Exposing the Hidden Costs of Renewables and Net Zero

Why did electricity prices rise as penetration of "cheap" renewables increased and gas prices remained stable up to 2020?

Introduction

It is often claimed that renewables are the cheapest form of electricity generation, for example by the World Economic Forum. In addition, others like the Natural History Museum (yes, that well known econometric think tank) have claimed that net zero “is cheaper and greener than fossil fuels”. These thoughts are propagated by the Government (BEIS) in reports such as their electricity generation cost reports from 2020 and 2016. What all of these sources fail to explain is why electricity costs rose as renewable penetration increased and gas prices remained stable up to 2020.

Figure 1 below shows the anticipated levelised cost of electricity for a range of technologies commissioned in 2025 or 2030. The non-nuclear sources are taken from the 2020 report. Nuclear costs were not shown in the 2020 report because they were not updated from 2016, so the figures from the 2016 report have been used for nuclear.

Note that there are some quite heroic assumptions about the future costs of wind in the 2020 report. These may well become the subject of another article, however, for the moment, let’s take them at face value. The BEIS work clearly tries to claim that renewable wind and solar are the cheapest forms of electricity generation. It should be noted that the fuel costs of gas are probably a vast under-estimate for current circumstances. To bring gas prices down we need to invest in new sources of supply. It is also worthy of note that “carbon costs” make up a very large proportion of the cost of electricity produced from burning gas. These carbon costs are an artefact of Net Zero policies.

Figure 1: BEIS Levelised Cost of Energy by Source (£/MWh)

These ideas are amplified by asset managers like Lazard, who produce their own Levelised Cost of Energy report. Activist organisations such as Carbon Brief further amplify these analyses with breathless reports on how cheap wind and solar power have become.

It is a puzzle why electricity costs rose sharply, even before the war in Ukraine, if penetration of the supposed cheapest sources of energy have been rising. Surely, generating a higher proportion of our electricity from the lowest cost sources should bring overall prices down?

[Update 20 April 2023: The Government is now consulting on ways to add extra subsidy to renewables see new article here.]

The purpose of this article is to answer the question, if we’re following Net Zero and generating more power from “cheap” renewables, why did electricity costs rise sharply before the war in Ukraine?

Industrial Energy Price Trends and International Comparisons

Let’s start by looking at how UK industrial energy prices compare to other countries and how they have changed over time. BEIS helpfully publish historical data comparing UK industrial gas and electricity prices over time (Tables 5.7.1 and 5.3.1 respectively). Each download has a chart showing how UK prices compare internationally.

As can be seen in  Figure 2 below, the UK had below average gas prices in 2021, although Canada, USA, Turkey and New Zealand had much cheaper prices.

Figure 2: BEIS Industrial Gas Price Comparison

However, as Figure 3 shows, the UK has the highest industrial electricity prices, nearly 40% above the international median and more than twice the costs in the USA. Notably, prices in Germany are almost as high, despite their massive investment in wind and solar projects.

Figure 3: BEIS International Industrial Electricity Price Comparison

CSEP have published an international electricity price comparison that includes key economic competitors China and India. Figure 4, taken from their Granular Comparison of International Electricity shows that in FY19, the UK had much higher prices than China or India. In fact, UK prices for industrial electricity were the highest in their study, conforming the BEIS reports.

Figure 4: CSEP Comparison of International Electricity Prices

Now let’s take a look at how UK industrial Gas and Electricity prices have changed. The same downloads from BEIS record the industrial gas and electricity prices over time. 2008 has been chosen as the starting year as this is the first year that wind and biomass generation became significant.

As can be seen in Figure 5, from 2008 to 2020, industrial electricity prices rose 53.8% while industrial gas prices actually fell slightly over the same time period. Both gas prices and electricity rose in 2021 as gas prices started to spike as demand increased after Covid lockdowns ended and supply could not keep up with demand. However, even though there was a spike in gas prices in 2021, the increase from 2008 is still only 33%, whereas electricity prices have surged 71.4% over the same period. The figures for 2022 are not yet available, but we might expect to see a big surge in both gas and electricity prices due to supply shortages resulting from the war in Ukraine.

Figure 5: UK Industrial Gas and Electricity Prices 2008-2021

If gas prices have stayed relatively stable to 2021, what has caused the massive increase in electricity prices since 2008? Let’s have a look at how the electricity generation mix has changed over time.

Changes in Electricity Mix

The Government publishes energy trends (their Table 5.3) that show electricity supplied by fuel in TWh and the changes over time.

