BNEF Chief Executive Michael Liebreich VIP Comment: UK energy policy - a time of consequences

Over the years I have attended hundreds of conference sessions on financing
clean energy. Every time, the main conclusion is that financiers need a
stable policy environment. Contrary to what the general public might
expect, most serious investors in renewable energy don’t spend their time
begging for bigger subsidies. Instead what they ask for is the assurance
that policy-makers are not going to change the rules during the development
of a project or, even worse, after it begins operating – as has happened
in Spain, the Czech Republic and now Bulgaria.


Policy-makers attend many of the same conferences. Whenever they hear the
demand for policy stability, they nod sagely, and take copious notes. Yet
around the world, in country after country, they seem congenitally unable
to respond. Stability doesn’t mean deciding a level of subsidy or support
and then keeping it unchanged for new projects into the distant future.
Policy-makers legitimately want to be able to dismantle programs that
outlive their usefulness, or that prove over-generous. It means being very
clear about the long-term role of a sector in a country’s energy mix;
putting in place sensible regulatory structures that have a five- or
10-year life; modifying levels of support progressively over time, in an
open, bipartisan process; and never changing the rules for a project once
investors have committed capital.

POLICY UNCERTAINTY

U.K. policy-makers have been among the most earnest nodders and
note-takers, first during 13 years of Labour and now two-and-a-half years
of the Coalition government. They have also been among the worst at
actually providing policy stability. The U.K.’s extraordinary renewable
energy resources, along with its strengths in science, engineering, energy
and finance, should mean that it has some of the lowest-cost clean energy
in the world. Instead you have seven of the world’s leading engineering
companies, employing 17,500 people in the U.K., writing to the Secretary of
Energy and Climate Change threatening to curtail investment plans over yet
another year of policy uncertainty. It is a shambles.


This is disappointing, given that the U.K. is one of the only countries in
the world which has passed legislation enshrining a long-term intention to
decarbonize its energy supply. And given that the Coalition has spent the
last two-and-a-half years consulting on an energy bill intended to create
the environment for energy investment through to 2030 and beyond. 


What would you do if you wanted to create uncertainty and cause clean
energy investors to put plans on hold? Shortly before the energy bill
reaches the floor of Parliament you would fire the minister who has been
leading work on it, building relationships with all the different energy
sectors. You would bring in a new clutch of energy and environment
ministers known to be skeptical about anything other than oil and gas, and
put onto your main energy committee a back-bencher with links to a
climate-change denying think tank. 


In what world would this make sense? The answer is: in a world in which the
government is dogged by a sluggish economy, having failed to produce a
coherent narrative about how to jump-start growth. Where a powerful faction
in government appears to have arrested its intellectual formation during a
period in which the biggest problem was over-regulation, demonstrating
difficulty in understanding emerging network technologies, including the
energy system. Where the highest decibels in favor of clean energy come
from a vocal, hard-left faction whose proposed solutions are almost
exclusively statist and anti-enterprise. And where powerful lobbyists for
oil and gas companies are given free rein to whisper siren words of a
return to cheap indigenous energy into ministers’ ears.


Do not get me wrong: I am excited about shale gas. Bloomberg New Energy
Finance is already test marketing a Gas Insight Service – contact us if
you want to know more. In the U.K., we should sort out regulatory
frameworks and get started with all vim and vigor to explore the resources
we might have here – as well as in other countries. Europe’s ban on
genetically modified organisms has significantly harmed the world’s
ability to feed itself in an era of rising population and increased weather
volatility. A ban on fracking, as has been imposed in France, would be
nonsensical. We should demand public disclosure of data on fracking fluids,
and also about costs and yields – so there can be an informed debate
about the role of shale gas in our energy mix. I want to see it done
properly: addressing the issues of surface water disposal, of methane
diffusing into drinking water, of earthquakes. Most importantly, I want to
see the issue of fugitive emissions tackled properly: methane is a powerful
greenhouse gas, and natural gas only beats coal if fugitive emissions are
reduced to near-zero. Still, I think engineers are smart, and they will
solve all of these problems.

