions might be achievedwithin an energy system which used fossil fuelsfor transport and biomass for heating. But anenergy system of this kind would be costly,given likely limits on the availability of land forbiomass and the cost of substituting biomassfor gas for heating. The conclusion is that ifmajor reductions in carbon emissions are to be

achieved without large costs to the economy,new approaches will be needed in heat and/ortransport fuel markets.

5.18 Research over the last 30 years into batterypowered vehicles has not produced a viablesystem, and fuels derived from biomass arelikely to be constrained by land use. Thechange which is most likely to reduce the roleof oil in transport is the development ofhydrogen fuelled vehicles.4 The use of ethanolfrom biomass in advanced hybrid engines is oneof the few configurations which could comeclose to the low carbon potential of hydrogen-powered fuel cells. However, althoughsubstantial technical challenges remain withhydrogen fuelled vehicles, there is growingconfidence that they can be overcome. All theworld’s leading vehicle manufacturers now havemajor R&D programmes. The PIU scenarioswhich meet the RCEP target all include a shiftto hydrogen in transport fuels. The transition tohydrogen fuel cell power itself will provide theopportunity for major improvements in fuel

4 Prospects for transport technologies and new fuelling infrastructures are discussed in the PIU Working Paper, Fergusson, M (2001).

Figure 5.4: Carbon emissions by scenario in 2050

2000 WM PE GS LS0

50

100

150

200

Car

bo

n e

mis

sio

ns

(MtC

)

Heat Power Transport

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efficiency in road transport. Only in the longer-term would hydrogen then be used in heatingfuel markets and this may not be appropriategiven the ease with which electricity, which hasmuch lower distribution costs, can be useddirectly.

5.19 The central question is how will thehydrogen be made? In the short-term, thecheapest source of hydrogen will be thereformation of fossil fuels – either “on board”

from petroleum fuels, or from natural gas.These options still give rise to significant carbonemissions – though overall higher efficienciescan reduce emissions in some instances.Perhaps more important for the long-term, theymay be essential to the development of ahydrogen fuel cell vehicle industry. The highefficiency of fuel cell vehicles and low levels ofother pollutants are further prospective benefitsfrom transition to hydrogen using fossil fuels.

Box 5.2: Towards a hydrogen economy? Energy futurologists have long predicted the rise of the hydrogen economy.

Hydrogen does not exist in major quantities naturally and therefore cannot be mined. It has tobe made, either chemically from fossil fuels or biomass, or by electrolysis of water. It is analternative means of delivering energy.

Hydrogen (or other hydrogen containing fuel) is required for fuel cells. Fuel cells are essentiallybatteries that use a fuel input. Most of the world’s major vehicle manufacturers are investingheavily in fuel cell vehicle R&D programmes.

The key advantages of hydrogen for use in fuel cells are that it:

● is clean at the point of use;

● is potentially cost effective;

● would be used in modular and small-scale devices;

● could be derived from many sources – central and decentralised;

● could be used introduced as a mixture with natural gas – "hythane";

● would have both transport and stationary use; and

● would provide zero carbon fuel storage.

However, there are some key problems to be resolved before the hydrogen economy can beintroduced. These include:

● perceived safety problems;

● low cost fuel cells;

● low cost hydrogen storage;

● development of a delivery infrastructure; and

● low carbon hydrogen production.

Storage is a key issue to be addressed within hydrogen research.

If low production costs can be achieved, hydrogen fuel cells are likely to prove very attractive intransport and some stationary power markets because of pollution and efficiency benefits.However, they only allow transformation to a very low-carbon energy system in the context ofzero carbon electricity supply. In this case, the storage potential of hydrogen may be a key factorin addressing renewables intermittency.

5.20 The long-term value of hydrogen is that itcould be a genuinely carbon-free fuel.5 Thereare two options for making hydrogen withoutcarbon dioxide emissions:

● reforming fossil fuels with sequestration ofthe carbon dioxide produced; and

● electrolysis of water using zero carbonelectricity.

Both imply major changes to energyinfrastructure over a 50-year timescale.

5.21 Hydrogen production by reformation offossil fuels with CO2 sequestration is as yetunproven on a large scale. Substantial CO2

disposal systems would be needed and theenvironmental risks and public acceptability ofthe technology are uncertain. In addition,engineered sequestration is likely to make mostsense on a large scale, which means that ahydrogen distribution network would need tobe constructed. This could prove costly, but it ispossible that a hydrogen network could evolvegradually and at modest incremental costs –one model envisages gradual upgrading of thenatural gas network to make it “hydrogenfriendly”, enabling an eventual switch tohydrogen. Reformation of natural gas withoutsequestration will be the lowest cost means tomake hydrogen in the first instance, and couldcontinue to be a low cost option even with thecosts of sequestration and hydrogen transportincluded. The electrolytic route would alsoentail substantial investments, electrical outputwould need to double in order to providesufficient energy for the road transport sector ifmost vehicles were run on hydrogen.

5.22 It is, therefore, not yet clear how the longrun costs of reformation with sequestration willcompare with the electrolytic route. It isperfectly possible to envisage a complementaryrole for both options, with the UK exploiting,

perhaps, both CO2 repositories under the NorthSea and the large renewable resources availableoffshore. Moving toward a low carbonhydrogen based economy could thereforerequire the development of both a substantiallow carbon electricity sector and C&S fromfossil fuels. Given the uncertainties it isimportant that action is taken now to ensureoptions are opened up for both CO2 captureand sequestration and for zero carbonelectricity.

5.23 The task of constructing the energyinfrastructure to supply hydrogen to the roadtransport sector will be large. Over thistimescale other policies also play a role: landuse planning and its implications for travel,public transport infrastructure and support forlow power alternatives such as cycling andwalking, can all make a substantial contributionin the long-term. These sorts of considerationsare outside the scope of this report, thoughthey may be critical to achieving long-termenergy policy goals.

5.24 The displacement of oil fuel from roadtransport would leave oil playing a major roleonly in aviation fuels. As kerosene is the onlyacceptable petroleum fuel for aviation, thiswould have implications for oil refineries. Itseems likely that carbon emissions from aviationwill increase substantially as demandsignificantly outstrips prospects for energyefficiency, at worst (in scenarios where carbonemissions increase) increasing by over 500% to2050.

Conclusions for 2050

5.25 On the evidence of the scenarios it seemspossible to deliver reduction in carbonemissions of 60% by 2050. It requirescontinued and substantial progress in energyefficiency, the construction of a large, low

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5 Though hydrogen itself has no direct global warming effect, hydrogen leakage would have some indirect impact on climate throughchemical interactions with other greenhouse gases in the atmosphere. But leakage rates would be low as any effect would be muchless than the climate impact of the fossil fuel emissions displaced.

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carbon electricity system, major progresstowards a low carbon road transport sector andmanaged growth in air travel. All of this willrequire a policy environment that encouragesthe development and adoption of low carbonoptions.

5.26 A transition to hydrogen is, however,unlikely to be completed by 2050. Further workis needed on the implications of a transition tohydrogen for hydrogen manufacture anddistribution, carbon dioxide sequestration,electricity network development and oilrefining.

The foreseeable future: 20205.27 The view to 2050 indicates the long-termpriorities required for substantial reductions incarbon emissions: energy efficiency, low carbonelectricity and hydrogen for road transport. Butit is less helpful in setting immediate policygoals. Many issues that affect developments to2020 do not require a scenarios-basedapproach. A second set of scenarios looks at2020, and provides the basis forrecommendations for more immediate policy.

5.28 The work again uses the Foresightscenarios, but also considers a BAU scenario.BAU assumes the Government’s existing policymeasures, including those set out in theNovember 2001 Climate Change Programme,are implemented, but that there is otherwiseminimum market intervention up to 2020. BAUshould not be interpreted as a preferred or evenmore probable scenario. Indeed, as shownbelow, it is not consistent with current policyobjectives.

5.29 Unsurprisingly, there is less divergencebetween results of the 2020 scenarios thanthere was in the 2050 scenarios. Even so, alarge proportion of power generation capacity,and most demand side equipment (apart frombuildings), will have been replaced by 2020.And some wholly new technologies, such as

fuel cells, will probably enter the market.However, it is unlikely that any new technologywill have major impacts by 2020 and much willdepend upon the rate at which currentlyavailable technologies replace the existingstock.

Trends in demand

5.30 Declining trends in energy demand forheating in industry and buildings heating arelikely to continue, and the growth in electricitydemand might also be modest if energyefficiency policies are pursued with vigour.Demand for road transport fuels is, at worst,likely to be broadly stable. This reflectsimproved fuel efficiency, and the assumption oflower rates of travel growth than in the past.More optimistically, a combination of efficiencyimprovements and sustainable transport policiescould reduce demand by 20%. Aviationdemand still seems likely to grow strongly, andthere is less scope for efficiency improvement.Aviation fuel demand is almost certain to grow,and, at worst, it might double.

Trends in supply

5.31 In the 2020 scenarios, oil remains thedominant transport fuel, though there could beniche markets for biofuels, gases and hydrogen.By 2020 it is possible that the UK will beimporting 80% of its oil needs (see Annex 7).Gas remains the dominant fuel for heating, andfurther growth in the gas market share is to beexpected. Indeed, the overall demand for gas isup by 30% if the BAU path is followed, and gastakes a major share of the electricity market.The UK could be importing 80% of its gas in2020 (see Annex 7).

5.32 Major fuel switching is only likely in thepower generation sector. About half the currentgenerating power capacity (36GW) is expectedto be closed by 2020. Changes in demandmean that up to 50GW of new capacity couldbe needed. But with strong energy efficiencyprogrammes this could be reduced to below

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25GW. The maximum required build rate of2.0-2.5 GW annually is not in itself a problem.This level has been achieved in the past. Themajor issues are around the type and fuel ofnew capacity. Figure 5.5 shows the way thatnew capacity might be constructed (or avoided)in different scenarios.

5.33 Without Government intervention in themarket, new capacity will be met primarily bygas, largely in Combined Cycle Gas Turbine(CCGT) stations. The share of gas in powergeneration might then rise as high as 75%.However, this is not inevitable. An emphasis ondiversity might lead to a role for nuclear powerand/or coal. Such an approach would requiresignificant intervention. Alternatively, anemphasis on environmental sustainability wouldlead to expansion of (gas-fired) CHP andrenewables.

Carbon emissions

5.34 Figure 5.6 shows the emissions by scenarioin 2020 compared to current levels. All thescenarios indicate a continuing dependence on

oil for transport and gas for heating, both ofwhich will be largely imported by 2020. Forheating, gas dependency and carbon emissionscan be reduced by increased energy efficiencyand wider adoption of CHP. There is wide scopefor changing the fuel mix in the electricitysystem where total carbon emissions could bereduced, however this will not occur withoutsupport for one or more of the low carbonoptions. Figure 5.7 shows how long-termcarbon emissions move in the differentscenarios.

5.35 Radical change in the energy system isunlikely by 2020. But if the system is to meetlong-term environmental goals, trends over thenext 20 years will be important. The UK willneed to increase the rate of energy efficiencyimprovement and to reduce the carbonintensity of energy. In energy supply, there ismost scope for change in electricity, inparticular through the expansion of renewableenergy and CHP. This will require action toaccommodate increased small generation inelectricity markets and networks.

Figure 5.5: New electricity generation by scenario

BAU WM PE GS LS

0

10

20

30

40

50

60

nuclear build coal build CCGT build CHP build Renewables build

New

cap

acit

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W)

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Figure 5.7: Trends in carbon emissions by scenario

2000 2020 20500

25

50

75

100

125

150

175

WM GSPE LS

Car

bo

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mis

sio

ns

(MtC

)

Figure 5.6: Carbon emissions by scenario by end use in 2020

0

50

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150

Car

bo

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mis

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(MtC

)

Heat Power Transport

2000 BAU WM PE GS LS

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6. OPTIONS FOR A LOW CARBON ENERGY SYSTEM

Summary

The PIU’s scenarios indicate that deep cuts in greenhouse gas emissionsby 2050 are possible. This would require the development of a widerange of low carbon options.

As well as broad market-based instruments, more targeted policies wouldbe needed, given market failures and other barriers to the developmentof low carbon technologies.

Criteria for assessing the low carbon options should be: scale of potentialcontribution; cost per tonne of carbon saved; potential for innovation,learning and cost reduction; extent of synergies and conflicts with otherpolicy objectives; flexibility; and applicability to UK circumstances.

Energy efficiency can make a very large contribution, has very low (ornegative) net costs, has no conflicts with other policy objectives, and isflexible. In the area of transport, there are substantial potentials butlimited knowledge about costs.

New renewables represent a huge potential UK resource, offer largesynergies (and very limited conflicts) with other policy objectives, and areflexible. Costs are generally high now, but innovation prospects aregood: costs should fall significantly via learning effects.

Nuclear power represents an established very low carbon technologywith substantial potential contribution. It offers scope for cost reduction,and has important synergies with other policy objectives, though thenuclear waste issue is unresolved.

Capture and sequestration of carbon may have a large potentialcontribution, but is presently subject to a wide range of uncertainties. Itneeds further study.

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6.1 Facilitating the delivery of a low carbonenergy system should now be at the heart ofenergy policy. The UK needs to position itself sothat it can move towards the levels ofgreenhouse gas emissions that are likely to beneeded as part of the global response toclimate change. Chapter 5 indicates that this ispossible, but policy action will be essential,both to ensure delivery of low carbon energyand to minimise the risks and burdens of doingso. While the UK will not want to commit itselfunilaterally – both because greenhouse gasesare a global problem, and because to do sowould damage competitiveness – it needs toact now to establish a range of low carbonoptions.

6.2 It should start with those options thatinvolve “no (or low) regrets” because they haveassociated economic and environmentalbenefits. Some developments are necessarilyinternational or even worldwide, but the UK isan important participant in the process andsome options, especially renewables and somekinds of energy efficiency, need to bedeveloped to meet particular UK circumstances.The energy system should be moving in theright direction so that emissions continue todecline and cost-effective options, which willallow for deep long term cuts, are broughtforward in a timely fashion.

6.3 There are three ways in which the energysystem can be moved in the right direction:

● reducing the overall demand for energyservices: transport, heat and power;

● reducing the amount of energy used todeliver a given amount of transport, heat andpower; and

● reducing the amount of carbon emitted foreach unit of energy consumed, requiring achange in the energy supply mix.

6.4 Long term changes in lifestyle – rural/urbansettlement and work/leisure patterns – couldhave profound effects on demand for energyservices, especially transport. Reduction oftransport demand could be critical to achievinglong term energy policy goals, and Governmentshould continue to work for this objective.Changes in the way customers relate to energymay also influence the types of technology thatdevelop. Though policy can influence overalllevels of demand for energy services, the focusof this chapter is on the other ways ofinfluencing the energy system.

6.5 This Chapter sets out the criteria by whichlow carbon options should be judged, explainsthe potential of different options, and drawsconclusions about synergies and conflicts withother objectives.

Transport fuel switching is very important for the medium to long term,and there are good prospects for hybrid and fuel cell vehicles, thoughcosts are currently high.

Increased support for technology development, including R&D anddemonstration, will be crucial to realising these options.

The analysis in this chapter provides the basis for the programme set outin Chapter 7.

The options and their potential

6.6 There is a range of options for moving theenergy system onto a low carbon path. ThisChapter considers the major options and Annex6 gives more details. The list is not exhaustive.Some potential technologies – for example,large tidal barriers, geothermal power, solar hotwater and micro-hydro – are not discussed. Thefocus is on those options which at the momentseem to have the greatest potential.

6.7 So far as is possible, the options areassessed against the following criteria:

● the scale of the potential contribution tocarbon emission reduction, both in 2020 andmore speculatively in 2050. This requires anassessment of the physical potential and thelikely build rates;

● costs per tonne of carbon saved.Estimates are made of the carbon content ofthe energy saved or displaced. Resource costsare negative (there are net economicbenefits) when the investment saves energymore cheaply than it can be supplied, andpositive when fuel switching requires energyto be produced by means which are moreexpensive than the cheapest commercialoption, which is assumed to be CCGT. Themain estimates are for 2020, but somecurrent figures are also presented;

● long-term potential for cost reductionthrough innovation, learning or marketgrowth. The various technologies andoptions are at varying stages of maturity.Where intervention favours a nascenttechnology, there are often significantprospects for future reductions in unit costsby way of learning by doing and economiesof scale;

● the extent of synergies or conflicts withother policy goals. The main object of thisChapter is to assess the merits of differentways of saving carbon, but where an optionalso helps to meet other objectives this is a

bonus, just as it is a cost where otherobjectives are threatened;

● flexibility of response. Options which allowa flexible response in the face of changingcircumstance and information are to bepreferred; and

● applicability to UK circumstances. Optionswhich are particularly well adapted to UKgeographical, commercial and politicalcircumstances are generally to be preferred,especially since technologies which suit othercountries better than the UK may be bestdeveloped elsewhere. If use is made of eachnation’s comparative advantage, then theworld as a whole is likely to develop thewidest range of new options.

6.8 Table 6.1 at the end of the chaptersummarises the potential contribution of eachoption in 2020 and 2050; the cost per tonne ofcarbon saved in 2020; and the potential fordevelopment specific to the UK.

Energy efficiency

Scale of potential contribution

6.9 Energy efficiency can significantly reducethe demand for energy, and so reduce theproduction of carbon. In just about every partof the economy there is a vast range oftechnical possibilities. The technical potential –the improvement to be had from using themost technically efficient technology currentlycommercially available – is very large. Whatmatters most for short-term policy is theeconomic potential – that part of the technicalpotential which yields energy savings whichmore than pay for any extra investment costunder standard investment criteria. Theseinvestments could reduce energy demand by30% in the economy as a whole, equivalent toa potential annual saving worth £12 billion (seeAnnex 6).

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6.10 There would be some offsetting second-round effects as people adjust to theimprovement (the “rebound effect”). In thebusiness sector, an increase in energy efficiencydelivers an increase in productivity. This istranslated into higher incomes and will, tosome extent, produce an associated increase inenergy demand. Equally, for some individuals,notably the fuel poor, the extra efficiency allowsthem to achieve greater comfort from the sameexpenditure, so that a large part of the extraefficiency does not produce a fall in theconsumption of energy. The rebound effect isexpected to reduce the energy savings fromimproving energy efficiency by only about10%.1

Cost

6.11 Costs per tonne of carbon are eithernegative (since there are net resource savings)or low.2

● The existence of a large, but untapped,economic potential implies either that thereare significant market failures; or that theanalysis ignores hidden costs, such asunrecognised risks, or management andconsumer time. Even if allowance is made forsome hidden costs, most energy efficiencymeasures provide a very low cost approachto reducing carbon emissions.

● For the vast majority of energy users, energyis a small fraction of total costs. In a complexworld, both households and most businesseshave higher priorities. They do not seek tomaximise the economic efficiency with whichthey use energy. Whether there are marketfailures or hidden costs, policies that transferresponsibility for energy efficiency investmentonto a smaller number of well-informedplayers are likely to be the lowest costapproach to delivering energy efficiencyimprovement.

Innovation

6.12 The scope for cost-effective energyefficiency improvement has remained broadlyconstant over the last 25 years. This is because,over time, innovation has created neweconomic potential from the technical andtheoretical potential, while barriers toimplementation have remained. While policiesproposed here should remove some of thesebarriers, a continued process of innovation inenergy efficiency can be expected, so thatenergy efficiency should remain a low costsource of carbon saving throughout the period.The Chief Scientific Adviser’s (CSA’s) review ofenergy research identified energy efficiency asone of six key areas in which increased fundingfor R&D and development could have asignificant impact on progress towards a low-carbon economy. In particular, it recommendedincreased support for cross-cuttingtechnologies, such as innovative software andhardware, and demonstration projects toexplore further the combined impact ofdifferent technologies.

Synergies and conflicts

6.13 Energy efficiency can contribute positivelyto all the key objectives for energy policy.

● Economic: to the extent that energyefficiency is cost effective, the cost savingscontribute to improved economic efficiency,reduce household energy bills, and improvebusiness competitiveness.

● Environmental: reducing energy demandcuts all the emissions associated with energy.

● Social: reducing the energy bills of lowincome households plays a central role in theGovernment’s strategy for reducing fuelpoverty.3

1 PIU (2001d).2 DTI (2002).3 DTI, DEFRA (2001).

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● Security: at any given level of economicoutput, energy efficiency reduces pressureson supply, including imports; it may alsoreduce the risk of energy systems havinginsufficient peak capacity.

6.14 Nevertheless, while the resource costs ofmany energy efficiency measures are negative(and the economic benefits positive), there maybe other economic and social costs associatedwith the chosen policy measures. For example:

● higher energy prices, reflecting theenvironmental externalities associated withenergy consumption, would be an importantmeans of improving the incentives tobecome more energy efficient, encouraginginnovation and drawing consumer andmanagement attention to the possibilities.Higher prices would, however, impactadversely on those consumers who do notincrease the efficiency with which they useenergy, and, if policies are not consistentwith other countries, would worsen thecompetitiveness of internationally tradedenergy-intensive sectors; and

● where subsidies are used to unlock thepotential, then the income transfers involvedwill need to be assessed.

Flexibility

6.15 Energy efficiency measures are by theirnature small scale and precisely targeted withinthe UK. They constitute a flexible response tothe need for carbon reductions. However inmany cases they can only be effectivelyimplemented at the point of capitalreplacement, so that (especially for buildings)the timescale for delivering the full potentialcan be lengthy.

Energy efficiency in transport

Scale of potential contribution 4

6.16 Significant improvements in energyefficiency are possible in the transport sector.The next round of EU agreements needs toreflect and help bring about these advances.Through the current EU voluntary agreement,car manufacturers have already pledged toreduce the CO2 emissions of new cars by 25%on 1995 levels by 2008. The early indicationsare that the agreement is proving an effectivemeans of securing better fuel efficiency andlower emissions. Hybrid engines, using bothbattery electricity and internal combustionengine technology, combined with advancedbody features could provide efficiency gains of50%. Fuel cell electric vehicles could deliverfurther efficiency gains.

Costs

6.17 There is currently very little data availableon the costs per tonne of carbon saved frominnovation in the transport sector. The costsand benefits of individual energy efficiencymeasures in transport do not seem to havebeen studied in as much depth as in someother sectors.5 The EU voluntary agreementindicates that significant improvements can bemade without serious detriment to the cost ofcars, or to the cost base of car manufacturers,so that the cost per tonne of carbon savedthrough efficiency measures to date is probablynegative. But the cost-benefit parametersshould be investigated further, in the context ofboth future EU voluntary agreements andfurther domestic action to improve vehicleefficiency.

Innovation

6.18 Hybrid electric petrol vehicles arecurrently commercially available at a price

4 Prospects for transport energy efficiency are explored in Ferguson (2001).5 The last comprehensive analysis was Department of Energy (1989). It is now outdated.

6 IPCC (1999).7 Social Exclusion Unit (2001).8 Based on ETSU (1998).

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premium of about 20%, partly offset by the factthat they have 15-25% better fuel efficiency.The cost premium is expected to fall rapidlyand hybrids are likely to be fully costcompetitive before the end of the decade.

6.19 In the aviation sector, IPCC predicts a 40-50% improvement in fuel economy might beachieved by 2050.6 However, this is less thanthe historical rate of improvement and is likelyto be significantly outstripped by projectedgrowth in air travel. There are options toimprove fuel efficiency more rapidly than BAU,but these are not cost-effective at the current(tax-free) price of kerosene. Efforts to improveaviation fuel efficiency will inevitably be mainlyat international or European level.

Synergies or conflicts

6.20 The transport sector is currently heavilydependent on a single energy source, oil and islikely to remain primarily oil-based for the nexttwo decades. On BAU projections, energyefficiency will offset road transport growth overthis period. This provides a synergy withsecurity objectives (no increased dependenceon oil) and environmental objectives (noincrease in greenhouse gas emissions; reducedvehicle noise).

6.21 Access to mobility is an important issuefor social inclusion, for both poor and ruralcommunities.7 Energy efficiency measures inroad vehicles could increase the price of newvehicles. This could have a knock on effect ondemand, and so on the prices of older vehiclesused by poorer people.

Flexibility

6.22 As for wider energy efficiency, most suchmeasures in the transport sector are, by theirnature, small and precisely targeted, thus theypresent an extremely flexible response to theneed for carbon reductions.

Efficiency in supply6.23 The most obvious way to reduce thecarbon emissions associated with energyproduction is to make that production moreefficient. In the electricity sector it takes onaverage 100 units of primary energy to make39 units of final energy. Energy is lost at eachstage of the process, including transportation tofinal customers. The effects of liberalisation havebeen beneficial in reducing these losses,because there are extra profits to be had fromincreased efficiency, and this has stimulatedinvestment in higher efficiency gas-fired powerstations and improvements in the use oftransmission and distribution networks.Innovation is likely to continue to be important,including technologies which further improveefficiency, such as fuel cells for distributed CHP.

Combined heat and power(CHP)

Scale of potential contribution

6.24 The major source of inefficiency in mostpower generation is heat loss in exhaust gases.CHP plant uses this productively: the exhaustheat is collected and used, instead of beingwasted. The process can be very efficient,especially if the plant is operated to match thedemand for heat, with electricity used on site orexported. The effective efficiency of powergeneration can be 80% or higher. CHP use hastraditionally focused on large industrial sites.However, smaller devices, including micro-CHPsuitable for individual homes, will soon be onthe market. Large-scale CHP investments havethe potential to save perhaps 3 MtC in 2020,8 asum equivalent to the savings available from anumber of generation options. However, thescope for longer-term growth is probably morelimited.

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Cost

6.25 For the foreseeable future, so long as fossilfuels are used in power generation, CHP will inthe right circumstances provide a cost-effectivecarbon reduction option. As Table 6.1 shows,estimates suggest that many schemes can yieldnegative costs per tonne of carbon saved (netresource gains), though the viability ofparticular projects depends on local conditions.CHP investment was stalled in 2001, partly as aresult of the treatment of CHP-producedelectricity in the early months of NETA, but alsobecause gas prices have been rising in realterms while electricity prices have been falling.This makes the economics of CHP much moredifficult than previously. It is not commerciallyviable to use expensive gas to make cheapelectricity, even though the process istechnically energy efficient. Small generatorsmay also face difficulties and high costsconnecting to local networks. However, evenunder these conditions, CHP may be a low costmeans of carbon abatement relative to otheroptions being considered.

6.26 The economics of micro-CHP appear tobe very favourable at the costs and efficienciesassumed by the manufacturers, but this has yetto be tested in the market.

Innovation

6.27 Industrial CHP is a mature technology.Micro-CHP has yet to be developedcommercially: it presents substantial futureprospects. The CSA’s review of energy researchidentified micro-CHP as an area which meritedfurther research. For example, the developmentof micro-CHP (eventually using fuel cells) couldhave widespread application in small-scalehousehold generation.


6.28 CHP, like demand-side energy efficiency,can contribute positively to all the keyobjectives for energy policy.

Supply options

6.29 Major changes in carbon production needfuel switching – so that the carbon content ofprimary energy is reduced – as well as energyefficiency. Fuel switching accounts for much ofthe downward trend in the carbon ratioidentified in Figure 2.8: the switch to gas andnuclear in electricity generation accounted formuch of the UK’s CO2 emission reductions inthe 1990s. The scope for further switching fromcoal to gas is now limited. As the Magnoxnuclear power stations close, the movementcould even be away from low carbon sources ofpower. Given the aim of switching to sources ofenergy which have zero, or near zero, carbonemissions, the main options are: the variousnew renewable technologies, new investment innuclear power, carbon capture andsequestration, and new transport technologies.Each is considered in turn, as are new transporttechnologies relying on one or more of the zerocarbon sources.

New renewable technologies

Scale of contribution

6.30 The UK is very well endowed withrenewable energy resources. It has the bestwind and marine resources in Europe. Whilerenewables are sometimes seen as ahomogenous group, they are in fact a widerange of quite different technologies, which canin principle contribute to the low carboneconomy in a variety of ways.

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6.31 Taken together the leading options –onshore wind, offshore wind, marine (wave andtidal stream), solar photovoltaic (PV), energycrops – have the potential to meet a substantialproportion of the UK’s energy needs. Offshorewind has potential for more than 100TWh/year, PV over 200 TWh/year, and waveand tidal power have potential up to 700TWh/year9 (compared to current UK electricityuse of 360 TWh/year). Energy crops can beused for electricity, heat or liquid fuel. The othertechnologies generate electricity.

6.32 There are other renewable technologies –hydropower, geothermal, biomass wastes, orsolar hot water – that are either technologicallymature or have more limited potential for use inthe UK.

6.33 Since most generating units are small,they would need to be installed in largenumbers in order to secure a substantialamount of energy.10

Costs

6.34 All renewable technologies offer very lowcarbon energy supply, with zero CO2 in use.While some renewable technologies are alreadycost effective, most are currently moreexpensive than fossil fuel alternatives. There is aconsiderable variation, depending on the stageof development.

6.35 In general, renewable energy sources areexpected to be subject to substantial reductionsin cost as volumes of plant rise. This is becauselearning effects and economies arising fromlarge-scale manufacture of small devices shouldlead to large reductions in unit costs. Thefeedback loop from experience in deploymentto improvements in design and cost reduction

is rapid for most renewables. Given thepotential for substantial reductions in costs asvolumes increase, current costs per tonne ofcarbon saved are therefore an incompletemeasure, since today’s investment buys a widerrange of options for the future. By 2020 sometechnologies could show negative costs pertonne of carbon.

6.36 System costs. In addition to the directcosts of the generating technologies,renewables have the potential to imposeadditional costs on the system. In particular,unlike all other generating options, wind, solarand wave energy produce variable andunpredictable output. The system costs ofunpredictable intermittency are disputed, butmany studies suggest they are low incomparison to generating costs.11 Analysis forthe PIU12 assessed the costs of intermittency onthe assumption that system services required todeal with increasing levels of intermittencywould be provided using electrolytic storageplants. In practice, lower cost options may beavailable, such as holding older plant availableon stand-by. The analysis suggests that:

– costs are negligible at low levels, indeedsmall amounts of intermittent generationcannot be detected by the system operator;

– costs are less than 0.1p/kWh for 10% ofelectricity from intermittents;

– costs are less than 0.2 p/kWh for 20% ofelectricity from intermittents.

The analysis also suggests that at largepenetrations (45% or more of peak demand)costs could rise to 0.3p/kWh or more. However,as such high penetrations are unlikely to bereached for many years, such costs are veryuncertain.

9 Technical potentials quoted based upon DTI figures; see PIU (2001h).10 However there are exceptions, such as the possibility of large tidal barrages (e.g. the Severn Barrage). Such a project would be

large-scale even in relation to a technology like nuclear power. The feasibility and costs of such a scheme have not been studied inthis review and would deserve a large separate study.

11 A review of studies is provided in Milborrow (2001).12 See Appendix to Chapter 7 for more details, and Milborrow (2001).

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6.37 Locational factors specific to renewablesmay also impact upon system costs. Connectioncharges to the grid are reflected in the costsquoted above, but charges that reflect anyneed to upgrade the local network are not.These are generally small in comparison togeneration costs, though there are exceptions.The fact that some marine resources are remoteand therefore of lower value to the system isreflected in the PIU’s assessment of carbonsaving costs (see notes to Table 6.1 below andAnnex 6). However, substantial upgrading ofthe national grid transmission network will notbe needed in the short-to-medium term.13 Inthe longer term, such changes might beneeded if a large contribution from renewablesis to be realised. The DTI’s proposed study of anoffshore cable from the West of Scotlandillustrates the range of possibilities. The long-term costs are uncertain but could besignificant.

Innovation

6.38 The results of a detailed analysis of thecost reduction potential of the leading options

over the next 20 years are summarised in Box6.1 (and see Annex 6). The work suggests thatthe leading options – onshore and offshorewind – have the potential to become amongthe cheapest low carbon options, althoughsustained support will be needed for some ofthe other technologies, such as solar PV andwave power, which offer significant potentialfor the long term.


6.39 Security of supply. These sources ofenergy are indigenous and generating units arelargely small scale. They also tend to bedecentralised and dispersed, making them lessvulnerable than larger units. The main securityissue concerns intermittence. Individualrenewable power plants pose no threat tosecurity. The design and operation of theelectricity network can be modified toaccommodate increasing levels of intermittentpower, overcoming security problems. And asindicated above, the costs are small.

Box 6.1: The costs of renewable technologies world-wide in 2020On-shore wind – likely to fall to 1.5–2.5 p/kWh.

Photovoltaics – likely to see sustained and substantial cost reductions over the next 20 years, butPV will inevitably do best in countries with the most sun: the cost in the UK could still be as highas 10-16 p/kWh.

Offshore wind – likely to fall to 2-3 p/kWh.

Energy crops – the cost of combustion will probably fall substantially, but reductions in the costsof crop production and processing will also be needed; the best estimates for the average costslie in the range 2.5–4 p/kWh.

Wave and tidal – cost reductions are uncertain, the issue is how rapidly large-scale devices willcome onstream; early devices may come through at 4-8 p/kWh.

Note: remote sources need to compete against wholesale electricity prices (currently around 2p/kWh) and need to be transported at a cost to consumers, while deeply embedded sources, likebuilding integrated PV, have the less stringent target of retail prices in commercial and domesticsector (around 5-7 p/kWh). The effect on generating costs of the intermittent nature of somerenewables is included in these cost estimates.

13 Upgrading some existing “pinch-points”, such as the England-Scotland interconnector, would benefit renewables, but the benefits arenot unique to renewables and do not represent a “cost” for renewables.

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6.40 Other environmental impacts. Mostrenewables produce negligible life-cycleemissions of local air pollutants or solid wastesand produce no other harmful by-products. Thepartial exceptions are energy crops, whichproduce manageable outputs of NOx and ash,and PV which uses some potentially harmfulheavy metals. The main impacts are local: visualintrusion, noise and wildlife impacts. While thenoise impacts of new wind turbines are small,visual intrusion is a significant factor, mostnotably for onshore wind.

6.41 Economic and social. The supportneeded to get technologies to the point whereunit costs fall substantially comes at a cost. Theexisting Renewables Obligation will cause aprice increase to domestic consumers whichcould be as large as 4.5% in 2010.14 Theproportionate increase on industrial bills will belarger: it could be double the size of thedomestic effect. Both increases will be phasedin gradually over the period as the obligationtakes effect. Looking to the very long term,profound changes to the way energy istransmitted and utilised may be required. Asalready discussed, if renewable energy powerplants are large and remote, significantupgrading of transmission capacity will beneeded, especially from Scotland. If plants aresmall and distributed throughout thedistribution networks, the design and operationof the network will have to change. This mayhave significant implications for expenditure.However, since the entire energy system will, inany case, need to be replaced over this timehorizon, there may be little or no net impact onbills.

Flexibility

6.42 Renewable technologies offer a flexibleresponse to the need for low carbon optionsbecause they come in small units, and are quick

to construct. While they may have highconstruction costs per unit output, total capitaloutlays can be small. The potential for costreductions is large, though inevitably uncertain.If costs do not respond to learning asenvisaged, then different options can bedeveloped.

Energy from waste


6.43 Waste management strategy needs tofocus on waste minimisation, reuse, recyclingand composting,15 however, to the extent thatincineration or other potentially energy yieldingoptions are required, maximising energy fromwaste can displace other sources of energy, inthe form of electricity or heat. To the extentthat fossil fuels are displaced, energy fromwaste can contribute to carbon emissionreduction.

6.44 The Waste Strategy 200016 outlines severalways in which energy can be recovered fromwaste. The most common method of energyrecovery is by waste incineration, but otheroptions include materials recovery with energyreleased as a by-product (for example,anaerobic digestion), and waste disposal, withfuel recovered as a by-product (for example,landfill gas).


6.45 Generating more energy from waste cancut down on landfill and also help to preservefinite primary materials, but is not asenvironmentally desirable as options higher upthe waste hierarchy.17 There is some publicanxiety concerning the health risks ofincineration plants, although this also extendsto other options, such as landfill sites. There is

14 OXERA (2001).15 A discussion of the various policy instruments for tackling waste operating at EU, national and local level, are included in PIU

(2001b).16 DEFRA (2000).17 The waste hierarchy is set out in DEFRA (2000)

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also a body of opinion that argues that policiesthat promote energy from waste could inhibitwaste reduction and other options higher upthe waste hierarchy. In addition, the flexibility offuture waste policy responses could becompromised if large-scale capital investmentwas dominated by waste incineration. Howeverthe Government believes that the recovery ofenergy from waste has an important role toplay in sustainable waste management,alongside recycling and composting. To thisend the Government is also keen to promotethe development of more efficient andenvironmentally benign technologies such asgasification and pyrolysis. An assessment ofwaste management issues and options is beingtaken forward in a separate PIU project.

Nuclear power18


6.46 Nuclear power could supply a substantialproportion of UK electricity and so could play amajor role in a low carbon economy. Nuclearpower currently produces around a quarter ofUK electricity. Over the coming 20 years all butone of the UK’s nuclear stations will havereached, or be very close to, the end of theircurrently expected lives.

6.47 Nuclear power stations are large: recentdesigns, all of which use thermonuclear fission,are typically 1-2 GW. There may be limitationson the availability of suitable sites for nuclearpower stations. The most likely outcome is thatnew stations would be built on existing nuclearsites.

Costs

6.48 Nuclear power stations emit zero CO2 inuse. Some CO2 is emitted during construction,

but overall carbon emissions per unit of energydelivered are very low compared to fossil fuels.The costs of producing electricity from a newnuclear station are uncertain, probably in therange of 2.5-4.0 p/kWh in 2020, using a mix ofPIU and industry analysis. Industry estimates lieat the bottom of this range, and are predicatedon assumptions of series build, rapidconstruction and very good operatingperformance and relatively low discount rates.On the industry’s estimates, nuclear powerwould be very competitive with other sourcesof zero carbon power. At the higher unit costs,it is less competitive. In either case nuclearpower seems likely to remain more expensivethan fossil-fuelled generation, especially in aliberalised market.

