TODAY’S STUDY: A LONG VIEW OF THE COST OF NEW ENERGY

Energy prices and bills – impacts of meeting carbon budgets

December 2012 (UK Parliament Committee on Climate Change)

Executive Summary

In our December 2011 report on household energy bills we assessed trends and key drivers of energy costs over the period 2004-2010 and we projected the impact of low-carbon policies on bills in 2020. We separately identified support for low-carbon technology which will increase bills, and opportunities to offset this through energy efficiency improvement.

In this report we update the analysis on household energy bills using new data on prices and consumption in 2011, and new information on future costs following agreement on support to be provided through the Renewables Obligation. We then extend the analysis to cover the commercial and industrial sectors.

We also provide a high-level assessment of bill impacts beyond 2020 associated with achieving a largely decarbonised power sector by 2030, as compared to a system largely based on unabated gas-fired generation. This complements analysis in our June 2012 progress report, which showed that it is economically sensible to invest in a portfolio of low-carbon technologies over the next two decades. Our new analysis illustrates the benefits from such a strategy as insurance against the risk of high prices associated with unabated gasfired generation, reducing the impact on household bills in the long term and enhancing competitiveness of UK industry (i.e. by reducing exposure to rising carbon prices and potentially high gas prices).

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Our key messages are:

• Historic increases in energy bills: Although energy bills have increased significantly for residential, commercial and industrial consumers in recent years, this is mainly due to increases in the international price of gas and investment in electricity/gas networks (e.g. contributing 62% and 16% respectively of the increase in household energy bills since 2004).

Impacts have been smaller from support for low-carbon technologies and support for energy efficiency improvement (e.g. less than 10% each of the increase in household bills since 2004).

• Projected increases in energy bills.

– Our analysis suggests that support for low-carbon technologies will increase annual energy bills by around £100 by 2020 (a 10% increase on the 2011 bill) for an average ‘dualfuel’ household (i.e. for the 86% of households that use gas for heating and electricity for lights and appliances).

– Energy costs will also rise significantly for commercial and industrial users due to lowcarbon policies (e.g. we project increases of around 20-25% from 2011 to 2020). However, average energy costs are only a small component of total costs for these sectors (i.e. less than 0.5% of costs in the commercial sector and around 3% of costs in the industrial sector). Therefore the impact of the increase in energy costs on total costs and final prices of goods and services will be very small (e.g. increased energy costs as a result of low-carbon policies to 2020 will add around one penny to every £10 spent on goods and services produced by the commercial sector, and six pence to every £10 spent on manufactured goods).

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– Projected bill increases to 2020 are consistent with our previous estimates of the costs of meeting carbon budgets (i.e. less than 1% of GDP in 2020).

– Beyond 2020, we project limited bill increases across residential, commercial and industrial consumers to support low-carbon investment.

– In an alternative scenario with investment focused on unabated gas-fired generation, there is a risk of much higher cost increases in the long term (e.g. the average annual household bill in a gas-based system could be as much as £600 higher in 2050 than in a low-carbon system if gas and carbon prices turn out to be high).

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• Energy efficiency opportunities. There is scope to offset the bill increases resulting from low-carbon policies through improvements in energy efficiency. However, incentives under current policies are insufficiently strong and new policies will be required if this potential is to be realised.

• Fuel poverty and competitiveness risks. The impacts of low-carbon policies will be largest for households with high electricity use (e.g. those with electric heating) and for a small number of energy-intensive industries. It will be important therefore to ensure that support for low-carbon technologies does not result in increased levels of fuel poverty, through targeting support for energy efficiency at vulnerable households, with a particular focus on those households using electric heating. It will also be important to ensure that potential competitiveness impacts for energy-intensive industries are addressed; we will provide a detailed analysis of competitiveness risks and potential mitigating measures in our competitiveness report in spring 2013.

We set out the analysis that underpins these messages in five sections:

1. The economic rationale for power sector decarbonisation

2. Residential energy bills

3. Commercial and public sector energy bills

4. Industrial energy bills

5. Projected bill impacts in the long term under low-carbon and gas-based systems

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By Sector

Residential energy bills

We focus on the energy bill for an average ‘dual-fuel’ household (i.e. for the 86% of households that use gas for heating and some cooking, and electricity for lights and appliances), and consider implications for non-typical households at a high level.

• Current energy bills. The average annual dual-fuel energy bill in the residential sector fell by £85 between 2010 and 2011, from £1,055 to £970 (i.e. by 8% in nominal terms, by 12% in real terms, allowing for general price inflation). Residential electricity and gas prices increased in 2011, mainly due to changes in the wholesale gas price, as in previous years. This was more than offset by falling energy consumption due to milder weather in 2011. The cost of low-carbon policies was broadly unchanged in 2011 – the cost of supporting investments in low-carbon generation (including renewables) remained at around £35 per household per year while the cost of funding energy efficiency improvements in homes, which has fuel poverty and affordability benefits, remained at around £50.