SHALE MIRACLE

We need to make sure we do not become so infatuated with shale gas that we
risk driving our energy system into a cul-de-sac. We cannot afford to spend
the next five years assuming that the U.K. will be awash with cheap gas. In
fact, those siren voices, whispering of the new Age of Abundance, need to
be challenged to explain why they expect long-term U.K. gas prices to go
down, rather than up.


The U.K. sources some 40 percent of gas demand from its domestic
continental shelf, another 28 percent or so from Norway, and the rest from
further away sources such as Qatar and Nigeria. Production from
conventional U.K. fields is declining. It is on track to fall to less than
20 percent of demand by 2030, according to projections shown by Royal Bank
of Scotland at the Scottish Low Carbon Investment Conference earlier this
month. Fiddling with the tax regime might slow the decline for a while, but
cannot reverse it. At that point, shale gas or non-U.K., non-Norway imports
would need to fill more than 50 percent of the U.K.’s gas demand.


Let’s deal first with imports. The key point is that if the U.K. becomes
more dependent on imports, it will be exposed to international gas prices.
And these are going to stay high for the foreseeable future. The U.K.’s
number one overseas supplier, Norway, will itself see declining output from
around 2020. Yes, there are lots of new supplies coming on stream –
Australia, East Africa and so on. And yes, by 2030 there should be other
parts of the world that will be producing large amounts of shale gas. There
are also huge new sources of demand.
 In Europe, you have Germany, Italy
and Switzerland shutting their nuclear plants and trying not to become
dependent on Russia. In Asia, before Fukushima, Japan was planning to
increase its dependence on nuclear electricity to 50 percent by 2040; now
that figure may well be zero, and Japan is going to be a huge gas buyer
forever. Then there are the insatiable sources of demand that are China and
India, as well as other hyper-growth developing economies. With Indonesia
making noises about restricting coal exports, gas supplies are going to be
at a premium throughout Asia. If suppliers can sell their gas at $10-18 per
million British thermal units into these markets, why would anyone sell
cheap gas to the U.K.?


So what about shale gas? There is no reason to believe that it will push
gas prices down in the U.K. in the same way as they have recently in the
U.S. Shale gas has been an astonishing success story there, within a few
years shifting the country from being a long-term gas importer to a
potential exporter, and pushing prices down from $6-11 per mmBtu to as low
as $1.73 in April. There are caveats. The U.S. gas price has rebounded by
over 90 percent from its lows, and is now around $3.50 per mmBtu. Some
wells can make money at very low prices, though most cannot. As Rex
Tillerson, Exxon Mobil Corp.’s chief executive, recently said of the U.S.
shale gas miracle: “We are all losing our shirts today. You know, we’re
making no money. It’s all in the red.”


The fact is that shale gas operators in the U.S. need a gas price of around
$5 per mmBtu in order to justify continuing to drill, frack and build
pipelines. All analysts expect the U.S. natural gas price to rise to $5 or
$6 per mmBtu. Bloomberg New Energy Finance’s own predictions are for a
price of $5.50 by end-2015. And that is in the U.S., where conditions are
ideal for shale gas: great geology, low population density, an existing
pipeline network, a fragmented regulatory environment, landowners with
sub-surface mineral rights and a liquid market for rigs and drilling
services. Given conditions in the U.K., it is hard to see shale gas coming
to market at much below $8 per mmBtu – around the same as the wholesale
prices that have been driving up utility bills in recent years.


What about imports from the U.S.? Liquefying, transporting and gasifying
liquefied natural gas adds $3-4 per mmBtu to its cost. So the potential for
exports from the U.S. might put an upper bound on prices at around $8 per
mmBtu, but there is no long-term prospect of large-scale trade driving
lower prices than we are currently seeing for wholesale U.K. gas.


Let’s also look at public acceptance. Sure, the British public does not
like onshore wind-farms near their homes. But then they do not like roads
either. Or chemical plants. Or nuclear power stations. Or sewage treatment
farms. Or homeless hostels. They are going to love fracking operations.


