New report by the Energy and Climate Change Committee

The report finds that the Conservative Government's string of unexpected energy policy changes, lack of long term vision and inconsistent messages has damaged investor confidence in the UK energy sector and may mean fewer new energy projects come forward in the next three to five years.

Investment in the UK energy sector

The UK needs £100 billion of investment in electricity generation and networks by 2020 according to DECC. Amber Rudd, the UK energy secretary, has acknowledged that no form of power generation can currently be built in the UK without government support. Energy projects have long lead times, often two or more (5 year) Parliaments, and investors in energy projects need to be able to predict how much support they will receive and price the project's risk accordingly.

Yet a number of policy decisions taken since the Conservative government took office in May 2015 have undermined investor confidence and there is a theme through this report that the government is guilty of short termism and knee jerk reactions, and is at the Treasury's beck and call in setting energy policy.

Why does investor confidence matter?

The Committee heard about how reduced investor confidence may have two serious consequences for the UK energy system

Firstly, new projects may have been put on hold whilst investors waited for further clarity on energy policy. There is anecdotal evidence that this is taking place, but no hard data as yet. It will be three to five years before it will become visible. The Committee recommends that DECC monitor the progress of projects through its Renewable Energy Planning Database and the Planning Inspectorate's Register of Applications and report back to the Committee annually.

Secondly, reduced investor confidence may lead to a higher cost to consumers in long term. The cost of capital for projects will be increased if investors are not confident, as they will impose a higher "risk premium" that factors in policy risk. That is, they will charge more for their investment on the basis that there is a risk that they may not get the full subsidy that they expected, if the government changes its policy. Ironically, the government's concern to reduce the cost to consumers in the short term, by clamping down on the Levy Control Framework (LCF) and cutting subsidies, will increase consumer bills in the longer term.

Factors affecting investor confidence

The Committee, in gathering evidence from the UK energy industry and its investors, has identified six factors that, when combined, serve to damage investor confidence:

• Sudden and numerous policy announcements

The report lists thirteen different policy announcements since May 2015, many of which were sudden and unexpected (such as the decision to scrap the CCS scheme). Investors need a stable and predictable policy environment and every policy change costs them money.

• Lack of transparency

When policy changes are made, investors need to know why. Investors criticised in particular the government's failure to make the LCF methodology and assumptions behind it public – more on this below.

• Not considering investor impacts enough

Many policy changes were made with little or no consultation, for example the change to Levy Exemption Certificates was brought in by the Summer Budget with no consultation (leading to a judicial review challenge), there was no formal consultation on the decision to close the Renewables Obligation early, and the changes to the Feed-in Tariff only had a four-week consultation period. Contrast this with the previous government's work on Electricity Market Reform where the industry were involved at all stages – this was held up as an example of good practice.

• Policy inconsistency and contradictions

Looking at policies and announcements as a whole, the broader signals that the government is sending out seem inconsistent and contradictory to investors. For example, the government's stated aim to decarbonise at lowest cost, yet halting onshore wind; or focussing on the LCF rather than the actual impact on customer bills (see below for more detail on this). Investors have understood the cumulative impact of the policy reforms as a significant shift away from low carbon technologies, even if this was not the intended purpose.

• Lack of long-term vision

Investors need more clarity about the Government's intended long term direction of travel. Amber Rudd's policy "reset" speech in November 2015 was the first real indication of this, six months after the election, but the direction is still not clear. Investors would welcome cross-party support for a long term energy vision.

• Policy "cliff edge" in 2020

Linked to the previous point is the lack of information about what is likely to happen after 2020 (when of course this session of Parliament ends). What will happen to the LCF and the carbon price floor? What will happen with the Contract for Difference (CfD) before then? No one is sure.

The Levy Control Framework (LCF)

Chapter 4 of the Report looks at the LCF in more detail as it appears now to have a central role in driving the direction of energy policy. The projected overspend of the LCT triggered recent policy announcements, but the Government seems to be looking only at the short term impact on consumer bills, not the longer term.

The LCF is a costs control mechanism, allowing the Government to set an overall cap on the amount of money that can be raised and spent through it to support low carbon electricity. It does not cover every low carbon policy that impacts on consumer bills. It covers the Renewables Obligation, the Feed-in Tariff and the Contract for Difference but it does not cover the Capacity Market, Warm Home Discount or ECO, even though they are also funded through levies on consumer bills. Investors see the fact that the Capacity Market is not covered as a flaw in the policy.

The other major flaw identified in the LCF is the lack of transparency on how its spending forecasts are calculated. Despite a long-running Freedom of Information request, DECC is refusing to set out the basis on which it makes its LCF calculations. Investors are suspicious of the £3.25 billion increase in LCF forecast spending in one year, suspecting that DECC have changed the underlying assumptions as to how the LCF budget is calculated. As the numerous subsidy reductions over Summer 2015 were a direct result of this change in forecast, investors understandably want clarity as to how the LCF forecast is calculated, so that they can plan in anticipation of future budgets and likely available subsidies. The Committee concludes that "there is no logical reason why the assumptions and methodologies used to calculate the projected spending should remain undisclosed".

Immediate actions

The Committee recommends the Government takes immediate action to address the CfD and policy "cliff edge" issue, addressing these unanswered questions:

• When will there be clarification on when the three CfD auctions will take place?
• What budget will be available for the CfD auctions and how far in advance will the Government communicate this to help investors plan?
• Which technologies will be able to take part in the CfD auctions?
• How much must costs fall by for offshore wind projects to remain eligible for CfD support? Does this condition apply to all technologies or just offshore wind?
• What will happen to the Carbon Price Floor beyond 2020?

Long term vision

The Committee suggests that the Government could use the Carbon Plan for achieving fifth carbon budget as opportunity to rebuild investor confidence and give a clear direction of travel for the UK energy sector. In developing the Carbon Plan the Government should: fully consult with the investment community; be open about any modelling or scenario work; be clear about how subsidies will reduce as new technologies become established; retain flexibility to adapt to new technologies and innovations like storage and demand-side response; and build a cross-party consensus.

The budget for the LCF post-2020 should be set in the context on the 4th and 5th carbon budgets and the Committee recommends introducing rolling annual updates on a ten-year horizon.

In the meantime, the Government should make the assumptions and methodologies used in its LCF calculations publicly available, and set out a plan for how it will deal with any future overspends.

Comment

It does seem from this report that the Committee thinks that this is a case of the Treasury tail wagging the DECC dog and that policy certainty is being sacrificed for quick cost savings that will end up costing more in the long run.