Mitigating the Risks of Ending Net Zero
The Tories’ and Reform’s commitments to end Net Zero contain risks that need to be mitigated.
Introduction
Reform fought last year’s election on a commitment to end what they term Net Stupid Zero. So far, their policy announcements have fallen short of a detailed plan to implement their commitment. However, they have threatened to strike down any contracts awarded in the current AR7 auction of new renewables capacity. Earlier this year, the Tories abandoned the Net Zero by 2050 target and last month put more flesh on the bones by committing to repeal the Climate Change Act and disband the Climate Change Committee. Shadow Energy Secretary Claire Coutinho has gone further, pledging to eliminate carbon taxes from gas-fired electricity and bring an early end to the Renewables Obligation (ROC) subsidy scheme.
While these announcements are welcome to those of us opposed to the senseless headlong rush towards Net Zero, they bring with them some risks that need to be mitigated.
Impact of Cutting Carbon Taxes and Ending ROCs
We have covered in earlier articles the impact of cutting carbon taxes and ending ROCs early. ROC-funded generators receive revenue based on the wholesale price of electricity and receive their ROCs in addition to that revenue.
Cutting carbon taxes will reduce wholesale prices by about a third and ending the ROC scheme early will also cut off the subsidy top-ups these generators receive. Cash flows and asset values will collapse and send a shockwave through the industry and as we discussed last week, bankers ought to be getting nervous.
Crystallisation of Decommissioning Costs
As we have previously discussed, the cash cost of decommissioning just the offshore wind fleet is of the order of £5bn. Neither the windfarms, nor the operating companies and investment vehicles that own the windfarms are setting aside ring-fenced cash to cover decommissioning liabilities. The Government will not release its estimate of the cost of decommissioning nor the types of guarantees in place.
The risk of cutting carbon costs and ending the ROC scheme early is that these windfarms become financially unviable overnight and do not have enough cash on hand to fund decommissioning liabilities, so the cost falls on to the taxpayer.
To mitigate this risk, any new Government could immediately upon taking office tighten the rules around providing for decommissioning. All windfarms would need to hold ring-fenced cash in the operating company to cover the present value of the liability in the expected decommissioning year. They should set a rule that no dividends or other cash could be paid to owners until the decommissioning liability is covered. If the cash generated by the windfarms is not enough to cover the liability in say two years, then the owners should be forced to inject cash into the operating companies.
The biggest loss to ROC-funded generators will be their ROC certificates, so perhaps the Government could implement the cut to carbon costs immediately and then end the ROC scheme slightly later to give some immediate benefit to consumers and some time for decommissioning cash to build up.
Those windfarms with Contracts for Difference (CfDs) that have yet to be activated are running on a merchant basis and receiving the (discounted) wholesale price for their output, which is typically above the CfD strike price. If carbon costs are removed from the wholesale price, then their revenue will fall and it maybe attractive for them to activate their CfD. It remains an open question whether these windfarms will be financially viable at such low prices, so it will be important for the Government to insist these units build ring-fenced cash to cover decommissioning liabilities, perhaps by taking a first charge over the assets.
Mitigating the Risk of Blackouts
As we have discussed in a previous article, our gas-fired power plants are aging and we are running the risk of blackouts. Indeed, we came very close to blackouts in January this year.
Removal of carbon costs and ROC subsidies will likely bring an early end to significant parts of the onshore and offshore wind fleet. This ought not to increase blackout risk, because these windfarms basically need 100% backup by reliable power plants, usually gas.
However, in the cut and thrust of politics, we can imagine a situation where half the wind fleet has shut down and a blackout occurs because we do not have enough dispatchable power capacity. It would be easy for the green blob to blame the early closure of wind farms for this outcome, even though it would be wrong.
Regardless of what happens to carbon costs and the ROC-scheme, we need a crash programme to build out reliable, dispatchable capacity. However, the lead time on new combined cycle gas turbines is around eight years and we need capacity much quicker.
Any new Government should therefore contemplate building a small new fleet of coal-fired power stations using supercritical technology to reduce SOx and NOx emissions. These should have a shorter lead time and act as a bridge to new nuclear coming on stream as well as diversifying fuel sources.
Cutting CfD Subsidies
Cutting CfD subsidies, such as repudiating AR7 contracts after they have been awarded is legally problematic. These contracts contain what are termed “Qualified Change in Law” (QCiL) provisions that protect investors from government-induced changes that could adversely affect their projects. Striking down the contracts would therefore trigger claims for compensation.