Figure 6 shows how UK electricity supply and net imports have changed since 2008 in TWh. Overall, there’s a ~16% reduction in production. Within that, the mix has changed dramatically. Renewables, meaning hydro, biomass, wind and solar have increased more than six-times. Imports have more than doubled, meaning we have become more reliant on continental countries for our electricity. Zero-carbon nuclear has declined 12.5%. Coal supply has declined more than 95%, oil by 73% and gas by nearly one third.

Figure 6: UK Electricity Supply by Source + Net Imports (TWh)

A slightly different story emerges looking at the change in share of supply each source represents. Figure 7 shows how the share of supply has changed between 2008 and 2021. First point to note is that coal has fallen from a 31.1% share to 1.9% share. As well as gas decreasing overall production, its share has decreased slightly from 45.6% to 37.8%.

Fgiure 7: UK Electricity Supply by Source Share

Overall, fossil fuels have fallen from nearly 80% to just around a 40% share. The share of renewables has risen more than 7-fold from 4.7% to over 36%. Most of this is driven by a massive increase in wind,solar and biomass generation. Net imports have risen from a 2.9% share to 7.7% and nuclear has remained roughly stable as a share around 13% despite overall nuclear generation falling.

How can it be that “cheap” renewables have risen as a share of generation by so much, gas prices have remained stable and yet we have seen a massive increase in the prices of electricity? Time to take a look at the hidden costs of renewables.

Hidden Costs of Renewables

There are a number of hidden costs of renewables. First, wind and solar in particular are intermittent sources of energy: no electricity is produced if the wind doesn’t blow (or blows too hard) or the sun doesn’t shine. They need to be backed up by reliable sources of generation and it costs a lot to keep these units on standby and even more to bring them online. Moreover, most “cheap” renewables require subsidies to make them economically viable. For instance, according to Drax’s Annual report, in 2021 they received £658m of Renewable Obligation Certificates from generation (note 3.3) as well as £235m in CfD payments (note 2.2) to burn wood pellets. Overall, there are three elements to the hidden costs:

• Levies, documented by the Office for Budget Responsibility (OBR)

• Feed in Tariffs (FiT), documented by Ofgem

• Grid Balancing costs arising from increased intermittent sources, documented by the National Grid ESO

Levies

Levies are made up of several components documented in the OBR’s Economic and fiscal outlook – supplementary fiscal tables: receipts and other publications. By far the largest component (£6.3bn in fiscal year ended March 2022) is Renewables Obligations (a levy on electricity suppliers who emit CO2). These are forecast by the OBR to rise in line with inflation. The next largest component is Capacity Markets Cost (£0.9bn). Contracts for Difference (CfDs) are the only other significant cost (£0.3bn). CfDs are the new way of subsidising renewable energy generators by fixing the price they receive for the electricity they produce. If they receive less than the CfD strike value for the power they produce, their revenue is topped up to the CfD price. Conversely, if they receive more than the strike price, they must make a contribution to reduce their revenue to the strike price. With continued high electricity prices, the cost of CfDs is expected to fall, in fact the OBR estimates they will turn from a cost to consumers to a net bill subsidy of £3.8bn FY2022-23. The strike price of CfD is also index linked, so we might expect the bill subsidy to fall as gas prices normalise and the strike prices rise with inflation.

Feed-in-Tariffs

Feed in tariffs (FiT) are paid to small renewable energy producers. Ofgem produces an annual report showing the cost of these FiT payments. These costs vary by the amount of energy generated and the unit payment. The unit payments are index linked, so the unit costs will rise sharply with continued high inflation. In year ended March 2022, the cost was over £1.5bn.

Grid Balancing Costs

Grid Balancing costs are documented by National Grid ESO in their Monthly Balance Service Summaries (MBSS). These reports show the amount spent each month to keep demand and supply in balance on the grid at all times. There are a number of components to these costs. The largest individual component is “Constraints” costs at £1.5bn in year ended March 2022. Essentially, these are payments made to wind generators to not produce. When the wind blows too much and demand is low or interconnectors to Scotland are saturated, then the wind generators have to be “constrained off” and they get paid compensation for not producing. Other generators may be paid to produce in areas with demand but no interconnector supply.

At other times, the grid needs to keep reliable generators on standby to produce when the wind is not blowing or the sun isn’t shining. This group of costs is split into a number of smaller parts including Operating Reserve, Short Term Operating Reserve (STOR), Fast Reserve, Response and Reactive. The total cost of balancing services was £3.1bn in year ended March 2022. The top-3 components were Constraints (£1.5bn), Operating Reserve (£0.6bn) and Response (£0.3bn).