Innovation

6.49 Nuclear power is a mature technologyand existing designs have relatively limitedtechnological “stretch”. Current developmentwork and radical new technologies couldproduce a new generation of smaller, modularand inherently safer reactors which might besignificantly more competitive than thoseavailable today. This development work is thesubject of international collaboration19 and willtake at least 15-20 years to reach commercialfruition. Fusion reactors are unlikely to reachcommercial maturity within a 50-yeartimeframe. The CSA’s review of energy researchrecommended that priority be given to work onmaterials capable of withstanding heat andplasma fluxes in an operating reactor over asufficient length of time.20


6.50 Security. Nuclear power is effectively anindigenous source of energy. Uranium can bestockpiled and reserves are large (potentiallyover 250 years’ worth of current world use).21

18 This section draws on Annex 6 and PIU (2001i).19 A leading example is the USDOE-sponsored programme for ‘Generation IV’ reactors.20 Annex 8.21 OECD NEA/IAEA (2000) p.29.

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Nuclear stations are large “point sources” ofenergy, and there must be sufficient availablecapacity to cope in the event of planned orunplanned outages.

6.51 The extent to which nuclear stations arevulnerable to deliberate attempts either todisrupt power supplies or to precipitate anaccident is not clear. Nuclear stations aredesigned to be highly robust physically. Thisvitally important issue requires the attentionthat it is already getting from specialists inmilitary/strategic security.

6.52 Environmental risks. At the momentthere is no agreed solution to the very longterm management of radioactive waste. DEFRAhas recently initiated a review of nuclear wastemanagement22 with the aim of reaching apublic consensus on acceptable ways to dealwith existing and unavoidable waste. It isenvisaged that this process will take five years.The CSA’s review of energy research identifiedwaste-handling as the key priority for publicly-funded R&D in relation to nuclear fissiontechnology.

6.53 The other main environmental issueassociated with nuclear relates to the risk ofaccidental radioactive releases, rather thanroutine emissions. Although stringent UK andinternational regulations mean this risk is verylow, the potential consequences of suchaccidents are very large. Innovations in nucleardesign may be able to offer inherently saferdesigns, which will also produce much lesswaste. These new designs are not likely tobecome available for 15 to 20 years.

6.54 Social and economic. As with the othertechnologies considered, any programme ofpublic assistance for new nuclear investmentwould carry costs for domestic and industrialconsumers or taxpayers. Nuclear power, likeother technologies, also needs to be acceptableto the general public and to those who live

near nuclear facilities. The acceptability of newbuild may or may not constitute a seriousproblem, and may improve if there is a moreobvious need for the technology, but cannot betaken for granted.

Flexibility

6.55 Nuclear investments are large-scale.Moreover, costs are best reduced if a series ofstations can be built to the same design.Nuclear power tends, therefore, to be arelatively inflexible source of carbon savings as aprogramme of series build would entailconsiderable investment in large-scale and long-lived plant. A sustained programme ofinvestment in currently proposed nuclear powerplants could adversely affect the developmentof smaller-scale technologies, including possiblenew generations of nuclear plant.

Carbon capture andsequestration


6.56 There is growing industrial interest inremoving CO2 from fossil fuels before it isreleased into the atmosphere, sequestering thecarbon in deep repositories so that it is “lockedup” and does not enter the atmosphere. CO2

capture and sequestration (C&S) can be, inprinciple, applied to any fossil fuel powerstation. It is also feasible to produce hydrogenfrom fossil fuels for use in transport, and tosequester the waste CO2. There are two discretesteps: first, the CO2 must be captured; andsecondly, the CO2 must be transported to ageologically appropriate repository. Thetechnique of carbon capture is well known, andlikewise there is already some experience ofsequestering CO2, although the CSA’s review ofenergy research identified this as an area inwhich fundamental research may be needed.

22 DEFRA (2001c)

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CO2 is already injected into some oil fields forenhanced oil recovery. But the two halves ofthe process have yet to be brought togetherand demonstrated on a large scale.

6.57 The size of the potential CO2 reservoirsavailable is uncertain. Estimates of the globalpotential of deep saline aquifers range from 10years global emissions at current rates to twicethe carbon content of estimated recoverablefossil fuel reserves.23 Estimates of the potential ofdepleted oil and gas reservoirs also vary.However, suitable sites are not evenlydistributed around the world, and the UK hasaccess to potentially large CO2 repositoriesunder the bed of the North Sea.

Cost and innovation

6.58 CO2 C&S can reduce emissions by 80-90%. Early indications are that CO2 C&Swould be able to provide power at 3-4.5p/kWh,24 without allowing for any associatedbenefit for enhanced oil recovery. Thetechnology has been demonstrated on a smallscale, but substantial uncertainties surroundboth costs and feasibility. If the CO2 could beused for enhanced oil recovery, there would beadded costs – for example at the wellhead –and benefits, from oil sales.


6.59 The main question about theenvironmental impact of C&S is whetherthe CO2 would stay in the ground.25 Asefficiencies are decreased by CO2 C&S, NOx

emissions would rise compared to plantswithout carbon capture. There is a relatedquestion of whether sequestration will bepublicly acceptable.

6.60 C&S could, if successful, offer substantialcarbon emission reductions from a range of

fossil fuels. If the CO2 from gas wassequestered, then there would be no obviousgains in security. If the process was applied toa coal-fired power station, then the continueduse of coal for power generation would bringassociated benefits to security. If CO2 C&Sprovided the basis for hydrogen productionthen this would allow the transport sector toreduce its dependence on oil.

Fuel switching in heating


6.61 The potential for switching to low carbonfuels for heating is probably limited. Heatmarkets which use oil or coal are now verylimited, and while gas will replace some ofthem, the contribution to lower carbonemissions will be small. The larger long-termissue is the prospect of using zero carbon fuelsfor heating. Apart from CHP, already discussedabove, the main possibilities seem to be somelimited use of biomass, and in the much longerterm, the possible use of hydrogen. Howeverboth biomass and hydrogen may have morecost-effective initial uses (CHP and transportrespectively). It could also be that if low carbonelectricity were cheap enough, it could beattractive to switch to electricity from directsources of heat, but this is at present a distantand uncertain prospect.

Coal mine methane


6.62 A small new industry is being establishedto tap the methane in abandoned coal mines.The methane can then be used to generateelectricity, displacing other sources of fuel. The

23 UNDP/WEC (2000). The main source of this wide variation is uncertainty about the integrity of geological formations – if only“capped” aquifers are suitable then the resource is much more limited.

24 PIU (2001f & h).25 The legal status of disposing of CO2 in the sub-sea strata needs to be clarified in the light of the OSPAR and London Conventions on

marine pollution.

economics depend on the size of the mine, andhence the volume of gas available. The largestmines provide enough gas for the process to beeconomic in its own right. But studies suggestthat, without some kind of support, it wouldnot be economic to exploit smaller mines. Arelated process – coal bed methane – taps themethane in virgin seams of coal, and it mayhave potential to provide a significant new (butnot carbon free) source of primary energysupply, though not to divert gases which wouldotherwise have leaked into the atmosphere. Theparticular merit of coal mine methane activity isthat it may use gases which would otherwisenot remain underground, but would leak to theatmosphere, forming part of the UK inventoryof greenhouse gas emissions. In such cases, theenvironmental gains are, therefore, significant.

Transport fuel switching


6.63 Transport is likely to remain heavilydependent upon oil for the next two decades.However in the longer-term a switch to lowcarbon energy vectors for road transportappears feasible. The reduction in CO2

emissions will depend on the technologicalroute. The most promising option currentlyappears to be hydrogen produced from low orzero carbon electricity or from fossil fuels withCO2 C&S. Biomass has low life cycle CO2

emissions. Given the high proportion of CO2

emissions from the transport sector, thesereductions could make a significant contributionto climate change goals.

6.64 In the aviation sector, there do not appearto be any alternative fuelling options tokerosene, even in the medium-term. Hydrogenmay offer possibilities in the very long term, butthere are significant technical barriers – such ason-board storage of hydrogen in aircraft – to beovercome.

Costs

6.65 As highlighted previously, the cost pertonne of carbon saved from efficiencyimprovements to date is probably negative, butthere is currently little detailed data available,and this issue should be explored further.Hybrid vehicle technology also looks likely to becheaper when it moves into mass production.The large technical and commercialuncertainties surrounding new fuelling optionsmakes it more difficult to forecast the costs ofthe longer-term technical possibilities. But fuelcell vehicles offer good prospects as a long-termCO2 reduction measure, though the timescalefor their becoming cost effective depends onprogress with the significant remainingtechnical hurdles.

Innovation

6.66 There is broad consensus amongst motormanufacturers and commentators thathydrogen fuel cell vehicles will replace thecombustion engine by 2050. The use ofhydrogen would require the development of anew infrastructure to make, transport and storehydrogen. However it is possible to envisage anevolutionary path towards a hydrogen network– for example gradual upgrading of the naturalgas network to make it hydrogen friendly,whilst continuing to produce hydrogen locallyfor (initially small) early markets. This may avoidthe need to develop an entirely new parallelinfrastructure from scratch. Any major changesto fuelling technologies or infrastructure wouldneed to mesh with international developments.

6.67 The use of ethanol from biomass inadvanced hybrid engines is one of the fewconfigurations which could come close to thelow carbon potential of fuel cells. In the shortterm, the use of biofuels in transport isconstrained by the availability of suitableagricultural land, crop yield and the demand forbiomass for other uses. From UK production,biofuels could provide niche markets and

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contribute to wider markets, but are unlikely tosupply most UK road transport fuel. In thelonger-term, new technologies that widen therange of crops suitable for liquid fuelsproduction could change this.26 Wider adoptionwould depend on the development of theseoptions and/or expansion of the internationalmarket.

Synergies or conflicts

6.68 Security of supply. Diversity in energy iscurrently focussed on the electricity generatingsector, with the transport sector largelydependent on oil. Fuel switching in roadtransport would significantly reduce ourdependence on oil. However, a wide variety ofnew transport fuels need not be sought, sinceadditional distribution infrastructure could haveadditional resource costs and diversity can besought in the origins of fuels rather than thetype of fuels.

6.69 Environmental. The move to lowcarbon fuels would significantly reduce local airpollutants. Hybrid and fuel cell technologieswould reduce vehicle noise. While hydrogencould potentially provide an alternative tokerosene in aviation, the impact of additionalwater vapour emissions at high altitude mayalso have significant global warming potential.

6.70 As Table 6.1 shows there is in all casesconsiderable uncertainty about the cost of thevarious options. Technologies which may bevery cost effective in some circumstances maybe less advantageous in others, and in all casesthe precise path of future cost reductions is indoubt. All the technologies and options whichshow negative carbon abatement costs in 2020– most obviously energy efficiency, CHP andwind – are obvious candidates for a “no (orlow) regrets” approach. However, sometechnologies which have the potential to reachthis point by 2020 are not there yet, and evenwhere resource costs are negative, somesupport may be needed to get things moving.Options which show a positive carbonabatement cost may also be worth pursuing,whether because of the longer-term potential,or simply because they may be needed in orderto meet low carbon commitments.

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26 Specifically to enable bioethanol production from woody crops and vegetable wastes.

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Table 6.1 Carbon abatement costs and potential contribution to carbon emissionreductions for the leading low-carbon options

* Based upon estimated cost ranges for 2020 (see Annex 6).

** Approximate and taking into account practical constraints on build rates by 2020 for nuclear and offshore wind; that land useconstraints limit the contribution from onshore wind; and assuming that the practicable potential for PV is constrained by the likelihoodof continuing high cost in a 20-year timeframe.

*** A large proportion of electricity could be generated in this way by 2050, reducing emissions by at least 20 MtC compared to usinggas. The potential increases substantially if electricity (or hydrogen made from it) is used to meet demands currently met from othersources, such as for transport.

General notes to Table 6.1:

Costs per tonne of carbon saved for all large-scale supply technologies assume that CCGT generation is displaced. Cost range for CCGTin 2020 is 2.0–2.3 p/kWh. This assumes that capital costs for CCGT decrease slightly and efficiency improves slightly, as widelypredicted (see Annex 6), and gas price increases to a range of 0.85–1.0 p/kWh.

Emissions saved by displacing CCGT are assumed to be approximately 0.1 kgC per kWh.

Emissions savings per kWh are assumed to be 1 for renewables, nuclear and energy efficiency, 0.9 for C&S and 0.4 for CHP.

Cost ranges for all power generation technologies include grid connection charges. The value of energy displaced by offshore wind andwave energy is reduced by up to 0.5 p/kWh to make allowance for the remote nature of these sources. Renewables costs allow for theinherent generation costs of intermittency – reflected in the relatively low load factors for these technologies. Additional system costsdue to intermittency are not explicitly included because compared to generation costs these are very small, and make an insignificantdifference to the inherent uncertainty surrounding estimates of generating costs.

“Deeply embedded” generation – PV and micro CHP – is assumed to displace end use rather than central station electricity. The costs ofenergy displaced therefore include an element of transmission and distribution costs, assumed to add 1.5–2.5 p/kWh to generatingcosts. The cost range of energy displaced for these options is therefore 3–4.8 p/kWh.

The energy efficiency costs are based on the work of the Government’s Inter-Departmental Advisory Group on Low Carbon Options. Avery wide range of measures is incorporated (see PIU 2001b). The cost range reflects the uncertainty about the extent to which costeffective measures are not adopted because of either market failure or hidden implementation costs (see Annex 6).

Carbon abatement cost Potential contribution to£/tC (2020)* carbon emission reduction UK specificity

Minimum Maximum 2020 2050(MtC) (MtC)

**

Domestic –300 50 15 30 StrongenergyefficiencyService sector –260 50 4 10 StrongEnergyefficiencyIndustrial –80 30 9 25 VariedenergyefficiencyTransport Probably Needs to 14 30 International industryenergy negative be assessedefficiency in detailLarge CHP –190 110 3 5 StrongMicro CHP –630 –110 1 5 Significant, given UK gas

dependenceOnshore wind –80 50 1 5 International industryOffshore wind –30 150 8 >20 Good prospects for UK

*** specific developmentsMarine (wave 70 450 small >20 Good prospects for UKand tidal) *** specific developmentsEnergy crops 70 200 3 10 International industrySolar 520 1250 <1 >20 International industryphotovoltaics ***Nuclear 70 200 7 >20 International industry

***Carbon 80 280 small >20 Good prospects for UKsequestration *** specific developments

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7. A PROGRAMME FOR A LOW CARBON FUTURE

Summary

This Chapter draws on the analysis of Chapter 6 to develop a programmeof action leading towards a low carbon future. A package of policies isrequired to:

● internalise externalities and create a level playing field for low carbonoptions;

● maximise synergies with other policy goals, such as energy security;

● support R&D, drive innovation and create new low carbon options;and

● remove or ameliorate specific barriers and market failures.

Energy efficiency should be at the centre of low carbon strategies – muchcan be achieved at very low cost. A step change in energy efficiency is

needed, with a new target of 20% improvement in household energyefficiency by 2010, and a further 20% improvement by 2020.

The wide range of renewable energy technologies represents the mostimportant priority among zero carbon supply options. Institutionalbarriers need to be overcome if the UK is to meet its current target of10% of electricity met by renewables by 2010. A new target of 20%should be set for 2020.

Nuclear power could be an important, zero carbon option for the future.The need now is to take a range of actions which keep the nuclear optionopen.

Combined heat and power (CHP) is an important low (but not zero)carbon option and needs further assistance to overcome institutionalbarriers.

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7.1 This Chapter draws on the analysis ofChapter 6 to develop a programme of actionleading towards a low carbon future. A packageof policies is required to:

● internalise externalities and create a levelplaying field for low carbon options;

● maximise synergies with other policy goals,such as energy security;

● support R&D, drive innovation and createnew low carbon options; and

● remove or ameliorate specific barriers andmarket failures.

7.2 The next section reviews each option in thelight of the analysis in Chapter 6 of potential,costs and benefits, and makesrecommendations concerning the policies thatwould best develop each option for the future.Chapter 3 explains the general context ofpolicy-making for low carbon futures – inparticular the need for a blend of market-basedand regulatory instruments. While many of thepolicies outlined below are concerned withtargeting low carbon options directly, in thelonger-term carbon valuation should becomemore important.

7.3 The overall approach to innovation is animportant part of this programme. The ChiefScientific Adviser’s Energy Research ReviewGroup1 has considered energy technologydevelopment needs, and has placed climatechange objectives at the top of its list of driversfor technology change. It has also suggestedthat there is a strong case for raising the level ofpublicly funded low carbon energy research,together with the possible establishment of anew Energy Research Centre (considered inChapter 8). It recommended that a range ofbasic and applied research, development anddemonstration activities is important to themajority of technologies, but emphasised thatthere should be sufficient focus on the basicresearch from which step change breakthroughsare more likely to come. The CSA’s review hasproposed six key areas in which increased levelsof funding could have a particularly significantimpact for new R&D. They are energyefficiency; carbon sequestration; wave and tidalpower; solar PV; hydrogen production andstorage; and nuclear waste. These priority areasfit well into the programme recommendationsmade in this review. DTI and OST shouldtake steps to increase the level of

Carbon capture and sequestration (C&S) could be important in allowinggreater use of fossil fuels in a low carbon world. UK efforts to reduceuncertainties surrounding C&S are urgently needed.

Transport energy use is a major issue in the long term. Policy shouldsupport improved energy efficiency in vehicles, development of long-term low and zero carbon options and reduction in aviation demand.

Government needs to keep asking what alternative strategies should beput in place to promote low carbon futures if energy efficiency,renewables and CHP deliver less, or are much higher cost, than currentlyexpected.

1 Chief Scientific Adviser (2001).

funding for low carbon energy R&D. Thepriority areas of the Chief ScientificAdviser’s Research Review Grouprepresent a good starting point.

Energy efficiency7.4 Energy efficiency has the closest matchwith all the major sustainable developmentobjectives. It can assist the economy as well ashelp to achieve social and environmental goals.2

Our examination of the potential has shownthat the long-term scope for improved energyefficiency is large (see Chapter 6); and ourassessment of potential futures (Chapter 5) isthat increasing the rate of energy efficiencyimprovement is very likely to be needed todeliver a low carbon economy. It can besupported on the basis of least cost and“minimum regrets” and can become the centreof a new energy policy.

7.5 As in other areas of low carbon policy,energy efficiency policy should seek to improveeconomic viability further, encourageinnovation, and address market failures. Pricingcarbon will assist the first of these goals (seeChapter 3). But much can be done even withprices at current levels. Market failures andother barriers that constrain the adoption ofenergy efficiency are set out in Annex 5.

7.6 Energy taxes as well as carbon taxes canencourage energy efficiency. The rates andbases of energy taxation vary markedly betweendifferent types of uses, transport, heat andpower, domestic and industrial. Differenttreatments are to be expected since taxes fulfila variety of purposes, including revenue raising.In the long-term, if policy goals are to beachieved, energy prices should be increased toreflect the environmental costs of energy use.Existing taxes should, over time, be looked atwith this end in view.

7.7 Multiple policy interventions are likely to berequired to achieve energy efficiency objectives,with a mix of regulations, negotiatedagreements and incentives. The strategy forGovernment should be to identify the agentsbest placed to deliver energy efficiency in eachsector and then:

● agree a long term framework for targets andpolicy;

● use regulation and targeted financialmechanisms to give strong incentives; and

● support technical and market innovationfrom research through to implementation.

7.8 Many energy efficiency policy instrumentshave been introduced in recent years. In manycases the priority is now to evaluate theirprogress and to enhance them with newresources, rather than seek new and differentapproaches.

7.9 Government should affirm the importanceof faster improvement in energy efficiency. Thereview has considered the case for setting anaspirational target for energy efficiencyimprovement across the economy. While thiswould send a strong message, there aredifficulties in defining and measuring energyefficiency at this aggregate level. On balance,setting targets for each sector will prove abetter approach. DEFRA should developenergy efficiency indicators, targets andmonitoring mechanisms for each sectorof the economy.

7.10 Energy efficiency programmes haveconcentrated largely on deploying cost-effectivetechnology. The role of innovation in long-termenergy policy requires a shift of emphasis. It is acommon misconception that energy efficiencyis always “low tech”. This has not been true inthe past, and certainly will not be in future. Forexample, developments of advanced controlsystems, micro-turbines, fuel cells and smartmetering will be very important. Public funding

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2 PIU (2001b).

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3 US National Academy of Sciences (2001).4 For example BRE (2001) sets out an approach for assessing the contributions that improved insulation and heating system efficiency

make to household energy demand changes, and the Market Transformation programme has relevant data for appliances. 5 PIU (2001c).

for R&D expenditure on energy efficiency in theUK is very low, although evidence fromoverseas, indicates it can be more cost-effectivethan R&D into energy supply.3

Household energy efficiency

7.11 The household sector has the mostconsumers and the biggest market failures. Ittherefore needs particular attention. DEFRAshould develop a Strategy for HomeEnergy Efficiency to set out a clear, long-term framework. This should include anaspirational target for home energyefficiency of 20% improvement by 2010followed by a further 20% improvementby 2020.

7.12 The analysis of possible futures indicatesthat targets for a 20% improvement by 2010and a further 20% in the following decadeseem suitably challenging, but deliverable. Atexpected rates of growth in energy services, thismight reduce household energy demand by10% in each decade. This is broadly consistentwith the goals of the UK Climate ChangeProgramme. Demand reduction targets wouldbe simpler to monitor. But targets for genuineefficiency improvements are preferable, andthere is data that can be used to monitorthese.4 The strategy will need to set out indetail how the target will be defined, deliveredand monitored. It is clear that new policyinstruments, or amplification of existinginstruments, will be needed.

7.13 If domestic energy efficiency can beincreased in line with the targets of successive20% improvements in energy efficiency, thenenergy savings averaging £5 billion annuallycan be released.5 The net gain to the economyis less than this since investments are needed tomake the savings. In very broad terms the netgain in a year would reach about 0.25% of GDPby 2020.

7.14 Different policy instruments will beneeded, building on existing approaches. Theseshould include:

● Government and energy supplierprogrammes;

● capacity building in local authorities,voluntary organisations and energy efficiencyinstallers;

● Building Regulations and product standards;

● incentives to action from “home movers”;and

● incentives to encourage energy servicesmarkets.

Government and energy supplierprogrammes

7.15 The Government’s aim is self-sustainingenergy efficiency markets, including energyservices, where the energy supplier deliversboth energy units and energy efficiency. Thiswill require major changes in the culture ofboth suppliers and customers, so may not beachieved rapidly. Medium-term policy will needto follow a twin track approach:

● an incentive framework for viable energyservices; and

● programmes to deliver activity in the currentmarket structure.

7.16 The Climate Change Programme targetfor emissions reduction of approximately 5 MtC/year by 2010 is not matched by long-term fully funded policy measures to deliver thelevel of investment needed. A long-termstrategy and target will go some way toaddressing this problem, but enhancedprogrammes will be needed too.

7.17 Energy efficiency work in vulnerablehouseholds (“Warm Front” in England and theequivalents in the devolved administrations) has

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a strong social focus, and therefore shouldcontinue to be supported by publicexpenditure.6 There are particular problemsaddressing the fuel poverty of the lowestincome households in “hard to heat” homeswith solid walls and no access to gas. It is rightto give greater attention to these homes,including through innovative measures such asmicro-CHP.7

7.18 Obligations on energy suppliers, such asthe Energy Efficiency Commitment (EEC),operate over a wider range of social groups.They are expected to deliver the largest carbonsavings in the domestic sector and have beenshown to be cost effective.8 These programmeswill operate in a revised and expanded formfrom 2002 to 2005. In order to reduceuncertainty in the industry, DEFRA and DTIshould make an early commitment toextending the EEC from 2005 to 2010, on thebasis that it would, at a minimum, be kept atexisting levels. Subsequently, and by the end of2003, the Departments should review the scaleof the commitment for this additional period inthe light of the initial experience.

7.19 Decisions on the future level of EEC willneed to consider the financial costs andbenefits. The costs of delivering the programmewill fall on household gas and electricityconsumers. It is estimated that the level of EECproposed for 2002-2005 will raise prices by1.2% over that period. The estimated benefitsin reduced energy costs will rise to about 1.6%of bills by 2005 and last for the lifetime of therelevant measures (8-40 years).9 However, thebenefits will not be uniformly spread andhouseholds that are not included in anyschemes will be losers. The net effect will be again in economic efficiency and welfare, butalso a cross-subsidy. Both effects will tend togrow if the programme is expanded.

7.20 Energy supplier programmes could riskreducing incentives for investment byhouseholders themselves as householders mightchoose to delay their own investment decisions.Programmes need to be designed to encourageinnovation and greater householderinvolvement. The framework of the EEC allowsenergy suppliers to improve their profitability bydelivering their obligations more efficiently thantheir competitors. This is a driver forcommercial innovation. Incentives for deliverythrough energy services will be increased. In themedium-term, further innovation might beachieved by including the domestic sector inemissions trading through a modification ofEEC.10

Capacity building and co-ordination

7.21 Expanded energy efficiency programmesincrease the challenge to overcoming thebarriers to public information, understandingand trust. Exhortation alone has not historicallybeen very effective; more targeted approachesare needed. Government and supplier schemeswill need to be supported by other activities –co-ordination, raising consumer awareness, andindividual advice. These need to be managedlocally. In particular, there needs to be activeinvolvement from the key agencies – includinghealth, social services and social housingproviders – working with vulnerablehouseholds.

7.22 Local Government is well-placed to act asa facilitator of local action, working with otheragencies. Energy efficiency needs to be broughtinto the mainstream of local authority work.Local authorities will need the powers, dutiesand funding necessary to play a bigger role,including in energy service companies. DEFRA’sreview of Local Authority energy efficiencyactivity will be important in this respect. Local

6 DTI, DEFRA (2001).7 DTI, DEFRA (2001).8 National Audit Office (1998).9 DEFRA (2001a).10 PIU (2001c).

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activity could draw on the network of EnergyEfficiency Advice Centres. These already providepersonal advice, but could play a wider role inlocal schemes. Other voluntary sectororganisations could also play an enhanced rolein innovative approaches, but they are generallyunder-funded.

Building and product standards andpolicies

7.23 Policy instruments should seek to limit theextent to which consumers make decisionsabout unfamiliar technical choices. Consumersdo not want to buy homes or appliances thathave high running costs and areenvironmentally damaging. They expectGovernment to set minimum standards andgenerally seem willing to accept any smalladditional purchase costs that result.11

7.24 A large proportion of energy is used tolight and heat buildings, and therefore a lowcarbon economy will require low carbonbuildings to become the norm. Plans for furtherimprovements will require changes inconstruction, initially to bring our standards upto those of other northern European countries.While regulatory changes which are wellsignalled can give greater certainty to business,regulation should allow designers and buildersfreedom in how to deliver a given performance.The performance levels specified will depend onRegulatory Impact Assessments. These shouldinclude an allowance for carbon value and costreduction through market transformation (seeChapter 3). Within this framework, standardsare likely to move progressively to require newhomes to meet very low energy requirementsfor space heating.

7.25 If major changes were to be brought intoo quickly, there would be very real concernsabout the construction sector. Detailedconsultation with the industry and other

stakeholders will be needed. A balance needs tobe found that promotes innovation, but at anacceptable rate. DTLR should review the costsand benefits of moving to “near-zero spaceheating” buildings well in advance of the nextreview of the energy efficiency component ofBuilding Regulations.

7.26 A long-term framework also needs toconsider the role of renewable energy, includingsolar water heating, especially in electricallyheated buildings. But building integratedphotovoltaics (BIPV) have the most potential.These are currently expensive, although theyare already economic as an alternative toexpensive cladding.12 Analysis indicates thatBIPV will approach cost-effectiveness sometimeafter 2020 (see Annex 6). With an allowance forthe benefits of carbon reduction andinnovation, inclusion in all new buildings mightbe justified somewhat earlier.

7.27 Building Regulations also play a role in theimprovement of the existing building stock.They already contain provisions relating to newboilers and glazing.

7.28 For appliances, energy efficiency shouldbe part of integrated product policy. The EU isthe appropriate level to set standards on tradedgoods. Energy efficiency labels are currentlyrequired on all the major appliances, andstandards are in place for boilers andrefrigerators. The Framework Directive promisedin the EC Energy Efficiency Action Plan13

provides the appropriate context for futureaction. DEFRA should take the lead in Europe inpressing for a more comprehensive programmeof cost-effective EU energy efficiency standardsand negotiated agreements. This will requirecollaboration with European partners. Theprogramme should pay particular attention tonew products in which market growth isexpected, like digital TV equipment and air-conditioning.

11 PIU (2001d).12 ETSU (1998).13 Commission for the European Union (2001b).

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Home movers

7.29 Moving house provides an opportunity forimproving energy efficiency, as renovation workand new financing are more likely at this time.Home movers may undertake energy efficiencywork which is otherwise considered toodisruptive. Financial incentives of various kindsare potentially most effective at this point. Theprivate sector should be encouraged to support“home mover” energy efficiency. EECprogrammes may be a useful source of finance.The rules and administration of EEC shouldallow energy suppliers to deliver their targets inthis way. One further option for financing isbanks and building societies. DEFRA’s Strategyfor Home Energy Efficiency should consider theoption of a negotiated agreement with thefinance sector to reduce the cost of financingenergy efficiency measures by funding them aspart of mortgage offers.

7.30 Market based measures of this typeshould form the basis of Government’sapproach to home movers. A morecontroversial option would be to regulateperformance levels for existing homes, forexample a requirement that all homes shouldbe brought up to a level achievable with cost-effective measures, but only at the point of saleor re-renting. This approach would have majorimplications for the housing market andenforcement agencies. It should not be adoptedat this stage. However, it might be reconsideredin future if more market-oriented policies donot prove successful.

Energy services

7.31 Many of the barriers to energy efficiencymight fall if suppliers marketed energy services.At the same time the level of Governmentintervention needed to promote energyefficiency might be reduced. But establishingenergy services businesses is risky. There can beno guarantee that household energy serviceswill ever be commercially viable. But supplymarket liberalisation provides new

opportunities. In the early years, the emphasishas been on cost reduction and customeracquisition and retention, but as costsconverge, suppliers are beginning to offer moreadded value services. And new products, suchas micro-CHP systems, may provideopportunities for establishing energy serviceoffers.

7.32 Government should not try to designcommercial packaging for energy services.Instead the policy framework should set theright incentives for commercial energy services.The new arrangements for the EEC from April2005 provide increased incentives. However,there are structural issues that could also beaddressed. It is not helpful to energy servicesfor long-term customer/supplier relationships tobe treated as inherently anti-competitive. Inparticular, potential energy services suppliersfind the “28-day rule” – which allows customersto change supplier at 28 days notice – aregulatory barrier. For contracts that includelonger-term energy efficiency financing (butonly for those contracts) Ofgem should modifythe 28-day rule, with other approaches used toprotect customers against excessive charging.

Non-domestic energy efficiency

7.33 Businesses have a key role to play indelivering climate change goals. To do this theyneed clear signals that Government willencourage energy efficiency innovation andimplementation. Energy efficiency in larger andenergy intensive companies is being addressed.The recent formation of the Carbon Trust,enhanced capital allowances, the NegotiatedAgreements linked to Climate Change Levyreductions and the Emissions Trading Scheme(ETS) are important new initiatives. TheNegotiated Agreements and Emissions Tradinggive strong incentives to many of the mostenergy intensive industrial sectors.

7.34 The success of the ETS could be importantin ensuring that UK business plays an early rolein international carbon trading, linking UK

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emissions reduction to a liquid market and aglobal price. Companies should continue to beencouraged to join the ETS in return forcommitments to additional carbon reductionmeasures.

7.35 Given the barriers to energy efficiencyinvestment, the Negotiated Agreements form akey part of the package. They are expected todeliver a large fraction of the total carbonsavings in the industrial sector.14 Ideally, in thelonger-term, the agreements should bestructured to deliver emissions reductions up tothe level which is cost-effective at theappropriate shadow price for carbon (seeChapter 3).

7.36 Greenhouse gas emissions and energy useare important issues for environmentalreporting. Ofgem, DEFRA, the EnvironmentAgency and the Electricity Association aredeveloping “key performance indicators” forthe energy sector. DEFRA has already producedgreenhouse gas reporting guidelines forbusiness. An earlier PIU report15 recommendedthat Government should consider the extent towhich voluntary measures and the proposalsfrom the Company Law Review will lead to alevel of reporting which meets its objectives.

Commercial buildings

7.37 In the commercial sector energy costs aregenerally a lower part of total costs than inindustry, so energy price signals are weaker andother instruments are needed. There are somesimilarities with the household sector. DTLRshould develop Building Regulations to deliver aphased transition to low energy commercialbuildings, including consideration of the use ofrenewable energy such as photovoltaics. Majorappliances and common equipment typesshould be addressed with the approach to

labelling, standards and Negotiated Agreementsset out above.

7.38 Tenanted buildings are a particular issuein the commercial offices sector. A bigger role isrequired from large commercial landlords andproperty managers. This could include energyaudits at each new letting or rent review with arequirement for action if a good practicethreshold is not achieved. The Governmentalready supports a proposed EU Directive onthe energy performance of buildings, which willprovide the basis for the necessary audit andcertification.16

7.39 Energy services offer a way forward in thecommercial sector, possibly more quickly thanin households. But the drivers are weak. Thelegislative framework allows for EEC outside thedomestic sector and extension to thecommercial sector should be considered.

7.40 Further policy measures are needed toinduce cost-effective energy efficiency measuresin commerce. The Government should giveearly attention to this area and consider a rangeof options.

Small and Medium-sized Enterprises(SMEs)

7.41 The scope for energy efficiency savings inSMEs is large. The problems of smaller SMEs arevery similar to those of the domestic sector.They face more barriers in implementing energyefficiency than other businesses, in particular inskills, access to capital and control of thebuildings they occupy.

7.42 Energy efficiency messages might becommunicated effectively as part of broaderSME advice and support activities. The PIUreport on resource productivity17 sets outproposals to develop a resource productivitystrategy for small businesses, including energy

14 DETR (2000).15 PIU (2001b).16 Commission for the European Union (2001e).17 PIU (2001b).

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efficiency, in conjunction with the smallbusiness community. This will address:

● advice services, provided wherever possiblethrough a “one-stop-shop” approach;

● linking advice to installation; and

● an enhanced role for regional and localbodies.

Public sector

7.43 Government needs to lead by example.Public sector buildings are major energy users.Targets for emissions reduction are set out inthe Climate Change Programme. These areimportant goals. The use of Governmentprocurement to improve environmentalperformance more generally is considered inthe PIU report on resource productivity.18

7.44 Government could play an important rolein establishing energy services markets bypurchasing its own energy in this way.Procurement procedures could also supporthigh standards of energy efficiency for officeequipment. Life cycle costs, rather thanminimum capital costs, are already the basis ofpublic procurement guidance.19 However, thesedo not reflect the environmental costs of energyuse or the potential for the public sector tocontribute to market transformation.

7.45 As part of Government’s leadership role inenergy efficiency, HM Treasury should includedepartmental energy efficiency targets in futurePublic Service Agreements, and the Office ofGovernment Commerce should develop modelenergy services contracts for use in tenderingthroughout the public sector.

Renewables7.46 Analysis in Chapter 6 suggests thatrenewables present the most flexible supplyoption in terms of carbon reduction potentialand compatibility with other goals. Renewablesare, therefore, likely to make a substantialcontribution to the low carbon programme inthe UK. They represent the most important newoptions that need to be made more commercialin order to ensure that the UK can put itself ona path to the low carbon future at anacceptable cost.

The current renewable energystrategy

7.47 The current renewable energy strategy ismade up of the Renewables Obligation (RO),capital grants, and wider support expenditure.The Obligation20 requires licensed electricitysuppliers to buy an increasing percentage(measured in TWh) of their supply from eligiblerenewable resources until the share reaches10% in 2010, subject to the extra cost beingnot more than 3p/kWh. They do this by buyingRenewables Obligation Certificates (ROCs) andpresenting them to Ofgem as proof that theyhave met their obligation.21

7.48 Capital grants are designed to meet partof the cost of the more expensive technologies,offshore wind and energy crops, so that theycan compete in the RO. There is a total of£230m of capital grants available until 2005.22 Itis expected that, as a result of the RO and thecapital grants, the costs of offshore wind andenergy crops will fall considerably over the nextfew years, thereby reducing the need for futurecapital grants. Other technologies, such asoffshore wave, tidal stream and photovoltaics,will then probably become the next generation

18 PIU (2001b).19 HM Treasury, DETR (2000).20 DTI (2001g).21 ROCs are issued to renewable generators by Ofgem.22 PIU (2001a).

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of technologies which would benefit fromaccess to grants. There will therefore be acontinuing need for capital grants after 2005.DTI should review the extent of the need forcapital grants for renewable energy after 2005.This need should be assessed in time for the2004 Spending Review.

7.49 Finally, a total of £55.5m is available forresearch and related activities into renewableenergy over the next 3 years.23 The ChiefScientific Adviser’s review of energy researchrecommends that, in this and other areas,spending over the longer-term should bebrought in line with the UK’s nearest EUcompetitors.

7.50 The current mechanisms are primarily,although not exclusively, focussed on renewableelectricity technologies. While a reasonableproportion of the available capital grants areeligible to household or community schemes,such schemes cannot access the extra value ofROCs unless the electricity is sold to a licensedsupplier. DTI should undertake further analysisof the possibilities and benefits of mechanismsor schemes to promote renewable energyproducing heat, plus household and/orcommunity projects, especially those which inpractice fall outside the Renewables Obligation.

How much investment is feasible?