In order to replace the decline of U.K. Continental Shelf gas production
through 2030 – before starting to replace any coal or nuclear power –
you would need 2,400 fracked wells. Assume 10 wells per pad, and that is
240 pads. Each one is an industrial development in the countryside, and
this number would extend over an area the size of Lancashire. In terms of
production per well, at its peak, one fracked well can produce enough gas
to match the output of 50 onshore or 15 offshore wind turbines. However,
the decline curve of a fracked well is so steep that within two years, each
well could replace as few as four onshore or one offshore turbine (and yes,
these figures are adjusted for the efficiency of gas generation and the
intermittency of wind).

UNCERTAIN ENVIRONMENT

The choice of fracking versus wind is a false dilemma, because the truth is
we need both. The future of the U.K.’s energy system is not – despite
all of the manufactured controversy – rocket science. We need dramatic
improvements in energy efficiency. We need to shut old, polluting
coal-fired power stations. We need to get a few carbon capture and storage
projects up and running so we can learn the technology. We need to prolong
the life of our existing nuclear capacity as far as we can, and try to
build some new plants (though U.K. taxpayers should only subsidize nuclear
if the technology benefits accrue domestically, not overseas). We need to
exploit our extraordinary renewable resources in such a way as to drive
down their costs and reduce their need for subsidies. And we need gas to
meet peak demands and balance the electrical network, as well as for
heating and industry – though we must do it in such a way that we are not
locked into an expensive and polluting energy source for the long term.


These goals should not be seen as being in opposition to each other, they
should be complimentary, pursued at the same time. This brings me to my
final point. The reason that energy policy is hard is that modern energy
systems have to meet a lot of different requirements. In the dim and
distant past, it was enough to produce reliable, universal supply, and
economic growth meant it was okay to over-invest in capacity. Then came the
oil shocks, and concern over security. Then deregulation, and the
requirement to push down prices while maintaining reliability. Then
environmental concerns, first oxides of sulfur and nitrogen, then carbon
emissions and fugitive methane. Where we are now is that energy is
increasingly the key to industrial dynamism, drawing as it does on
technologies like materials science, nanotechnology, bioengineering and
software and communications. Energy is therefore the driver of future
employment and economic health, though not, as some would have it, via the
facile “green jobs” argument.


Energy policy not only has to optimize all these functions, it also has to
do so dynamically in an uncertain environment. We can chart experience
curves, which will drive down the cost of clean energy and shale gas
fracking in a fairly predictable way. We cannot forecast breakthroughs. We
can try to forecast future energy prices. We cannot forecast social
movements like the Tea Party or the Arab Spring, and we cannot forecast
geopolitical developments – when Iran’s regime will fall, or whether
unrest will envelop China if its economy slows. There are even huge areas
of human behavior we do not really understand, such as people’s responses
to privacy issues, or requests to save energy.


What all of this volatility and uncertainty means is that options have
extraordinary value. If you do not know whether gas is going to be cheap or
expensive, do not build an energy system that is dependent on it. What you
need to do is invest in technologies that increase your flexibility: energy
efficiency, smart grid, demand management, power storage, international
interconnects and electric vehicles. Sure, these may not seem cost
effective on the face of it, particularly before they have reached scale,
though they offer the opportunity to flex the system to respond to future
conditions. It is the role of our leaders not to chase rainbows, but to
insulate the country’s future economy from risk.


To quote Winston Churchill: “Owing to past neglect, in the face of the
plainest warnings, we have entered upon a period of danger. The era of
procrastination, of half measures, of soothing and baffling expedience of
delays, is coming to its close. In its place we are entering a period of
consequences.” 


Within a few weeks the first major piece of energy legislation in the U.K.
for 15 years will reach the floor of Parliament. Is it perfect? No. Is it
good enough to provide a framework? Yes. Now policy-makers must create the
policy certainty that investors in all parts of the energy system need, so
they can get their heads down and build the flexible, robust, integrated
system we are going to need for the coming decades.

By Michael Liebreich
Chief Executive
Bloomberg New Energy Finance