The renewables trap
The central economic challenge confronting the UK is the need for cheap energy. Without it, there is no path to higher growth, lower debt, productivity growth or rising living standards. High energy costs are now the binding constraint on the British economy.
The scale of the challenge becomes clear the moment you look at the cost of the grid, which is now around £80 billion per year. That's an extraordinary number. Twenty years ago the equivalent figure was not much more than half as much (in today's money). The comparison is even less flattering if you also note that we consume rather less electricity than we did in the noughties. We are paying more for less.
It's unsurprising that we have among the highest electricity prices in the developed world. And it's going to get worse. The Clean Power 2030 plan will add £20 billion or more to the cost of the grid.
The painful fact is that if we are to get prices down we will probably have to close the renewables fleet – doing so is simply unavoidable if we are to avoid economic meltdown.
However, why this should be so is not obvious. Why would you close all those renewables having only just built them? It’s easiest to understand what is going on if you look at the grid in terms of what it costs to build and run (capital and operating costs) rather than how we cover those costs (market prices, subsidies and so on).
The increase in retail prices has not been driven by fuel costs. Of that £80 billion current cost, just £5 billion is fuel. Back in 2003, before renewables took off, the cost was only £12 billion. Even in 2022, when gas prices were through the roof, we only spent £22 billion.
Some of the overall cost increase is due to higher levels of imports, but once you have taken that into account, it becomes clear that the vast majority is driven by the fixed costs of the grid: building, financing and maintaining the generation, transmission and distribution equipment, and the expenses of the electricity supply companies. The annual bill for this element of the grid is now a staggering £45 billion higher than it was just over two decades ago, and this is why electricity prices are now at crisis point.
Why should the fixed costs have soared so far? The answer is of course renewables. While it is frequently noted, correctly, that the wind and sun, like all natural resources, are free, this only implies only that there are no fuel costs to pay. It says nothing about the costs of collecting such diffuse energy sources, often in environments that are either hostile – the North Sea or on northern hilltops – or sited far from centres of demand, or both. Seen in this light it is inevitable that the fixed capital and operating costs of renewables and the grid needed to deliver their output to market will be very high indeed.
This analysis is also useful in enabling us to see through some of the much-hyped schemes that their promoters claim will improve grid efficiency and thus bring prices down again. For example, Octopus Energy has touted the idea of zonal pricing – having a different wholesale market in different areas of the country. Beneath the complexity, the essence of the scheme is that, by better use of the renewables fleet, we might run the gas fleet less often, thus reducing our fuel use. With this understanding of the proposal, we can see that the current spend of £5 billion is the maximum possible saving. A more realistic figure is £3 billion, since there will always be times when the wind doesn’t blow, the sun doesn’t shine, or both, and the gas fleet will be required to step in and keep the lights on.
Similarly, promises that widespread deployment of electricity storage can save billions are seen to be empty. This scheme aims to reduce so-called grid constraints, when windfarms are paid to switch off and gas fired power stations are paid to switch on to satisfy the otherwise unmet demand. Putting the troublesome wind surplus into storage would eliminate this double payment, thus saving some fuel, but at the cost of a staggering fixed cost increase through the outlay on batteries. The net effect would be to raise prices.
The problem is that efficiency gains can never deliver a reduction in the fixed costs that are the main driver of the price rises. The clue is in the name. Fixed costs don’t change, even if the output of a windfarm or power station – or indeed of the whole grid – changes; capital costs are sunk, annual maintenance and refits are always needed.
One way to reduce the burden of all the fixed costs is to cut the subsidies. This doesn’t make the cost go away – it’s a fixed cost after all – it’s making the investors pay for it rather than consumers. That said, we can’t cut the £1bn off subsidies paid to gas-fired power stations because they’d simply shut up shop entirely and the lights would go out next time the wind failed to blow. However, cutting the £12 billion of renewables subsidies would in principle leave the grid fully functional, albeit at the cost of some very angry investors.
But while a £12 billion saving would be very welcome, it would still leave us with very expensive electricity prices. If Britain is serious about getting back to growth, a paradigm shift is unavoidable. Policymakers must confront the fact that the problem is caused by renewables, put aside the idea that axing the Climate Change Act or restructuring legacy subsidy contracts will be enough to fix it, and instead give serious consideration to phasing out all the wind and solar fleets entirely.
Doing so would eliminate considerable cost from the grid without pain to anyone. Windfarms that have been shut down do not incur any maintenance costs, so nobody loses in this respect, apart from those who hoped to do the work. However, a huge capital writeoff would be unavoidable, and the pain would have to be shared between the owners and consumers present and/or future.
Even in normal circumstances, closing down the renewables fleet would be a dramatic and difficult step to take, with investor confidence hit and legal challenges likely from every quarter. However, with the British constitution allowing any government to legislate away the predilections, vanities and delusions of its predecessors – “No government may bind its successors”, as generations of schoolboys used to understand – it should be possible for a determined administration, at least in principle.
In practice, however, it may be very hard indeed. Those who planned the renewables transition seem to have been well aware that it would lead to extreme economic pain, that eventually the pips would squeak, and that ultimately someone would seek to change course. They therefore went to great pains to prevent any such correction taking place, regardless of the ongoing human cost and any constitutional niceties.
For example, the decarbonisation programme as a whole is protected by an array of bilateral treaties, which seem to have been specifically designed to overcome the fundamentals of the constitution. The recent Trade and Cooperation Agreement with the EU, the Trans-Pacific Trade Partnership, and the bilateral trade treaties with Japan, Australian and New Zealand all specify no backsliding on Net Zero. Failure to stick to the terms of the agreements could lead to the imposition of tariffs, all out trade war, or worse.
The renewables sector has protections of its own. For a start, the majority of wind and solar generators have contracts that specify compensation if their commercial interests are harmed by pretty much any government action. Any attempt to reduce the fixed costs of the grid, cancelling subsidies, or reorganising the grid in a way to make it less friendly to renewables would fall foul of these clauses.
Parliament could, if it chose, declare the contracts annulled, but then there is the Energy Charter Treaty, which guarantees that there will be no discrimination against foreign investors in the energy sector. On the face of it, this would cause no problems so long as the government was even-handed in scrapping subsidies or sending windfarms to the scrapheap, However investment tribunals have interpreted the treaty text as giving broad protection to international investors beyond that enjoyed by their domestic counterparts. Any UK government that tried to shut down the windfarms would almost certainly find itself sued for compensation by foreign owners.
And it is only possible for a government to even start down this road if it can overcome what is likely to be a furious rearguard action from the House of Lords, whose inmates are entirely insulated from the financial suffering elsewhere in the country, and slavish enough in their devotion to the climate cause to put up a very determined fight. It is not hard to imagine it ending in a historic standoff.
Thus any government that is serious about reducing electricity prices faces economic, legal, diplomatic, political and constitutional chaos, perhaps for years. Alas, the alternative being economic meltdown, this may be the path of least resistance.