7.51 Chapter 6 established that the resourcebase for renewable energy is very large. Themain technical consideration is the feasible rateof deployment. In order to get more than 20%of electricity from renewables by 2020, buildrates for the leading options would need to beat levels never before seen in the UK. Onshoreand offshore wind would need to be installed ata rate of between 1-2 GW per year in theperiod 2010-2020.24 This would be a challenge,

but 1.5 GW and 1.6 GW of onshore wind wasbuilt in Germany in 1999 and 2000respectively, and a further 1.2 GW was installedin the first eight months of this year. Build ratesof 1 GW per year were also seen Spain in 2000,and 600MW in Denmark in the same year.25

There is also a potential need for upgrading ofelectricity transmission from Scotland if marineand wind resources from the far North andWest are to be exploited. The DTI’s recentproposal to examine the feasibility of anoffshore cable along the West Coast is animportant first step (see also paragraphs 7.139-7.143).

The cost of the investment

7.52 Cost can be assessed in two ways: theimplied cost per tonne of carbon over thelifetime of a programme of investment; and theburden on the current generation of consumersif they are required to support the investment.

7.53 While renewables do not generally dowell on the criterion of the current cost pertonne of carbon, the potential for future costreduction is large.26 This suggests that theobjective should be to create markets thatenable “learning by doing”27 in order to secureeconomies of scale and reduce costs. At thesame time, R&D should be stimulated so as toencourage step changes in renewablestechnologies which could significantly reducetheir costs. In this case, investment today buys aset of options for the future. Uncertainties makeit difficult to calculate rates of return to thiskind of option investment. Preliminary work ofthis kind suggests that renewables costs need tofall quite rapidly (as Chapter 6 suggests ispossible) if such investment is to be competitivewith other low carbon options.

23 PIU (2001a).24 This takes account of low load factors.25 www.windpower-monthly.com26 Analysis of long-term renewables costs is briefly described in Annex 6. See also PIU (2001a).27 IEA (2000).

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7.54 The RO now aims to ensure that by 2010,10% of electricity is sourced from renewableenergy, providing the costs are acceptable. Thisimplies a maximum increase of up to 4.5% onthe average domestic customer’s prices by2010, using the buy-out price as the indicationof maximum cost.28 The cost will be lower thanthis if supply develops to meet demand and thebuy-out price is not used. The impact onindustrial consumers will be greater than this,perhaps double the domestic burden inpercentage terms.

7.55 If there were a target of more than 10%,then this would increase costs to consumers,though it would reduce the costs of meetingthe 10% target.29 The exact cost will depend onthe prospects for reducing the costs ofsupplying renewable energy and the size of theoverall demand for electricity. Detailed analysisof the costs of meeting targets in the 20%-30%range has been carried out. This suggests thatthe total cost of meeting a 20% target in 2020would be around a 5%-6% addition tohousehold electricity prices.30

The balance between technologies

7.56 There is more than one approach torenewables development. Two extreme caseswould be:

● a very cautious approach would aim to openup a few renewable options at minimumcost, but avoid significant deployment ifcosts were higher than the cheapestalternative energy sources; and

● an ambitious approach would aim to open awider range of renewable options and seekto maximise deployment of the lowest costrenewables, even if their costs were for thetime being higher than alternatives.

7.57 In practice, the cautious option is difficultto sustain. If costs are to be brought down by

the learning process, the full establishment ofrenewable options requires a significant level ofdeployment. This is a system issue, not just aquestion of stand-alone investment. Forexample, if offshore wind is to be developed,investment is needed in associatedinfrastructure (like specialist barges). Thisrequires much more than the demonstration ofa few separate offshore plants.

7.58 If renewable options are to be genuinelyavailable for the future, it will be necessary toshow that renewables can be deployed onsome scale – exactly how far and how fast thisdeployment should be pushed depends on theevolution of the costs of each technology. Thisrequires not only the development ofinfrastructure – i.e. the skills and equipmentnecessary to deploy technologies – but also analtered electricity network culture whereby“new” technologies, renewables or otherwise,become accepted as “normal”.

7.59 Maximising deployment of cheapertechnologies would contribute more to short-term carbon emission reductions, but at theexpense of having fewer options for the longerterm. Opening up a wider range of options,including some deployment for each of them,suggests higher costs for the presentgeneration. It also means – given limits toacceptable total programme costs – less short-term contribution to carbon emissionreductions. In practice, neither extreme(cautious or highly ambitious) seems desirable;by 2020 policy needs to aim both for significantdeployment of the cheaper renewables, butshould not neglect the development of a widerrange of future alternatives.

A new renewables target

7.60 Continuing financial and political support,coupled with institutional change, will beneeded until such time as the costs of different

28 OXERA (2001).29 OXERA (2001).30 Derived from OXERA (2001).

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forms of renewable energy are competitive withthe cheapest alternatives. There is anestablished programme of financial support inplace to 2010 for renewable energy throughthe RO,31 and a series of capital grantprogrammes to 2005. The RO has not yet beenlaunched, and it is too early to judge its successor otherwise. It will be reviewed in 2006/7.Around that time other developments, such asEuropean Directives and international climatenegotiations should also be reviewed.

7.61 Should the targets be expanded beyond2010? The arguments against a larger targetare:

● the RO is only just coming into effect so it istoo early to say what the costs of a newtarget would be;

● the UK would be unwise to make a firmcommitment to a larger target for 2020 untilit knows the extent of its internationalobligations;

● most renewables are currently an expensivelow carbon option, so it would be better tomeet any commitments we have byadopting lower cost options first; and

● existing approaches might conceivablyestablish options capable of meeting at least20% of all the UK’s electricity needs.

7.62 The arguments for a larger target are:

● a target is the obvious and clear means ofannouncing a long-term commitment;

● the industry needs greater assurance thatdemand for renewables will continue to growafter 2010 than is currently on offer: if this isnot forthcoming the impetus of shorter termdevelopment to 2010 may falter;

● the UK Government needs to continue tosupport options which have a particularapplicability in the UK environment, sincenobody else will;

● it would allow deployment at a rate whichenables learning to occur in order to reducecosts significantly and thereby fully establisha wider range of renewables options;

● it would act as a stimulus to R&D;

● it would reduce the cost of meeting the2010 target;32 and

● the need to develop the infrastructurerequired to deploy these investments.

7.63 The balance of the argument favoursmaking a firm commitment to a larger targetfor 2020 in the near future.

Recommendation:

● Any process of target-setting for almost 20years ahead is inevitably ambitious, given theuncertainties about costs and other marketand political developments. In order toencourage a range of renewableoptions, and maximise the chances ofrapid and long-term learning and costreductions, DTI should immediately seta firm target of 20% of electricity tobe supplied from renewables for 2020.While this target is best presented inpercentage terms, uncertainty about the levelof electricity demand means that in practicethe target should be set in physical terms. Afurther 39TWh is a reasonable target(equivalent, over the further ten years to2020, to the RO up to 2010). This will turnout to be 20% of electricity supply if energyefficiency policies work to the extent thatelectricity demand in 2020 is mid-waybetween a business as usual future and themost environmentally sustainable of ourscenarios. If energy efficiency programmesare as effective as hoped, this target mightturn out to be more than 20% of electricitysupply.

31 The RO actually lasts for 25 years, up to 2027, but the percentage target does not rise after 2010.32 OXERA (2001).

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What mechanisms should be used?

7.64 It would be imprudent for theGovernment to commit itself to the policyinstruments that could deliver larger post-2010targets until it is clear how well the maincurrent instrument – the RO – is operating.New mechanisms and approaches may or maynot be needed. The RO combines an obligationwith competition, and a limit on costs toconsumers. Existing mechanisms mighttherefore be built upon to deliver moresubstantial long-term targets. However, thereare several uncertainties about the futuredevelopment of renewables which could affectthe type of mechanism required – for example,

the rate of deployment of renewables, the rateof fall of costs of renewables, and the extent towhich institutional barriers are overcome. It istoo early to specify a particular mechanism. TheRO is due to be reviewed in 2006/7. By 2008,DTI should establish the renewableenergy support mechanisms to ensurethat the 2020 target of 20% is met.

7.65 If the UK was to introduce a widerscheme for carbon valuation, the need for aspecial scheme directed at renewables onlywould decline, though some continuingsupport for renewables would probably still beneeded, perhaps on grounds of the associatedlearning effects.

Question Answers

Doesn’t intermittent power ● While intermittents supply below 5% ofneed costly back-up elsewhere electricity, the costs would be insignificant.33

in the system?● Between 5-10% of supply from intermittents, the

cost would be about 0.1p/kWh rising to 0.2p/kWhfor 20%.34

Are systems with a high proportion ● Renewable energy poses no problem for systemof renewable energy secure?35 security. Indeed, such sources probably improve

local security.● Distributed generation tends to improve strategic

security.

Don’t planning problems stop ● Because of their size, most renewable energyrenewable energy projects planning applications are considered by localgetting off the ground? authorities – unlike larger energy projects that are

decided by the Secretary of State.● Average planning application success rate are the

same as for most planning sectors, but this ratevaries with technology and wind and biomassprojects in particular have had problems inobtaining permission.

Aren’t the costs of renewables ● Costs range from 2.5-3.0p/kWh – i.e. levelshigh? which are close to competitive – for electricity from

landfill gas and onshore wind, through to 4-5p/kWh for offshore wind, 6-8p/kWh fromenergy crops and higher for tidal stream, wave andphotovoltaics.

Table 7.1: Questions which are frequently asked about renewable energy

33 Milborrow (2001).34 Milborrow (2001).35 Strbac and Jenkins (2001).

Institutional and market barriers tothe greater use of renewablegeneration

7.66 The progress of new renewablegeneration is by no means straightforward; anumber of barriers stand in the way of thedeployment of these technologies – notably theprices received by intermittent generators in theelectricity markets; the costs of connectingembedded generation to the network; and theworking of the planning process. All need to beaddressed urgently. If they are not it will not be

possible to make enough progress towards eventhe existing renewables target.

7.67 The Appendix to this Chapter deals withthese issues, and with investment in Scottishnetworks, in detail. It also contains detailedrecommendations. In essence these are:

● Measures are underway which may helpsmall generators with respect to NETA.Ofgem should develop transitionalarrangements to be ready to beimplemented by January 2003 in casecurrent measures are unsuccessful in

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Question Answers

Aren’t the costs of renewables ● But long-term projections show reduced costs sohigh? (continued) that some renewables are likely to be the cheapest

low carbon energy source by 2020.

Isn’t the scale of the ● Renewables are typically smaller thancontribution which can be conventional technologies and individualby made renewables too small generating units may range from a few KW to tensto make a real difference? of MW.

● But installation can be in large numbers. Offshorewind farms are typically in the50-500MW range, with many such schemesplanned in Europe.

● 20 GW of onshore wind is already built world-wide,and the capacity is rising by 4.5GW/year.

Is there sufficient resource to ● The UK resource is in principle more thanmeet demand? sufficient to meet the UK’s energy needs.

● UK’s wind and marine resources are the best inEurope.

Aren’t the other environmental ● Modern wind turbines are very quiet inimpacts of renewables harmful? operation.

● Wildlife impacts are generally very small. ● Visual intrusion is an issue for onshore wind.

Will technological progress be ● Wind energy and biomass use is alreadyas rapid as has been assumed? widespread and these are low risk technologies.

● Photovoltaics are a well-known technology, butrequire more R&D to capture cost-reductions.

● Other technologies e.g. wave and tidal stream arestill at the demonstration level, and are thereforemore risky.

Table 7.1: Questions which are frequently asked about renewable energy – continued

helping small generators.Consideration should be given topotential legislation to move theagenda forward.

● For network investment for embeddedgeneration, Ofgem should ensure thatthat the recommendations of theEGWG are implemented by 2005. DTIshould consider legislation to movethis forward in the event of obstaclesto progress.

● Ofgem should ensure that futurechanges to electricity trading and gridaccess arrangements do notdiscriminate unfairly againstrenewable and CHP generation.

● For planning: detailed recommendations arepresented in Chapter 8.

Energy from Waste7.68 Energy from waste incineration is exemptfrom the Climate Change Levy, and it iscurrently proposed to include new, cleaner,energy from waste technologies, such aspyrolysis or gasification, as well as landfill gas,in the RO. Energy from waste incinerationprojects will count towards the 2010 target forrenewable sources if this waste is derived fromnon-fossil sources, but will not be eligible forROCs.

7.69 Although the potential for energy fromwaste is modest, energy from waste needs tobe extracted as cleanly as possible. There are,however, thought to be a number ofdisincentives to the development of energyfrom waste. These centre on problems with theplanning process (which are dealt with inChapter 8). Other issues that need to beaddressed include:

● stricter environmental standards, monitoring,reporting and sanctions – examples mightbe: more incentives to pre-treat waste priorto incineration; tighter limits on the

proportion of the waste stream that goes toincineration; restricting new incinerators toan appropriate fixed proportion of the wastestream;

● strengthened commitment to creatingtransparency in local authority plans (wastecontracts etc), while at the same time tryingto ensure that local decision making is basedon a clear understanding of risk and nationalneed, and that facilities are appropriatelysited to be able to exploit local industrial,commercial or domestic sector demand forCHP; and

● more support for R&D into newtechnologies; for example pilot schemes forgasification, pyrolysis and anaerobicdigestion, enabling the environmental effectsof new techniques and treatments to be fullyunderstood.

Nuclear power7.70 As with renewable technologies, thissection considers: the role which nuclear powermight play in a low carbon economy; thebalance of interest in the different sorts oftechnologies; the case for governmentintervention; the mechanisms which might beused; and the barriers which currently stand inthe way of new investment.

7.71 Nuclear power offers a zero carbon sourceof electricity on a scale which, for each plant, islarger than that of any other option. If otherlow carbon options were to prove difficult todevelop, then the case for using nuclear powerwould be strengthened.

7.72 A decision whether to bring forwardproposals for new nuclear build will lie with thecommercial sector, and so would need to meetprivate investors’ criteria. As outlined in Chapter6, nuclear power will probably remain moreexpensive than fossil fuelled generation, thoughcurrent development work could produce anew generation of reactors in 15-20 years thatare more competitive than those available

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today. Nowhere in the world have new nuclearstations yet been financed within a liberalisedelectricity market. But, given that theGovernment sets the framework within whichcommercial choices are made, it could, as withrenewables, make it more likely that a privatesector scheme would succeed. Fully liberalisedenergy markets are still relatively new, and so itis too early to say whether or not new buildmight be financed in such a market.

7.73 Nuclear power based on fission is a maturetechnology, and there is a well-establishedglobal industry, with nuclear stations currentlybeing built in some countries. In this it differsfrom renewables where support is justified onthe grounds that they are nascent industries,needing support if they are to fulfil theirpotential to help with the long-term carbonproblem.

7.74 The general approach taken in this reviewis that, if there is to be public support, the aimshould be to try to create options which areboth flexible in their deployment, and whichoffer new prospects. The desire for flexibilitypoints to a preference for supporting a range ofpossibilities, each of which could beabandoned, should it fail to meet its promise.The desire for new options points to the needto develop new, low waste, modular designs ofnuclear reactor, and new types of renewableand decentralised energy, rather than to publicsupport for a large and inflexible programme.There is no current case for public support forthe existing generation of nuclear technology.

7.75 There are, however, good grounds fortaking a positive stance to keeping the nuclearoption open. The reasons relate to possiblefuture needs if existing approaches both to lowcarbon electricity generation and energysecurity (see Chapter 4) prove difficult topursue cheaply enough. At present, the leadtime from announcement of a proposal to builda new nuclear station and its commissioningwould be long: the aim should be to ensurethat if nuclear were to be supported some timein the future, the lead time would have been

reduced substantially. DTI and DEFRA mightconsider what realistic lead times currently arefor new nuclear build, and the scale ofreduction that might prove possible should therecommendations in this section be followed.Keeping the nuclear option open also meansmaintaining an adequate skills base both forR&D and to ensure sufficient personnel to staffnew nuclear stations.

7.76 The main reason why the option will stillbe open, at least for some years, is that thenuclear industry is an international one, usingdesigns which have been developed to meetcircumstances in many countries. Nuclearpower stations are still being built, notably inEast Asia. More than most technologies, nuclearpower station designs are developed to besuitable for a wide range of countries, eventhough substantial technological knowledge(including regulatory knowledge) is needed totransplant them to individual countries. Theavailability of nuclear design of internationalorigin is not going to change for some years tocome. But two actions are needed now tomaintain the necessary UK presence:

● the DTI should contribute to theinternational process of developing radicallyimproved reactor designs, engaging withothers in the development of new low cost,low waste designs (we note that theGovernment’s objectives already include theimportant aims of promoting the adoption ofsafe and secure new reactor designs in allcountries which choose in the future to buildnew nuclear plant); and

● DTI is currently sponsoring a Nuclear SkillsGroup to assess needs in the nuclearindustry, including the need to maintainintelligent customer capability if we are tokeep the nuclear option open. The DTIshould ensure that UK regulators areadequately staffed to assess any newinvestment proposals, and are also pursuingopportunities for common internationalsafety standards.

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7.77 The DTLR’s proposals for the treatment ofmajor infrastructure projects within theplanning system36 (referred to in more detail inChapter 8) address the current concerns whichinvestors have concerning the planningprocesses applicable to large projects, includingnuclear power plants. These processes havebecome long and cumbersome.

7.78 As the Government establishes a newframework for encouraging a low carboneconomy, it should also aim to ensure that thenuclear industry is treated fairly in relation tothe other alternatives. There are tworecommendations:

● DTI and HM Treasury should ensure that anynew nuclear build should benefit from anymethods that will be used to value carbonand internalise the externalities of fossil fueluse. In addition, any new investment inexisting stations that substantially raisednuclear capacity (and which would reducecarbon emissions) should be considered forsimilar treatment, subject to independentevaluation of any case made; and

● DTI should ensure, using independentevaluation, that the nuclear industry fullyinternalises its external costs, including riskssuch as waste cost escalation.

Both should be signalled early in order toprovide incentives for the industry. The DTIshould also take the necessary actions tokeep the nuclear option open, as specifiedabove.

7.79 The focus of public concerns about nuclearpower are on the unsolved problem of long-term nuclear waste disposal, and perceptionsabout the vulnerability of nuclear power plantsto accidents and attack. The problem of nuclearwaste is mainly an historic one, since newnuclear stations would make only a smalladdition to the total (there would be a roughly10% increase in the total stock of waste if all

current reactors were replaced by new nuclearcapacity). Nevertheless, these concerns overlayall the choices. Any move by Government toadvance the use of nuclear power as a means ofproviding a low carbon and indigenous sourceof electricity would need to carry widespreadpublic acceptance, which would be more likelyif progress could be made in dealing with theproblem of waste. It is important thatGovernment should act to resolve the wasteissue as soon as possible, learning as necessaryfrom international best practice. Publicacceptance, in waste and other areas, wouldneed to be built on an open and transparentpublic debate.

● DTI and DEFRA should stimulate a publicdebate about nuclear power, and inparticular on the trade-offs between nuclear-specific risks and carbon abatementpotential. This needs to be part of the widerpublic debate on energy recommended inChapter 10.

7.80 Does this approach do enough toaddress current needs? About 9 GW ofexisting nuclear capacity is expected to havebeen removed from the system by 2020.Continued pressure to improve energyefficiency will reduce the needs for supply. Butsome replacement capacity will be needed. Theelectricity industry has, in the past, had to copewith this scale of replacement and can do soagain. A wide range of technologies is available– gas-fired stations; renewable power; CHP;coal-fired stations; energy from waste resources;coal-mine methane; and on-site generation –though gas-fired stations are generally the mostcompetitive.

7.81 The private sector will continue to be freeto put forward an application for new nuclearconstruction. Indeed, it has been suggestedthat nuclear capacity should be replaced withnuclear capacity. The industry’s presentproposals are for a large programme of new

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36 DTLR (2001b).

build, amounting to some 10 GW. This wouldbe beneficial in terms of the carbon savings,and, the industry argue, in terms of the costreductions that could be achieved. Certainlylearning effects apply to nuclear technology aswell as to renewables, though historically theyhave been often overlain by the costconsequences of more stringent regulation.However, the desire for flexibility points to apreference for supporting a range ofpossibilities, rather than a large and relativelyinflexible programme of investment such as isbeing proposed by the nuclear industry.

7.82 There is no requirement, in system terms,to replace any particular generation technologywith the same type of generation. It is not clearhow quickly decisions need to be taken byinvestors on new build, partly because the leadtime to completion is unclear. Whileconstruction times could be shortened, currentlicensing and planning procedures could addmuch to cost and be lengthy. Regulatory riskneeds to be minimised wherever possible toensure private finance, but the public needs tobe assured that the highest standards of safetyand environmental protection will continue toapply.

CHP7.83 CHP is a low cost option for carbonabatement. DEFRA should publish, as soon aspossible, its strategy to deliver its 2010 target ofachieving 10 GW of “good quality” CHP. In thelong-term CHP will benefit from policies thatput an appropriate value on carbon. However,industrial CHP is a mature technology and notzero carbon. It does not merit or need supportthrough a premium price to encourage“learning by doing” cost reduction in the sameway as new renewable technologies. However,CHP should be given sufficient support toovercome current market and institutionalbarriers.

7.84 CHP generators face potentially non-cost-reflective elements in wholesale power markets.And there are barriers to the connection ofgeneration in distribution systems. These issuesare considered and recommendations broughtforward in the section on renewables. Inindustrial markets, CHP faces many of the samebarriers as other energy efficiency investments,in particular because environmental benefits arenot fully internalised, especially for exportedpower.

7.85 The Government announced in the Pre-Budget Report that, subject to legal and otherconstraints, it would consider the environmentalcase for providing more favourable treatmentfor CHP within the CCL, taking account of therole which CHP might play in meeting the UK’sClimate Change targets. In addition, thefollowing recommendation would assist CHP:

● DTI should ensure that policy towardsSection 36 consents requires proposers toshow they have considered alternative siteswith heat loads, if Government is asked toapprove a proposal not linked to CHP. Butthis should not, as far as possible, impose anew planning burden on stations.

7.86 Although there is likely to be furtherdevelopment of industrial heat networks inconjunction with major CHP projects onindustrial sites, it is not likely that such networkswill be either large enough, or complexenough, to require regulation as naturalmonopolies. It is also unlikely that new heatnetworks for domestic or small business heatingwill become a cost effective option outsideindividual buildings or small groups ofbuildings, even in the context of measures forcarbon abatement and increases in small scalelocal generation. This is because:

● heat transport is some 20 times moreexpensive than gas transport;

● heat networks lose significant energy intransport, while gas networks lose very little;

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● local gas-fired boilers are generally a fuelefficient alternative; and

● local systems offer greater control to thecustomer.

7.87 The conclusion is that there is no case forspecific government support for such networksin addition to whatever wider support isavailable for CHP. Nor are new heat networkslikely to develop in such a way as to requiredetailed regulation.

7.88 Micro-CHP is a new technology and facessome different obstacles. Its deployment willrequire changes to electricity distributionnetwork and market operation to enable verysmall-scale generation. Ofgem should ensure formicro-CHP that:

● there are simple and standardised connectionterms;

● settlement profiles allow the technology tobe used without the costs of installing two-way meters, where the scale of powerexports does not justify these costs; and

● in the medium-term, advanced meteringtechnology should be introduced.

CO2 C&S7.89 The potential benefits of CO2 C&S are thatit could be:

● a means to preserve diversity of fossil fuelsources for power generation, including highcarbon fuels such as coal, while at the sametime meeting the need for deep cuts in CO2

emissions; and

● a potential source of low carbon hydrogenfor transport and other applications

It also has the merit of being well suited to UKcircumstances, especially if linked to enhancedoil recovery in the UKCS.

7.90 At the moment uncertainties surroundingcosts, safety, environmental impacts and publicand investor acceptability are large. Stepsshould be taken to reduce these uncertainties. Itappears impossible to do this unless thetechnology is demonstrated on a large scale inthe UK context. At present it is not clear howbest to do this, and the crucial next step is toundertake much more detailed analysis of theappropriate role for government, coupled withpossibilities for international collaboration.Estimates of the cost-effectiveness of this optionas a means of saving carbon are contained inTable 6.1: for 2020 the estimates range from£80/tC to £280/tC. The costs will differdepending on the fossil fuel used. Manyestimates show gas-fired generation asproviding the cheapest base, but since the costsof gas and coal-fired plant depend onassumptions about gas prices, the relativeposition may change over time, with coal-firedgeneration becoming more competitive. Thetechnology holds fewer prospects for substantialreductions in unit costs than renewabletechnologies, but efficiency improvements canbe expected (possibilities for cost reductions incoal gasification technologies are discussed inAnnex 6).

7.91 The DTI Review of the case forGovernment support for cleaner coaldemonstration plant,37 which ran in parallelwith the PIU review, endorsed the case forsupport for the development of carbon captureand storage mechanisms, while recognising thatthere was the need for more work on theenvironmental, technical, legal, economic,infrastructure and social issues involved. TheDTI Review also suggested that further attentionshould be paid to ensuing that, if carboncapture develops satisfactorily, it should be ableto benefit from generalised regimes whichreward low or zero carbon options. We support

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37 DTI (2001h).

the recommendations of this DTI Review. DTIshould decide whether to support aprogramme for carbon capture andsequestration, and if so by what means.

Coal Mine Methane7.92 The potential for tapping coal minemethane is discussed in Chapter 6. Methane isan important greenhouse gas and there is aclear environmental gain in using it, forexample to generate electricity, provided itwould otherwise have escaped. Specialtreatment to incentivise use of this sourcewould need to be linked to evidence of actualleakage.

Transport7.93 The scenario analysis shows thatachievement of CO2 emissions reductions in linewith the RCEP recommendations would requiredevelopment of a low carbon transport system.The Government recently published aconsultation draft of its Powering Future Vehiclesstrategy.38 This aims to promote thedevelopment, introduction and take-up of lowcarbon vehicles and fuels, and to ensure the fullinvolvement of the UK automotive industry inthe new technologies. The recommendationsbelow consider the role of transport in theenergy balance.39

7.94 The transport sector is likely to remainprimarily oil-based until at least 2020. While oilsecurity is not a major current concern, oureconomic dependence on transport, increasingdependence on fuel imports, constraints on fueldiversity in the transport sector in the medium-term and potential resource depletion in thelong term, all reinforce the need to monitor theoil supply situation, and to achieve the potentialfor energy efficiency in conventional roadvehicle engines. Issues relating to the security ofoil supplies are addressed in Chapter 4.

7.95 There is currently little data available onthe costs per tonne of carbon saved, eitherfrom energy efficiency or fuel switching in thetransport sector. DTLR and the Inter-Departmental Analysts’ Group on Low CarbonOptions should consider how best to addressthis lack, in particular in relation to newtechnologies.

7.96 The transition to a low carbon transportsystem would need to engage a wide range ofindustry and other players. Government mustarticulate clear objectives. Targets can helppromote progress to shared goals, but theymust fit within a strategic framework alignedwith international developments. Targets shouldbe outcome-based and not, wherever possible,be technology prescriptive. The longer-termpossible shift to zero carbon hydrogen poweredvehicles needs to be considered as part of thedevelopment of the energy system as a whole,so that it goes hand-in-hand with thedevelopment of low carbon electricity.Intermediate steps may be needed, so that, forexample, the next round of EU voluntaryagreements need to reflect and bring about thetechnological potential in hybrids. DTLR shouldwork with EU partners and motormanufacturers to secure furtherimprovements in the energy efficiency ofroad vehicles and to open options for lowcarbon fuelling in the longer term.

7.97 There are major challenges in theintroduction of radically new approaches:

● there are significant technical challenges yetto be overcome in commercialising the fuelcell hydrogen car, and these concern boththe fuel cell technology itself and means ofon-board production or storage of hydrogen;

● new and unfamiliar technologies need to besupported by standards, guidelines anddesign norms. There is a natural reluctanceto undertake such efforts until it is clear thata new technology will be forthcoming;

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38 DTLR, DTI, DEFRA, HMT (2001).39 Much of the analysis in this section draws on Ferguson (2001).

● there are barriers to public acceptance ofradically new technologies. People need tobe reassured that new systems are both safeand reliable;

● with all alternative fuels, there is a “chickenand egg” problem whereby vehiclemanufacturers will not deploy newtechnologies if there is no refuellinginfrastructure, whereas energy supplycompanies are reluctant to invest while thereis no significant demand; and

● with a range of vested interests competingfor future markets and the constraint onpublic policy not to “pick winners”, there is adanger that the “pathway dilemma” willpersist making actors hesitate to back anyone technology decisively.

7.98 If the hydrogen route is taken, thedevelopment of a UK infrastructure to deliverhydrogen would be a major endeavour.Investment in most new infrastructures hasdepended on Government intervention, mainlyin nationalised industries. At this stage, whenthe future course of development is uncertain, itwould be wrong to commit to oneinfrastructure so that we were potentially“locked-into” an inappropriate technology. Thissuggests an incremental approach: wherebysmall-scale projects are financed asdemonstrations. Depot-refuelling vehicles are anideal for such demonstrations.40

7.99 The UK is already well placed in someaspects of fuel cell R&D but should considerdoing more to support demonstration projects.UK funding for energy R&D including transportis lower than that in many other countries,41

and consideration should be given to increasedfunding, given the strategic priority andtechnical challenges faced by the transportsector. The Chief Scientific Adviser’s review ofenergy research identified hydrogen production

and storage as one of six key areas in whichincreased support for R&D and developmentwould be particularly beneficial. It advised thatthere be a dedicated hydrogen researchprogramme separate from, but complementaryto, that for fuel cells.42

7.100 Public policy, conducted internationallythrough negotiations between vehiclemanufacturers and a range of governments,needs to keep these problems in mind. Thedanger is that the technological developmentscurrently envisaged fail to become viable.Transport demand management policies, suchas congestion charging and land use planning,are already being used in pursuit of objectivessuch as congestion reduction as well asenvironmental objectives. If technologicalsolutions do not realise their potential, it mayprove necessary to address the transport energybalance through greater dependence on suchmeasures.

7.101 Aviation is a major problem with demandoutstripping energy efficiency and noalternative to kerosene on the horizon.Handling the projected growth in aviationenergy use and CO2 emissions must become apriority for the transport community. Airtransport issues need to be considered in widertransport planning. DTLR should prioritisediscussion of taxation and other measures tomanage aviation demand in EU andinternational forums.

7.102 Even if major reductions of CO2

emissions and energy consumption areachieved in the transport sector, this will notaddress wider concerns such as congestion,social exclusion, air quality, noise and roadcasualties. In addition, different fuels (thoughnot inherently more hazardous than presentfuels) will call for new health and safetystandards, to protect both workers andconsumers.

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40 Transport for London are to take delivery of three fuel cell buses in 2003 which will be refuelled at depots.41 Chief Scientific Adviser (2001).42 Chief Scientific Adviser (2001).

Seeing the programme as awhole7.103 The aim of the above programme is toenable the UK to develop the basis for a lowcarbon energy system, by maximising supportfor the options that offer the largest benefits,and securing options for the future. Policyshould:

● place much greater emphasis on end-useenergy efficiency and CHP – these offer lowcost CO2 savings and synergies with otherpolicy goals;

● expand support for renewables beyond 2010– these have the potential to securesubstantial cost reductions;

● keep the nuclear option open, while ensuringthat the energy system can respond flexiblyto new information;

● consider how to open up the option ofcapture and sequestration of CO2 as part ofthe clean-coal programme; and

● support both energy efficiency in vehiclesand the development of zero carbon fuellingoptions for the long term.

7.104 Policies to encourage innovation and newtechnologies have here been assessed in termsof the contribution they can make to openingup a wider range of low carbon options. Adifferent case can also be made in terms of thepossibilities for generating new UK industries,poised to obtain significant exports, if andwhen the world as a whole starts down a lowcarbon route. In practice, the range of energytechnologies which the UK could sell to the restof the world in these circumstances will neverbe limited just to renewables. Elsewhere in theworld substantial environmental gains can oftenbe made by investment in cleaner and moreefficient conventional plant. These possibilitiesshould not be forgotten. Nevertheless, the

potential to export new technologies is aconsideration to be weighed with the otherbenefits.

Who pays?7.105 Looking out over the period to 2020, itappears likely that many renewables, andnuclear and CO2 C&S will all continue to costmore than fossil fuel alternatives. We expectthat unit costs of all will fall over this time, mostdramatically for some renewables. This meansthat larger contributions need not imply everrising net costs. It is, however, clear that thepolicies advocated for developing these optionswill place some burden on consumers ortaxpayers. Finance will also be needed forenergy efficiency investments. In the very longterm, it appears likely that further costs will beentailed in developing new infrastructures.These costs are uncertain. If new infrastructurescan be developed as existing investments arereplaced, incremental costs may turn out to bemodest.

7.106 Households in general will already bearhigher prices than otherwise as a result of theexisting EEC and the RO. Whether householdfuel bills will actually rise or fall will, of course,depend on the course of primary energy pricesand the scope for continuing gains in efficiencyin the energy industries. And most householdsshould be able to contain their bills byincreased attention to energy efficiency andmany will receive help under the EEC.

7.107 The existing RO could increase averageelectricity bills by about £12 a year.43 If theproposals contained in this review were tosucceed in giving additional confidence to therenewables industry, then this might reduce thiscost. However, the establishment of a newtarget for 2020 would have the effect ofincreasing electricity bills by perhaps £15 a year,though this would occur after 2010, and by

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43 Based on an average domestic electricity bill of £260/p.a.

then many other factors will have worked bothto raise and to lower bills. This could be morethan offset by the effect of the EECs whichwould, if continued to 2010, as proposed inParagraph 7.18, reduce average bills for gasand electricity by approximately £20 by 2010.

7.108 The burden of the RO, but not the EEC,also falls on industrial and commercial users.Given the lower unit prices charged to industrialconsumers, a given cost of renewables supporthas a greater proportionate impact on bills.Again, the proposals contained here would notimpact until after 2010. At that point, attentionwould need to be given to the effect of thisincrease in costs on the competitiveness ofthose industries that are the heaviest users ofelectricity, in the context of their total energycosts relative to their overseas competitors.

7.109 Serious problems of this kind are focusedon a limited number of industrial firms in theinternational trading sector. In the non-tradedsector the problems are much less significant.Nevertheless, the impacts of higher prices couldbe serious for energy intensive companies,especially since most firms of this kind arealready energy efficient. It may be possible tofind means of compensating these industries.The potential competitiveness problemreinforces arguments against the UK gettingmuch ahead of its competitors in carbonpricing terms. The problem is one that theGovernment should keep under review.

Fuel poverty 7.110 The overall balance of net costs ondifferent consumer groups is not yet clear.Much will depend on success in delivering costreductions and on how effectively the uptake ofcost effective energy efficiency and CHP can befacilitated. Continued targeting of energy

efficiency to the fuel poor is particularlyimportant. Fuel poverty is primarily a socialchallenge. But it is difficult to address it throughconventional social policy alone. Incomes,house size, energy efficiency levels and prices allcontribute. The reason most of our northernEuropean neighbours do not face similarconcerns is not that their energy is cheaper, butthat their housing stock is of better quality.

7.111 While incomes may be expected to rise,future price levels are uncertain. Figurespresented in the Government’s Fuel PovertyStrategy indicate that a reasonable rate of pricemovements to 2010 are between increases of15% for gas and 5% for electricity and falls of10% for gas and 2% for electricity.44 Theproposals in this review are estimated not toraise this by more than about 1%.45 In the leastenergy efficient homes, on which keyprogrammes are targeted, we expect anyincreases to be more than offset byimprovements in energy efficiency over thesame period. Predictions beyond this period arevery difficult to make.

7.112 Targeting income subsidies to addressthe problem is likely to prove difficult until thenumbers involved are substantially reduced.Fuel poverty therefore constrains the use ofpricing instruments in the domestic sector.Given the importance we attach to suchinstruments, this is an important constraint andemphasises why fuel poverty should be tackledas quickly as possible. This is already theintention of the Government and devolvedadministrations.46

7.113 Currently cost-effective measures of thetype being implemented through Warm Frontand the EEC can achieve a lot. At currentenergy prices, they can reduce the costs ofaffordable warmth, in even a “hard to heathome”47, to about £400 per year, provided gas-

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44 DTI, DEFRA (2001), para. 3.30.45 Calculations set out in Annex 4.46 DTI, DEFRA (2001).47 Approximately 6 million homes, mainly built before 1920, have solid walls. They are significantly more difficult to insulate and

therefore to keep warm than other homes.

fired central heating is available. This sum isonly 8% of the single pensioner minimumincome guarantee. New technology, inparticular, micro-CHP offers scope for furthersubstantial reductions in energy bills. There aremore difficult, though not intractable, problemswhere there is no gas supply.

7.114 We conclude that fuel poverty should betackled as soon as possible, partly to open upnew opportunities for pricing instruments in thedomestic sector. With substantial energyefficiency programmes and likely rises inincomes, fuel poverty should be substantiallydiminished by 2010. Government should stagethe introduction of policies which have animpact on costs in order to minimise theadverse effects on the fuel poor. However,timing is uncertain and Government shouldkeep the scope for policy change of this typeunder constant review.

The aggregate costs ofmeeting a long-term carbontarget7.115 Looking further forward to 2050 it isworth asking how much it might cost theeconomy in aggregate terms to get to a 60%reduction in carbon emissions. The Inter-Departmental Analysts’ Group (IAG) spent sometime analysing this issue and, though there ismuch uncertainty so far into the future, somebounds can be put on to the likely cost. Thereare various ways of expressing this cost. Thesimplest is probably in terms of the loss ofeconomic growth. On the assumption thateconomic growth will continue at the historicannual rate 2.25%, GDP would triple over fiftyyears. IAG estimates suggest that 0.02percentage points might be lost from thegrowth rate – equivalent to a loss of onlyaround 6 months’ GDP growth over 50 years.In other words, we might lose only 1% of allthe economic growth we expect over the nexthalf a century. In return, the benefits would be

a major contribution to the international effortto mitigate climate change. While achieving a60% cut in carbon emissions by 2050 would bechallenging, it could be done while stillachieving economic growth rates of around2.25%.