Figure 8 shows the combination of the data from all three sources since 2010. The CRC Warm Home discount has been stripped out from Levies and the Capital Markets cost indicated has been added to the cost in each report. The National Grid ESO data before 2013-14 is no longer available on their website. However, the NAO helpfully produced a report in 2014 containing the data from earlier years in their Figure 9. Using their chart, I have estimated the MBSS costs for the earlier years to +/-£20m.

Figure 8: Cost of Levies, FiT and Grid Balancing (£bn)

As can be seen, the cost of the Levies component has soared over the years from £0.5bn in 2010 to £9.7bn in 2020. Levies stabilised in 2021, then fell back in 2022 as CfD costs fell. However, total costs didn’t fall as much because Grid Balancing costs continued to rise. The OBR expects total Levies to fall to £3.7bn in FY2022-23 but rise again to £9bn in 2025-26. It should be expected that FiT costs will rise in line with inflation. Grid balancing costs are likely to continue to rise sharply.

Figure 9 shows how grid balancing costs have risen since 2010 compared to the share of wind and solar in overall supply. The solid orange bars show the full year outturn released by National Grid ESO. The grey bars show the balancing costs for the seven months to October for the prior three financial years. The hatched orange bar for year ended March 2023 is estimated based upon the most recent release to October 2022. The average multiplier from the prior YTD numbers to the full year outturn has been used to produce the full year estimate for 2023. Balancing costs rose sharply once the share of wind and solar got above about 18% of total supply in 2017/18. Balancing costs now appear to be rising faster than wind and solar’s share of the market, although we probably need more data to confirm that trend. However, we should expect grid balancing costs to continue to rise.

Figure 9: UK Grid Balancing Costs vs Wind + Solar Share of Generation

Overall, these hidden costs of Levies, FiT and Grid Balancing are likely to dip from the £13.2bn peak in 2021 this year because of falling CfD costs. However, this fall will be partially offset by increasing FiT costs and increasing grid balancing costs. Costs are then likely to continue rising thereafter.

Impact of Hidden Costs of Renewables

It is now possible to pull all this together and show the impact of these hidden costs on electricity prices.

Figure 10 shows how the increasing hidden costs of renewables have risen with increasing market share, pushing up the overall industrial electricity price.

Figure 10: Electricity Supplied by Source, Prices and Hidden Costs

We can also calculate the hidden cost of renewables per MWh supplied. Using the total renewables supply from Figure 6, we can divide the total of Levies, FiT and Grid Balancing costs by the total renewable supply. The result is shown in Figure 11. Although the costs per MWh have fluctuated, there is an obvious upward trend that belies the claims that renewables are getting cheaper. In 2021, just the hidden costs of renewables amounted to £114/MWh. The true costs are even higher because the renewable generators also get paid for the electricity they produce. In addition, the not inconsiderable costs of connecting these new wind and solar farms to the grid have not been included in this analysis.

Figure 11: Cost of Levies FiT and Grid Balancing vs Cost per Renewable MWh

It should be noted that the £114/MWh hidden costs of renewables is very much higher than the £44-57/MWh levelised cost of wind and solar suggested by BEIS in Figure 1. In fact, these costs alone are higher than nuclear and higher than gas if the “carbon costs” are stripped out.

This analysis has also spread the hidden costs evenly between wind, solar, biomass and hydro generation. Although there are big environmental problems with biomass (burning trees), generally it is producing baseload power so the grid balancing costs shouldn’t really be attributed to it. The £3.1bn in grid balancing costs should really be attributed to solely wind and solar, further increasing their hidden costs per unit.

Conclusions and Recommendations

Although the Government, investment banks and net zero advocates claim renewables are cheap, they are wrong. Their claims are not borne out by the facts of rising electricity prices. Their analyses are fatally flawed by the the hidden costs of renewables from Levies, FiT payments and Grid Balancing Costs.

So what is to be done about it? Here are some ideas:

1. Remove the subsidies from new wind and solar projects and let the market decide the value of new projects.

2. If that is not palatable, then ensure hidden costs are properly accounted for when new contracts are awarded.

3. Invest in new sources of gas supply such as fracking or North Sea development to bring down prices in the short term.

4. BEIS’s own figures show that after hidden costs are taken into account, nuclear becomes the cheapest low-carbon, reliable source of electricity generation. Therefore, in the medium term, we should invest much more in nuclear power.

5. Remove the market distorting subsidies that encourage plants like Drax to burn trees which is both expensive and bad for the environment.

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A new article with updated data was published on 21 January 2024.

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