High energy prices can dampen economic activity, drive inflation and reduce the UK’s industrial competitiveness. The effects are most keenly felt by energy intensive industries such as steel and chemical manufacture, as well as lower income
households who are forced to spend an increasing proportion of their income on basic energy services. Price volatility is an important factor for consideration alongside absolute prices, as this can impact adversely on businesses and other consumers attempting to manage their costs.
4.1 The challenges
Affordability is one of the Government’s three energy policy objectives115, and it faces two major challenges. First, increasing international competition for resources has driven up coal, oil and gas prices, increasing energy bills in the UK which in turn has added pressure to consumers and businesses already struggling through a period of recession and low economic growth. Electricity prices have increased by 51 per cent since 2003116, driven mainly by the rising costs of fossil fuels, which still provide the majority of today’s power generation and heating.
A second challenge is managing the large amount of investment needed to replace old power stations and upgrade network infrastructure. Between 2012 and 2020 up to 20 gigawatts of old power stations - a fifth of total capacity – are expected to close. These could be replaced with up to 30 gigawatts of new renewables and possibly new unabated gas plants. Significant investment is also needed in the transmission and distribution network, both to connect new sources of power and overhaul parts of an ageing network. The challenge for policy is to ensure that this investment takes place, and that it is done as efficiently as possible. Decisions made in the next few years will determine the shape of the power sector for decades to come, and in turn, the future costs of electricity. There are multiple uncertainties currently facing policy makers:
How far and fast the cost of renewables may fall Future whole-life costs of nuclear power
The future prices of fossil fuels
The costs of Carbon Capture and Storage technology The future price of carbon
Although prices in the UK have risen sharply in recent years, it is worth noting that prices remain close to European and World averages. Household electricity prices have been third or fourth lowest in the EU 15 for the past four years, with prices similar to the EU 15 median for small and medium industrial consumers and slightly higher than the median for large and extra-large industrial customers117. However, the overhaul of old infrastructure and transition to lower carbon energy will require significant investment over the next decade, in turn increasing the cost of electricity in the UK.
115 DECC (2011) Planning Our Electric Future: A White Paper For Secure, Affordable And Low-Carbon Electricity 116 DECC (2012) UK Energy Sector Indicators 2012
4.2 Cheaper today
Figure 7 compares estimated average, or levelised, costs of electricity generated by different sources, dividing total power station lifetime costs per megawatt-hour produced. It shows that unabated gas and nuclear, followed closely by onshore wind and biomass co-firing, to be the lowest cost forms of generation.
The orange bars in this analysis indicate carbon prices118, to reflect the introduction of the Carbon Price Floor, a tax on fossil fuels used for power generation, as of 1 April 2013. Excluding the cost of carbon, as was the case until the introduction of the EU Emissions Trading System in 2005, gas and coal become the cheapest forms of generation. This is why, historically, investment has flowed to these types of power plants and their use continues to grow worldwide. Carbon taxes will begin to ensure that fossil fuel power generation reflects the environmental costs of its associated carbon pollution.
Figure 7: Levelised cost estimates for projects starting in 2012
Source: Department of Energy and Climate Change, Electricity Generating Costs (October 2012) Notes: 1) Gas is combined cycle gas turbine
2) Coal is advanced super critical with flue gas desulphurisation 3) Nuclear is first of a kind
4) Offshore wind is round two and onshore wind is UK and >5 megawatts 5) Dedicated biomass is >50 megawatts
6) 2012 prices assuming a 10 per cent discount rate
Whilst a useful starting point, it should be noted that this is a simplified analysis. It rests on numerous assumptions including capital, fuel, and operating costs as well as
118 £16 per tonne of carbon dioxide emitted
0 10 20 30 40 50 60 70 80 90 100 110 120 130
Gas Coal Nuclear Offshore
wind Onshore wind Dedicatedbiomass ConventionalCo-firing ConversionBiomass
Le ve li se d c o st (£/mega wa tt -h o u r)
Pre-Development Costs Capital Costs Fixed Operating & Maintenance Variable Operating & Maintenance Fuel Costs Carbon Costs
wind, solar and marine technologies creates new demands on the grid that may require additional investment in storage and interconnection (see chapter three).
Fuel price uncertainty
Figure 7 provides a useful breakdown of costs, and shows the extent to which the cost of electricity generated from fossil fuels is dictated by fuel prices – it accounts for approximately 80 and 50 per cent of the lifetime costs of electricity from gas and coal power plants (excluding carbon prices). Fossil fuel power generation costs will be in large part determined by these costs, which are difficult to predict. Capital dominates the cost of most low carbon alternatives - the on-going costs of wind, solar and marine are composed of smaller and more predictable operation and maintenance overheads. Similarly, nuclear fuel costs are a small proportion of total costs, although there is more uncertainty regarding the costs of decommissioning and waste management. The future cost of electricity from fossil fuels will be less predictable than that from alternative technologies.
Finding 26
Gas and coal generation are subject to higher degree of future price risk than alternative forms of generation.