The Risks7.116 The risks posed by these varied lowcarbon agendas are very different. For example,the renewables risk is that the main barriers toinvestment will not be overcome, so thatdeployment will be too low to offer a crediblelow carbon option. The move to a low carbontransport option requires the development ofnew technologies over the next 20 years.

7.117 While a continuing commitment torenewable generation, together with enhancedenergy efficiency and a low carbon transportsector, is seen now as the primary means ofmoving towards a low carbon economy, what ifthis policy fails? While the prospects of successare good, it is prudent to be aware from thestart of the continuing need to review progress,and to be ready with alternative approaches.The uncertainties are too large for us to be surehow much any one option might cost in 2020,let alone 2050. It will therefore be prudent tohave insurance against the failure of theseoptions to deliver in full. This can be providedby keeping open other low carbon powergeneration options.

7.118 DTI and DEFRA should monitor theextent to which energy efficiency, renewablesand CHP achieve current expectations, so thatfallback strategies can be developed if needed.In particular:

● what action should be taken if investment innew renewables is slow to come forward,perhaps because of continued difficulties ingetting projects through the planningsystem, or because it is difficult to achieve asufficiently large scale of activity? Chapter 10

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considers how possible reactions to failuremight change over time. In the event of thefailure of renewables and carbonsequestration to deliver, new investment innuclear power would need to be considered.The option will not have been closed if theright actions are taken today;

● what action should be taken if it the energyefficiency and CHP policies recommended donot deliver? The recommendations aredesigned to encourage the take-up of costeffective energy efficiency through self-sustaining energy efficiency markets,incentivised by targeted and market-basedinstruments. They need to be given time towork. But if after 5 years it is clear that theapproach is not working, a new approachwill be needed, possibly involving strongerelements of direct regulation; and

● what action should be taken if the potentialof low carbon transport technologies is notrealised? The progress of technologies needsto be carefully monitored and if concerns arereal, greater emphasis will need to be placedon other policy tools such as land useplanning, public transport infrastructure,congestion charging and support for lowpower alternatives such as cycling. Inaddition measures to control aviationdemand should be pursued at EU level incase full international agreement is notreached.

Overcoming the inertia in theenergy system 7.119 There are many differences between theconventional energy system and thoseenvisaged in some of the energy scenarios. Theenergy systems which some people see for thefuture are very different from that of today interms of:

● the small scale of new technologies;

● the greater variety of options;

● the ways in which generation is connected tothe network;

● the way in which electricity flows throughthe network; and

● the way in which customers choose howmuch energy to use and where it comesfrom.

7.120 While the technologies and commercialpossibilities have changed enormously, theenergy system has significant inertia. Yetchange will have to occur if many of the lowcarbon options are to come through.


Main Recommendations

21. OST should take steps to increase the levelof funding for low carbon energy R&D. Thepriority areas of the Chief Scientific Adviser’sResearch Review Group represent a goodstarting point (7.3).

22. DEFRA should develop energy efficiencyindicators, targets and monitoring mechanismsfor each sector of the economy (7.9).

23. DEFRA should develop a Strategy for HomeEnergy Efficiency to set out a clear, long-termframework. This should include an aspirationaltarget for home energy efficiency of 20%improvement by 2010 followed by a further20% improvement by 2020 (7.11).

24. In order to encourage a range of renewableoptions, and maximise the chances of rapid andlong-term learning and cost reductions, DTIshould immediately set a firm target of 20% ofelectricity to be supplied from renewables for2020 (7.63).

25. DTI should, by 2008, establish therenewable energy support mechanisms toensure that the 2020 target of 20% is met(7.64).

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26. In respect of NETA, Ofgem should developtransitional measures to be ready to beimplemented by January 2003 in case currentmeasures are unsuccessful in helping smallgenerators. DTI should consider legislation tomove this objective forward (7.67).

27. Ofgem should ensure that that therecommendations of the EGWG areimplemented by 2005. DTI should considerlegislation to move this forward in the event ofobstacles to progress (7.67).

28. Ofgem should ensure that future changesto electricity trading and grid accessarrangements do not discriminate unfairlyagainst renewable and CHP generation (7.67).

29. DTI should take the necessary actions tokeep the nuclear option open (7.78).

30. DTI should decide whether to support aprogramme for carbon capture andsequestration, and if so by what means (7.91).

31. DTLR should work with EU partners andmotor manufacturers to secure furtherimprovements in the energy efficiency of roadvehicles and to open options for low carbonfuelling in the longer-term (7.96).

32. DTLR should prioritise discussion of taxationand other measures to manage aviationdemand in EU and international fora (7.102).


33. DEFRA and DTI should make an earlycommitment to extending the Energy EfficiencyCommitment from 2005 to 2010, on the basisthat it would, at a minimum, be kept at existinglevels. Subsequently, and by the end of 2003,the Departments should review the scale of theCommitment for this additional period in thelight of the initial experience (7.18).

34. DTLR should review the costs and benefitsof moving to “near zero space heating”buildings well in advance of the next review ofthe energy efficiency component of BuildingRegulations (7.25).

35. DEFRA should take the lead in Europe inpressing for a more comprehensive programmeof cost effective EU energy efficiency standardsand negotiated agreements (7.28).

36. DEFRA’s Strategy for Home EnergyEfficiency should consider the option of anegotiated agreement with the finance sectorto reduce the cost of financing energy efficiencymeasures by funding them as part of mortgageoffers (7.29).

37. For contracts that include longer-termenergy efficiency financing (but only for thosecontracts) DTI and Ofgem should modify the28-day rule, with other approaches used toprotect customers against excessive charging(7.32).

38. DTLR should develop Building Regulationsto deliver a phased transition to low energycommercial buildings, including considerationof the use of renewable energy such asphotovoltaics (7.37).

39. As part of Government’s leadership role inenergy efficiency, HM Treasury should includedepartmental energy efficiency targets in futurePublic Service Agreements, and the Office ofGovernment Commerce should developmodel energy services contracts for use intendering throughout the public sector (7.45).

40. DTI should review the extent of the needfor capital grants for renewable energy after2005. This need should be assessed in time forthe 2004 Spending Review (7.48).

41. DTI should undertake further analysis of thepossibilities and benefits of mechanisms orschemes to promote renewable energyproducing heat, plus household and/orcommunity projects, especially those which inpractice fall outside the Renewables Obligation(7.50).

42. DTI should contribute to the internationalprocess of developing radically improvednuclear reactor designs, engaging with others inthe development of low cost, low waste designs(7.76).

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43. DTI should ensure that UK regulators areadequately staffed to assess any new investmentproposals, and are also pursuing opportunitiesto develop common international safetystandards (7.76).

44. DTI and HM Treasury should ensure thatany new nuclear build should benefit from anyfuture methods that will be used to valuecarbon and internalise the externalities of fossilfuel use. In addition, new investment in existingstations that substantially raised nuclearcapacity (and which would reduce carbonemissions) should be considered for similartreatment, subject to independent evaluation ofany case made (7.78).

45. DTI should ensure, using independentevaluation, that the nuclear industry fullyinternalises its externalities, including risks suchas waste cost escalation (7.78).

46. DTI and DEFRA should stimulate a publicdebate about nuclear power, and in particularon the trade-offs between nuclear-specific risksand carbon abatement potential, as part of awider debate on future energy policies andneeds (see Chapter 10) (7.79).

47. HM Treasury should ensure that electricityexported to the network from CHP schemes is,for fiscal purposes treated in the same way aspower used on site (7.85).

48. DTI should ensure that policy towardsSection 36 power station construction consentsrequires proposers to show they haveconsidered alternative sites with heat loads, ifGovernment is asked to approve a proposal notlinked to CHP (7.85).

49. Ofgem should ensure for micro-CHP, thatthere are simple and standardised connectionterms, that settlement profiles avoid recourse toexpensive metering and in the medium-term,that advanced metering technology should beintroduced (7.88).

50. DTLR and the Inter-Departmental Analysts’Group on Low Carbon Options should considerhow best to address the lack of data on costs ofenergy efficiency and fuel switching in transport(7.95).

51. DTI and DEFRA should monitor the extentto which energy efficiency, renewables and CHPachieve current expectations, so that fallbackstrategies can be developed if needed (7.118).

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48 Ofgem (2001a).49 Intermittent reflects generation which occurs in relation to the whims of nature.50 Predictable reflects generation which occurs at predictable times but may not occur outside those times.51 Flexible reflects generation which can be generated at any time.52 CHP features in all three categories.

APPENDIX TO CHAPTER 7

Institutional Barriers to theDeployment of RenewablesOptions

The New Electricity TradingArrangements

7.121 NETA was introduced on 27 March 2001.Since then there has been rising concern overthe impact of NETA on small generators, and inparticular on intermittent or less predictablegeneration from wind farms and on some CHPunits. A review of the first two months impactof NETA on small generators by Ofgem48

showed that prices, income and output were allconsiderably lower, although prices for smallgenerators did not appear to have fallen moresharply than prices for generators as a whole.

7.122 Because electricity is non-storable,centrally designed balancing mechanisms arerequired in competitive markets and these arenecessarily complex. There are no easy answersto the design of these mechanisms and a widerange of approaches has been adopted indifferent countries. Increasing percentages ofrenewable generation could add costs to therunning of the electricity system. The extent ofany extra costs will depend on the proportionsof the generation which are intermittent49 (windenergy, wave energy and solar), predictable50

(tidal energy) and flexible51 (biomass, wastes)52

and on the types of generation displaced.Intermittent power imposes greater costs thanthe others since more actions must be taken by

the system operator, or some other party, tocompensate for unpredicted fluctuations.

7.123 Additional flexibility of various sorts mustbe acquired in order to compensate for possiblefluctuations in the level of wind generation.Costs may be incurred as follows:

● to keep additional generation capacity inreadiness (to meet peak demand if wind isunavailable);

● to obtain additional flexibility fromgenerators or on the demand-side tomaintain energy balance in each meteredperiod (half-hourly in the UK); and

● to obtain additional flexibility fromgenerators or on the demand-side tomaintain power balance continuously withinhalf-hourly trading periods.

7.124 Small and intermittent generators areinterested in three values:

● the cost imposed on the system byincreasing percentages of intermittentgeneration;

● the balancing and other costs they faceunder NETA by virtue of their intermittenceand scale; and

● the price discount that they actually face inthe market.

7.125 The central question is the cost of back-up needed to cover for the periods whenintermittent generators cannot generate (mostobviously because there is a lack of wind) andwhether NETA reasonably reflects those costs.

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7.126 PIU has had a survey made of the currentknowledge concerning the costs associated withintermittent generation.53 Different assumptionsproduce different figures. It is clear that atcurrent levels of penetration the system costsassociated with intermittent generation arenegligible: the small changes in outputassociated with individual plants are “lost”within the normal fluctuations in demand andsupply within the network.

7.127 At some point, as the proportion ofpower derived from intermittents rises, someallowance will need to be made for back-up tocover unexpected fluctuations in supply. Otherplants will need to be incentivised to holdthemselves in readiness to meet shortfalls insupply, or electricity storage will need to beincentivised. The calculations done for the PIUassume that storage is used, and this may havetended to over-estimate the costs. As a roughrule of thumb, while the share of intermittentsremains below about 5%, the system costswould be insignificant. With a share between5% and 10% costs start to rise to about0.1p/kWh. Costs continue to increase beyond10%, with current estimates suggesting a costof about 0.2p/kWh when intermittents provide20% of electricity.54

7.128 Under cost-reflective tradingarrangements one would expect the value ofintermittent generation to be less than that ofconventional generation by approximately theseamounts. An important determinant of theNETA price for intermittents is the spreadbetween system sell and system buy cash-outprices. The greater this spread, the greater thediscount faced by intermittents. At the start ofNETA the spread was very volatile but averagedaround 5p/kWh for the first few weeks. It hassubsequently fallen to around 2p/kWh in recent

months.55 Analysis undertaken for the PIU andestimates by National Wind Power56 suggestthat at this 2p/kWh spread, assuming noconsolidation and 3.5 hour gate closure theNETA discount would lie around 0.4p/kWh. TheDTI has put forward a 0.3p/kWh figure forconsultation.57

7.129 A modification has been put forward toreduce gate closure of the BalancingMechanism from 3.5 hours to 1 hour. This mayreduce the NETA discount. Nevertheless, thefigures in paragraph 7.128 are sufficiently abovethe costs derived in paragraph 7.127 toprovide the basis for the claim that theImbalance Settlement Prices of NETA provideinappropriate incentives for reliable powerversus intermittent power, favouring the formerover the latter to an extent greater thanwarranted by their underlying values to thesystem. Given these uncertainties, werecommend that further analysis is undertakenof these costs.

7.130 In addition, the price offered by suppliersto intermittent generators, and smallergenerators in general, is further below thisprice.58 The DTI is hoping that consolidation willreduce this problem. They have asked Ofgem toset up a Working Group to investigate thebarriers to consolidation. Even if consolidationworks well – and there are very seriousobstacles to its progress – it will imposetransaction costs and take some time to occur.

7.131 There is also a view that NETAundervalues small-scale generation relative tolarge-scale generation,59 thus giving a doubledisadvantage to most intermittent generatorswhich are small scale.

7.132 Thus, the evidence suggests thatintermittent generation is suffering as a result of

53 Milborrow (2001).54 Milborrow (2001).55 www.bmreports.com56 Moore (2001).57 DTI (2001e).58 BWEA (2001b).59 ILEX (2001).

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a range of issues related to NETA. Whileintermittents are having particular problems,other smaller generators are also experiencingdifficulties, as Ofgem has recognised.60 Althoughmeasures are underway which are intended toaddress these difficulties, it is not clear that theywill be successful or by when this might be.Furthermore, any transitional mechanism tohelp small and intermittent generators wouldprobably take 6 months to a year to establish.

7.133 There are two recommendations:

Given this analysis, and the Government’s goalsfor renewable energy and CHP, much of whichis intermittent or produced in small units:

● there are sufficient grounds to recommendthat Ofgem develops transitionalarrangements which by-pass the particulardifficulties imposed by the current electricitytrading arrangements. Measures areunderway which may help small generators.Transitional arrangements should bedeveloped in parallel to be ready to beimplemented by January 2003 in casethe current measures are unsuccessfulin helping small generators.61

Consideration should be given for potentiallegislation to move the agenda forward.

● NETA was introduced to establish a tradingmechanism that aims to be cost-reflective.However, it is not clear that NETA is properlyreflecting the relative costs that small andintermittent generation impose on thesystem. To facilitate a move to a low carbonsystem, it is important that the tradingarrangements develop in such a way as toensure that renewables and CHP are treatedin a non-discriminatory manner. Whiletrading arrangements should not favourthese options, they should ensure thatintermittent electricity (such as wind energy),

predictable but variable electricity (such astidal power) and small-scale generation – ofwhatever sort – are not under-valued. Wherethere is real uncertainty as to whatconstitutes cost-reflective, or non-discriminatory pricing, options from withinthe range of possibilities should not bechosen without careful consideration of theenvironmental impacts of the alternatives.

Network connection and useof system charges7.134 The electricity system has evolved todeliver power from large-scale remotegenerators to consumers. Several technologiesthat would lead to significant carbonreductions, including photovoltaic panels, CHPand wind farms, require a system able toaccommodate small and intermittent sourceson the distribution (as opposed to transmission)network. This requires the Distribution NetworkOperators (DNOs) to operate and design theirnetworks differently, thereby accommodatingmore embedded generation.

7.135 A joint DTI/DETR/Ofgem Report of theEmbedded Generation Working Group(EGWG)62 looked at this problem and explainedwhy the DNOs do not have an economicinterest in connecting embedded generation. Itmade a number of recommendations abouthow to develop a new approach to designingand operating the network. Theserecommendations should be implemented assoon as possible. Unless this occurs, distributedgeneration will continue to have problems inconnecting to the grid. Changes may, however,have to wait until the 2005 Distribution PriceControl Review. But any further delay would putthe 2010 renewables and CHP targets injeopardy.

60 Ofgem (2001a).61 Success could be measured in terms of MW installed.62 DTI, DETR, Ofgem (2001). A Scottish Embedded Generation Working Group followed up the EGWG report by examining issues of

particular interest to Scotland.

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63 The EGWG recommended that a Group should be set up to oversee the implementation of the EGWG recommendations. This hasnow occurred and has been named as the DGCG.

64 SEGWG (2001).65 These charging options were based on the current NGC system and combined with shallow connection charges and entry and exit

charges on all actors with distribution networks.

7.136 There are three recommendations:

● the EGWG recommendations should beimplemented fully, no later than through the2005 Distribution Price Control Review;

● while it will be difficult to implement theEGWG recommendations before 2005, in theinterim, alternative policies should beprepared so that they would be ready forimplementation in 2007 if it became clearthat the changes laid out by the EGWG werenot coming into effect; and

● network access charges and use of systemcharges must change if renewables and CHPare to be deployed. Given concerns that theEGWG recommendations will not provide thenecessary impetus for DNOs to alter theirattitude to embedded generation, even withnew regulatory incentives, earlyconsideration should be given to the scopefor legislation to move the agenda forward.

A move to Active andIntelligent DistributionNetworks7.137 Technologies are available which allowdistribution networks to provide new servicesand operate in different ways. “Smartmetering” and information technology mayfacilitate greater use of energy services anddemand side management. This area wastouched on by the EGWG. PIU wouldrecommend that the Distributed GenerationCo-ordinating Group (DGCG)63 examines thisissue further and makes recommendations in itsreport in 2002.

Investment in Scotland7.138 The Scottish Executive co-ordinated aScottish Embedded Generation Working Group(SEGWG).64 Except in a few policy areas relatedto Scotland, SEGWG supported therecommendations of the EGWG. Scotland has avery large potential renewable energy resource,so that a substantial portion of new renewablegeneration is likely to be in Scotland. Scotlandalready has a surplus of generation, and itexports power to England. Consequently,SEGWG considers that the network operators inScotland are concerned with the impact of adistributed generation scheme not only on thelocal distribution network, but also on thetransmission system.

7.139 Given Scotland’s rapidly increasing windenergy deployment and large resource of otherrenewable energy technologies, there are threeissues:

● is the investment in transmission necessary;

● if so, how should it be paid for; and

● if so, who should pay for it?

7.140 It has been argued that there might bethe need for a “strategic” investment project,aimed at opening up a new transmission routefor Scottish renewable energy southwards. Thisproject would be so large that it would noteasily fit the regulatory mechanism. The criteriafor “strategic” and “standard” investmentwould have to be very carefully defined.

7.141 As the SEGWG makes clear, additionaltransmission system costs should not falldisproportionately on Scottish customers, ifthey are incurred in part to meet renewablestargets for England and Wales. The EGWG putforward a number of charging options.65

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Levying an exit charge on all customers wouldbe a fair and transparent way to pay for such ascheme, if it were decided that it were strategic.

7.142 The recommendation is that:

● Analysis of the potential need for strategicprojects should be added to the remit of theDGCG.

Difficulties in obtainingplanning permission7.143 The planning system, and attitudes toinfrastructure development, will have a keyimpact on the development of a low carbonenergy system. The broader discussion of theseissues takes place in Chapter 8. Renewableenergy faces particular difficulties.

7.144 There have been several surveysconcerning public attitudes to renewable powerplants. Most have been surveys done either forrenewable developers or for opposition groups-and the results have tended to support theposition of the sponsor. Those surveys whichhave been undertaken by independentinstitutions, such as the BBC, the ScottishExecutive, academics, RSPB and local councils,have generally been supportive to renewableenergy.66 The surveys also suggest that supportincreases once a power plant has been built.67

7.145 Nevertheless, the business of obtainingplanning permission for renewable investments,particularly onshore wind in England and Wales,remains costly and time-consuming, andsuccess rates for some technologies are lowerthan the national average.68 Unless success ratesincrease targets will not be met. Chapter 8discusses potential means for overcoming thesedifficulties.

66 RSPB (2001), BWEA (2001b).67 Scottish Executive (2000b).68 Hartnell (2001).

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8. INSTITUTIONS

Summary

This chapter examines the institutional requirements of a low carbonfuture. The main conclusions are:

● despite the strengths of existing government institutions,institutional changes will be needed to take the UK towards a lowcarbon future while balancing the economic, social and securityimpacts of energy policy;

● the UK should continue strongly to champion liberalisation in the EUenergy markets and support the European Commission in playing aneffective and appropriate role;

● in the long-term, the Government should aspire to bring togetherresponsibilities for energy, transport and climate change policy in onedepartment. In the short-term, a new Sustainable Energy Policy Unitshould be established. Responsibility for energy efficiency and CHPshould be brought together with other aspects of energy policy;

● it is essential that the Devolved Administrations are involved with theimplementation of this report and the on-going development of UKenergy policy;

● Ministerial guidance to Ofgem on environmental objectives shouldbe more specific about the outcomes Government wishes to acheive;

● a review should be undertaken to ensure that activities of nationalagencies that deliver low carbon policies are fully co-ordinated;

● central Government needs to support local authority and voluntarysector activities in facilitating local activity in energy efficiency andclean, small-scale power generation; and

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Introduction8.1 This review develops a challenging agenda.There is no single correct path towards a lowcarbon economy: there will be an on-goingneed to balance objectives; the risks whichbeset energy systems must be managed; andthe requirements of policy implementation willbe extensive and complex. Some of these tasksfall directly to government and regulators,others will be tackled by market participantswithin the framework developed bygovernment. How far can we rely on existinginstitutions to do the job?

8.2 Our conclusion is that, despite the strengthsof existing institutions, changes are needed.These would improve the process of resolvingconflicts between objectives and the delivery ofpolicy. This Chapter considers institutions atinternational, national and regional/local levels,and concludes with a discussion of the planningsystem.

International institutions

Climate change

8.3 As previously discussed, energy policy willincreasingly be set within the framework ofinternational commitments and negotiations onclimate change. The international response tothe problem of climate change is negotiatedand taken forward under the auspices of theUnited Nations Framework Convention onClimate Change. The most significantdocuments produced to date under the UN-FCCC are the Kyoto Protocol, which sets targets

for developed countries, and the MarrakeshAccords which set out in detail the way inwhich the Protocol will be implemented.Negotiations on post-Kyoto targets must beginin earnest by 2005, and will deal with targetspost-2012. This next stage of negotiations mayalso try to bring more countries into the target-setting process. The UK will maintain thecurrent approach of negotiating officiallythrough the EU, with its own individual targetdecided through a burden-sharing process.

The European Union

8.4 While there are no treaty powers specific toenergy policy, the European Union already has asignificant influence on UK energy policythrough areas such as internal marketprovisions, competition policy andenvironmental policy.

8.5 Two European developments are likely to beof growing importance over the next ten years:

● enlargement – there could be up to tenadditional member states by 2004, changingthe EU’s political and economic centre ofgravity. Russia and the Middle East willbecome immediate neighbours and, withincreased import dependence, relations withthese countries will rise up the politicalagenda. The accession countries will extendthe EU infrastructure, increasing the need forregulation and investment; and

● greater European Parliamentary involvementwill increase democratic representation butwill also add a further layer of complexity tothe policy-making process.

● national planning guidance should set out clear arguments whenthere is a national case for new investment in energy-relatedfacilities. Greater prominence should be given to energydevelopments in regional guidance and sub-regional plans.

8.6 As a result of these factors, alongside thegrowing importance of climate change and theliberalisation of European energy markets, theEuropean Commission seems likely to play anincreasingly important role in energy policy.

8.7 Current EU priorities include the completionof the energy single market and increasing thediversity of gas suppliers to create greatercompetition in the gas market. These prioritiesare important for the achievement of UK energypolicy goals, including maintaining competitivepressures on energy prices and providingdiversity of fuel sources for energy security. Asdiscussed in Chapter 4, the UK should continueto champion the liberalisation of EU energymarkets and support the European Commissionin pressing forward with the relevant directives.The EC also has a role in the completion ofEuropean energy networks.

8.8 The European Climate Change Programme1

proposes a range of policies and measures todeliver the EU’s climate change targets underthe Kyoto Protocol. The EU’s status as asignatory to the Protocol provides impetus toUnion-wide measures to reduce greenhouse gasemissions. The most significant of these is theproposal for an EU emissions trading scheme. Itwould feature mandatory caps on the powersector, and could significantly affect theeconomics of new generating capacity. Whileindividual member states should retainauthority on the approaches used to achievecarbon reductions, in line with the principles ofsubsidiarity, the principle of emissions tradingbetween member states is to be welcomed.

8.9 The Commission has also recently produceda Green Paper on security of supply which iscurrently under debate (its recommendationsare discussed in Chapter 4). The Commissionhas proposed the need for a “consistent andcoordinated energy policy at Community level”.The UK consultation on the Green Paper hasnot revealed a pressing demand for treaty

powers for energy. The UK should thereforecontinue to oppose a change in the treaty base:an energy chapter or other further treatypowers are unnecessary as competition issuescan be dealt with under single marketmeasures, and most other matters can behandled by national energy regulators.

8.10 There is no need for a European energyregulator: each member state will have its ownregulatory authorities. Some coordination ofapproaches is likely to be necessary asliberalisation proceeds: this can be achievedthrough EU forums and is to be welcomed.

8.11 In conclusion, while there is no need for achange in EU treaty powers, the EuropeanCommission will have an increasingly importantinfluence on UK energy policy through its rolein development of climate change policy,pushing through energy market liberalisation,coordinating energy security concerns andmanaging an enlarged EU. Effective action inthese areas is important for UK energyobjectives and the UK should continue tosupport the Commission in playing an effectiveand appropriate role.

National institutions

Whitehall departments and agencies

8.12 In reviewing options for institutionalchange, the following principles wereconsidered. Any new structure should:

● provide clarity of responsibilities withoutduplication;

● support public accountability;

● balance the collation of related policy areasagainst institutional size;

● improve the policy-making process, withappropriate expertise and minimalbureaucracy;

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1 Commission of the European Union (2001) and other documentation available athttp://www.europa.eu.int/comm/environment/climat/eccp.htm

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● ensure the separation of roles while handlingpotential conflicts of interests; and

● justify the cost and disruption ofrestructuring through improvedperformance.

8.13 The existing structure of institutionsinvolved in UK energy policy making anddelivery lacks coherence. At a departmentallevel, transport policy is located within DTLR,climate change policy along with energyefficiency and CHP policy/sponsorship inDEFRA, and the remainder of energy policy withDTI. It has been suggested that one route togreater unity would be to return to aDepartment of Energy, but such an approachwould fail to bring together the range ofinterests involved in energy decisions. While theinterests connected to energy are so wide thatthere is no obviously correct organisation ofdepartments, the Government should aspirein the long term to bring together in onedepartment responsibilities for climatechange, energy policy and transportpolicy. Sponsorship of energy industries shouldremain in DTI. This recommendation wouldrequire fundamental change to existingdepartmental structures and significant forwardplanning. In the shorter term, there are actionsthat could be taken to enhance the currentdepartmental arrangements.

8.14 An enhanced central capacity is requiredto support energy policy by permanentlymonitoring key developments in energy useand supply, and assessing implications for policyon energy, transport and climate change. Thisanalytical centre should co-ordinate a forumwithin which those interested in energyoutcomes can engage in the analysis of theimpact of new policy initiatives. In addition tothose with direct responsibilities for energy,transport and climate change, the Treasuryshould have an integral role particularly becauseof the future importance of carbon valuationand, given the growing influence of imports

and international markets, FCO should be morefully integrated into the energy policy-makingprocess. Given the range of devolved powers,close contacts would have to be establishedwith the Devolved Administrations.

8.15 It is recommended that aSustainable Energy Policy Unit (SEPU) isestablished to undertake this role. The Unitwould report directly to Ministers and also tothe Ministerial Sub-Committee on Energy Policy(DA(N)). Initially the Unit could be based withinthe DTI, but its position should be consideredon the same time-scale as the organisationalreview of the DTI Energy Group (discussedfurther below). While the Unit will have toremain formally linked to one department (afully independent body would requirelegislation which is not justified at the currenttime), the Unit should stand apart fromindividual departmental interests and be drivenby a cross-Whitehall responsibility forsustainable energy. Proposals for the SEPU areset out in Box 8.1, but further consideration willclearly have to be given to the Unit’s policyresponsibilities, structure and staffing. There isno direct precedent for a Unit of this sort andimagination will be required in setting it up. Itsfuture position will depend on the developmentof the roles of climate change, energy policyand transport policy within Government.

8.16 This proposal is made at a time when theDTI is reviewing the organisation of its EnergyGroup. The group currently performs a numberof different functions – policy-making, policyanalysis, industry sponsorship, regulation,licensing and policy delivery. DTI is seeking toachieve greater clarity, with less mixing of roles.We support this, especially if the result can be aclearer and more objective focus on policy-making. Industry sponsorship and energypolicy-making should, so far as possible, beseparated. Separation of these functions willminimise the risk of regulatory capture andconflicts of interest.

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8.17 Alongside the Energy Groupreorganisation, some streamlining of variousexecutive functions may be possible, forexample in the granting of licenses for all fossilfuels both on and offshore. Further thoughtmight be given to the possibilities forestablishing a composite Fossil Fuels Authorityoutside the DTI. This body would have theauthority to license and encourage the efficientextraction of UK fossil fuel resources.

8.18 The review considered a further element ofWhitehall organisation: the location ofresponsibility for energy efficiency and CHPpolicy, and sponsorship of the energy efficiencyand CHP industries. Responsibility for theseareas was given to the Department of theEnvironment when the Department of Energywas disbanded, as there were considerablesynergies from placing the responsibility within

a department responsible for construction,including building regulations. The link totransport was also helpful since there isconsiderable potential for increasing the energyefficiency within this sector. But, with thecreation of DEFRA and DTLR, these synergieshave been lost.

8.19 There are good reasons why responsibilityfor energy efficiency and CHP could be in eitherDEFRA or the DTI. There are gains from havingenergy efficiency pursued alongside the generalresponsibility for the UK climate changeprogramme. But it can also be argued thatresponsibility for both the use and provision ofenergy should be placed together as there areincreasing links between demand and supplyside technologies. It will also be increasinglyimportant to pursue energy efficiency policy inthe light of a thorough understanding of the

Box 8.1: A new Sustainable Energy Policy Unit (SEPU)Analytical capability. The Unit would have a strong analytical capability responsible formonitoring key developments in energy use and supply and for assessing implications for policyon climate change, energy and transport. The Unit would be responsible for ensuring greater co-ordination of energy-related analytical work across Government. It should ensure that thenecessary long-term analysis is carried out and that this analysis is open and inclusive. It wouldprovide a forum where different interests across Whitehall could debate key issues.

Strategic policy. The Unit would lead on the development of strategic policy, drawing on theevidence of its analytical work. It would be important that the Unit work closely with theDevolved Administrations. The Unit would not be responsible for policy issues relating to specificindustries, sponsorship or policy delivery.

Staffing. The Unit would be staffed by officials on loan from government bodies (including DTI,DEFRA, DTLR, HMT, FCO, the Devolved Administrations, Ofgem and the Environment Agency)and external secondees. Staff should be recruited in the most part through open competition,with an appointment board consisting of people from both across Whitehall and outside. A Unitof about 50 people is envisaged, including specialists, administrators and support staff.

More inclusive working methods. It would be vital for the Unit to adopt an open andinclusive method of working: establishing new networks, drawing on inputs from the full rangeof stakeholders and making maximum use of web-based communications.

It would be for consideration as to how the existing DTI Energy Advisory Panel would relateto this Unit. The Unit would probably create more than one advisory group, for example onenergy modelling, demand side projections, and gas and oil market developments.

2 DTI (2001b).

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workings of liberalised markets. Therefore it isrecommended that, in light of experience withthe Sustainable Energy Policy Unit,consideration should be given to locatingresponsibility for energy efficiency andCHP policy with the other aspects ofenergy policy.

8.20 The proposal for a Ministerial Group onLow Carbon Vehicles and Fuels, announced inthe draft Government strategy Powering FutureVehicles, is welcomed. The Ministerial Group willwork alongside DA(N), focusing on theimplementation of the strategy for promotingthe development, introduction and take-up oflow carbon vehicles and fuels, and the fullinvolvement of the UK automotive industry inthe new technologies.

8.21 The Chief Scientific Adviser’s review ofenergy research recommended thatconsideration should be given to setting up anational Energy Research Centre. This wouldfacilitate a multi-disciplinary approach whichcould take account of the environmental, socialand public acceptability aspects of energytechnologies, as well as the basic science whichunderpins them. It could be a “networking”centre and play a role in co-ordinating UKresearch, facilitating collaboration betweengovernment, academia and industry, and UKparticipation in international projects. A nationalEnergy Research Centre could fulfil a valuablefunction in contributing to enhanced andimproved energy R&D and innovation. It isrecommended that more detailedproposals be developed.

Devolved administrations

8.22 As set out in Box 1.1, energy efficiencyand (to some extent) support for renewableenergy are devolved matters in Scotland andWales. (Northern Ireland is outside the remit ofthis review.) Given the importance placed onthese two aspects of energy policy, it is essentialthat the Devolved Administrations are involved

with the implementation of the review’s findingand the on-going development of UK energypolicy. This will include both close liaison withWhitehall, in particular through directparticipation in the Sustainable Energy PolicyUnit, and the development and implementationof policy on devolved issues.

Energy regulators

8.23 The Sustainable Energy Policy Unit shouldinvolve experts from both Ofgem and theEnvironment Agency. The SEPU should beinvolved in major new initiatives by eitherregulatory body, ideally helping in the wideranalysis and co-ordination of new proposals.

8.24 We recognise the importance of preservingthe independence of economic regulatorswhose main objective is to protect the interestsof consumers by promoting competition andensuring that prices are no higher than neededto deliver the services required. Thisindependence is an essential means ofproviding investors with the assurance that theirdecisions will not be undermined by politicalintervention in regulatory matters. However, itwas recognised in the Utilities Act 2000 that itis appropriate for DTI to give guidance toOfgem, given that its activities can contributeto or conflict with Government objectives in theareas of social and environmental policy. Ofgemshould have “due regard” to the guidance. Thismeans that Ofgem would modify its actions totake account of the guidance so long as this didnot contravene its statutory duties.

8.25 Guidance serves a useful purpose byenabling Government to give Ofgem a clearstatement of its social and environmentalobjectives, and the weight it attaches to them,so that Ofgem can carry out its duties in amanner that is alert to the wider policy pictureand, where possible, supportive of it. Howeverwe do not think the existing draftguidance on environmental concerns2 issufficiently specific about the outcomes

Government wishes to achieve and whenit wishes to achieve them. For example:

● The draft says that “the Governmentencourages the Authority to assess theimpact of the New Electricity TradingArrangements on CHP and renewablesgenerators”. However, it does not say whatan environmentally desirable outcome fromthis assessment might be.

● The draft says that Ofgem should haveregard to a number of environmental issueswhen considering how competition might bepromoted through embedded generation.However, it does not indicate how urgentthese issues are.

Given its duties, Ofgem may or may not beable to respond to the Government’s priorities,but at least the context within which it isoperating will be clear. Given the purpose ofthe guidance, it should be reviewed morefrequently than the 5 year intervals proposed byDTI.

8.26 The review has not argued for afundamental change in the relationshipbetween Government and Ofgem. However,Chapter 3 concluded that the Government canonly deliver many environmental objectives,especially climate change objectives, throughthe energy system. This means there are verylikely to be tensions between Governmentenvironmental objectives and the duties ofOfgem. Where these tensions cannot beresolved through guidance the alternative is touse legislation. It will be for Government todecide in each case whether the circumstancesjustify the legislative route, but more frequentresort to legislation is likely to be a consequenceof using energy policy to achieve environmentalobjectives.

8.27 Detailed recommendations concerningOfgem’s approach to network regulation andNETA are contained in Chapter 7. Further tothis, our work has led us to believe that Ofgemshould always produce comprehensive

analyses of significant regulatoryproposals, taking full account of costsfalling on the energy industry andconsumers.

8.28 Finally, there has been a debate onwhether the separation between Ofgem’sregulation of onshore gas pipelines and theDTI’s role in regulating offshore infrastructure isthe best approach. Submissions to the PIU showa general feeling that the present arrangementsfor offshore regulation are broadly satisfactory,and that companies of all sizes are able toobtain the pipeline capacity they need atcompetitive market prices. There is, however, acontinuing need for consultation between theDTI, Ofgem and the industry to ensure thatactions affecting onshore and offshoreinvestments are co-ordinated appropriately.

National non-departmental deliveryagencies

8.29 There are currently a large number ofbodies involved in the delivery of low carbonpolicies. Examples of the main institutions arelisted in Figure 8.1, focusing on thosepromoting energy efficiency.

8.30 In general, energy efficiency and lowcarbon programmes are best delivered viamarket and regulatory mechanisms, forexample the Energy Efficiency Commitment,building regulations, standards and theemissions trading scheme. The key role forinstitutions is to overcome information failures,and relevant activities are therefore to provideinformation, advice, advocacy, capacity buildingand supporting innovation. These roles arecurrently played primarily by the Energy SavingTrust and the Carbon Trust. The mainexceptions are the current fuel povertyprogrammes. These should be integrated withother energy efficiency programmes at a locallevel so that funds are used effectively. There isa new initiative – Warm Zones – which isattempting to do this.

