Dear Energy Secretary, I’m afraid to tell you there is no money….

May 12, 2015

In 2010, the then outgoing Chief Secretary Liam Byrne famously left a note to his successor saying “Dear Chief Secretary, I’m afraid to tell you there is no money. Kind regards and good luck!” To my knowledge, the outgoing energy secretary, Ed Davey, has left no such letter. But the new Secretary of State for Energy, Amber Rudd MP, may find that the energy and climate change budget is in a similarly depleted state.

The vast majority of energy and climate change policies are funded through levies on consumer bills, rather than taxes. In total these represent around 7% of the average dual fuel bill. Certain levies related to renewables are managed under the so-called ‘Levy Control Framework’, which was agreed between DECC (Department for Energy and Climate Change) and HM Treasury in 2010. The LCF cap has been set at £4.3bn in 2014/15, rising to £7.6bn in 2020/21 (in 2011/12 prices). If costs look likely to exceed the cap, then DECC must take steps to bring them within budget.

However, DECC’s performance in managing this budget over the past few years has been poor. The LCF cap was exceeded in all of the last three financial years. The bulk of this overspend relates to the small scale Feed in Tariff – which provides subsidies for small scale solar and other renewable energy installations – and which exceeded its original budget by 100% (or £450 million) in the last financial year.

Looking forward to 2020, official figures from DECC (in its Annual Energy Statement) suggest that the remaining budget amounts to £1 billion per annum in 2020/21. However, new analysis by Policy Exchange, which will be detailed in full in a forthcoming report, suggests that DECC has significantly underestimated the cost of existing policies. There are three main reasons for this:

  • Firstly, the outlook for wholesale electricity prices has reduced substantially over the past year as a result of falling commodity prices. This increases the subsidy payable to renewables projects under the new ‘Contract for Difference’ subsidy model – since projects are topped up from the market price to a pre-agreed ‘strike price’. DECC has already downgraded its wholesale forecasts, and independent forecasters are projecting even lower prices.
  • Secondly, DECC is vastly underestimating the cost of the small scale Feed in Tariff – which appears to be growing out of control. DECC assumes that the cost of the scheme will increase by around £60m per annum to 2020, but the cost of the scheme has been growing at £160 million per annum to date. Solar PV has been deploying at an unprecedented rate. DECC’s assumptions as to the future cost of the scheme appear to be based on wishful thinking rather than hard evidence.
  • Thirdly, it appears that DECC has systematically underestimated the subsidy payable to new offshore wind farms. DECC assumes a ‘load factor’ (a measure of energy output per unit of capacity) for new projects of 38%, based on the current fleet average. However, recent improvements in technology mean that the new generation of offshore wind farms being built over the next few years is likely to achieve much higher load factors – e.g. potentially 45%+. The higher the load factor and output of the project, the greater the subsidy payable under the current mechanism. This overspend has not been factored into DECC’s budget calculations.

Analysis by Policy Exchange suggests that the combination of these three factors would wipe out the entire budget remaining under the Levy Control Framework (assuming no further changes in policy). The implication of this is that DECC may have already committed the entire budget out to 2020, which will make it difficult or impossible to proceed with any additional projects, unless actions are taken to stem the rise in other costs. Not only that, but DECC is locked into supporting some pretty expensive technologies, and may have little or no money left to focus on the cheaper options available. DECC has recently implemented a successful model for allocating subsidies on a competitive basis (the ‘Contract for Difference’ auction), but there is a risk that the entire energy and climate budget has already been spent via other means.

The new Energy Secretary needs to take urgent steps to address this situation. The Conservative Manifesto committed to cutting carbon emissions as cheaply as possible, but did not provide much detail on what this means in practice. Given the state of the energy and climate budget, such an approach now looks not only desirable, but essential.

DECC must first recognize that the energy and climate budget has already been stretched to the limit – and factor this into its thinking. The government then needs to shift rapidly to more cost effective ways of meeting energy and climate goals – for example focusing on mature low carbon technologies as well as energy efficiency – whilst halting the expansion of the most expensive policies and technologies. Such an approach would stretch the existing budget further. The scrutiny and transparency around the energy and climate change budget has been poor, and needs to be substantially improved.

Policy Exchange will shortly be publishing a report detailing recommendations to achieve energy and climate objectives at lower cost.

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