At last week’s World Economic Forum in Davos, governments and businesses discussed how to contend with a negative economic and geopolitical outlook. The ongoing Russian aggression in Ukraine is impacting energy security and policy responses across the globe, and predictions suggest that a third of the global economy is set to be in recession this year. If that was not enough, the summit is taking place during one of the warmest months of January ever recorded, and the snowless landscape is a stark reminder that tackling climate change needs to be at the very core of fixing our economic problems.
In the UK, government and businesses recognise that a transition to clean energy and a move towards net zero can indeed improve our economic fortunes by catalysing innovation, boosting productivity, driving investment in skills, and creating jobs. Last week, Chris Skidmore’s Net Zero Review, Mission Zero, reinforced these points and recognised that net zero is opening up ‘a new era of opportunity’. But against the backdrop of an economy in recession, we need to consider seriously how we can make it a reality, as a growing number of economies are competing for limited resources and know-how to make the transition happen.
If in 2019 the UK was a top investment destination for companies looking to pivot their business models towards net zero, we are now in a very different place. More and more countries have taken significant steps to attract investment in clean energy solutions. For example, in the 12 months to November 2022, the global pipeline of offshore wind projects more than doubled to 967GW. In the next 10 years, RenewableUK’s analysis currently forecasts the global installation of 600GW – an 11-fold increase in the total capacity installed to date worldwide. These ambitions show that the competition for skills, supply chains and capital is going to be fierce, and the UK cannot take for granted its attractiveness as an investment destination.
Many investors are already eyeing the US market, particularly following the passage of the Inflation Reduction Act, which incentivises investment in clean energy. In addition, the US market offers advantages in terms of scale, better access to a local manufacturing base (and therefore fewer bottlenecks) and a higher capacity to scale up supply chains and sustain growth over the long term. The EU is set to follow suit and offer its own set of incentives for clean energy investors.
In this context, the UK government must be mindful of reinforcing the country’s position as a good place to invest in clean energy and homegrown supply chains, and minimise destabilising interventions in the market. Indeed, the energy crisis combined with the need to address a budget deficit has seen a range of such interventions in energy markets, which are already impacting investment.
Firstly, mechanisms like the energy price cap, quickly replaced by the windfall tax (also known as the Electricity Generator Levy - EGL), have served to destabilise our policy and regulatory environment at a time when trust in the UK had already been shaken after the mini-budget. The EGL is also reducing the viability of projects being taken forward on a purely merchant basis, thereby impacting the deployment of renewable energy at a time when lessening dependence on gas is a key priority for the government. Even though the windfall tax covers both renewables and fossil fuels, the government has offered more generous capital allowances for fossil fuels. An oil and gas operator can receive an allowance of 80% if they install a wind turbine on their installation, whereas the capital allowance deduction rate for renewable generators is limited to 18%, dependent on the asset’s useful life.
Whilst tackling unexpected profits is a goal supported by the sector, there has been little analysis of whether these profits have actually been made in practice. In fact, rising costs of commodities, labour rates and energy have exacerbated the cost pressures on the pipeline of renewable energy projects, and are eroding margins significantly. According to the International Energy Agency, the levelised cost of energy (LCOE) has increased by 20% in the past year and is still rising. Whilst the renewable energy sector delivers by far the cheapest form of energy generation, it is not immune to rising supply chain costs. There needs to be a recognition of the fact that the very low prices seen at the previous Contracts for Difference auction round (of £37.35/MWh) may not be matched in future auctions, especially in an inflationary environment.
Without sustainable pricing, we risk the growth of supply chains supporting jobs and economic activity across the country. The investment value to the UK economy from renewable projects in the latest CfD allocation round alone is £15bn, and the construction of these projects generates the bulk of the demand for UK supply chain companies such as blade manufacturer Siemens Gamesa in Hull and the new JDR and SeAH factories. With sustainable pricing and ambitious deployment, we can also create demand and support investment in our manufacturing industries – according to the Crown Estate, a single 10MW turbine uses over £880,000 worth of steel.
At a time of energy crisis, the clean energy transition is helping households and businesses save money. It can also be the foundation for solving the UK’s productivity and levelling up challenges. But for this to happen, we need to ensure that we continue attracting the investment needed to deliver a secure, affordable and clean energy system.