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Institution Funding (annual 2001 unless Key areas ofotherwise explained) expenditure

Sources of funding

Carbon Trust - Enhanced Worth £70M depending on Encourages businesses Capital Allowance scheme take-up, in the form of a tax to invest in approved

allowance energy efficiency technologies

DEFRA – Emission trading £215M (over 5 years on a UK The scheme aims towide basis) sign business up to

beyond business-as-usual reductions of greenhousegases

Ofgem – Energy Efficiency Currently around £50M. Will Sets energy efficiency Commitment rise to the equivalent of targets for energy

around £150M in EEC4 suppliers through (2002–5), for which Ofgem household energy will have operational efficiency installations.responsibility. Overall Funded by energy obligation is set by suppliers, who may pass Government. the costs on to their

consumers (max. £3.60per customer per fuel perannum for the £150mfigure)

Delivery Bodies

Carbon Trust Around £50M from CCL Will accelerate the takeuprevenues and the Energy of cost effective, low-carbonEfficiency Best Practice technologies and other programme (UK total) measures by the business

and public sector

Climate Change Projects Joint funded by DTI Advises business on Office and DEFRA – £0.3m opportunities for reducing

carbon overseas

DEFRA – Energy Efficiency £18M (UK total) Domestic and business Best Practice Programme best practice. Due

to be split and given tothe EST and the CarbonTrust to manage

Energy Agencies Receive funding through the The Agencies promote EU Save programme for the the use of renewable first 3 years energy and energy

efficiency in non-domesticbuildings

Figure 8.1 Main low-carbon institutions

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8.31 Where schemes are directed towardsdifferent clientele there is a case for institutionalseparation. This is one of the justifications forthe current structure, with the Carbon Trusthaving a stronger focus towards industry andinnovation than the Energy Saving Trust, whosemain activities centre on domestic users and onthe transport sector. However, there are areas of

overlap between both sectors, for exampleSMEs and technologies like micro-CHP and fuelcells. There would be advantages in mergingthe EST and the Carbon Trust over the mediumterm to maximise the synergies between thedifferent sectors and ensure that there is nooverlap.

Institution Funding (annual 2001 unless Key areas ofotherwise explained) expenditure

Energy Efficiency Advice Part funded through the Advice mainly to Centres EST, local authorities and households on energy

private organisations efficiency measures and grant availability

Energy Saving Trust (EST) £49M (UK Total) for 2001-02 Energy efficiency forhouseholds, SMEs andcleaner fuelled vehicles –information, grants,accreditation, training,networks

FCO – Climate Change £0.5M per annum to date Provides funding to help Challenge Fund business and developing

countries meet the challenges of climatechange

Government Offices Provide a link to otherprogrammes

Home Energy Efficiency £75M old HEES up to 1 June New HEES provides a Scheme 2000 £150M per annum package of insulation and

2000-04 (England only) heating measures tailored to the householders’needs and the propertytype

Joint Environment Joint funded by DTI and DEFRA Encourages the Management Unit development of a strong,

competitive UKenvironmental industry

Source: DEFRA

Figure 8.1 Main low-carbon institutions – continued

8.32 There is also a more general lack ofcoordination between the various sources offunds. For example, the relationship betweenthe funds available for the emissions tradingscheme and the sources of funding available forbusiness from the Carbon Trust is unclear, andthis creates confusion among businesses, localauthorities and others seeking to exploit them.Given the importance of energy efficiency andthe proposal to “re-launch” all existing schemesand activities, there is a need for an in-depthreview of low carbon delivery activity toensure that delivery organisations arearranged in the most effective manner and thatthere is no overlap in activity. The review shouldlook not simply at existing programmes but atfuture requirements, and further considerationshould be given to the Royal Commission’srecommendation for a single agency topromote energy efficiency in all sectors.3

Regional and local decision-making8.33 Increased use of small-scale anddecentralised technologies is expected in a lowcarbon future. This will place a greater focus onregional and local activity in the energy sector,so that regional and local institutions will haveto play a larger role.

8.34 Local authorities already provide servicesand regulate some energy activities, but theirkey future role in the energy sector will be asleader and facilitator in their local communities.In this context they will have five importantfunctions:

● leading by example, as an energy andtransport user and a land owner;

● setting the local framework through land useand transport plans in light of the recentGreen Paper about fundamental changes tothe planning system (discussed below);

● building consensus for local action viaCommunity Plans and Local StrategicPartnerships;

● facilitating local action, working with otherstatutory agencies (e.g. health authorities),businesses (such as energy suppliers) and thecommunity; and

● ensuring information and advice is providedto homes and that small businesses aredirected to the most appropriate sources ofadvice.

8.35 Local authorities’ existing duties under theHome Energy Conservation Act (HECA) focuson a target for improvement of the wholehousing stock and reporting to Government onprogress. These are being reviewed in the lightof the changing role of local government. Theseduties need to be modernised to emphasisebuilding local partnerships, providing adviceand coordination of local programmes toaddress fuel poverty and energy efficiency.

8.36 Voluntary groups are widely trusted andinvolved in community action. They cantherefore play a number of roles. Specialistvoluntary organisations may prove the mosteffective way to provide energy efficiencyadvice and to initiate innovative communityprojects. Local authorities should encouragecommunity groups and local groups of nationalorganisations to play a bigger role in localpartnerships, for example in fuel povertyprogrammes.

8.37 Central Government should consideradditional resources for capacity buildingin local authorities and the voluntarysector to play a more active role in theenergy sector, in particular in support ofenergy efficiency (discussed further inChapter 7).

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3 Royal Commission on Environmental Pollution (2000), recommendation 12

Planning8.38 A persistent theme of the review has beenthe problems, either experienced or perceived,that energy projects have in gaining planningpermission. Examples presented to us include:renewable energy generation, in particular windand biomass; new coal mining developments;gas storage plans; electricity generation usingcoal-bed methane; energy from wastedevelopments, and individual householdmeasures, such as PV, solar hot water heatingand external wall insulation, especially inconservation areas. Nuclear projects raiseplanning issues of particular complexity.Problems are often the result of the differentconcerns of potential developers and localresidents. However, if the UK is to meetenvironmental, social and economic objectivesthen a range of new supply- and demand-sidemeasures will have to gain planning permission.

8.39 The Government is reviewing theoperation of the planning systems in Englandand has recently issued a Green Paper.4 DTLRhas also released a consultation document5 onthe treatment of major infrastructure projectsby the planning process and is committed toreviewing its national planning guidance onrenewable energy6 as soon as possible. TheNational Assembly for Wales is also currentlyreviewing its planning policy guidance and hascommenced the process of developing a Walesspatial plan,7 and the Scottish Executive hasrecently revised its national planning guidance8

for renewable energy developments and iscurrently also carrying out a review of strategicplanning.

8.40 The main challenge that planners face is tobalance the national costs and benefits of adevelopment against the local costs andbenefits. Energy projects must often be sited at

or near the primary resources, whereas theenergy produced may be consumed elsewhere.The result is that one part of the country mayresent bearing what it sees as a cost in order tobring advantage to others. Public participationis an integral part of the planning process. Theattitude of local communities to proposals fornew energy development is a materialconsideration and they must continue to havetheir say in the planning process. (The processof engaging the public in the energy policydebate is discussed further in Chapter 9.)

8.41 A range of actions can help immediately:

● national planning guidance currently onlycovers renewable energy facilities. As part ofthe review of all national planning policyguidance announced in the recent GreenPaper, Government needs to make clearwhen there is a national case for newinvestment in any energy-relatedfacilities where planning decisions aremade by local authorities. This should bedone by establishing the relevant nationalcontext for each type of development,whether it be the production of primaryenergy, energy storage, energy productionand distribution, or demand-side measures;and

● given the pace of technical change,information given on technologies within theguidance or in technical annexes to theguidance needs to be continually updated.

8.42 Energy developments are graduallyreceiving an increased profile in regionalguidance and sub-regional plans. However,more rapid progress is required: as we movetowards more renewable and decentralisedgeneration and a greater emphasis on demand-side technologies, energy developments should

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4 DTLR (2001c).5 DTLR (2001b).6 Department of the Environment (1993).7 National Assembly for Wales (2001).8 Scottish Executive (2000a).

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be given greater prominence within thesedocuments. This should be achieved by:

● regional planning bodies placinggreater prominence on energy issues inregional planning guidance includingincorporation of the results of the recentregional renewable energy studies9 inEngland. Regional Development Agenciesshould set regional targets for renewableenergy production in their RegionalSustainable Development Frameworks. Thesetargets should be set initially at indicativelevels following the conclusion of the DTI’scurrent review of the studies; and

● placing greater emphasis on pro-activeplanning for energy developments at asub-regional level. This should includeidentifying areas that could be appropriatefor specific types of developments. If theLocal Development Frameworks proposed inthe DTLR revision of the planning system areimplemented, it will be important thatenergy developments are well representedwithin the frameworks.

Planning is a devolved issue (see Box 1.1) and itis for the Devolved Administrations to considerthe most appropriate policy for Scotland andWales.

8.43 Some promising renewable options involveharnessing energy in, or over, the sea. Offshoreenergy projects could also ease the pressure forland use in the UK. This is beginning to happenfor wind projects, and there is potential forwave and tidal stream generation in the future.Currently there is no authorisation processoffshore comparable to the planning processonshore: offshore developers must gain a seriesof consents in order to proceed. There is alsono clear vision of how developments willprogress offshore over the next few years.

Therefore, the Government should consider thefollowing:

● the onshore planning agencies and thebodies that grant offshore consents need towork closely together. The DTI/ScottishExecutive proposal to coordinate the processof gaining a number of different consents foroffshore wind is a good example; and

● since, over the next few years, the number ofoffshore energy developments is likely toincrease, there are likely to be conflicts withother offshore activities such as fishing,transport, defence activities, and oil and gasinfrastructure. DTI should develop apolicy on strategic offshore issues toinform Government decisions. While it isthe duty of Crown Estates to lease sea-bedrights to potential developers, there is a needfor Government to develop appropriatepolicies on a number of issues, drawing forexample on DTI experience with the oil andgas industries. Issues to be addressed include:site selection (this will be primarily fordevelopers, however, Government will needa policy on this); size of offshoredevelopments for which consents can begrante; grid access and rules fordevelopments outside the 12-mile territorialwaters zone. This will be particularlyimportant to ensure that the growingmomentum behind offshore wind is not lost.

Section 36 & 37 Applications

8.44 Generation projects over 50MW apply forplanning permission direct to the DTI/ScottishExecutive in accordance with section 36 of theElectricity Act; this covers applications for muchof the generation plant currently in existence inthe UK. Overhead transmission lines must gainpermission under Section 37 of this Act.

9 All the Government Offices in England and Wales were asked to undertake regional renewable energy studies to assess the potentialfor renewable energy developments within each region. These studies are now complete and the results are being assessed by DTIand DTLR.

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8.45 Some of the larger and more complexgeneration and infrastructure projects, forexample Sizewell B and the North Yorkshiretransmission line, have historically suffered fromhaving very long and expensive publicenquiries. DTLR are currently consulting onproposals to streamline the planning process formajor infrastructure projects10 and it is likelythat these proposals will benefit future projectsof this scale.11

8.46 In particular, we support the principle setout in these proposals that it is useful to debatecommon themes of a type of development,such as its technical ability and cost and theestablishment of a national policy statementaround that type of development, before andseparate to an enquiry on the local sitingaspects of a project. However, any debate oncommon themes must seek early and activeengagement with a wide range of stakeholders,and must involve the local communities whichmay be affected.


Main recommendations

52. Government should aspire in the long-termto bring together in one departmentresponsibilities for climate change, energypolicy and transport policy (8.13).

53. Government should set up a cross-cuttingunit (initially based in DTI, described above asthe “Sustainable Energy Policy Unit” (SEPU)) tooversee the future direction of energy policy; toimplement the findings of the PIU report; andto provide an enhanced energy analyticalcapability (8.15).

54. DA(N) to consider whether responsibilityfor energy efficiency and CHP policy should belocated with other aspects of energy policy(8.19).

55. SEPU/OST to develop more detailedproposals for a national Energy Research Centre(8.21).

56. DTI to sharpen Ministerial guidance toOfgem on environmental issues (8.25).

57. Ofgem to produce analyses of significantregulatory proposals, taking full account ofcosts falling on the energy industry andconsumers (8.27).

58. DEFRA/DTI to carry out a review of lowcarbon delivery organisations (8.32).

59. DTLR/DEFRA to consider additionalresources to build capacity in local authoritiesand the voluntary sector, in particular forenergy efficiency activities (8.37).

60. DTLR with DTI to update national planningguidance, making it clear when there is anational case for new investment in energy-related facilities (8.41).

61. Regional planning bodies to give greaterprominence to energy developments in regionalplanning guidance (8.42).

62. Local authorities to ensure that greateremphasis is placed on proactive planning forenergy developments in sub-regional plans(8.42).

63. DTI should develop a policy on strategicoffshore issues for new technologies to informGovernment decisions (8.43).

10 DTLR (2001b).11 Projects that may qualify under the new proposals include nuclear plant, thermal power stations with a heat output of 300MW or

more, renewable energy generation over 150MW in size, overhead lines with a voltage of 220kV or more, crude oil refineries, somegas storage and large open cast mines. A full list of projects that may qualify is in DTLR’s consultation document.

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The European Union

64. An EU energy chapter or other furthertreaty powers are unnecessary (8.9).

65. There is no need for a European energyregulator (8.10).

National Institutions

66. Industry sponsorship and energy policy-making should, so far as possible, be separated(8.16).

67. DTI should give further thought to thepossibilities for establishing a composite FossilFuels Authority outside the DTI (8.17).

68. It is essential that the DevolvedAdministrations are involved with theimplementation of the report’s findings and theon-going development of energy policy (8.22).

69. There is a continuing need for consultationbetween the DTI, Ofgem and the industry toensure that actions affecting onshore andoffshore investments are co-ordinatedappropriately (8.28).

Regional and local decision-making

70. Local authorities’ duties under the HomeEnergy Conservation Act (HECA) should bemodernised to emphasise building localpartnerships, providing advice and co-ordinating local programmes (8.35).

71. Local authorities should encouragecommunity groups and local groups of nationalorganisations to play a bigger role in localpartnerships (8.36).

Planning

72. Information given on technologies withinplanning guidance or in technical annexes tothe guidance needs to be continually updated(8.41).

73. Energy developments should be givengreater prominence within regional guidanceand sub-regional plans. Specific measures bywhich this should be achieved are (8.42):

● Regional Planning Bodies should incorporateof the results of the recent regionalrenewable energy studies in England.

● Regional Development Agencies should setregional targets for renewable energyproduction in their Regional SustainableDevelopment Frameworks.

● If the Local Development Frameworksproposed in the DTLR revision of theplanning system are implemented, it will beimportant that energy developments are wellrepresented within the frameworks.

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CONCLUDINGTHEMES

9. CONCLUDING THEMES

Summary

Binding international commitments for UK GHG emission reductions canonly be met through action in the energy system. An overarchingstatement of energy policy could therefore be “the pursuit of secure andcompetitively priced means of meeting our energy needs, subject to theachievement of an environmentally sustainable energy system“.

The case for significant government intervention in markets on securitygrounds appears weak at this point in time. The present role ofgovernment should instead be in assessing the security risks and takingsteps to ensure markets are able to make effective choices on security.

Government should create powerful incentives to create low carbonoptions that would put the UK in a favourable position to move to a lowcarbon future.

Innovation needs to play a central role in meeting the low carbon future.

Energy policy should be kept under regular review: in particular, theGovernment needs to be aware of the need for contingency plans ifpresent policies seem not to be working as expected.

The Government needs to conduct an open public debate about energysystems, covering the issue of security, the shift to a low carbon economyand the role of the various low carbon technologies, including nuclearpower.

This radical agenda implies substantial change and widespread publicacceptance. The timescales are long, but the time for action is now.

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Framework9.1 In setting future energy policy, the guidingpolicy principle for government should besustainable development, requiring theachievement of economic, environmental andsocial objectives. It is also vital to maintainadequate levels of energy security at all pointsin time. There will be tradeoffs and synergiesbetween these objectives.

9.2 There is no simple guide to resolving trade-offs, but because greenhouse gas abatement isparticularly important among sustainabledevelopment objectives and can only bedelivered through the energy system, energypolicy is likely to give preference to thisobjective. An overarching statement of energypolicy could be “the pursuit of secure andcompetitively priced means of meeting ourenergy needs, subject to the achievement of anenvironmentally sustainable energy system”.

Security9.3 The basic approach adopted in this reviewis to start from a belief in the power of marketsto make effective choices in energy system. Thesuccess, within the UK, of the process ofliberalisation confirms this. While the reviewquestions whether markets can address allsecurity issues, it gives general endorsement tothe market-based approach. The case forsignificant intervention in markets on securitygrounds appears weak at this point in time.Rather, the present role of Government is incarrying out assessments of the potential risksto the energy systems and to ensure that themarket has taken adequate measures tomanage these risks. Some residual interventionis needed. Policy-makers and regulators willneed to be constantly alive to the possibilitiesfor under-investment in networks, and fordistortions in the incentives to invest in newgeneration capacity in electricity markets,though the present position is satisfactory.

9.4 Some people may consider that this reviewtakes too relaxed a view of future oil and gassupplies. There is a difficult balance to be struckbetween a hasty response to new concerns andinaction. The UK will become more dependenton trade for its oil and gas supplies, just as weare already dependent on trade for imports ofother basic needs. Trade is generally a means ofincreasing diversity of supplies. Nevertheless,such a shift brings with it new risks andchallenges, and it is not something to which wecan be indifferent. It means, for example, thatthe Government must give greater attention torelations with the countries that we will dependon for supplies.

9.5 So far as gas supplies are concerned, risksmay in part be managed by reliance on backup– storage or LNG – in part the answer may beto ensure that we do not become over-relianton imports from just one country, which mayrequire new international interconnections. Butthough these problems should be confrontednow, they are not pressing, particularly sincethere is still a lot more production to be hadfrom the UKCS. There are already internationalmechanisms in place to increase oil security,and growing attention is being paid to ways ofsecuring gas networks. The liberalisation of EUgas markets will add to security since it willincrease the ease with which fluctuations inEuropean demand and supply can beaccommodated. UK policy should continue tooffer active support to this process.

9.6 The review has not been convinced by theargument that, in order to secure diversity ofelectricity supplies, purchase obligations shouldbe used to carve the market up into pre-determined shares for gas, coal, nuclear, CHPand renewables. The review takes the view thatthe risks can be managed in other ways. This isnot a popular view: there are many interestsopposed to what may be seen as an excessivelylaissez-faire view. The approach does not meanthat the Government or the regulator canwithdraw from active involvement in the

development of the market. But the losses fromconstraining the market in this way would belikely to out-weigh the gains, and the potentialrisks can be managed. The case for arenewables obligation is special, and relates tothe need to develop new low carbon options.

Low carbon policies9.7 This review identifies a programme ofchange to be delivered through a newinstitutional structure. It does not develop aprogramme of legislation – though it is possiblethat some legislation might be needed.Nevertheless, it presents a radical agenda.Keeping the UK on a path towards a lowcarbon economy could not be otherwise.

9.8 The roots of the programme are alreadycontained in existing policy approaches. What isnew is the priority accorded to climate changeobjectives. If big cuts in carbon are required thiswill require focused attention.

9.9 The RCEP target of 60% reductions incarbon emissions covers a period of some 50years, which will be characterised by greatuncertainty. Nevertheless, if there was to be atarget of this kind, a number of important taskswould need to be to be undertaken as soon aspossible, some within the next five years. Thesetasks would comprise detailed policy analysis,the creation of new policy instruments and thereordering of R&D priorities.

9.10 Some of the tasks reflect changes in theframework for decision-making. Policy should:

● move more quickly to determine the rightbalance of policy instruments – taxes,permits, regulation – in order to createpowerful incentives for long-term carbonreduction, particularly where substantialcapital investment and technical change areinvolved. Good policy will normally require amix of different instruments including actionsthat directly tackle specific market failures,but the Government should prepare for

greater future use of economic instrumentsthat enable the wider environmental costs ofcarbon to be incorporated into marketprices;

● consider the central role of innovation.Innovation often needs to be seen in aninternational context, but in some cases a UKspecific approach may be required;

● consider which measures would mostappropriately be taken by the UK unilaterally,or collectively on an EU (or widerinternational) basis. In this context, decisionswould need to be compatible withsafeguarding the UK’s internationalcompetitiveness; and

● consider the appropriate institutionalarrangements to deal with the size andcomplexity of the task involved.

9.11 In establishing the basis for long-termpolicies, three considerations stand out:

● given the size of the task, involving thetransformation of UK energy supply and use,the RCEP objective could not possibly beachieved except as a prolonged, cumulativeprocess, involving, among other things, theprogressive adaptation or replacement ofmost of the existing capital stock;

● adverse underlying long-term trends meanthat, even if the measures in the latestClimate Change Programme achieved all theplanned CO2 savings by 2010, at some pointthereafter emissions would once againresume an upward trend in the absence offurther measures; and

● many of the measures to reduce CO2 haveinherently long lead times as a result of thelarge-scale capital projects involved, thepreparatory work needed to removetechnological uncertainty and market barriersand distortions, or the lengthy internationalnegotiations required.

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9.12 The timeline for action is set out in detailin Chapter 10. However, immediate prioritiesinclude:

● energy efficiency should be prioritisedat the highest levels of government and anew aspirational target set for improvementsin domestic energy efficiency. Ministersshould extol the prospects, and throughoutthe public and private sectors investorsshould review the possibilities;

● innovation, including in energy saving. Ifthe UK can focus on technical challenges –like the challenge of improving efficiency inolder homes – then we may make some realbreakthroughs. These are potentially majornew opportunities for British business;

● the renewables programme needs tobe reaffirmed and Government needs tobe sure that it has in place all themechanisms needed to meet the targets setfor 2010. Some institutional barriers still needto be removed. Thereafter a further target of20% for 2020 is needed;

● three institutional barriers to renewables havebeen identified in this review: the treatmentof small and intermittent generators inNETA; the need for new approaches tocharging for and running, localelectricity distribution networks; andthe workings of the planning system. Animmediate task for the Sustainable EnergyPolicy Unit should be to monitor progress inremoving these barriers. If change is notpossible within existing structures, then theuse of legislation to remove the barriers willneed to be considered; and

● transport may not be the most cost-effective area in which to make major newimprovements now, but in the longer-termthe world as a whole needs to be trying tomove away from oil-based transport. Asproposed in the Powering Future Vehiclesconsultation, the Government should settargets for and monitor progress towards a

low carbon transport sector. Handling theprojected growth in aviation energy use andCO2 emissions must become a priority forthe transport community.

Fuel poverty9.13 Achievement of the social objective toovercome fuel poverty is an importantgovernment objective, particularly in the shortterm. The UK Fuel Poverty Strategy target isthat no vulnerable household will be in fuelpoverty by 2010, with other households beingtackled once progress has been made in thepriority vulnerable groups. Therecommendations in this review will influencethe factors determining the number ofhouseholds in fuel poverty (see Annex 4).Additional improvements in energy efficiencywill further reduce the numbers suffering fromfuel poverty though some of therecommendations in the review will raise costsand probably prices. This establishes theimportance of early progress towards fuelpoverty targets as a means of reducing theconstraint on environmental and securitypolicies. Government should consider othermeans to tackle residual fuel poverty in a worldwhere energy prices may be higher than today.

Managing risk: responding touncertainty and newinformation9.14 It is central to our recommendations thatgovernments should accept the uncertaintiessurrounding energy policy interventions. Wecannot know for sure how successful givenpolicy initiatives will be. Government can setthe framework within which markets operate,but it cannot determine precisely whichtechnologies will work best or whichopportunities will prove most commercial.Although the review is generally opposed topicking winners, some generalised preferences

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are necessary in order to get low carbontechnologies on the move. Similarly, securityconcerns mean that some interventions areneeded now and further intervention could beneeded later if adverse trends becomeapparent.

9.15 Government’s aim should be to createoptions for the future and, so far as possible, topreserve some flexibility of response. This mustnot be taken as a recipe for inaction: quite thereverse. Action is needed to assist innovationand to create new options, and action is alsoneeded to manage risk.

9.16 Some decisions that are recommended forthe present must be reviewed through time toensure that they are working as planned. If theyare not, then various means of mitigation needto be considered. The likelihood that particularmitigation measures would be adopted changesover time. Thus, while the initial reaction to theapparent failure of a policy should generally beto try to improve the original policy framework,longer-term signals that things are not workingas planned are likely to call forth more drasticremedies, until finally the original approachshould be abandoned. These ideas aredeveloped further in Chapter 10.

9.17 One consideration is the time taken torespond, once a decision has been taken tochange direction. Some indication of responsetimes is given in Annex 7.

Opening the debate9.18 The implementation of an ambitious lowcarbon policy would be a demanding task. Thepublic should be in no doubt about the politicalcommitment behind the proposals. Changeslike these could not be produced as a result ofquick technical fixes: technology has a largepart to play, but just as important are changesin attitudes and assumptions. Commitment to alow-carbon energy policy would imply a

general shift in perception. A wide range ofactors within and outside the energy industrywould need to evaluate their energy policydecisions, and gradually move towards lowcarbon use. Given the inertia in the energysystem, and the fact that the most low carbontechnologies are barely part of the currentconventional energy system, a change ofdirection would be difficult to achieve. It wouldbe wrong to imagine that everything can be“win-win”: there are some hard choices andthere will be losers as well as winners. For thisreason the Government needs to take the issuesto the public soon.

9.19 The PIU review has, to the extent possible,been conducted in the open. A wide range ofcontacts has been made with representativebodies, NGOs, the energy industry and, bycorrespondence, with members of the public.But it has not engaged fully with members ofthe public. This was deliberate: the review wasconducted against a rapid timescale andcontacts were inevitably compressed into aboutfour months. A proper process of publicconsultation and debate would take longer andbe much more intensive. During the review,proposals were made to the PIU for a process ofpublic engagement. This should constitute acentral part of the implementation of thefindings of the review (see Chapter 10).

9.20 This debate has several facets:

● one is the potential role of nuclear energy infuture energy systems. This is a difficult andpolarised debate. It will be interesting to seehow far more information can resolve thedifferences but ultimately different values areat stake;

● there is an equivalent debate about thefuture contribution of renewable resources:this will be big, but quite how big is a matterof dispute. Again some of these differencescan be resolved by more information andanalysis; and

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● more active involvement of consumers andcommunities, coupled with greaterunderstanding by customers of the impactsof, and the potential for, altering their energychoices would be a valuable tool in meetingthe objectives of sustainable development. Inpart this involvement can be brought aboutby new technologies, like metering, but itwould also reflect a different process ofpublic discussion and debate about energyoptions, for example in the planning system.

9.21 This review has not outlined a blueprintfor a new energy economy. It establishes thefirst step only. Sustainable energy is vital for theUK in the medium to long run. It needs to bechampioned within government. But the newagenda will take all the participants in energymarkets – producers and consumers – into newrealms. This review will be the start of a debaterather than its conclusion.

9.22 A radical agenda implies substantialchange, and widespread public acceptance ofthe need for change. The nation must not belulled into inaction by the focus of much of theexpert debate on long time scales, and onenergy systems in a future that will belongmainly to our grandchildren. The time foraction is now and all players in the energysystem have a role to play. Given that there isconsiderable inertia in the system, and thatmost low carbon technologies are not part ofthe conventional energy system, a change ofdirection will be difficult to achieve. It wouldrequire considerable clarity of purpose in allparts of the Government.

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10. IMPLEMENTING THE RECOMMENDATIONS

Introduction10.1 The challenge of this review was todevelop a vision for energy policy for the nextfifty years and a strategy and practical stepstowards it. The aim of this Chapter is to set outthe timing of the action required to implementthe main recommendations. It does not coverall the recommendations made. The full list ofrecommendations can be seen at the end ofeach Chapter.

10.2 Given the remit of the review, therecommendations relate predominately to thecentral government departments. However, asdiscussed in Chapter 1, a number of key areasrelating to energy policy are devolved mattersin Scotland and Wales. Given the importanceplaced on these aspects of energy policy, it isclearly essential that the DevolvedAdministrations are involved with theimplementation of these recommendations.This will include close liaison with Whitehall, inparticular through direct participation in theSustainable Energy Policy Unit, and thedevelopment and implementation of policy ondevolved issues.

Timeline for action10.3 Some of the main recommendations, ifthey are accepted, need to be acted uponimmediately; others are pointers to futureaction. It is important to recognise issues oftiming. The review emphasises the importanceof allowing energy policy to evolve as newinformation arrives. In some cases, given thelong lead times associated with energy marketinvestments, action should not be delayed. Inothers, given uncertainties – about internationalco-operation, technologies, costs and demand –

it makes sense to wait until more informationhas accumulated with the passing of time

10.4 The main recommendations are dividedinto three time scales: those that requireimmediate action; those that need to beimplemented over the next three to four years;and those that can afford a slightly longer timescale, taken here to be between five to tenyears. Each main recommendation has a leaddepartment and implementation dateidentified; and we would expect the MinisterialSub-Committee on Energy Policy (DA(N)),chaired by the Deputy Prime Minister, to takean active role in ensuring that theserecommendations are implemented within thetime scales set out below.

Immediate action required inthe follow-up to the review10.5 There is some immediate action requiredby Government in response to this review:

● Following the publication of this review, theDTI should start a process of full publicconsultation and engagement in energypolicy. The debate on long-term energypolicy was started by the publication of theRCEP report in June 2000. The debate shouldnow be starting to move towards aconclusion. This means that the Governmentshould publish its response to this report,and separately to that of the RCEP, wellbefore the end of the year. These responses,which should have been informed by publicviews on energy and environmental issues,should follow a process of publicengagement that must be set in train soon.By March 2002, the DTI should start toinvolve the wider public in these debates.

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One technique that might be used is that ofthe Citizens Panel and the ConsensusConference.1 This first round of public debateshould be completed by August 2002.

● Following this public consultation, the DTIshould publish a response on behalf of theGovernment by October 2002. This responsecould take the form of a Governmentstatement to Parliament or a White Paper. Itwould foreshadow any new legislation andwould indicate whether the generalstatement of the overall objective of energypolicy should be redefined.

● Government should set up a cross-cuttingunit (initially based in DTI, described aboveas the “Sustainable Energy Policy Unit”(SEPU)) to oversee the future direction ofenergy policy; to implement the findings ofthe PIU review; and to provide an enhancedenergy analytical capability. A shadow unitneeds to be in place by May 2002, with theunit being fully operational by October2002.

● The Unit, initially located in the DTI, wouldreport to the Energy Minister and throughhim to DA(N), chaired by the Deputy PrimeMinister, which should have responsibility foroverseeing the implementation of this review.The Committee should formally review theprogress of implementation 12 months afterthe Government statement on the review(and, if required, 24 months after theGovernment’s statement).

● The Ministerial Group on Low-CarbonVehicles and Fuel, should be responsible foroverseeing the implementation of the finalPowering Future Vehicles strategy, workingalongside DA(N).

Main recommendations thatshould be implemented overthe next three years10.6 There are some main recommendationsthat should be implemented almostimmediately, and in any case within the nextthree years:

2002-5

Framework recommendations

● Where energy policy decisions involve trade-offs between environmental and otherobjectives, then environmental objectives willtend to take preference over economic andsocial objectives. The DTI should redefine itsgeneral energy policy objective. The newobjective could be “the pursuit of secure andcompetitively-priced means of meeting ourenergy needs, subject to the achievement ofan environmentally sustainable energysystem” (by end 2002) (3.35 and 3.37).

● There is no simple way to resolve residualtrade-offs. Each case will demand separateanalysis. It is recommended that to assist thisprocess HMT should establish, and keepunder regular review, shadow prices for keyenvironmental externalities and other non-economic policy objectives (by end 2002)(3.44).

● HMT and DEFRA should give earlyconsideration to expanding the use ofcarbon valuation through taxes or tradablepermits to cover as much of the energymarket as possible. This could involveexpansion or modification of the currentEmissions Trading Scheme and should ensurethat UK companies could participate ininternational carbon trading schemes,

1 A consensus conference is a forum at which a citizens’ panel, selected from members of the public, questions experts (or witnesses)on a particular topic. The Panel then assesses the responses, discusses the issues raised, and reports its conclusions at a pressconference. A distinctive feature of this approach is that the citizens’ panel is the main factor throughout. Consensus conferences areespecially suited to dealing with controversial issues of public concern at a national level which are often perceived as being toocomplex or expert dominated. Source: UK Consensus Conference on Radioactive Waste Management, Executive Summary.

including the draft EU scheme, as soon asthese are introduced (by end 2004 and on-going thereafter) (3.79).

Security recommendations

● The recently established DTI/OfgemWorking Group on Security of Supply(WGSS) should expand its existing activitiesto take on responsibility for monitoring all ofthe risks to security of the energy systemdiscussed in Chapter 4. In order to do thiseffectively it will need to:

● expand its membership to includerepresentatives from the FCO, since manyof the risks have an importantinternational element (immediate);

● build on the Group’s existing monitoringindicators to monitor all risks to security ofsupply discussed in Chapter 4 – onecompletely new area for the group will berisks to oil supplies (by the end of 2002);and

● conduct ongoing monitoring of all ofthese indicators, in order to establish howthe risks alter over time (ongoing)(4.112).

● FCO should ensure that foreign policy ismore fully integrated into the energy policyprocess (ongoing, but to start immediatelywith their integration into the WGSS) (4.60and 4.65).

● DTI should continue to champion theliberalisation of European energy markets andsupport the European Commission inpressing forward with the relevant Directives(immediate and ongoing) (4.60).

● There is no case for restricting the share ofgas in the power sector at this time.However, the WGSS should monitor thissituation, in particular to assess the marketsignals surrounding gas prices (ongoing, butto have started by end December 2002)(4.27).

● DTI should carry out an assessment of thecost-effectiveness of policy responses thatcould enhance security of the system, someof which are suggested in Chapter 4. Theseresults should inform decisions on anycontingency action taken in response to themonitoring (by end 2003) (4.28).

Low Carbon recommendations

● DTI and OST should take steps to increasethe level of funding for low carbon energyR&D. The priority areas of the Chief ScientificAdviser’s Research Review Group represent agood starting point (immediate andongoing) (7.3).

● DEFRA should develop energy efficiencyindicators, targets and monitoringmechanisms for each sector of the economy(by end 2003) (7.9).

● DEFRA should develop a Strategy for HomeEnergy Efficiency to set out a clear, long-termframework and the policy instruments thatmight be used in this strategy. This shouldinclude an aspirational target for homeenergy efficiency of 20% improvement by2010 followed by a further 20%improvement by 2020 (by September 2002)(7.11).

● In order to encourage a range of renewableoptions, and maximise the chances of rapidand long-term learning and cost reductions,DTI should set a firm target of 20% ofelectricity to be supplied from renewables for2020 (immediate) (7.63).

● In respect of NETA, Ofgem should developtransitional measures in parallel to be readyto be implemented (by January 2003) incase current measures are unsuccessful inhelping small generators. DTI shouldconsider potential legislation to move thisobjective forward (for immediateconsideration, but process to have finishedby end 2003) (7.67).

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● DTI should take the necessary actions tokeep the nuclear option open (ongoing)(7.78).

● DTI should decide whether to support aprogramme for carbon capture andsequestration, and if so by what means (byend 2003) (7. 91).

● DTLR should work with EU partners andmotor manufacturers to secure furtherimprovements in the energy efficiency ofroad vehicles and to open options for lowcarbon fuelling in the longer-term (ongoing)(7.96).

● DTLR should prioritise discussion of taxationand other measures to manage aviationdemand in EU and international forums(immediate and ongoing) (7.102).

Institutional frameworkrecommendations

● DA(N) to consider whether responsibility forenergy efficiency and CHP policy should belocated with other aspects of energy policy(by end 2003) (8.19).

● SEPU and OST to develop more detailedproposals for a national Energy ResearchCentre to take forward co-ordinated lowcarbon R&D (by September 2002) (8.21).

● DTI to sharpen Ministerial guidance toOfgem on environmental issues (by end2002) (8.25).

● Ofgem to produce comprehensive analysesof significant regulatory proposals, taking fullaccount of the costs falling on the energyindustry and consumers (immediate andongoing) (8.27).

● DEFRA and DTI to carry out a review of lowcarbon delivery organisations (by end 2003)(8.32).

● DTLR and DEFRA to consider the need foradditional resources to build capacity in localauthorities and the voluntary sector, in

particular for energy efficiency activities (byend 2002) (8.37).

● DTLR in liaison with DTI and others, toupdate national planning guidance, makingclear the circumstances where there is anational case for new investment in energy-related facilities (by end 2003) (8.41).

● Regional planning bodies to give greaterprominence to energy developments inregional planning guidance (immediate andongoing) (8.42).

● Local authorities to ensure that greateremphasis is placed on proactive planning forenergy developments in sub-regional plans(immediate in current planningarrangements, then subject to DTLRreform of planning) (8.42).

● DTI should develop a policy on strategicoffshore issues for new technologies toinform Government decisions (by end 2002)(8.43).

Main recommendations thatshould be implemented overthe next ten years10.7 There are other main recommendationsthat will require a slightly longer time-scale toimplement:

2005-10

Security

● SEPU and WGSS to continue to monitor theindicators of security of supply (ongoing)(4.112).

Low carbon recommendations

● DTI should establish the renewable energysupport mechanisms to ensure that the 2020target of 20% is met (to be in place by theend of 2008) (7.64).

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● For network investment for embeddedgeneration, Ofgem should ensure that thatthe recommendations of the EGWG areimplemented (by end 2005). DTI shouldconsider legislation to move this forward inthe event of obstacles to progress (startconsidering legislation early in 2005 ifnecessary) (7.67).

● Ofgem should ensure that future changes toelectricity trading and grid accessarrangements do not discriminate unfairlyagainst renewable and CHP generation(ongoing) (7.67).

Institutions

● Government should aspire in the long-termto bring together in one departmentresponsibilities for climate change, energypolicy and transport policy (ongoing) (8.13).

Next Steps

● DA(N) to oversee the 2007 Energy policyreview (discussed below).