However, the definition of a QCiL typically includes protection for changes in law that are not foreseeable at the time of contract signing. If, representatives the Conservatives and Reform were to make statements in Parliament before AR7 contracts are signed that they would change the law to negate them if they gained office, then it might be argued that QCiL provisions do not apply. This might be enough for bankers to back away from financing these projects, so they never reach Final Investment Decision (FID). They could maybe sweeten the pill by committing to compensate developers for costs incurred prior to their announcements in Parliament.
The biggest recipients of CfD subsidies are the early projects awarded Investment Contracts such as Beatrice, Dudgeon and Walney Extension, with strike prices now sometimes over £200/MWh. AR1 contracts like East Anglia One also receive high subsidies, with the current strike price of £171/MWh. Any attempt to claw back subsidies from these generators directly would be legally difficult. However, a non-discriminatory law that increased corporation tax on all generators generating total revenue more than say £50/MWh above the wholesale price might generate tax income that could be used to reduce energy bills.
It is not worth the reputational risks to rip up AR3 and AR4 contracts - the strike price is low enough to mean subsidies will never be a big problem. There were no offshore wind contracts in AR5 and AR6 is largely taking care of itself since Orsted cancelled Hornsea 4. Cancelling AR7 and taxing AR2 and earlier generators ought to be enough.
Plan to Deal With Stranded Assets
Ofgem is busily giving the go ahead for extra transmission infrastructure to connect more and more remote renewables to the grid. They said this extra spending would cost £80bn add £74 to bills by 2030. Similarly, the cost of the Capacity Market is set to soar from ~£1bn last year to £4bn by 2027/28, with some contracts being awarded for 15 years.
Focusing on cheap, concentrated and reliable power means these extra transmission lines and backup batteries will not be required. Ending the Net Zero agenda will leave stranded assets and legacy contracts. There needs to be a plan to stop this spending and/or end the contracts early or billpayers will be saddled with the cost of redundant infrastructure for decades. It should be made clear to investors that their expected returns will not be materialising to deter further spending.
Conclusions
The Net Zero agenda is crumbling before our eyes and it is encouraging that the once impregnable political consensus has been broken. It is a welcome development that both Reform and the Conservatives appear committed to dismantling the green blob and delivering cheap and reliable energy.
However, taking action to reduce energy costs brings with it some risks. It is important that both political parties think through these risks and work out appropriate mitigating actions so any downside risks such as decommissioning costs falling on the taxpayer are mitigated.
You can help reduce energy costs by writing to your MP to ask them to demand Ed Miliband cancels AR7. Net Zero Watch have a page that helps you do this with just a few clicks:
https://www.netzerowatch.com/email-your-mp
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Before Trump 2.0 was elected, he had a team working flat out for almost 4 years on a plan of action through transition and for immediate implementation after inauguration. The Heritage Foundation worked with them to map out all the stupid things the Biden administration has done and a prioritized road map to reverse it all and address new priorities.
I mention this because it is only because of all this work that Trump was able to move so quickly on so many fronts, because it was all mapped out beforehand.
I fear that Reform don't have the infrastructure and/or resources to do all that so will be fumbling and bumbling around as they go along in true British fashion. Net Zero is just one of many issues that will need urgently addressing in detail and far better to have it all mapped out in detail in advance because time will be of the essence. Farage needs to get in place a transition team for each of the critical policy areas to develop at least a policy priority and action plan and I see no evidence of it happening.
As ever well written with clear language that even a ECO Zealot could understand.
The way the whole CC scam has been handled is too tie it up neatly in legalise and any attempt by a future non CC committed Government would lead straight to legal action for recovery of real or imagined financial losses.
Sensible people have always gone along with the idea of a “any system that produces cheap, low cost energy” market- be it Coal, Gas, Wind, Solar, Hydro, Tidal or Nuclear.
They do not see the need for subsidies or Carbon Taxes, if a energy source is efficient it will pay for itself with reckless subsidies offered to give the appearance of competition.
When you look at subsidies, those of us of a certain age can recall the years of “nationalised”. Industries- Steel, Rail, Coal, Post, Car, and the cost both via poor to zero productivity, consistently calling strikes, and the general feeling that nothing was affordable.
De-nationalisation brought sanity to those industries, however, now that we have the Worlds highest energy costs, those industries are dying, the Green Revolution has moved primary production to China, India and the Far East. The lesson is simple- Power is Everything, Economic Power is Critical to Survival and we are in a battle, a battle for economic survival which we are losing at a accelerating pace.