Involving the DevolvedAdministrations10.8 As policy evolves, Whitehall departmentswill need to ensure that their actions are co-ordinated with the parallel development ofpolicy in the Devolved Administrations. This canpartly be done through the SEPU, but othercontinuing contacts are also needed. Since theenergy situation in the territories of theDevolved Administrations is distinctive, it seemsinevitable that there will differences in timingand emphasis. For example, Scotland’selectricity balance is currently highly dependenton nuclear power, while there is potentially ahuge capacity for renewable generation. Thesefactors are likely to influence the focus of theScottish policy debate. In Wales too there aredistinctive views about the balance betweenrenewables and other options. Energy policy in

Northern Ireland is fully devolved, but newpolicies will need to be related to parallel GB,and indeed EU, developments.

The need for periodic reviews10.9 This review and its recommendations havefocused on the steps needed to start theprocess of change, within the context of a fifty-year period. It does not present a detailed planfor energy systems to 2050. The uncertaintiesinherent in the energy markets dictate that sucha review could not have been otherwise.Maintaining the drive towards a low carbonfuture will require constant monitoring of theenergy system by the SEPU. It will also require aseries of periodic reviews to take stock of theprogress made in relation to the overall goaland to see what, if any, changes to policy arerequired.

10.10 We recommend that the first of thesereviews should be carried out in 2007. Withinthe time scale to 2007, a number of mainevents are likely to have happened andsufficient time will have elapsed to allow for thetrends since the review to be observed. Thesekey events are described in Box 10.1.

10.11 2007 would therefore seem a naturalpoint at which to carry out a full review of theprogress made. An important element of the2007 review will be a re-assessment of theissues highlighted in this review. In many cases,the passing of time will have brought a greaterlevel of certainty.

10.12 The main questions for the 2007 reviewwill be:

What have been the main developments,both in the UK and globally, since the 2001review in each of the following areas:

● International climate change agreements;

● low-carbon technologies: energy efficiency;CHP; renewables; nuclear, carbonsequestration and transport;

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● fuel mix: the share of each fuel in theprimary fuel mix;

● liberalisation of the European energymarkets;

● security of supply; and

● institutional events?

Have the policy recommendations from the2002 review been successful? And if not, hasthis been a fault with the policy? Or is therea more fundamental problem inherent inthe energy system?

What future policy recommendations areappropriate in relation to the low carbontechnologies, fuel mix and fuel sources?

10.13 A major theme of this review has beenthe risks and uncertainty inherent in the energymarket. Uncertainty about government policycan itself add to market uncertainty. IfGovernment periodically sets out a vision forenergy policy, and restricts major changes in

policy to these reviews, this should help toreduce some of the uncertainty. Thus, animportant function of the 2007 review will beto re-state the long-term vision for energypolicy. It should also set the date for the nextperiodic review.

Ad hoc reviews10.14 In an ideal world there would be no needfor changes in energy policy between eachperiodic review. However, events can happenthat mean that the path on which energysystems are moving has to be temporarily, oreven fundamentally, changed.

10.15 Although, by their very nature, suchevents are impossible to predict, the continuousassessment of long-term trends in the energymarket carried out by the SEPU will put the UKin a better position to spot quickly thefundamental shifts to the energy system.Further, continuous analysis will put the UK

Box 10.1: Events that are likely to have happened by 2007Events related to the low carbon agenda:

● the shape of post-Kyoto agreements will have become clearer;

● the impact of latest EU directives on acid rain will be more apparent;

● the EU carbon emissions trading scheme should have been introduced;

● the Renewables Obligation will have been subject to a review;

● more of the Magnox stations will have closed; and

● DEFRA’s review of nuclear waste will have reached its conclusions.

Security related events:

● the European energy markets should have been liberalised; and

● the UK may have moved from a position of net exporter to that of net importer for gas and, willbe moving much closer to that position for oil.

Institutional events

● the DTLR ten-year plan for transport will be reaching its final stages;

● the DTLR review of the planning mechanisms will have been implemented; and

● further progress will have been made to reduce fuel poverty.

Government in a better position to react in atimely and appropriate manner to adverseevents, or trends, when they occur.

10.16 In the event of such adversedevelopments there may well be a case for adhoc reviews of the basis for policy. Examples ofthe type of events, or trends, that mightwarrant such ad hoc review include:

Low carbon technologies

● a low carbon future is rejected by theinternational community;

● the take up of low carbon technologies, inparticular energy efficiency and renewables,has been slow and/or much more expensivethan anticipated at the time of this review;and

● the development of new low-carbontechnologies, for example new transportfuels and renewable energy technologies, ismuch slower than envisaged in this review.

Security

● EU liberalisation fails to proceed at the speedset out in the EU gas directive, and hencethere is a lack of a large and deep liquidmarket for gas;

● there is a sustained period of high andvolatile energy (especially oil and gas) prices;

● there are increasing signs that the investmentrequired to maintain the systems, includingthe networks, are not likely to be made; and

● there is a fundamental shift in the reliabilityof the oil and gas exporting countries.

Engaging the public10.17 Monitoring the system and carrying outreviews are only part of the story, and will notin themselves be enough. If the UK is to meetthe vision set out in this review, there needs tobe a fundamental change in the way that weview, and use, energy. In pursuing a newapproach to energy policy, the Governmentneeds to understand the views and concerns ofthe general public. The Government has a dutyto explain its own approach to the public, but italso needs to gather feedback. Following thepublication of the PIU review, there will be aperiod of debate on the recommendations.However, this is only the beginning. And theconsultation carried out in the aftermath of thisreview should be seen as only the beginning ofa longer programme of public engagement inenergy issues.

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The Performance andInnovation Unit1. The creation of the Performance andInnovation Unit (PIU) was announced by thePrime Minister on 28 July 1998 as part of thechanges following a review of the effectivenessof the centre of government by the CabinetSecretary, Sir Richard Wilson.

2. The PIU’s aim is to improve the capacity ofgovernment to address strategic, cross-cuttingissues and promote innovation in thedevelopment of policy and in the delivery of theGovernment’s objectives. The PIU is part of thedrive for better, more joined-up government. Itacts as a resource for the whole of government,tackling issues that cross public sectorinstitutional boundaries on a project basis.

3. The unit reports direct to the Prime Ministerthrough Sir Richard Wilson. A small centralteam helps recommend project subjects, andmanages the unit’s work. Work on projects iscarried out by small teams assembled both frominside and outside government. About half ofthe unit’s current project team staff are drawnfrom outside Whitehall, including from privatesector consultancies, think tanks, NGOs,academia and local government.

4. Comprehensive information about other PIUprojects can be found on the PIU’s website athttp://www.piu.gov.uk

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ANNEX 1. THE ROLE OF THE PERFORMANCE ANDINNOVATION UNIT

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ANDADVISORYGROUP

ANNEX 2. PROJECT TEAM, SPONSOR MINISTER ANDADVISORY GROUP

The report was prepared by a multi-disciplinaryteam, drawn from the public and privatesectors, and guided by a Ministerial Sponsorand Advisory Group with Government and non-Government representation.

The TeamThe team was led by Nick Hartley, onsecondment from OXERA Consulting Ltd.Catriona Laing, Team Leader for the ResourceProductivity and Renewable Energy project (onsecondment from Department for InternationalDevelopment), worked with Nick Hartley onmanaging the integration of the energy aspectsof the two projects.

The project team consisted of the following:

● Stephen Aldridge – PIU, Chief Economist

● Sam Armstrong – on secondment fromEnvironmental Resources Management Ltd

● Allan Brereton – PIU

● Jake Chapman – part-time team member,National Energy Services Ltd

● Ian Coates – PIU, Government Economist

● Emily Corsellis – on loan from theDepartment of Trade and Industry (DTI)

● Nick Eyre – on secondment from the EnergySaving Trust

● Robert Gross – on secondment from ImperialCollege Centre for Energy Policy andTechnology

● Alison Kilburn – PIU, Government Economist

● Gordon MacKerron – on secondment fromNational Economic Research Associates

● Catherine Mitchell – on secondment fromthe Centre for Management underRegulation, Warwick Business School

● Bill Nickerson – on secondment from theMassachusetts Institute of Technology (Juneto August 2001)

● Richard Penn – on loan from DTI

● Alison Sharp – PIU

● Iain Tomlinson – PIU

● Shane Tomlinson – PIU

Consultants to the project team providedexpert input on a part-time basis during thecourse of the analysis. The project team itself isresponsible for the report’s finding and finalrecommendations.

● John Chesshire, Freelance Consultant

● Malcolm Eames, Policy Studies Institute

● Malcolm Fergusson, Institute for EuropeanEnvironmental Policy

● David Milborrow, Freelance Consultant

● Robin Smale, OXERA Consulting Ltd

● David Smol, ILEX Energy Consulting Ltd

● Goran Strbac and Nick Jenkins, University ofManchester Institute of Science andTechnology

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Sponsor Minister and AdvisoryGroupThe team was greatly assisted by being able todraw on the expertise and advice of its SponsorMinister and Advisory Group. The teamgratefully acknowledges the advice and timegiven by each Advisory Group member.

Brian Wilson Minister for Industry and Energy,DTI (Sponsor Minister)

Michael Meacher Minister for the Environment,DEFRA

Paul Boateng Financial Secretary, HM Treasury

Peter Hain Minister for Europe, FCO

David Jamieson Parliamentary Secretary, DTLR

George Foulkes Minister of State, ScotlandOffice

Don Touhig Parliamentary Secretary, WalesOffice

Anna Walker DTI (replaced by Geoff Dart,November 2001)

Richard Bird DEFRA

Harry Bush HM Treasury

Chris Segar FCO

Geoffrey Norris Senior Policy Adviser, No 10

Callum McCarthy Chairman of GEMA andChief Executive of Ofgem

David King Government Chief Scientific Adviser

Sir Tom Blundell Chair, Royal Commission onEnvironmental Pollution

Paul Jefferiss RSPB

Tony Cooper Prospect

Sir John Collins Chief Executive, the VesteyGroup and Chairman of the DTI EnergyAdvisory Panel

Ann Robinson energywatch

Geoff Mulgan Director, PIU

171

ORGANISATIONSCONSULTED

ANDSUBMISSIONSRECEIVED

ANNEX 3. ORGANISATIONS CONSULTED ANDSUBMISSIONS RECEIVED

Adam, Gordon

AEAT

AES Limited

Anketell, Judith

Akintewe, Maureen

Alkane Energy plc

Allard, Paul

Allday, Con

All Party Parliamentary Coalfield CommunitiesGroup

Allsobrook, Christopher

Alstom UK

Alun L Shaw

Amalgamated Engineering and Electrical Union

Amerada Hess

Amos, J H

Architects & Engineers for Social Responsibility

Arthur D Little

Ash, Sir Eric, et al

Assirati

Association for the Conservation of Energy

Association of Coal Mine Methane Operators

Association of Electricity Producers

Atkinson, Sean

Atomic Energy of Canada Ltd

Audland, Sir Christopher

Babtie Group

BAE Systems

Baker, Elizabeth

Baker, Emma

Ball, Alex

B & Q plc

Barfield, Katie

Barraclough, Richard

Barry, Marilyn

Bates, James

Baxi-Sigma dCHP Collaboration Team

Bayes, A

BEAMA

Beason, Richard

Beauchamp, Nichole

Berry, Andrew and Frances

Beuker, Jenny

BG Group

Biddulph, Tim

Biox Consultants

Bitor

Bizz Energy

Blandford, Dr Alan

Bloodsworth, Colin

Blundell, Neil

British Nuclear Energy Society - YoungGeneration Network

BNFL

Boardman, Mike

BOC Group

Bonass, Helen

Bodenham, Paul

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ANDINNOVATIONUNIT

Bond, Graham

Bond, John

Border Biofuels

Borman, Michael

Bowman, A I

Bowman, Graeme

BP

Bradford, Mark

Bradley, Stephen

Braid, Dr Neil

Brake, Joe

Brake, Tom

Brassington, A R

Brayshaw, H

Bringing the Climate Criminals to Justice

British Association for Biofuels and Oils

British Association of Colliery Management

British Biogen

British Cement Association

British Energy

British Energy Association

British Energy Nuclear Industry Forum

British Nuclear Energy Society

British Sugar

British Wind Energy Association

Brough, David

Brown, Mark

Brown, Hilary

Brownlow, Julia

Bruley, Clive

Brutton, Florence

Buckley, Carolyn

Buckley, David

Butler, Kelly

Button, John

Buxton, John

Bywater, Lucy

Cabinet Office European Secretariat

Cain, Anthony

Cairns, Professor R A

Callaghan, Sue

Calvert, Jack and Ann

Campaign for the Protection of Rural Wales

Carbon Trust

Cargill plc

Carpenter, Chris

Carroll, Malcolm

Castagnera, Christopher

CBI

Centre for Better Homes plc

Centrica plc

Channell, Oliver

Chatham House

Chatfield, David

Chemical Industries Association

Chown, Katie

Christian Ecology

City and Council of Swansea

Clarke, Tasha

Clearvision International

Cloot, Peter and Sheila

Coal Authority

Cobb, Rosanne

Combined Heat and Power Association

Commission for the European Union,Directorate General for Energy and Transport

Communique PR

Confederation of UK Coal Producers(COALPRO)

Conoco

Confederation of Renewable EnergyAssociations

Confederation of UK Coal Producers

Consumers Association

Conway, Vida

Cook, Lindsey

Coombe, Miles

Coppice Resources Ltd

Corry, Rupert

Cottenden, Karen

Cottrell, Sir Alan

Countryside Agency

Couzens, Michele

Cowell, Charlotte

Cowper-Lewis, Meg

Cox, Nicholas

Cumbrians Opposed to a RadioactiveEnvironment (CORE)

Corus

Country Land and Business Association

CPRE

CREA

Cresswell, P S

Crown Estates

Crozier, Richard

Darby, Mari

Davies, D J L

Davies, Jill

Davis, Kevin

Dawes, Mark

Department for Environment, Food and RuralAffairs

Department of Trade and Industry

Department for Transport, Local Governmentand the Regions

Dickens, Susan

Dingman, Mark

Dixon, Alex

Dixon, Harry

Donely, Gary

Donnelly, Tracey

Downs, Sophie

Drinkwater, David

Dunbar, Lindsey

Dunkley, Nicola

Earle, Patrick

Earls, David

Edison Mission Energy

Edkins, Wendy

Edwards, Alison

Edwards Energy Limited

Edwards, Leila

Electricité de France

Electricity Association

Electricity Supply Trade Union Council

Energy Action Scotland

Energy Advisory Panel

Energy Club

Energy from Waste Association

Energy Intensive Users Group

Energy Saving Trust

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energywatch

English, Clare

Ennis, Mary

Enron Europe

Environment Agency

Environmental Industries Commission Limited(EIC)

Enterprise Oil

Ericson, Katarina

Erlam, Andy

ETSU

EURATOM-UKAEA Fusion Association

ExxonMobil

Fairhead, Tim

Fawcett, Michelle

Fellowes, Brian

Fells Associates

Finnegan, Sarah

First Renewables

Flack, Paula

Fleming, David

Ford, C B

Ford, Sally

Fordham, Rodney

Foreign and Commonwealth Office

Foresight (Energy and Natural EnvironmentPanel (ENE))

Forestry Commission

Forster, Louise

Fortin, J

Forward Strategy Unit, Cabinet Office

Fox, J & N

Fox, John

Fraser, Barbara

Friends of Eden, Lakeland and LunesdaleScenery (FELLS)

Friends of the Earth

Friends of the Earth (S D Eades)

Frith, David

Fremlin, J H

Fryer, Andy

FT Energy

Fuel Cell Power

Fuel Cell World

Gaffney Cline Consultants

Gammon, Christopher and Linda

Garnham, David

Gas and Electricity Markets Authority

Gas Forum

Gas Industry Emergency Committee

GASTEC at CRE Ltd

Gibbins, Dr Jon

Gilroy, Dr K S

Global Commons Institute

Global Oil Watch

GMB

Godfrey, Michou

Gomersall, Fiona

Goodwin, Jenny

Grainger, Anne

Gratton, Peter

Green Alliance

Greenpeace

Grimshaw, Jane

Haines, Professor M G

Hackney, Janet

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Harding, K

Harpuc, P

Hartson, Caroline

Hayes, David

Hayles, J M

Heads, Kiri

Health and Safety Executive

Helm, Dr Dieter

Hendserson, Casper

HM Treasury

Holland, Catherine

Holland, Philip

Holliday, Professor Sir Frederick

Hondros, John

Hopcraft, Keith

Horsler, Andrew

Hubble, Dr David

Hughes, Dick and Angela

Hugill, Jan

Hyder

ICCEPT

Iddon, Mike

Impax Capital Corporation Limited

Incoteco (Denmark) ApS

Independent Chief Executive’s Forum

Industry Leadership Team

Ingham, John

Inglis, Graham

Innogy

Institution of Civil Engineers, The

Institute of Energy

Institution of Professionals, Managers andSpecialists

Institute of Energy and SustainableDevelopment

Institute of Energy

Institute of Nuclear Engineers

Institute of Physics

Institute for Public Policy Research

Inter-Department Analysts Group

International Energy Agency

Intronic

Ireland, D E

Jackson, R F

Jacoby, Ivan

Jefferiss, Paul

JM Associates

Joels, Judith

Jones, Catherine

Jones, Jim

Jukes, Martin

Keech, Pennie

Kemp, Professor Alex

Kemp, Jonathan

Kemp, Martin

Kern, Renee

Kirk, Dr Andrew

Kronschabl, Ana

Lansford, Lewis

Lattice Group

Lawrence, Matthew

Lawrence, Rachel

Lehman, Peter

Lewis, David

Limbert, Derek

Linford, Diana

175



Linnegar, Simon

Livingstone, Steven

Llewelyn, John

Local Government Association

London Electricity

Lonsdale, Jane

Lord Brook, Chairman, House of Lords SelectCommittee on Energy

Lord Ezra

Lord Hardy of Wath

Ludwig, Blake

Lyon, Stephanie

Mackenzie, Elspeth

Mackey, Kate

Macnee, Lorna

Major Energy Users Council

Marathon Oil UK Ltd

Marsden, Heather

Mathieson, Jennifer

Matthews, Roy

Maybank, Janda

McGovern, Donna

McNeill, Paula

Mears, Laura

Melzack, Geneva

Merritt, A

Micro Power

Middlemiss, Nigel

Middleton, Andrew

Milborrow, David

Millar, June

Miller, Emma

Miller, Patrick

Mills, R B

Mining Scotland Ltd

Mitchell, Lynne

MOD Safeguarding

Morrison, Jean

Moulton, Anna

Mulhall, Peter

National Assembly for Wales

National Association of UK Licensed OpencastOperators (NALOO)

National Energy Association

National Farmers Union

National Grid

National Lotteries Opportunities Fund

NEMEX 2001

NERA

Newbery, Professor David

Newell, Christopher

Nirex

NGC

NNC Ltd

NOF

No Opencast

Northern Electric

Northern Ireland Department of Enterprise,Trade and Industry

Norwegian Embassy

Nottingham and Derbyshire Local AuthoritiesEnergy Partnership

Nuclear Free Local Authorities

Nunn, Alan

Ocean Graham

Octagon Energy Ltd

Odell, Professor Peter

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ANDINNOVATIONUNIT

Office of Gas and Electricity Markets (Ofgem)

OFREG

Office of Science and Technology

Oil Depletion Analysis Centre

O’Neill, Cathy

Ongena, Dr Jef

Open University

Orr, Sean

OXERA

Oxford Environmental Change Unit

Oxford Trust

Page, Matthew

Palmer, Jane

Parks, Sally

Patterson, Kirstin

Pavit, Bridget

Payne, Janet

Peachey, Graham

Pearson, Alan

Peed, Nick

Phelps, Sid

Phillips, M

Pilkington, Joanne

PILOT

Pitcairn, Neil

Pontefract & Castleford Constituency LabourParty

Pooley, Derek

Postlethwaite, Ian

Powell, Janet

Powergen

Power Generators Contractors Association

Prescott, Alison

Prew, Colin

Progressive Energy

Prospect - Supported by The Electricity SupplyTrade Union

Prospect - Supported by Trade Unionists forSafe Nuclear Energy

Radioactive Waste Management AdvisoryCommittee

Randon, Claire

Rawlings, Tomas

Reaction Engines Limited

Regional Government Offices

Renewable Power Association

Renewable Producers Association

Renue

Rexconsult

Rice, Gayle

Rice, Jeff

Roaf, Professor Susan

Ross, David

Rothman, Sarah

Royal Academy of Engineers

Royal Institute of International Affairs, Energyand Environment Programme

Royal Society

Royal Society of Chemistry

Russell, Alex

Sackin, Michael

Salerno, Mariella

SCARF

Schroder Salomon Smith Barney

Scotland Office

Scottish and Southern Energy

Scottish Coal

177



Scottish Conservative MSP Group

Scottish Council for Development and Industry,The

Scottish Environment Protection Agency

Scottish Executive

Scottish Natural Heritage

Scottish Opencast Action Group

Scottish Power

Scott, Mary

Seagrave, Jonathon

SEEBOARD plc

SERA

Severn Barrage Project

Severn Tidal Power Group

Sharp, Caroline

Sharpe, Maureen

Shaw, Alan

Shell International Ltd

Sittingbourne Analytical Laboratory

Slator, Margaret

Slingsby, Tom

Smith, Derek

SNP

Social Exclusion Unit

Society of Motor Manufacturers and Traders

Solar Century

Solar Trade Association

Solomon, Justin

Spare, Paul

Spencer, Matthew

SSMB

Stancer, Adam

Statoil

StrataGas

Steeland, Craig

Stockwell, Richard

Stokes, Susan

Stone, Yvonne

Stuart-Anderson, J

Sullivan, Richard

Sumerling, Roy

Supporters of Nuclear Energy

Sustainable Energy Limited

Sustainable Energy Task Force (CAN-UK andLINK)

Sustainable Development Commission

Sweeney, Darren

Talbot, Viv

Talisman Energy

Tamaris Energy

Tansley, Denise

Targett, Anthony

Tasker, Samantha

Teearu, Tina

Teeside Power

Tickell, Sir Crispin, et al

Thompson, Dr K

Thompson, Neil

Thorp, David

TotalFinaElf Gas & Power Limited

TotalFinaElf UK Ltd

Tozer, M C

Trade Union Congress

Transco

Trickett, Emma

Truswell, Linda

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ANDINNOVATIONUNIT

TXU Europe Group plc

Uglow, P

UK Advanced Power Generation Task Force

UK Coal Mining

UK Coal plc

UK Offshore Operators Association Ltd

UK Permanent Representation, Brussels

UK Petroleum Industry Association

UK Power Sector Group

UNISON

United Utilities

Universities Nuclear Technology Forum

University of Manchester

Upton, Anne

Urenco

US Department of Energy

US Embassy London

US State Department

Valentine, Gilbert

Voice, Dr Eric

Wales Office

Walker, Dr Martin

Wall, Sarah

Walter, Guy

Ward, S

Ward, Sarah

Waring, Kit

Warren, Andrew

Warrington, Julie

Waterson, Joan

Watson, L C

Welsh Anti Nuclear Alliance

Wenke, Stefanie

Whittle, Kate

Wilenius, Mr and Mrs

Williams, Chris

Williams, Clive

Williams, Mark

Williamson, Gillian

Willis, Helen

Wills, Helga

Wilson, Helen

Wilson, Paul

Wilson, Richard

Windsor, Colin

Witt, Nicholas

Wolff, Gerry

Woodlands Trust, The

World Fuel Cell Council

World Nuclear Association

Wright, Sarah

WWF

Yorkshire Coal Task Force

Zadurian, Natalie

ZEPG Group

179



1. A fuel poor household is one that cannotafford to keep adequately warm at reasonablecost. The most widely accepted definition of afuel poor household is that it is one whichneeds to spend more than 10% of its incomeon all fuel use and to heat its home to anadequate standard of warmth. This is generallydefined as 21°C in the living room and 18°C inthe other occupied rooms (temperaturesrecommended by the World HealthOrganisation).

2. The Government launched its UK FuelPoverty Strategy on 21 November 2001. Thissets out how the Government and the DevolvedAdministrations will tackle fuel poverty in theUK and sets a target for vulnerable householdsto ensure that by 2010 no older householder,no family with children, and no householderwho is disabled or has a long-term illness, needrisk ill health due to a cold home.

3. Recommendations for policy change made inthe energy review have been analysed for theirpotential impact on the number of householdsin fuel poverty. Fuel poverty is caused by acombination of factors including:

● energy efficiency in the home;

● fuel costs; and

● household income.

4. There are significant difficulties in estimatingthe impact of changes to 2010, 2020 andbeyond due in particular to wide potentialvariations in fuel prices. For the purposes ofestimating the effects of price changes onfuture numbers of households in fuel poverty,

the Fuel Poverty Strategy proposes that areasonable range of price movements between1999 and 2010 would appear to be:1

● for domestic gas prices – plus 15% to minus10% in real terms

● for domestic electricity prices – plus 5% tominus 2%

5. These figures include:

● the rising trend in fossil fuel prices ininternational markets;

● the downward pressure through competitionand regulation;

● a potential 4% increase to electricity prices to2010 due to the Renewables Obligation; and

● a 1.2% increase in gas and electricity pricesdue to the Energy Efficiency Commitment to2005.

It is emphasised that possible price movementmay fall outside these ranges, primarily becauseof uncertainty about the future path of fossilfuel prices and, to a lesser extent, the impact ofregulation on distribution and transmissionscosts.

6. If these extremes were realised, the DTIestimates that the number of households in fuelpoverty could either increase by 0.8 million orfall by 0.3 million.2 These figures do not includethe impact of energy efficiency improvementsin the housing stock or growth in income levels,so any increases could be significantly lower.The uncertainties in fuel price projections makemore detailed analysis unproductive.

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ANNEX 4. IMPACT OF ENERGY REVIEWRECOMMENDATIONS ON FUEL POVERTY

1 DTI, DEFRA (2001), para 3.30. The range of possible price movements identified takes account of plausible changes in fossil fuelprices and the Energy Efficiency Commitment to 2005. For electricity they also take account of distribution and transmission pricecontrols and the Renewables Obligation, whilst for gas they take account of efficiency improvements.

2 DTI, DEFRA (2001), para 3.32. The figures cover the two definitions of fuel poverty discussed in the Strategy (including and excludingHousing Benefit and Income Support for Mortgage Interest) to give the widest possible range of changes.

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ONFUELPOVERTY

7. Within this context of wide futureuncertainty, three sets of energy reviewrecommendations were analysed for theirpotential impact on the number of householdsin fuel poverty: support for energy efficiency,support for renewables and infrastructurechanges. These were the areas thought mostlikely to influence fuel prices and fuel poverty.

8. An extension of the Energy EfficiencyCommitment from 2005 to 2010 could lead toan increase in fuel prices of approx 1%.3

Average fuel bills for low income householdsover the same period could reduce by around1.2%4 due to the energy efficiencyimprovements provided through theCommitment. The net result for fuel poorhouseholds may be a small fuel bill reduction to2010 with benefits continuing to accruebeyond that date.

9. The proposal for extension of theRenewables Obligation to 20% to 2020 wouldnot create an additional price effect to 2010but could increase electricity prices by around5-6% to 2020.5 Based on the DTI estimatesreferred to above, this price change could todayresult in up to about 1/2 million additionalhouseholds falling into fuel poverty. Whenlooking to 2020, it is reasonable to assume thatimproved energy efficiency will reduce thevulnerability of households to falling back intofuel poverty (noting the difficulty of improvingenergy efficiency in households without cavitywalls and not linked to the gas network), andso the impact will most likely be smaller.

10 The proposals for developments ininfrastructure are not considered to have asignificant impact on fuel prices to 2010.However, the implications of issues raised in the

review, including carbon valuation, could leadto fuel price increases in the longer term. (Theenergy review has not considered the issuessurrounding extension of the gas network andits potential impact on the number of houses infuel poverty as these are being considered by aworking group established by Government.6)

11. Thus, it is estimated that the additionalactions proposed by the energy review couldresult in a small fall in fuel bills to 2010 butcould lead to increases to 2020. The impact onthe number of households in fuel poverty willbe reduced by improvements in energyefficiency and staging of future policy actionshould be considered to minimise adverseeffects. However, the uncertainties surroundingfuture fuel prices emphasises the need forregular monitoring of fuel poverty measuresand being ready to review policies andprogrammes to take account of newcircumstances, as set out in the UK Fuel PovertyStrategy.

3 DEFRA (2001a).4 The benefit of a 2-year period of EEC is estimated to be equivalent to approximately a 1.6% fall in average bills. However, low income

households usually take on approximately 70% of this benefit in increased comfort (i.e. the real fuel bill fall will be approx 0.5%).Therefore an EEC extension for 5 years would result in a fall of approximately 1.2%.

5 Derived from OXERA (2001).6 DTI, DEFRA (2001), paras 3.34 and 9.13.

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CHAPTER HEADINGSANNEX 5. ENERGY EFFICIENCY – THE BASIS FORINTERVENTION

Introduction1. Improving energy efficiency is broadlyconsistent with all the major objectives forenergy policy. An increase in the pace ofimprovement is very likely to be needed if weare to achieve a low carbon energy system,certainly if we are to do so at a low cost.

2. The technical and economic potential forimproved energy efficiency has been examinedin detail in the course of the PIU’s work.1 It issummarised in Annex 6 and is broadlyconsistent with the analysis of the Inter-Departmental Group on Low Carbon Options.2

3. Energy efficiency will clearly benefit from theproposals that the costs of climate changeshould be reflected in the price of fossil fuels.However, this is not all that needs to be done.Many energy efficiency opportunities arealready cost-effective. In these cases the marketfailures and barriers that constrain earlyadoption need to be addressed. But ifimprovements in energy efficiency are to besustained, policy also needs to encourageinnovation in the technology and marketing ofenergy efficiency.

4. The following sections consider:

● the nature of the barriers to energyefficiency,

● the benefits of innovation for energyefficiency, and

● the broad principles for policy that flow fromthese considerations.

Barriers to energy efficiency5. The current, apparently cost effective,potential for energy efficiency is approximately30% of final energy demand. The potentialfinancial benefits in reduced costs to consumers(net of taxes) are £12 billion annually. And thepotential carbon reductions are 40 MtC/year(see Annex 6). This is a very significantpotential. It is broadly consistent with estimatesfor other countries3 as well as the analysis thatunderpins the UK Climate Change Programme.4

6. There is a broad consensus across the energyefficiency professionals who have beenconsulted. They agree that the key barrier canbe described as follows. Energy users do notseek to optimise the economic efficiency withwhich they use energy. In a complex world,people have many concerns and most have ahigher priority than energy efficiency. Soprojects that are primarily about energyefficiency are often not even considered. And ininvestment decisions and purchases that involveenergy use, energy efficiency is usually a minorconsideration.5 This underpins and reinforcesthe other barriers described in the box.

7. There are some exceptions. A few industrialenergy users are very energy intensive. And infuel poor households, energy costs are a largepart of disposable income. For them energycosts and energy efficiency are important. But,energy bills average less than 3% of costs inhouseholds as a whole and only 1.3% inbusinesses. Even quite substantial price riseswould not make energy costs a major issue formost energy users.

1 PIU (2001c).2 DTI (2002).3 Intergovernmental Panel on Climate Change (2001).4 DETR (2000).5 The practice of limiting the number of issues that are considered in making a decision is commonly referred to as ‘bounded

rationality’.

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FORINTERVENTION

8. Of the barriers listed above only theenvironmental externalities lend themselves tocorrection through energy pricing. Increasedprices might also increase the demand forinformation. The remainder are more rooted inthe structure of the market.

9. There are two possible analyses of thesebarriers to cost-effective options. Either:

● there is some form of market failure; and/or

● not all the costs have been identified.

10. There can be costs not fully accounted forin the calculation of the potential. The “hiddencosts” of management time and personal timeinvolved in decision-making are probably themost important. But there may be othersincluding:

● disbenefits such as intrusion of builders intohomes; and

● risks of unforeseen cost increases or

reduction in benefits due to fuel price falls orproduct under-performance.

The alternative explanation is that energyefficiency markets are imperfect. All of thebarriers identified in the box can be thought ofin this way.

11. Both explanations are plausible. Doubtlessboth are part of the truth. The extent to whichthere is genuine market failure cannot bedetermined theoretically – it is an empiricalissue. The best evidence we have comes fromGovernment energy efficiency programmes thathave been carefully monitored.

12. In the domestic sector, the National AuditOffice has confirmed that the predecessorprogrammes of the Energy EfficiencyCommitment (EEC) were highly cost effective.6

They saved electricity at less than half theavoidable cost of supply. The “hidden”implementation and management costs of the

Barriers to Energy EfficiencySome of the barriers to investment in improved energy efficiency that have been identified are:

● Many energy users have imperfect information about energy efficiency opportunities anddistrust of information available from what they see as vested interests.

● There is often better information on capital costs of investments than on their running costs,leading to adverse selection of inefficient goods.

● Capital markets are incomplete for many borrowers, for example low income households mayfind it difficult to borrow, even for very cost effective projects.

● Inadequate contractual relationships with builders and other traders result in sub-optimaldesign, and the risk that that projects may not be implemented correctly.

● Tenancy arrangements provide no incentives for either landlords or tenants to make cost-effective energy efficiency investment in rented properties.

● Regulatory arrangements discourage potentially beneficial long-term contracts betweenlicensed energy suppliers and domestic customers.

● Some fiscal measures treat energy efficiency less favourably than energy supply.

● The price of energy, in most cases, fails to take into account the environmental costsassociated with its supply and use, i.e. there are externalities.

6 National Audit Office (1998)

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energy suppliers are included in the assessment.In this case, the time costs for the customer arelargely removed by supplier activity. In business,the investments stimulated by the EnergyEfficiency Best Practice programme (EEBPp)have typical payback periods of 2 to 4 years.EEBPp has provided targeted information andadvice to reduce the costs of management andthe perceived risks of these investments.

13. There are, therefore, genuinely costeffective investments that are not adopted in allsectors. The key point for policy-making is thatGovernment intervention can reduce thesecosts. Both EEC and EEBPp do this, in differentways. The implementation costs in the absenceof the programmes can be conceptualised aseither “hidden costs” or “market failure”. Butthe implication is the same – it points toGovernment intervention in the market in amanner that reduces implementation costs.

14. Whether the barriers to energy efficiencyare “hidden costs” or market failures hasimplications for the cost effectiveness of carbonsaving using energy efficiency. This has beenstudied in considerable detail.7 If the wholeexplanation is market failure, energy efficiencyinvestment is extremely cost-effective and thereare major economic benefits associated withcarbon reduction (costs of saving carbon are –£300/tC to -£100/tC). If the whole explanationis hidden costs, the costs are positive (£30-£50/tC), but still lower than typical supply sideoptions for carbon reduction. Given ouranalysis, that Government intervention canreduce hidden costs, the lower end of the costrange may be more probable. So, economicbenefits, possibly significant ones, areassociated with carbon reduction throughenergy efficiency.

Looking to the Future –Innovation15. The technical and economic potentials forenergy efficiency outlined in Annex 6 are asnapshot taken at the current time. Thepotential is not fixed. Innovation can bothincrease the potential and improve theeconomics substantially. This is what hashappened over recent decades. Since 1970,decreased energy intensity has contributedtwice as much as changes in the energy supplymix to reductions in carbon emissions (seeChapter 2). But the scope for further progressin energy efficiency has not been used up.Innovation has increased the potential at aboutthe same rate that cost effective measures havebeen adopted. The result is that the “currentcost effective potential” has remained largelyunchanged. Innovation is critical to thisprocess.8

16. Most of the potential for future advances inenergy efficiency will rely on technologicalimprovements in materials technology, designand control. These are the types of changewhere the pace may accelerate in theknowledge economy. In this way, improvedenergy efficiency is expected to be an integralpart of economic modernisation. Specificintervention may be needed in some areas. Butthe priority is to ensure that the importance ofinnovation is designed into other energyefficiency policy instruments.

17. In the buildings sectors the slow turnover ofthe stock prevents very rapid improvements.Even if the scope for currently cost-effectivetechnology is exploited over the next decade,new technologies will continue to add to thetechnical and economic potential. These includenew construction techniques, micro-CHP, heatpumps, super-insulating windows and highefficiency appliances, as well as designimprovements to use solar energy.9

7 DTI (2002).8 DTI (2002) Appendix D.9 Chief Scientific Adviser (2001).

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18. In the industrial sector, significantimprovements have been made in recent years.But a very large potential remains, especiallythrough more fundamental changes toproducts and processes. Technologies that arealready known, but currently not widely used,include membrane and crystallisationseparation, process intensification, advancedrefrigerants, absorption heat pumps, hightemperature CHP and advanced motorcontrols.10 And technologies that might be incommon usage by the middle of the centurymay yet to be discovered.

19. In the transport sector, most potential lies inredesign of the car. Electric traction based onhybrid technology is already in commercialproduction. Fuel cell technology is the focus ofmajor R&D programmes. Both offer large “well-to-wheel” efficiency improvements.11 Withadvanced controls and battery storage theycould facilitate other improvements includingbraking energy recovery, individual wheelcontrol and engine capacity reduction.Combined with lightweight materials andaerodynamic design improvements, these canyield major efficiency improvements. Vehicleswith fuel consumption of 3.4 litres/100 km (83mpg) are already on the road. Design conceptscould deliver 2.5 l/100km or less.

20. Energy efficiency innovation needs to beunderstood more broadly than changes intechnology. Social and institutional change maybe just as important. Liberalised energy marketsmay be a driver. To date the focus in supplymarkets has been on competition oncommodity price. But as the scope for furtherreduction in supply costs falls, suppliers mayincreasingly look to commercial innovation anda wider package of products. In this context,there is the prospect for greater activity inenergy services. There may well be systemicinnovation with synergies between technicaland commercial changes. For example, there

are important potential linkages between micro-CHP, new metering technology and energyservices marketing.12

Policy Principles 21. Three broad approaches can assist theadoption of socially cost-effective energyefficiency:

● raising the marginal cost of energy toaccount for its external costs;

● targeting barriers to reduce hidden costs orovercome market failure; and

● encouraging energy efficiency innovation.

22. Pricing environmental externalities hasimplications for all low carbon options. It needsto be used in a context of wider internationalaction and attention to the distributionalimplications, in particular fuel poverty (seeChapter 3). It is important for long term energyefficiency policy. But energy pricing is not theonly policy tool that can make a substantialdifference. On the contrary, the existence ofmarket failures and importance of innovationpoint to the use of a range of targetedinterventions.

23. The analysis points to the importance ofreducing high transaction costs that act as abarrier. In this context, the best policyinstruments need to incentivise activity byorganisations with the potential for the lowestcosts, increase their capacity to deliver, andreduce transaction costs. The role ofGovernment is to:

● identify the organisations best placed todeliver in each sector;

● incentivise (or regulate) them to deliver moreenergy efficiency investment; and

● reduce their information and transactionscosts through targeted advice and capacitybuilding.

10 See, e.g. the results of the Atlas Project, Commission for the European Union (1997).11 Fergusson, M. (2001).12 PIU (2001c) – Annex 4.

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24. Government has already made a start onthe agenda of defining responsibilities:

● for vulnerable and low income households,the Government and DevolvedAdministrations have fuel povertyprogrammes supported by publicexpenditure;

● for the wider range of households, theEnergy Efficiency Commitment is a regulatoryrequirement on licensed gas and electricitysuppliers;

● in new buildings, Building Regulationsrequire energy efficiency action by thebuilders;

● for household and commercial appliances, EUstandards and negotiated agreements placeresponsibility on manufacturers;

● in some industrial sectors the ClimateChange Negotiated Agreements give astrong fiscal incentive;

● in the public sector, Governmentdepartments have energy efficiency targets;and

● for cars, there are EU voluntary agreementswith vehicle manufacturers.

Other policies and programmes give supportinginformation and incentives.13

25. This type of approach needs to be usedwith care. Whilst it cuts through the raft ofbarriers that restrict energy efficiencyinvestment, it is important that it is cost-effective and does not discourage innovation.To this end, long timescales and tradablemechanisms are preferable.

26. There remain energy use sectors wherethere are no strong incentives, in particular inthe commercial sector and those industriesoutside negotiated agreements. The ClimateChange Levy provides a price incentive. But ifprice elasticities are low, the energy saving

impact is limited and this is reflected in therelatively low contribution these sectors make tothe UK Climate Change Programme. This pointsto new policy interventions in commerce andSMEs.

27. Product regulation addresses informationbarriers directly by excluding low efficiencyproducts from the market. It is particularlyeffective where barriers are strong and energycosts are small, e.g. for buildings and consumerproducts. Long regulatory timescales areneeded to minimise business uncertainty. Whereproducts are internationally traded, the EU isthe appropriate level for regulation, althoughGovernment can actively encourage agreementon appropriate intervention by the EU.

28. Negotiated agreements may be used as analternative in some cases. These can have moreflexibility. However, it is important they aretransparent to Government, business and thirdparties, through independent monitoring andverification. They are most likely to be effectivewhere Government indicates that alternativepolicy instruments will be used in the event ofno agreement.14

29. Energy efficiency regulation and marketmechanisms are not in conflict. New forms ofregulation seek to create new markets. Keyexamples are the Emissions Trading Schemeand trading of Energy Efficiency Commitments.Both allow a given target to be delivered morecost-effectively, and thereby potentially allowmore ambitious obligations than non-tradableconstraints.

30. Public expenditure is most appropriatewhere energy efficiency goals have a strongsocial component, in particular to address fuelpoverty amongst low-income households. Itallows vulnerable households to be targetedwith minimum deadweight.

31. Financial incentives (e.g. subsidies, taxreductions and enhanced capital allowances)

13 DETR (2000).14 Green Alliance (2001).

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reduce investment costs. Where there isinformation asymmetry, they are best applied atthe point of capital investment or productpurchase. They need to be carefully scrutinisedfor cost-effectiveness and to minimisedeadweight loss. They are most effective wherecross-price elasticities are high, e.g. todifferentiate efficient products from othersproviding the same energy service.

32. Our analysis has found little evidence tosupport general information campaigns.Targeted advice is more effective, along thelines for example provided to industry andbuildings professionals through the EEBPp, tohouseholds by Energy Efficiency Advice Centres(EEACs) and to consumers by clear labelling andbranding. Government has a role, working withother players, to ensure these activities aredelivered.

33. Capacity building through training andsupport is necessary where organisations thatcan play a useful role do not have the resourcesrequired, for example in the energy efficiencyinstaller sector that is dominated by SMEs. Localauthorities and the voluntary sector will alsoneed additional resources to play a bigger rolein advising households.

34. Government already supports energyeducation through the National Curriculum.This has a key long-term role in improvingunderstanding of the principles of energy useand its relationship to environmental problems.In the short-term, compulsory education haslimited impact. But, the practical involvementof adults can be fostered through communitygroups.

35. Government has a major role through thepublic sector, not only in direct improvementsin energy efficiency, but also in setting anexample in the wider economy. This will requireaddressing the barriers that affect public sectorenergy efficiency, by setting targets for energy

efficiency, then allocating the resources todeliver them. Procurement policy will play a keypart in this.

36. Government has a major role in supportingand incentivising innovation in environmentaltechnologies. Evidence from the USA indicatesthat Government funded R&D on energyefficiency can be highly cost effective comparedto other energy R&D.15 In the UK, per capitaenergy efficiency R&D expenditure is very muchless than in some other countries andsignificantly lower than on the supply side.16

This has been exacerbated by the privatisationof key energy industries that previouslyundertook most energy efficiency R&D.17 TheGovernment’s Chief Scientific Adviser’s advisorygroup on energy research has identified energyefficiency R&D as a key priority. The CarbonTrust plans to use a significant portion ofClimate Change Revenues to increase lowcarbon R&D (including energy efficiency).

37. Government can play a key role as apromoter of energy efficiency innovation,through its own procurement policies, incentiveschemes to develop niche markets and bybuilding partnerships between market players inthe (generally rather weak) energy efficiencysector.

38. In the context of a long-term, low carboneconomy, market transformation is a usefulconcept for addressing innovation. It involvesfundamental change to the nature of goodsand services on the market. It tends to require anumber of different instruments workingtogether, for example regulatory mechanisms toremove the lowest efficiency goods from themarket, fiscal or other incentives to shift themass market and niche market creationmechanisms to encourage new high efficiencydesigns. Energy efficiency policy instrumentanalysis needs to include implications for long-term market transformations as well asimmediate effects.

15 US National Academy of Sciences (2001).16 Chief Scientific Adviser (2001).17 PIU (2001b).

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CHAPTER HEADINGSANNEX 6. THE POTENTIAL FOR COST REDUCTIONSAND TECHNOLOGICAL PROGRESS IN LOW CARBONTECHNOLOGIES

Introduction1. A number of low carbon technologies areavailable. Technical potentials are large.1 Butwhat is technically feasible is often noteconomically viable and many options arecurrently more expensive than fossil fuel-basedalternatives. The relative merits of the differenttechnologies change over time, with costsfalling with technological progress and marketgrowth.

2. In order to compare the costs per tonne ofcarbon saved, based on expected futuretechnology costs, the PIU undertook a detailedanalysis of each of the main low carbonoptions, in collaboration with the DTI-ledInterdepartmental Analysts Group on lowcarbon technology (IAG) and independentexperts.

3. Full detail of the PIU’s work on cost reductionpotentials for the leading electricity generationoptions is provided in PIU (2001f), (2001h) and(2001i); for transport technologies in Ferguson(2001); and for energy efficiency in PIU(2001c). Key findings are summarised inChapter 6. Future changes are difficult topredict in advance, as the uncertainties arelarge. This Annex outlines the techniques used,and the main findings for each low carbonoption.

Approach4. The work focuses on an assessment ofpotential changes in costs between now and2050. Energy markets will tend to favour theleast-cost mix of technologies. Relative costs will

change, as a result of technologicaldevelopment and changes in fuel prices. Giventhe uncertainties over a long time horizon, thePIU’s quantitative assessments focus on 2020,with a qualitative assessment of likely trendsfrom 2020 to 2050.

5. The analysis uses two broad approaches:

● engineering assessments, based on expertjudgement of likely reductions in costs,placing technologies on a spectrum from“infant” or “emerging”, to “mature”; and

● extrapolation and interpretation of historicrelationships between cost reductions andcumulative production, so called “learningcurves”.

Engineering Assessment6. Mature technologies are those that are wellestablished and near the limit of incrementaltechnological development. Emergingtechnologies are those with considerablepotential for further development and costreductions through innovation.

7. “Technology stretch” is the potential forfurther technological development andrefinement – for continued innovation. This isbased upon detailed assessment of the potentialfor refinement and development of thetechnologies, and of manufacturing processes.Cost reductions already achieved in closelyrelated technologies, or those using similarproduction techniques, are often used as a“benchmark” against which potential costreductions may be assessed.

1 Discussion of technical potentials is provided in PIU (2001h).

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INLOW-CARBONTECHNOLOGIES

8. The main advantage of engineeringassessments is that they need not rely uponprevious trends in cost reduction. The maindisadvantage is that they depend upon expertjudgements, which may differ.

Learning curves9. The main alternative method is to useexperience curves, based on “learning-by-doing”.2 They are widely used in business, buthave not been used extensively for theassessment of UK energy policy. Evidence froma very wide range of technologies and sectorsdemonstrates a clear relationship betweenproduction and cost; put simply, as cumulativeproduction increases, costs fall. This is not tounderplay the complexity of the drivers of costreduction – technological innovation,economies of scale, improved utilisation oflabour and capital, etc. – but the conclusion isthat most “learning” and cost reduction comethrough production and market experience.

10. “Learning rates” – the proportionate costreductions that occur with every doubling ofcumulative production – vary by technologyand at different stages of development of agiven technology. They tend to be steeper inthe early stages of technology development.Typically, for industrial products, the learningrate is in the range 10 to 30%, which meansthat for each doubling of cumulativeproduction, costs fall by between 10 and 30%.For all of the technologies under considerationhere, markets, and learning rates, are for themost part global, thus cumulative worldproduction, rather than UK application alone, isthe key variable for learning assessment –though some technologies are moreappropriate for UK conditions than others, andmany have UK specific attributes.

11. Learning curves have proved a robust toolfor assessing cost reductions in a wide range ofproducts and sectors, though they have anumber of limitations as a tool for estimatingfuture costs:

● in the case of new technologies it can bedifficult to use early experience to predictlonger-term developments; and

● cost reductions can only be predicted on thebasis of projections of production growth-sensitivity analysis may be used to assess theimpact of different market growth rates.

12. The PIU uses both learning curves andengineering assessments. Both approachessupport the following conclusions:

● newly emerged technologies that have asmall market share have much largerpotential for cost reduction than moreestablished products;

● established technologies can “lock out” lessdeveloped alternatives that are initially moreexpensive, even if such technologies have thepotential to become much cheaper in thelonger term;3 and

● uncertainties about the potential for costreduction decrease as market experienceincreases.

Cost ranges13. An overview of what both approachessuggest for each low carbon option is providedbelow. In all cases a range of costs is provided.In many cases the range reflects uncertaintyabout capital costs, and in some, about futurefuel and O&M costs. In the case of renewables,site specific aspects, such as wind regimes andcost of installation and connection, also have aprofound affect on costs, the PIU’s analysis

2 The energy policy applications of learning curves were recently examined at length by the IEA (2000b), the findings are discussed inmore depth in PIU (2001 h).

3 The rate and means by which innovations progress into established markets has been explored for many technologies and markets.Typically new technologies progress through high value niche markets. In highly capital intensive markets with limited productdifferentiation, such as electricity, this process can be slow. See Utterback (1997).

therefore takes in a range from high cost to lowcost sites. The intermittent nature of somerenewables is reflected in the load factors theyachieve and is built into these costs. Systemcosts due to intermittency are discussed below.

14. These ranges also reflect differentassumptions about financing conditions, inparticular the impact of different discount ratesand amortisation periods. Where possible, thePIU have undertaken sensitivity analyses thattake in both high and low discount rates (8%and 15%, real) and amortisation periods thatreflect financing conventions (15 or 20 years),in addition to different capital cost estimates.Full details may be found in the relevantworking papers.

The technologies15. There are many energy technologiescovering every stage of the energy chain fromfuel extraction, transportation and refiningthrough generation, transmission and end use.New energy vectors, particularly hydrogen, andenergy storage technologies are also consideredseparately. The technologies that we considerare:

● energy efficiency in power generation and

end use, including fuel cells and combinedheat and power;

● renewable energy;

● nuclear power generation;

● carbon capture and sequestration;4 and

● fuel switching and energy efficiency intransport.

16. Low carbon options cannot be consideredin isolation, as “conventional” fossil fuels willalso be expected to experience cost reductions.The PIU have therefore also assessed thepotential for progress in;

● natural gas fired power generation ; and

● oal fired power generation.

Low carbon options

End use energy efficiency: summaryof current potential

17. The current cost effective potential forenergy efficiency in all sectors is summarised inTable 1. It amounts to approximately 30% offinal energy demand. The potential financialbenefits in reduced costs to consumers (net oftaxes) are £12 billion annually.

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4 The separation of CO2, either pre- or post-combustion, and the engineered sequestration of this, deep underground. This technologyis considered separately from the individual fossil fuelled power options because of its potential importance in reducing carbonemissions, because of its relative novelty, and because it is essentially an “add-on” that can remove carbon from a range of powergeneration options and fuels for other purposes, such as transport.

Table 1Summary of Current Economic Potential for Energy Saving

Estimated Potential for Currently Economic Savings

Energy (Mtoe/year) Per cent Financial (£M)

Domestic 17.4 37.2% 5000

Service 3.8 21.0% 1190

Industry 8.6 23.8% 1380

Transport 19.3 35.0% 4700

Total 49.1 31.4% 12300

18. This is a very significant potential. Theextent to which all of this potential is cost-effective is still disputed. However, there is aconsensus on the broad conclusion that muchof it is, both from empirical work on existingprogrammes and studies of future potential, aswell as amongst the stakeholders that we haveconsulted. It is broadly consistent withestimates for other countries summarised by theIntergovernmental Panel on Climate Change.5

19. Historical empirical evidence for cost-effective energy efficiency is from reliablesources. In the domestic sector, the NationalAudit Office has confirmed that existingregulatory programmes are highly cost-effective.6 They save electricity at 22% of thepurchase price (and less than half the avoidablecost of supply). In the business sectors, theinvestments stimulated by the Energy EfficiencyBest Practice Programme are now estimated tosave over £800 million annually, with a typicalpayback period of 2 to 4 years.

20. Studies by and for Government form thebasis of the future energy efficiencyprogrammes that are central to the UK ClimateChange Programme – both the EnergyEfficiency Commitments in the domestic sectorand the Climate Change NegotiatedAgreements in industry.

21. This scope for significant economic benefitsis an important conclusion of our work. It iswidely understood that improving energyefficiency can assist in delivering environmentaland energy security objectives. The largepotential for cost-effective investment makesimproving energy efficiency a key part of theeconomic and social dimensions of energypolicy as well. And, in the longer-term, it is partof the agenda for an efficient, innovative andsustainable energy system.

Energy efficiency in energyprovision – Combined Heatand Power22. Medium and large scale combined heat andpower (CHP) (with typically 30kWe to 30MWeoutput) is a well – established technology.These technologies are already cost-competitivewith conventional power – typically less than2.0 p/kWh. Smaller scale CHP-often known asmini-CHP – has become available for smallercommercial buildings. The smallest scaleproducts, micro-CHP (MCHP) – suitable forindividual homes – is an emerging technologywith the first units on commercial trial now.

23. The electrical efficiency of CHP tends toreduce with the size of plant, the best achieving45% and the current micro-CHP units 10% to15%. However, in all cases, because of theassociation with a heat load, the effective powergeneration efficiency (the efficiency with whichadditional gas use is converted to power) istypically 80%-90%.

24. The economics of CHP are complex.Compared to the current alternative of CCGTfrom centralised power plants, there areadditional costs associated with the distributionof heat, but savings from increased efficiency.However, there are also different costsassociated with the locations and scale at whichgas is used and electricity is produced. Theeconomics are, therefore, crucially dependenton the gas-to-electricity price difference, whichis a function of real cost and market structures.

25. The greatest potential for growth by 2050 isin micro-CHP; a direct replacement for aconventional gas boiler at an additional cost ofa few hundred pounds.7 Several manufacturershave units based on Stirling engines. At thesecapital costs, the effective generating cost isaround 3.5 p/kWh, perhaps falling to

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5 IPCC (2000).6 National Audit Office (1998). 7 Early units are expected to have a premium of £600 which is expected to fall to £400 once mass production starts. This can be

expected to reduce further, to £200-300 once the market matures.

2.5 p/kWh as the market grows. Within adecade it is expected that units based on fuelcells will become cost effective, these will havea significantly higher electrical efficiency.

Energy efficiency in energyconversion – Fuel cells26. Fuel cells use electrochemical processes toconvert hydrogen (or a hydrogen-rich fuelstream) and oxygen into electricity. Theycombine high efficiency with very lowemissions. If run on hydrogen the only emissionat the point of use is water. If run onhydrocarbons (or hydrogen derived fromhydrocarbons), local emissions are near zero,with CO2 emissions dependent upon thehydrogen source. If hydrogen is derived fromzero carbon sources such as renewables,nuclear, or C&S (see below), then fuel cells offerthe prospect of “zero emission” power. Fuelcells are also modular, and potentially suitablefor application at a wide range of scales frommicro-generation (tens of kW) to large scalepower generation.

27. Interest in fuel cells in currently focusedupon two areas of application:

● road transport, where zero emissions of localair pollutants, combined with highefficiencies and high power density (highpower from small units), is drivingconsiderable R&D activity;

● stationary power generation – primarily forsmall scale decentralised (less than 1 MW)applications – where fuel cells offerconsiderable efficiency gains overcombustion technologies. Quiet operationand availability of waste heat for CHP8 makethem particularly suitable for CHPinstallations in commercial and residentialbuildings.

28. Some analysts argue that combined cyclefuel cell plants could eventually displacecombustion-based CCGT for large-scale power.9

29. There are several basic designs of fuel cell;some are commercially available for nichemarket applications, others remain at thelaboratory stage. Different types of fuel cellshave different characteristics. At present, fuelcells are not cost competitive with combustiontechnologies in most applications. Estimates ofcurrent costs suggest a range from $2000/kW(£1600) to $10,000/kW (£7500) – however itshould be noted that the commercial market forfuel cells is very small and many designs areeffectively prototypes (which tend to be highcost).

30. The speed with which fuel cells will achievecost reductions is not yet clear. It has notproved possible to provide estimates of costs in2020. There is widespread agreement, based onengineering assessment, that fuel cells willbecome competitive in many applications,10

with decentralised stationary CHP as the firstmarket, followed by transport applications. Thecentral uncertainty is how quickly this willhappen.

Transport31. Carbon emissions from transport may bereduced in three ways:

● shifting to less energy intensive modes;

● improving the efficiency with whichconventional fuels are used; and

● switching to lower carbon fuels.

32. The PIU’s work on technologies has focusedon the latter two options. However a keyconclusion from the scenario work is thatmanaging demand growth in the more energy

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8 Fuel cells are often divided into “high temperature” (<500C) and “low temperature” (>100C) designs, generally speaking hightemperature designs are further from commercial application and better suited to larger-scale stationary applications, they are alsoable to operate on a wider range of fuels. Interest in transport applications has focussed more upon low temperature designs.

9 UNDP/WEC (2000).10 UNDP/WEC (2000), ICCEPT (2001), Brandon and Hart, (1999).

intensive modes is likely to be essential if deepcuts in emissions are to be achieved.

33. Both road and air transport are almostentirely dependent on oil. These are the sectorsexpected to experience the highest growthrates. Analysis undertaken for the PIU suggeststhat the potential for fuel switching in the roadtransport sector is limited in the period to 2020,and that aviation may remain oil-fuelled evenuntil 2050. Efficiency gains will therefore play akey role for both sectors. The potential fortechnological advances in this area is large forroad transport, but appears to be more limitedfor the aviation sector.11 Hybrid vehicles andweight reductions could deliver 50%improvements in fuel efficiency for road vehiclesby 2020. Estimates of costs are not available.

34. In the longer term most analysts expectmore fundamental shifts in both fuel sourcesand motive power units for road vehicles,though this appears less likely for aviation.Much attention is focussed on the potential offuel cells for road transport, with substantialindustry R&D efforts underway, driven in largepart by legislative pressure in the US andelsewhere to reduce local air pollutants radically.

35. The potential of these developments toreduce carbon emissions depends upon fuelsource. Although fuel cells are more efficientthan internal combustion engines, thisadvantage is lost if petroleum based fuels areused, as on-vehicle reformation of petroleum(to produce hydrogen) absorbs considerableenergy. The role of the fuel cell in securingsignificant carbon emissions advantages istherefore intimately bound up with thedevelopment of low carbon supplies ofhydrogen and the infrastructure, including on-board storage, that might be needed to

facilitate this. Again, the long-run costs of sucha transition are difficult to quantify, particularlygiven uncertainties about fuel cell costs.

Renewables36. There are many renewable energytechnologies that can make some contributionto meeting UK energy demand. The PIU’sanalysis has focussed on those options thathave the potential to provide the largestamounts of energy in the long term – thosewith the largest technical potential.12 Details ofthe UK’s renewable resources are provided inPIU (2001h). The technologies considered are:

● solar photovoltaics;

● wind (onshore and offshore);

● wave and tidal stream; and

● energy crops.

37. With the exception of the last, thesegenerate electricity. Energy crops may be usedfor power, heat or liquid fuels. This list excludessome important technologies that are alreadycost competitive, considered technologicallymature, or have more limited potential forexpansion in the UK.13

38. New renewable energy technologiescurrently contribute less than 1% of globalenergy demand, and less than 3% of electricity,but collectively have the potential to deliverorders of magnitude more. The scope for costreduction is therefore very large. Current costsdiffer substantially, from 2.5–3.0 p/kWh foronshore wind in good sites, through 5–6 p/kWhfor offshore wind, around 8p/kWh for energycrops, to around 70p/kWh for PV.

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11 Studies by the IPCC and others suggest that efficiency gains in aviation are likely to be dramatically outstripped by demand growth.Prospects for transport technologies and new fuelling infrastructure are discussed in Ferguson (2001).

12 Based upon estimates of technical potential derived from DTI (1998).13 In particular solar hot water, hydropower (large and small), biomass wastes, geothermal. This is not to suggest that technologies not

listed do not have a valuable current or potential role, either in the UK or elsewhere. We focus on a limited number of technologiesin order to develop a broad picture of the potential of renewables to provide cost-competitive power on a large scale over a longtime horizon.

39. With the exception of energy crops,renewables are intermittent. This, together withsite specific aspects such as local wind regimesaffects load factors and is built into the costsquoted above, and the projected costssummarised below. Renewables that are bothintermittent and to some degree unpredictablealso impose additional system costs – thesystem must be able to cope with unpredictedfluctuations in output. Not all intermittentrenewables are unpredictable: tidal energy iscompletely predictable; wave is morepredictable than wind; and predictive capacityfor wind is improving. The costs to the systemof coping with unpredictable intermittencyhave been explored in detail with NGC andindependent experts – see Milborrow (2001).These costs are small in comparison togenerating costs and are discussed in the finalsection of this annex.

40. Detailed conclusions of the PIU’s work onrenewables are as follows:

● there is good evidence, based on detailedassessment of learning curves and marketgrowth rates, that onshore wind is likely tobecome amongst the cheapest of allgenerating technologies within 20 years –less than 2 p/kWh in good wind speedlocations, with a typical range of 1.5–2.5 p/kWh;

● there is equally robust evidence that PV islikely to continue to experience sustainedand substantial cost reductions over the next20 years.14 However, though PV will becomecost competitive in many applications insunnier climes, it will still be some way frombeing generally cost competitive in the UK– 10 to 16 p/kWh – even taking intoaccount the value of being a decentralisedsource of power. PV is widely expected tocontinue to secure cost reductions after

2020, and could become cost competitivewith retail electricity in the UK around 2025;

● though we can be less certain aboutdevelopments in offshore wind, where worldexperience is limited, engineering assessmentof offshore technology issues suggests thatoffshore wind is likely to fall to 2 to 3p/kWh;

● advanced combustion technologies forenergy crops also have considerable potentialfor cost reduction, with capital costsprojected to fall by around 50% oncedemonstration plants move into commercialdeployment. Whilst market and learning ratedata are available for conventionalcombustion technologies, they are notavailable for advanced technologies.Reductions in crop production andprocessing will also be required if energycrops are to become cost-competitive. Thismakes cost reductions in biomass moredifficult to assess. Best estimates lie in therange 2.5–4 p/kWh;

● more uncertainty surrounds wave and tidaltechnologies, with many competing devicescurrently at an early stage of development.Commercial markets do not exist, and alearning curve based approach is notpossible. Estimates of potential costs suggestfigures of the order of 4 to 8 p/kWh for thefirst commercial-scale device.15 The UK iscurrently at the forefront of wave and tidalpower.

Nuclear Power 41. Nuclear power (fission) is a well-establishedtechnology and currently supplies around aquarter of UK electricity needs. Designs forcurrent nuclear stations are in the 1GW to 2GWrange and in principle nuclear power could

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14 The PIU’s analysis is based upon a learning rate of 18% and market growth of 25% per year, and discount rates of 8% and 15%. SeePIU (2001h). Other analyses using both engineering assessment and learning curve approaches suggest similar results, seeUNDP/WEC (2000).

15 Based upon assessment of figures produced for the DTI in Thorpe (1999) and House of Lords (2000): see also PIU (2001a).

supply very large amounts of virtually zerocarbon power in the future. Uranium isplentiful, easy and cheap to store, and likely toremain cheap. This means that nuclear power isessentially an indigenous form of energy. Anylimits to nuclear power growth are likely tocome from siting problems (it will be mucheasier to use existing nuclear sites than move togreenfields) and from public acceptance issues,including resolution of nuclear waste strategy.

42. No new-build nuclear has been financed inliberalised markets. In the UK, the costs ofSizewell B, the most recently constructednuclear unit, was around 6p/kWh (2000 prices,8% discount rate),16 while the nuclear industry’sexpectation of generation costs for a twin PWRat the time of the Government’s Nuclear Reviewin 1995 was 3.5p/kWh (same basis as Sizewell Bfigure above.) The proposal from the nuclearindustry is now for a programme of the AP-1000 design (owned by BNFL/Westinghouse),expected to cost between 3p/kWh for the firstunit, and 2.5p/kWh, across a large programmeof 10GW, even at a higher discount rate. It isclear that, whether through “learning” in thenarrow sense, or wider processes of costreduction, the nuclear industry consider thecosts of new nuclear generation in the UK areon a steep downward path.

43. The industry also expects, as is implied bythe range of 2.5p/kWh to 3p/kWh, that therewill be substantial learning and scale effectsfrom a standardised programme, so that afourth double unit might cost almost a quarterless than the first such unit. Strict learningeffects are difficult to measure in the nuclearpower case because more stringent regulationhas often counteracted learning effects.However in the right regulatory conditionsthere is every reason to expect learning to takeplace in nuclear power as in other technologies.The pace and extent of learning may however

be slower for nuclear than for renewablesbecause:

● relatively long lead times for nuclear powermean that feedback from operatingexperience is slower;

● relicensing of nuclear designs further delaysthe introduction of design changes; and

● the scope for economies of large-scalemanufacturing of components is less fornuclear because production runs are muchshorter than for renewables, where hundredsand even thousands of units may beinstalled.

44. The nuclear industry argues that it can buildthe AP1000 in the range 2.5p/kWh to 3p/kWh.Such a result will depend on achievingconstruction costs below the bottom end of therange in the IEA’s recent report on nuclearpower in the OECD;17 on the achievement ofvery high operating availability; on a series buildof 10 identical reactors; on short constructiontimes; and on regulatory stability. Such anoutcome is clearly possible.

45. On the other hand, AP1000 technology(though based on established components) isyet to be built anywhere in the world, withassociated first of a kind risks; there has been noordering of new nuclear plant in OECD Europesince 1993; it seems unlikely that constructioncost and performance guarantees can be as firmfor nuclear as for CCGTs; operatingperformance wil be difficult to guarantee at thelevels suggested; there is no certainty that a10GW programme could be completed in anorderly way; and the economic results aresensitive to changes in several of the aboveparameters.

46. Making minor adjustments for some of theissues in paragraph 44, and applying the PIU8% and 15% discount rates and a 20 year

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16 Most of the numbers in this section are explored in more detail in PIU (2001i).17 IEA (2001c).

amortisation period, the central inter-quartilerange of nuclear costs is 3p to 4p/kWh, withboth lower (industry) and higher outcomespossible. Such a result still represents a majordecrease in costs compared to all previousnuclear construction in the UK, includingSizewell B.

47. Such costs are likely to apply in 2020, giventhat an AP1000 programme could not becompleted any earlier than twenty years fromnow. Beyond that date, new designs of smaller,more modular reactors with inherently safercharacteristics could become available. Capitalcosts might be reduced to $1000/kW(£690/kW), and in such circumstances nuclearcosts could fall further beyond 2020.Commercial nuclear fusion is not predicted toappear within this timeframe.18

Capture and engineeredsequestration of CO2 (C&S) 48. There is growing industrial interest inremoving CO2 from fossil-fuels before it isreleased into the atmosphere, sequestering thecarbon in deep repositories (or beneath theocean bed) so that it is “locked up” and doesnot enter the atmosphere. There are twodiscrete steps: first, the CO2 must be captured,secondly, the CO2 must be transported to ageologically appropriate repository. Thetechnique of carbon capture is well known, andlikewise there is already some experience ofsequestering CO2 – indeed, CO2 is alreadyinjected into some oil fields for enhanced oilrecovery. But the two halves of the process haveyet to be brought together and demonstratedon a large scale.

49. C&S would allow fossil fuels, including highcarbon fuels such as coal, to continue to

contribute to energy supplies withoutprecluding deep cuts in CO2 emissions. C&Scan in principle be applied to any fossil fuelledpower station or large combustion plant. It isalso feasible to extract hydrogen from fossilfuels and sequester the waste CO2. Thehydrogen could then be used in transportapplications.

50. C&S allows CO2 emissions to be reduced byaround 80%. The size of the potential CO2

reservoirs available is uncertain. Estimates of theglobal potential of deep saline aquifers rangefrom 10 years global emissions at current ratesto twice the carbon content of estimatedrecoverable fossil fuel reserves.19 Estimates of thepotential of depleted oil and gas reservoirs alsovary. However, suitable sites are not evenlydistributed around the world, and the UK hasaccess to potentially large CO2 repositoriesunder the bed of the North Sea.

51. Engineering estimates suggest that gas-firedand coal-fired generation with C&S would costbetween 3.0 and 4.5 p/kWh, if developmentsucceeds.20 Considerable uncertainty surroundsthese figures. These costs represent “firstcommercial” application and, as such, could besecured before 2020 if development proceedsrapidly, though the pace of development isuncertain. As the technologies involved in C&Sare mature, dramatic cost reductions by 2020appear unlikely. In the longer term it appearsprobable that costs could continue to fall asexperience is gained and technology improves.Uncertainties about the scale and speed ofdevelopment make this difficult to quantify.

52. Uncertainty still surrounds C&S, inparticular as to the safety, environmental risksand public acceptability of sequestration. Theseaspects, as much as the technologiesthemselves, will have a profound impact on thedevelopment of this technology.

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18 PCAST (1995). 19 The main source of this wide variation is uncertainty about the integrity of geological formations – if only capped aquifers are

suitable then the resource is much more limited UNDP/WEC (2000).20 UNDP/WEC (2000).

Combined cycle gas turbines(CCGT) 53. CCGT technology is currently the cheapestgenerating option in all locations with well-developed natural gas supply infrastructure, andis the least-cost option in the UK. CCGT plantcombines low capital cost and relatively shortbuild times (2 to 3 years) with high thermalefficiency relative to coal-fired plant.

54. CCGT offers a number of additionaladvantages: it is economic at a range of scalesfrom around 300MW to 1500MW, and, in theUK at least, the widespread availability of gasmeans that CCGT plant may be located whereit is needed on the national grid, close todemand. In addition, gas-fired power stationsface relatively few planning constraints. Bycontrast coal, nuclear, wind and some otherrenewable energy face considerable constraintsupon where they may be located.

55. Current capital costs of a modern CCGTplant are around £270 /kW and deliveredenergy costs around 2.2 p/kWh. Capital costsare widely projected to continue to declinemarginally – falling to around £260/kW by2020. Engineering assessments suggest thatfuture development will be focused oncontinued efficiency improvements. Today’sCCGTs deliver electricity at around 55%thermal efficiency. The next generation arewidely predicted to raise efficiency to around60%.21 These capital cost reductions andefficiency gains would reduce costs to around2.0 p/kWh by 2020, given today’s gas price, adecrease of around 10%. Possible increases ingas prices (by 20 – 30% to around 1.0 p/kWh)would increase CCGT power prices to around2.3 p/kWh.

56. Important though these efficiency gainsundoubtedly are there is little doubt that thedays of rapid cost reductions in gas turbine

technology are over. Learning rates of around20% were typical in the period to 1980, butfigures of 3% to 10% are commonly cited forthe period 1980-95.22 Gas turbines are widelyconsidered to be mature. However continuedinnovations in combined cycle plants arepredicted, in the longer term many analystssuggest that gas-turbine technologies will giveway to fuel cells in combined cycle stations.

Coal technologies57. Current coal-fired generation, based uponsteam-cycle pulverised coal technologies, withflue gas desulphurisation (PC-FGD) are not cost-competitive with CCGT in the UK or mostcountries with well-developed natural gasinfrastructures. Coal plant is more capitalintensive, has longer build times and offerslower efficiencies than gas. In addition, currentcoal technologies produce much higheremissions of all air pollutants than CCGT, andflue gas desulphurisation results in largequantities of solid or liquid waste.

58. There is considerable world-wide interest inadvanced coal technologies, to raise efficienciesand reduce pollutant emissions, compared tocurrent designs. Interest in coal is drivenprimarily by the widespread availability of coalcompared to gas, with particular interest incountries with cheap coal and limited access togas, like India and China.

59. Leading options for 2020 include super-critical pulverised coal steam cycle plants andintegrated gasification combined cycle plants(IGCC). Examples of both technology types areoperating in many countries, and though IGCCis not yet considered fully commercial it isconsidered by many analysts to offer the bestprospects for the long term.23 We therefore takeIGCC technologies as the “benchmark” for2020.

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21 UNDP/WEC (2000)22 IEA (2000a), UNDP/WEC (2000)23 UNDP/WEC (2000)

60. IGCC technologies gasify coal (or indeedother solid or liquid fossil fuels) to produce“syngas” – essentially hydrogen and carbonmonoxide – which is then burned in acombined cycle gas turbine. The mainadvantages of IGCC are improved efficiency,43–45% for current designs, with 50%estimated for new designs. By comparison 35%is typical for PC-FGD. IGCC plants also offermuch lower emissions of local air pollutants,and somewhat lower CO2 emissions. IGCC isalso well suited to CO2 separation andsequestration, as a relatively pure CO2 streamcan be removed from the syngas pre-combustion, rather than extracting highlydiffuse CO2 from the exhaust gases.

61. IGCC technologies are currently moreexpensive than conventional PC-FGD designs,with capital costs of the order of £900–£1200/kW and £700–£900 /kW respectively.24 As yet,though many commercial scale IGCC plants arein operation around the world, the technologyhas yet to be deployed on a fully commercialbasis. Commercial IGCC designs withefficiencies of around 50% and lower capitalcosts are predicted to be available post-2010-such designs would have capital costs of around£750–£900 /kW, and, if coal prices remainsimilar to today’s levels, would deliver energy ata range of approximately 3.0–3.5 p/kWh. Thisappears to be a reasonable estimate of costsfor 2020. In the longer term, efficiencies as highas 65% appear possible. Continued costreduction in the gasification cycle is alsobelieved to be achievable.

Costs per tonne of carbonsaved62. The costs per tonne of carbon saved thatflow from these cost projections aresummarised in table 5.1 of the main text. The

assumptions that underpin this table are asfollows:

● costs per tonne of carbon saved for all supplytechnologies are in comparison with CCGTgeneration. Cost range for CCGT in 2020 is2.0–2.3 p/kWh as discussed above;

● emissions saved by displacing CCGT areassumed to be approximately 0.1 kgC perkWh;

● emissions savings per kWh are assumed to be1 (100%) for renewables, nuclear and energyefficiency, 0.8 (80%) for C&S and 0.4 (40%)for CHP;

● cost ranges for all power generationtechnologies include grid connectioncharges, but do not include any additionallocational charges – which range frompositive to negative and cannot begeneralised;

● additional system costs due to intermittencyfor renewables are not explicitly included. Atvery low penetrations (<5% of peak demand)these are negligible, at modest levels(5–20%) these are uncertain and vary bytechnology but could add between 0.1 and0.2 p/kWh. If borne solely by renewablesgenerators this would result in an increase of5 to 10% at the low end and 1 to 3% at theupper end of renewables cost ranges. Giventhe wide range of inherent uncertaintyindicated in the table (50–200% variation incosts), these effects are lost in the “noise” ofthe uncertainty inherent in these cost ranges.

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24 UNDP/WEC (2000), AEAT (2001)

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Summary of key findings

Technology 2020 cost Basis for Confidence Cost trendsassessment in estimate to 2050

End use efficiency Low25 Engineering assessment High Decrease,but variable26

Fuel Cells Unclear Engineering assessment NA Sustaineddecrease

Large CHP Under 2 p/kWh Engineering assessment High LimitedDecrease

Micro CHP 2.5–3.5 Engineering assessment Moderate Sustainedp/kWh decrease

Transport efficiency Low Engineering assessment NA Unclear – fuelswitching

PV 10–16 p/kWh Learning rate and High Sustained market growth rate decrease

Onshore wind 1.5–2.5 Learning rate and High Limitedp/kWh market growth rate Decrease

Offshore wind 2.0–3.0 Engineering assessment Moderate Decreasep/kWh and onshore learning rate

Energy crops 2.5–4.0 Engineering assessment Moderate Decreasep/kWh and learning rate

Wave 3.0–6.0 p/kWh Engineering assessment Low Uncertain

Fossil generation 3.0–4.5 Engineering assessment Moderate Uncertainwith CO2 C&S p/kWh

Nuclear 3.0–4.0 Engineering assessment Moderate Decreasep/kWh

CCGT 2.0–2.3 Engineering assessment High Limitedp/kWh and learning rates decrease

Coal (IGCC) 3.0–3.5 Engineering assessment Moderate Decreasep/kWh

25 Energy efficiency measures are usually cost effective (see Annex 5) and therefore costs of saving energy are below the costs of supplyto the relevant final user.

26 Costs of individual technologies are expected to decrease with innovation, but much of the lowest cost potential will progressivelybe deployed.

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ANNEX 7. TIMELINES AFFECTING DECISIONS

1. The purpose of this Annex is to consider thetimescales associated with the energy system.These timescales will affect the timing and theimpact profile of energy policy decisions.Figures quoted in this Annex are all broadapproximations made by PIU based on a rangeof sources.

2. The following timescales are important:

● How long does energy producing and usingequipment last?

● How long does it take to construct key itemsof energy infrastructure?

● How long will indigenous UK energy supplieslast?

● How long does it take to create new energyoptions?

● What will happen to UK carbon emissions?

3. Energy assets, like other assets, have noclearly defined lifetimes. How long they last willdepend on developments during their liveswhich could on the one hand lead to earlyobsolescence or on the other to life extension.

How long does energyproducing equipment last?4. Many energy producing assets have longlifetimes compared to other assets. Table 1gives an approximate indication of how longsome sorts of assets might last.

5. To some extent, all the above arecomposites of various pieces of equipment withdifferent lives. During the life of the overallasset, some pieces of equipment may bereplaced several times. Gas pipeline andelectricity transmission and distribution systemsare characterised by rolling programmes ofcapital replacement. The systems as a whole arenot replaced but rather they evolve over time.The figures in Table 1 indicate the periods overwhich the whole of these systems might berenewed.

6. The key messages to take from Table 1 are:

● a high proportion of the energyinfrastructure will be replaced over a 50 yeartimescale, but:

● developments to gas and electricity networks

Asset Type Years

Gas pipelines and terminals 60

Electricity tranmission and distribution wires 50

Nuclear Power stations 40

Conventional Fossil Fuel Power Stations 40

Combined Cycle Power Stations 30

Wind Power Stations 20

Hydro Power Stations 100

Oil refineries 50

Table 1: Lifetimes of energy producing assets

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undertaken in the next few years, togetherwith some kinds of power stations built inthe near future, could still be operational inthe middle of this century; and

● almost all assets built from now on could stillbe operational in 2020.

7. Existing assets: whilst Table 1 gives a generalidea of assets lives, it is also necessary toconsider the probable lives of the existing assetstock. It is particularly important to concentrateon power stations since the turnover of powerstations can have significant impacts on carbonemissions and the diversity of fuel sources.

8. Most existing coal and oil stations are already30 years old or more. Future levels of operationwill come under increasing pressure fromtightening limits on acid gas emissions unlesssubstantial sums are spent on refurbishment.1

Some of the stations are likely to close by 2010and most that do not carry out majorrefurbishment seem likely to close by 2020.Coal stations that have refurbished to meetstrict acid gas emission limits, and those that doso in future, could continue operating to 2020or even beyond.

9. Nuclear: the Magnox stations are expected toclose by around 2010 and little prospect for lifeextension is foreseen. Most of the AGR stationsare expected to close in the period 2010–2020,although some life extensions may be possible,whilst the one existing PWR should last tobeyond 2030.

10. All the existing gas capacity has been builtsince 1990 and should last until at least 2020.

But by 2020, some of the earliest stations willbe approaching the end of their lives.

11. The current level of electricity generatingcapacity in Great Britain is about 70 GW. In verybroad terms, we would expect about one fifthof this to need replacing by 2010, one half by2020; three quarters by 2030 and almost all by2040.2

How long does energy usingequipment last?12. Lifetimes of most energy using equipmentare a good deal shorter as shown by theapproximate figures in Table 2. The mainmessage from the table is that over a 50 yeartime-scale, the bulk of energy using equipmentis likely to be changed two or three times andthat most of it will be changed at least oncebefore 2020.

13. Building design and construction is a veryimportant determinant of the amount of energyneeded to light and heat them. Houses last 100years or more and many commercial buildingscan also have very long lives. It is probable thatabout half the existing building stock will stillbe in use 50 years from now, as will almost allnew buildings.

Table 2: Lifetimes of energy using equipment

Asset Type Years

Cars and motor vehicles 10-15

Electrical appliances 5-20

Household boilers 15

1 For example, installing flue gas desulphurisation equipment.2 Assumes that electricity demand remains at least at current levels. If demand falls, plant can be retired without replacement.

How long does it take to buildkey items of energyinfrastructure?14. The focus is mainly on power stations forthe reasons given in Paragraph 7. Constructiontimes vary considerably and will also be greatlyaffected by the time taken to obtain therelevant planning permissions. Table 3 givesapproximate indications of build times, on theassumption that the projects concerned do notface major planning obstacles.

15. Table 3 suggests that significant amounts ofgas and renewable generating capacity can bebuilt within 5 years or less but that build timesare longer for clean coal with carbonsequestration or for nuclear. A key message isthat the process of learning and cost reductioncan happen more quickly with renewables thanwith nuclear or coal sequestration, because theturnaround time for projects is faster.

How long will indigenous UKenergy supplies last?16. Gas: At present, the UK is a net exporter ofnatural gas. DTI estimates are that by 2010, theUK may need to import up to one-third of itsgas requirements and by 2020 it may need toimport over 80%. Future production figures3

take no account of output from as yetundiscovered reserves. However, DTI considersuch contributions are likely to be small andcould be offset by lower output from knownreserves. DTI projections are summarised inTable 4. The demand projections are based onthe central growth scenarios of Energy Paper684 and may be on the high side since they donot allow for the effects of the Climate ChangeProgramme.5 The projections also assume thatall new electricity generation capacity, exceptthat needed to meet the 10% renewablestarget, is gas fired.

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Table 3: Build times for energy assets

Asset Years

Nuclear power station 10 *

Clean coal station with carbon capture and sequestration 7

Gas fired power stations (including large CHP) 3

Renewable generating stations 1-3 **

Micro-CHP and domestic photovoltaic Days / weeks

Gas/electricity link to Europe 5

Gas storage facility 3

LNG terminal 5

* Could be less with already licensed designs.** Range reflects wide range of renewables technologies. Would be longer for large hydro projects.

3 Based on proven plus probable plus possible reserves4 DTI (2000b). 5 DETR (2000).

17. Oil: At present, the UK is a significant netexporter of oil. DTI projections, once againbased on known discoveries, suggest thatproduction levels in 2010 may be only halfcurrent levels and may fall to less than 20% ofcurrent levels by 2020. As well as oil for energyneeds, the UK currently uses some 12 mtoe perannum for non-energy purposes. The demandprojections in Table 5 assume non-energy oiluse will remain at current levels. They indicatethat the UK could be a modest net oil importerby 2010 and a large importer by 2020. Energydemand for oil is again based on Energy Paper68.

18. Coal: At present coal accounts for about15% of the UK energy mix, but its use seemslikely to drop over the next 20 years in almostall scenarios. UK production of coal also seemslikely to drop, as existing deep mines’ reservesare progressively exhausted and as falling localdemand, and competition from imported coal,threaten the commercial viability of new deepmines.

19. Nuclear and Renewables: By 2020, nuclearoutput is expected to fall to about one-third ofits current level, but renewables output, oncurrent targets, would reach 10% of electricity.

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Table 4: Future Production and Demand for Gas

Mtoe 2000 2010 2020

Production 108 70 20

Demand 95 109 125

Net Imports (13) 39 105

Table 5: Future Production and Demand for Oil

Mtoe 2000 2010 2020


Demand* 86 97 107

Net Imports (52) 27 87

* including non-energy use

Table 6: UK Production and Use of Energy

Mtoe 2000 2010 2020


Demand 244 257 266

Of which gas: 95 109 125

Imports (46) 74 196

Imports as % Demand (19%) 29% 74%

Gas as % Demand 39% 42% 47%

20. Combining the figures for the individualfuels, Table 6 shows projections of the overallenergy balance.

21. The key messages from Table 6 are:

● by 2020, imports reach about three-quartersof UK energy needs;

● gas accounts for close to half overall UKenergy needs.

22. Uncertainties: It should be recalled that theabove projections for UK oil and gas productionare very uncertain and that the historical trendhas been for projections of this sort to turn outto have been too pessimistic.6 The extent towhich this happens in future will depend partlyon future oil and gas prices. The projectionsmay also overstate energy demand. Takingthese uncertainties into account suggests thatthe UK might still be broadly self-sufficient inenergy in 2010. However, it would take asubstantial divergence from the projections forthe UK to remain close to self-sufficiency in2020. It is also possible that oil demand, mainlyfrom transport, will grow less than anticipated,and that coal use will decline faster, perhapsfrom stronger carbon reduction pressures – insuch cases gas use could well exceed 50% oftotal energy needs by 2020.

How long does it take tocreate new energy options?23. There is no easy answer to this question. Asalready noted options which can be quicklydeployed, such as some renewables, can bedeveloped more quickly than those which takea long time to deploy, such as a new type ofnuclear reactor.

24. Options which need considerable furthertechnical work, such as new nuclear reactors,

some types of renewables (e.g. wave and tidalenergy), and ways of storing electricity orhydrogen, will probably need longer to becomeestablished than those where the main barriersare economic or institutional (e.g. greater takeup of energy efficiency).

25. Development of some options may berelated to the regulatory cycle for the naturalmonopolies, currently 5 years. Options in thiscategory include significant changes to thedesign of electricity distribution systems and,related to this, greater take up of small scaleonshore renewables and CHP. Significantdevelopment of larger renewable resources inScotland (onshore and marine) could beinfluenced by electricity transmission regulationas well.

26. It is extremely hard to predict when majortechnological advances may arrive which couldbe highly disruptive to existing systems. Anexample from history is the internal combustionengine which revolutionised the style andavailability of transport. Not only are suchinnovations very hard to predict, but oncemade, they can have very long lasting impacts.Our transport system today is still dominated bythe internal combustion engine and likely toremain so for several years to come.

What will happen to UKcarbon emissions?27. The DETR Climate Change Programmeshows UK greenhouse gas emissions falling by14.9% from 1990 levels by 2010, but thenrising by around 3% over the subsequentdecade.7 These estimates were before takingaccount of the additional measures announcedby the Government in that Programme.

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6 For example, IEA (2000a) takes a more optimistic view of UK oil production prospects.7 DETR (2000). Table 1 page 53.

28. Estimates including the impact of theseextra measures show greenhouse gas emissionsdown by 23% from 1990 levels in 2010, withemissions of carbon dioxide down by 19%.8

Further small reductions are possible frommeasures set out in the programme but whoseimpact was not quantified. Reductions on thisscale would be comfortably within our Kyotolimits which require reductions of 12.5% ingreenhouse gas emissions over the period2008-2012.

29. The Climate Change Programme does notquantify how emissions might develop beyond2010 once account is taken of the extrameasures. However, if it were supposed thatthese measures had no extra impact after 2010,then 2020 emissions of greenhouse gaseswould still be some 20% below 1990 levels.

30. In broad terms, the above projections aresimilar to PIU projections for World Market andProvincial Enterprise scenarios (see Chapter 5 ofthe main report). PIU projections for GlobalSustainability and Local Stewardship scenariosshow considerably lower emissions by 2020,driven by differences in the assumed policybackground.

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8 DETR (2000), page 124.

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ANNEX 8. CHIEF SCIENTIFIC ADVISER’S ENERGYRESEARCH REVIEW – SUMMARY ANDRECOMMENDATIONS

Executive summary1. This report has been prepared by the ChiefScientific Adviser and a group of twelve expertsassembled to assist him in a review ofGovernment support for research, developmentand demonstration activities. The review wascommissioned by the Secretary of State forTrade and Industry to inform the wider reviewof energy policy being undertaken by thePerformance and Innovation Unit.

2. The group was asked particularly to considerwhether the overall level of expenditure onresearch, development and demonstration(RD&D) was sufficient, whether it was beingtargeted at the right areas and who should infuture maintain an overview of expenditure.

3. The group agreed that increased RD&Deffort was crucial to identifying new energyoptions which would deliver a secure andsustainable supply of energy with substantiallylower carbon emissions. It welcomed the stepsthe Government was already taking toencourage innovation and the transition to alow-carbon economy.

4. The group concluded, however, that the UK’sspending on RD&D should be raised to bring itmore in line with that of its nearest EUcompetitors. The group laid particular emphasison the importance of building a strong base offundamental research activity. It felt that energywas still an insufficiently high priority foracademic research and that the leading edgescience was now going on elsewhere in theworld. Consequently, UK companies could loseout on the opportunity to capitalise on publiclyfunded research and take advantage of thegrowing export market for energy and lowcarbon technologies.

5. The Group put down a marker that work isrequired to assess, quantify and seek remediesto any skills gaps in the UK energy sector.

6. The group called for more socio-economicresearch into the various factors that determinethe uptake and successful commercialisation ofnew technologies, including the regulatoryclimate, the impact of fiscal incentives andpublic perception of environmental effects andlifestyle changes.

7. The group identified six broad areas ofscientific research which it felt had the strongestcase for being treated as priorities, based oncriteria which included the degree oftechnological potential or “headroom” forresearch to yield step-change benefits. Thesewere: CO2 sequestration; energy efficiency;hydrogen production and storage; nuclearpower; solar photovoltaics; and wave and tidalpower. With regard to nuclear power, the groupconsidered that, whether or not there is anycommitment to new nuclear build, the priorityfor publicly funded research should be researchinto the handling and storage of nuclear waste.More generally, it emphasised the importanceof exploring how different technologies couldinteract and the centrality of infrastructureissues to the commercialisation of alternativeenergy options.

8. The group noted the difficulties it hadencountered in obtaining data on precise levelsof spending in particular areas. It recommendedthat a suitable body be given the task ofcollecting and co-ordinating such data.

9. It also called for the establishment of adedicated national research centre to boost theprofile of energy research and attract high-calibre scientists into the field. The group

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ANDRECOMMENDATIONS

emphasised that such a centre should be basedon a multidisciplinary approach and wouldneed to stimulate research into a range of cross-cutting technologies in order to supportadvances in the six key areas it had identifiedduring the course of its work.

10. Finally, the group concluded that its reviewhad raised many relevant issues which it hadnot had time to explore fully in the short timeavailable for its work. It recommended that theGovernment find means to continue a strategicexploration of such issues, including thelegislative and regulatory drivers for research,energy storage technologies and infrastructure,and socio-economic research. More detailedrecommendations could then be developed.

The full set of the group’s recommendationsand all supporting documentation can be foundin a Working Paper on the Chief ScientificAdviser’s Energy Research Review Group reportat www.piu.gov.uk

ERRG recommendations ERRG recommendation 1: Given theirimportance in determining the level and type ofenergy research being undertaken in the privatesector, as well as the commercial uptake oftechnologies, there should be further strategicinvestigation and appropriate research into non-technical policy drivers, including regulatory aswell as social, commercial and economicdrivers. Particular attention should be paid tounderstanding the market context into whichnew technology is deployed.

ERRG recommendation 2: Government shouldhave regard to the impact which differentaccounting treatments have on how theenvironmental costs and benefits are assessedwhen evaluating different energy options.

ERRG recommendation 3: In allocatingfunding for publicly supported energy researchprogrammes, the Government should ensure

that there is a sufficient focus on basic researchactivities.

ERRG recommendation 4: Government shouldencourage and support more cross-boundaryresearch to look at how different technologiesmight be optimised to deliver overall energypolicy objectives.

ERRG recommendation 5: Energy research andits proper co-ordination should be key prioritiesfor Government. Spending, over time, shouldbe brought more in line with that of our nearestindustrial competitors in Europe. Theopportunities for increasing co-operation withthe European Commission and other EUMember States in jointly funded programmesand projects should also be considered.

ERRG recommendation 6: Further work isrequired to assess and quantify the extent ofskills gaps in the UK energy sector, and seekremedies to them.

ERRG recommendation 7: Research is neededto support the continuing development of allthe relevant technologies and practices,including the underpinning sciences. Thefollowing were identified as key areas:

● CO2 sequestration;

● energy efficiency;

● hydrogen production and storage;

● nuclear power (nuclear waste);

● solar PV; and

● wave and tidal power.

ERRG recommendation 8: There should beincreased support for important cross-cuttingenergy efficiency technologies such asinnovative software and hardware for energymanagement systems, sensors and controls,and for research into energy strategies andsystems analysis. Projects which combineseveral energy efficiency technologies todemonstrate their cumulative impact andimprove understanding of their relative

contributions and interactions may beparticularly advantageous.

ERRG recommendation 9: The Government’sresearch programme has thus far incorporatedresearch on hydrogen into its work on fuel cells.It is now appropriate to establish a dedicatedhydrogen research programme which wouldcomplement the continuing work on fuel cells.Research priorities should include storagetechnologies, particularly those which couldlead to a step change in performance, andsustainable methods of hydrogen production.There should also be a limited demonstrationprogramme.

ERRG recommendation 10: The key priority forpublicly funded research in relation to nuclearfission should be to improve the methods bywhich nuclear waste and spent fuel can besafely and cost-effectively handled and stored.Even if there were to be no new commitmentto nuclear build, the need to deal with legacywastes argues strongly for a researchprogramme aimed at finding innovative ways oftreating them.

ERRG recommendation 11: With regard tonuclear fusion, priority should be given to workon materials capable of withstanding the heatand plasma fluxes in an operating fusion reactorfor a sufficient length of time. Without suchmaterials, realising nuclear fusion’s potential asan energy source may not be possible.

ERRG recommendation 12: R&D on novelemerging PV material systems such asorganics/polymers could provide step-changedecreases in the cost of production. Given thatthis is the case, it may be advantageous for theUK to focus efforts more on these innovative“next generation” technologies and theassociated systems.

ERRG recommendation 13: A suitable bodyshould be entrusted with the mission ofcollecting and co-ordinating information, sothat policy makers and research planners in thisarea are able to avoid unwittingly funding

activity which is already adequately supportedelsewhere, or neglecting a strategic requirementbecause of inadequate or mistaken informationabout what others are doing. The body carryingout the task would need to be seen asindependent and have access to the necessarydata, or the powers to collect such data. Such abody need not be located in government,although if it were, it ought to be placed so asto access the relevant expertise.

ERRG recommendation 14: Considerationshould be given to setting up a dedicatednational energy research centre. We welcomethe proposals for such a centre currently beingdeveloped jointly by the Research Councils incollaboration with others. We also welcome theinterest being shown by universities, business,the Energy Saving Trust and the Carbon Trust.Such a centre should be the hub of a widernetwork encompassing new and existingcentres of excellence in specific areas.

ERRG recommendation 15: The Governmentshould find means to continue a strategicexploration of a wide range of relevant issues,including those raised by the review’s originalterms of reference as well as issues such aslegislative and regulatory drivers for research,energy storage technologies and infrastructure,and socio-economic research. This wouldenable those charged with the task to work upmore detailed recommendations based on theoutline which we have set in place.

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209

GLOSSARY

ANNEX 9. GLOSSARY

28 day rule Domestic customers areentitled to change their gas orelectricity supply at 28 daysnotice and contracts are notallowed to preclude this right.

AGR stations Advanced Gas Cooled Reactornuclear power stations

BAU Business As Usual

Biofuels A fuel produced from dryorganic matter or combustibleoils produced by plants.Examples of biofuel includealcohols (from fermentedsugar), black liquor from thepaper manufacturing process,wood and soybean oil.

Biomass The total dry organic matteror stored energy content ofliving organisms. Biomass canbe used for fuel directly byburning it (e.g. wood),indirectly by fermentation toan alcohol (e.g. sugar) orextraction of combustible oils(e.g. soybeans).

Carbon Reducing/diminishing carbonabatement produced; measures to

prevent CO2 emissions

Carbon C&S Carbon capture andsequestration (see below)

Carbon capture Removal of CO2 from fossilfuels either before or aftercombustion. In the latter theCO2 is extracted from the flue-gas.

Carbon The long-term storage ofsequestration carbon in the forests, soils,

ocean, or underground indepleted oil and gasreservoirs, coal seams, andsaline aquifers (see engineeredsequestration).

Cash-out prices The price paid to/bygenerators and suppliers toremove imbalances from theelectricity network. Cash-outprices are paid as part of thefinancial settlement ofBalancing Mechanism tradesto deal with those whosegeneration or consumption ofelectricity is out of balancewith their contracted position.

CHP Combined Heat and Power

CCL Climate Change Levy

CCGT Combined Cycle Gas Turbine

CO2 Carbon Dioxide (a greenhousegas)

CSA Chief Scientific Adviser

DEFRA Department for theEnvironment, Food and RuralAffairs

DETR Department of theEnvironment, Transport andthe Regions (Note: DETRceased to exist after the 2001General Election. Itsresponsibilities were splitlargely between DEFRA andDTLR.)

DGCG Distributed Generation Co-ordinating Group

Distributed Synonym for embeddedgeneration generation

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Decentralised Synonym for embeddedgeneration generation

Diversity (in the Having primary or secondaryenergy system) energy provided by a range of

fuels or sources of fuel.

DTI Department of Trade andIndustry

DTLR Department of Transport,Local Government and theRegions

EC Commission for the EuropeanUnion

EU European Union

Embedded Embedded generation coversgeneration smaller power plants

connected to a regionalelectricity company’sdistribution network (asopposed to the high voltagetransmission network wheremost current power plants areconnected).

EGWG Embedded GenerationWorking Group

Emissions/ A scheme introduced to cutcarbon trading down on greenhouse gases in

the atmosphere and alsocomplement other climatechange measures.

Engineered Carbon sequestrationSequestration achieved artificially by piping

carbon dioxide into geologicalstrata or the deep ocean.

EST Energy Saving Trust

Equity Fairness; use of principles ofjustice/fairness tosupplement/implement law

Exogenous Independently determined. Avariable in an economic model(e.g. crude oil deposits) is saidto be exogenous if it is not a

function of any other variablein the model (e.g. the price ofoil). The opposite ofexogenous is endogenous.

Externality An action by anyproducer/consumer thatdirectly impacts on anotherproducer/consumer, which thelatter has not chosen toaccept and so is not reflectedin the market price of theaction. Externalities can beeither positive (i.e. beneficial)or negative (i.e. adverse).

FCO Foreign and CommonwealthOffice

Fuel cells An energy conversion devicewhich produces electricityfrom the electrochemicalreaction between hydrogenand oxygen.

Fuel poverty The most widely accepteddefinition of a fuel poorhousehold is: one which needsto spend more than 10% of itsincome on all fuel use and toheat its home to an adequatestandard of warmth.

GEMA Gas and Electricity MarketsAuthority

GW Giga Watt – a measure ofpower, one billion Watts.

Greenhouse Atmospheric gases that partly gas absorb and re-emit

downwards infrared radiationemanating from the earth’ssurface.

HSE Health and Safety Executive

IEA International Energy Agency

Interconnectors A pipe or other means oftransportation of fuel betweencountries for example there is

a pipeline connecting Englandand Belgium.

Intermittents Intermittent power plantsharness energy fromunpredictable natural sources(for example, wind or waves).Output is therefore notreliable, in the sense that itcannot be turned on and offas required.

IPPC Intergovernmental Panel onClimate Change

Liberalisation Occurred in the UK energyutilities over 15 years from themid-1980s onwards andentailed the privatisation ofgas, electricity and coalindustries and a gradualincrease in the level ofcompetition.

kWh kilo Watt hour. Unit ofelectrical energy – onethousand Watts of electricalpower provided for one hour.The basic unit of electricalsales.

LNG Liquified Natural Gas

Market failure Used by economists todescribe the situation wherethe unconstrained operationof markets leads to a situationin which society is less well-offthan it should be, using someobjective measure. An attemptto rectify the failure is usuallymade through some form ofGovernment intervention,such as regulation, economicinstruments or some otherpolicy tool.

Micro- Generation of electricity on ageneration small (e.g. domestic scale), for

example by photovoltaics orfuel cells.

Micro-turbines Gas turbines operating on asmall scale, one of thetechnologies associated withmicro generation

MW Mega Watt – one millionWatts

MWh Mega Watt hours – onethousand kWh

NETA New Electricity TradingArrangements

NGC National Grid Company

NGO Non-GovernmentalOrganisation

NOx Nitrogen Oxides (local andregional air pollutants)

Ofgem Office of Gas and ElectricityMarkets

OPEC Organisation of the PetroleumExporting Countries

OST Office of Science andTechnology

Photovoltaics Apparatus which transforms(PV) light directly into electricity.

PIU Performance and InnovationUnit

p/kWh Pence per kWh – the commonform of pricing energy sold toconsumers.

RD&D Research, Development andDemonstration

R&D Research and Development

RCEP The Royal Commission onEnvironmental Pollution

Renewables Energy production usingnatural resources in aninexhaustible manner.

Renewables The obligation placed onObligation licensed electricity suppliers

to deliver a specified fractionof their electricity from

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GLOSSARY

renewable sources or pay apenalty to Ofgem.

Resource Measures the ratio ofproductivity economic output to natural

resource input and thus theefficiency with which we useenergy and material in powergeneration, manufacturing,services and households.

Scenarios Internally consistentdescriptions of possible futurestates of the world that set aframework in which social,economic and technologicaldevelopments (in our caseenergy systems) may beanalysed.

SEPU Sustainable Energy Policy Unit(proposed new body withinGovernment)

SMEs Small and Medium-SizedEnterprises

SOx Sulphur Oxides (local andregional air pollutants)

Strategic The risk of interruption to the(or fuel-related) supply of fuel from overseas.risk The origin of the problem may

be market power, or politicalinstability, or lack ofinvestment in overseasinfrastructure.

Sustainable Development that meets thedevelopment needs to current generations

without reducing the ability offuture generations to meettheir needs. The concept ofsustainable developmentintegrates the threeconventionally separatedomains of economic,environmental and socialpolicy.

Synergy Occurrence or policy which ismutually beneficial to morethan one party

Domestic risk The risk of interruption to the(to an energy flow of energy within the UK.system) The origin of the problem may

be low or inappropriateinvestment in energyequipment (production,transportation or storage),technical failure, terrorism orcivil unrest.

TENS Trans-European Networks

TWh One billion (1,000,000,000)kWh

TWh/yr Units of electrical energyproduced/consumed in a year

UKCS United Kingdom ContinentalShelf

UNFCCC United Nations FrameworkConvention on ClimateChange

Vesting The moment (1st April 1990)when the switch was madefrom the old electricityindustry structure in Englandand Wales (comprising theCentral Electricity GeneratingBoard and the Area ElectricityBoards) to the new marketstructure (comprising a rangeof companies carrying out thefunctions of generation,transmission, distribution andsupply, together with thewholesale market known asThe Pool). Most of the newcompanies were privatised inthe subsequent 12 months.

Watt The conventional unit tomeasure a flow rate of energy.One Watt amounts to 1 jouleper second.

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213

REFERENCES

ANNEX 10. REFERENCES

AEAT (2001), Database on Energy Technologies(corporate data source of AEAT Ltd)

BP plc (2001), BP Statistical Review of WorldEnergy

Brandon and Hart (1999), An Introduction toFuel Cell Technology and Economics

Building Research Establishment (2001),Domestic Energy Fact File

British Wind Energy Association (2001a),Notes of Meeting Between OFGEM and BWEA,15 October

British Wind Energy Association (2001b),Review of Surveys

BTM Consult (2001), International WindEnergy Development, World Market Update2001

Chief Scientific Adviser (2001), EnergyResearch Review: Full Report

Commission for the European Union (1997),The Atlas Project

Commission for the European Union (2001a),Communication on the implementation of thefirst phase of ECCP, COM (2001) 580

Commission for the European Union (2001b),Energy Efficiency: Action Plan

Commission for the European Union (2001c),Greenhouse Gas Emissions Trading within theEuropean Community, COM (2001) 581

Commission for the European Union (2001d),Green Paper – Towards a European Strategy forthe Security of Energy Supply, COM (2000) 769Final

Commission for the European Union (2001e),Proposal for a Directive on the Energy

Performance of Buildings, COM (2001) 226Final

Darmstadt, J, Titlebaum, P, Polach J (1971),John Hopkins Press for Resources for the Future

Department of Energy (1989), Energy Use andEnergy Efficiency in Transport

Department of the Environment (1993),Planning Policy Guidance Note 22: RenewableEnergy

DEFRA (2000), Waste Strategy 2000 forEngland and Wales

DEFRA (2001a), Energy EfficiencyCommitments 2002-2005 Consultation Paper

DEFRA (2001b), Digest of EnvironmentalStatistics (derived from NETCEN, 2001, UKGreenhouse Gas Inventory, 1990-1999, AGSalway, TP Murrells, R Milne, S Ellis)

DEFRA (2001c), Managing Radioactive WasteSafely Consultation Paper

DETR (2000), UK Climate Change Programme

DTI (1997), Energy Paper 66 – EnergyConsumption in the UK

DTI (1998), New and Renewable Energy:Prospects in the UK for the 21st Century,Supporting analysis

DTI (2000a), DUKES, 2000, Emission factors offossil fuel in 1998, Table B.1.

DTI (2000b), Energy Paper 68 – EnergyProjections for the UK

DTI (2000c), The Energy Report 2000

DTI (2000d), UK Energy Sector Indicators 2000

DTI (2001a), Digest of UK Energy Statistics

DTI (2001b), Draft Social and EnvironmentalGuidance to GEMA

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DTI (2001c), Energy Sector Indicators

DTI (2001d), Energy Trends, ProvisionalEstimates for CO2 emissions by sector, March

DTI (2001e), Government Response to Ofgem’sreports ‘The New Electricity TradingArrangements – Review of the First ThreeMonths’ and ‘Report to the DTI on the Reviewof the Initial Impact of NETA on SmallerGenerators’ of 31st August 2001

DTI (2001f), Quarterly Energy Trends

DTI (2001g), Renewables Obligation StatutoryConsultation

DTI (2001h), Review of the case forGovernment support for cleaner coaltechnology demonstration plant, Final report

DTI (2002), Inter-Departmental Analysts’ Groupon Low Carbon Options report on Long TermReductions in Greenhouse Gas Emissions in theUK

DTI, DEFRA (2001), The UK Fuel PovertyStrategy

DTI, DTLR, Ofgem (2001), EmbeddedGeneration Working Group – Report intoNetwork Access Issues, Vols 1 and 2

DTI, Scottish Office (1995), The Prospects forNuclear Power: Conclusions of theGovernment’s Nuclear Review, Cm 2860

DTLR (2000), Transport Statistics

DTLR (2001a), Building Regulations. Part LApproved Document, May

DTLR (2001b), New Parliamentary Proceduresfor Processing Major Infrastructure Projects

DTLR (2001c), Planning Green Paper- Planning:Delivering a Fundamental Change

DTLR, DTI, HM Treasury (2001), PoweringFuture Vehicles

ETSU (1998), The Value of Electricity Generatedfrom PV Power Systems in Buildings (forDepartment of Trade and Industry)

Federal Energy Regulatory Commission(2001), Ensuring Sufficient Capacity Reserves inToday’s Energy Markets: Should We? And HowDo We? Study Team Discussion Paper

Ferguson, M (2001), see list of Working Papers

Goddard, S (1991), ‘Future Programmes’ inWhere Are We Now on Nuclear Power, pp. 59-70, London, Institute of Energy

Green Alliance (2001), Signed, sealed anddelivered? – The role of negotiated agreementsin the UK

Hartnell, G (2001), ‘Planning and renewables:implications for meeting the targets’ RegionalPlanning Targets: rationale, progress andpractical implementation, CREA Conference atImechE, 1 Birdcage Walk, London, 22 March

HM Treasury, DETR (2000), EnvironmentalIssues in Purchasing, guidance note

House of Commons Science and TechnologyCommittee (2000-01), Seventh Report onWave and Tidal Energy

ICCEPT (Imperial College Centre for EnergyPolicy and Technology) (2001), Scoping R&DPriorities for a Low Carbon Future, ImperialCollege report on priorities for the Carbon Trustcommission by the Carbon Trust andDepartment of Environment, Food and RuralAffairs

IEA (2000a), Energy Policies of IEA Countries,OECD

IEA (2000b), Experience Curves for EnergyPolicy, OECD

IEA (2001a), Energy Balances of OECDCountries, 1998-1999, OECD

IEA (2001b), Natural Gas Information 2001(2000 data), OECD

IEA (2001c), Nuclear Power in OECD, Paris,OECD

ILEX (2001), see list of Working Papers

Intergovernmental Panel on Climate Change(1999), Aviation and the Global Atmosphere

Intergovernmental Panel on Climate Change(2000), Third Assessment Report, WorkingGroup III

Intergovernmental Panel on Climate Change(2001), Climate Change 2001: Mitigation.Contribution of Working Group III to the ThirdAssesment

International Atomic Energy Agency (1November 2001), Press Release – Calculatingthe New Global Nuclear Terrorism Threat

Layfield, F (1987), The Sizewell B PublicPlanning Enquiry

MacKerron, G (1994), The Capital Costs ofSizewell C, submitted to Government’s NuclearReview, COLA 3

McDonald, A & Schrattenholzer, L (2001),‘Learning rates for energy technologies’ EnergyPolicy 29, pp. 255-261

Milborrow, D (2001), see list of Working Papers

Ministry of Fuel and Power (1965), FuelPolicy, Cmnd 2798, HMSO

Moore, A (2001), e-mail from Alan Moore (MDof National Windpower), Wind under NETA, 3December

Murry, R (2001), Creating Wealth from Waste,DEMOS

National Assembly for Wales (2001), WalesSpatial Planning: Pathways to SustainableDevelopment – consultation

OECD Nuclear Energy Agency and theInternational Atomic Energy Agency (2000),Uranium 1999: Resources, Production andDemand, Paris

OXERA (2001), see list of Working Papers

National Audit Office (1998), The Office ofElectricity Regulation (1998): Improving EnergyEfficiency Financed by a Charge on Customers.

Report by the Comptroller and Auditor General,HC 1006 1997/98

Office of National Statistics (2001), UKNational Accounts

Official Journal of the EuropeanCommunities, 2001, Directive 2001/77/EC ofthe European Parliament and the Council of 27September 2001 on the promotion of electricityproduced from renewable energy sources in theinternal electricity market, L283/33-40

Ofgem (2001a), Report to the DTI on theReview of the Initial Impact of NETA on SmallerGenerators

Ofgem (2001b), Submission to PIU EnergyReview

PCAST (Presidential Committee of Advisors onScience and Technology) (1995), Report of theFusion Review Panel

PCAST (Presidential Committee of Advisors onScience and Technology) (1997), Report to thePresident on Federal Energy R&D Challenges forthe 21st Century

PIU (2001a), Renewable Energy in the UK

PIU (2001b), Resource Productivity: Makingmore with Less

Royal Commission on EnvironmentalPollution (2000), Energy – The ChangingClimate

Royal Society for the Protection of Birds(2001), RSPB Market Research Project 0136 –The GB public’s views on energy issues, on

Scottish Embedded Generation WorkingGroup (2001), Report into Network AccessIssues – a Consultation Document from theJoint Government Industry Working Group onEmbedded Generation

Scottish Executive (2000a), National PlanningPolicy 6: Renewable Energy Developments

Scottish Executive (2000b), Public AttitudesTowards Wind Farms in Scotland, August,

215

REFERENCES

Shell (2001), Distant Gas – Will it arrive ontime? European Autumn Gas Conference, 7November

Social Exclusion Unit (2001), Transport andSocial Exclusion Consultation

Strbac, G, Jenkins (2001), see list of WorkingPapers

Thorpe (1999), A brief Review of Wave Energyin the UK

UNDP, WEC (United Nations DevelopmentProgramme & World Energy Council) (2000),The World Energy Assessment

US National Academy of Sciences (2001),Energy Research at DOE: Was it Worth it?Energy Efficiency and Fossil Energy Research1978-2000, US Department of Energy

US National Energy Policy DevelopmentGroup (2001), Reliable, Affordable andEnvironmentally Sound Energy for America’sFuture

Utterback (1997), Mastering the dynamic ofinnovation, Harvard University Press

Wind Power Monthly, January 2001

Working Papers

These can all be found on the PIU website:www.piu.gov.uk

Chief Scientific Adviser (2001), EnergyResearch Review: Full Report

Ferguson, M (2001), Working Paper onTransport

ILEX (2001), Working Paper on NETA and SmallGenerators

Milborrow, D (2001), Working Paper onPenalties for Intermittent Sources of Energy

OXERA (2001), Working Paper on RenewableEnergy Cost Modelling

PIU (2001c), Working Paper on EnergyEfficiency Strategy

PIU (2001d), Working Paper on EnergyProductivity to 2010 – Potential and Key Issues

PIU (2001e), Working Paper on EnergyScenarios to 2020

PIU (2001f), Working Paper on Energy Systemsin 2050

PIU (2001g), Working Paper on EnvironmentalCosts and Risks

PIU (2001h), Working Paper on GeneratingTechnologies: Potentials and cost reductions to2020

PIU (2001i), Working Paper on The Economicsof Nuclear Power

Strbac, G, Jenkins, N (2001), Working Paperon Network Security of the Future ElectricitySystem

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A PERFORMANCE AND INNOVATION UNIT REPORT – FEBRUARY 2002

The Energy Review

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