• Projected energy bill impacts to 2020. We project that the annual bill for an average dual-fuel household will be around £40 higher in 2015 than 2011 and around £100 higher in 2020 (in real terms, i.e. before general price inflation) due to support for investment in low-carbon generation technologies (i.e. renewables, nuclear and CCS, including costs of required investments in the electricity grid to support low-carbon technologies). The £100 impact in 2020 comprises £75 of direct support and £25 of support via increases in the carbon price, which will also raise revenue for the Exchequer.

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• Opportunities for energy efficiency improvement. There are opportunities to more than offset the increase in bills due to low-carbon policies through better insulation, purchase and use of more efficient appliances, and behavioural measures. We expect that bills will be reduced by around £35 on average in the period to 2020 due to the replacement of old inefficient boilers. Further savings of £85 are available from more efficient lights and appliances and £25 from improved efficiency in heating systems, mainly through insulation measures (this figure is an average across all households, with much higher savings at the level of individual households that improve insulation). Whether all of these are realised will depend on the policy framework and the extent to which incentives for uptake of measures are strengthened, particularly as regards more efficient appliances.

• Non-typical households. Households with electric heating (less than 10% of all households) will be particularly exposed to the increasing costs of supporting low-carbon investment since these affect the electricity price, but not the gas price. It will be important therefore to bring forward measures to mitigate bill impacts for these households. One opportunity is through the Energy Company Obligation (e.g. a share of the spending under ECO is expected to benefit households with electric heating), and the Government should continue to develop policies to protect vulnerable households in electrically-heated homes and more generally.

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• Energy bill impacts beyond 2020. Achieving a largely decarbonised power sector by 2030 will require further increases in the average annual bill of around £25 per household through the 2020s, with probable reductions thereafter. Bill increases in the 2020s would be higher in a scenario with extensive investment in unabated gas-fired generation, with significant further increases beyond 2030 and a risk of much higher bills in the long term (e.g. the average annual bill in a gas-based system could be as much as £600 higher in 2050 than in a low-carbon system).

This reflects our expectation that carbon prices will continue to rise in an increasingly carbon-constrained world, and the inherent uncertainty in gas prices, which could also rise.

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Commercial energy bills

In the commercial sector our analysis focuses on medium-sized users that pay the Climate Change Levy (CCL – a tax on energy use) and are covered by the CRC Energy Efficiency Scheme (formerly known as the Carbon Reduction Commitment – a scheme aimed at improving the energy efficiency of large non-energy-intensive consumers). We also consider other types of firm, such as those outside the CRC, and find that the expected impacts of low-carbon policies are broadly comparable.

• Energy bill trends. Energy bills in the commercial sector increased by around 110% from 2004 to 2011 (compared to general price inflation of 22% over the same period), largely due to increases in the wholesale price of gas. Policies that reduce carbon emissions contributed a 33% increase in energy bills from 2004 to 2011, of which about half was due to support for low-carbon investments in electricity generation, and half was due to the CRC.

• Projected energy bill impacts to 2020. We project that average bills in the commercial sector will increase in real terms by around 25% to 2020 due to low-carbon policies (i.e. slightly less than they have risen since 2004 due to low-carbon policies). Given that energy costs make up only 0.4% of total costs for the commercial sector, the impact of projected energy bill increases on the total costs and final prices of goods and services produced by the sector is very small (e.g. increased energy costs as a result of low-carbon policies to 2020 will add around one penny to every £10 spent on goods and services produced by the commercial sector).

• Energy efficiency opportunities. There is an opportunity to offset at least some of the increase in bills through implementing energy efficiency measures, but the size of the potential and the costs involved are highly uncertain.

For example, whilst we identify potential to reduce energy consumption by at least 10% (i.e. enough to offset just under half of the energy bill impact), we also note that some businesses have achieved significantly greater reductions. In order to unlock this potential it will be important to strengthen policies, including through setting ambitious minimum standards for the private rented sector under the Green Deal legislation.

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Industrial energy bills

We analyse energy bills for industrial users (i.e. manufacturers) on average and also consider the impact on energy intensive users specifically (i.e. those for which energy costs are at least 10% of gross value added). Our analysis covers the impacts of the Climate Change Levy (CCL), discounts on the CCL available under Climate Change Agreements (CCAs) and increased costs of electricity as a result of support for investment in low-carbon generation.

We do not include costs of EU Emissions Trading Scheme allowances bought directly by industry, since enough allowances will be allocated for free to industrial firms to cover emissions up to 2020.

• Current energy bills and trends. Average energy costs increased by around 140% in total since 2004 (compared to general price inflation of 22% over the same period), largely due to changes in wholesale fuel prices. Energy costs increased by around 15% due to support for low-carbon generation and increases in the CCL.

• Projected energy bill impacts to 2020. We project that industrial energy bills on average will increase by 19-23% in real terms to 2020 as a result of low-carbon policies. Given that energy costs make up around 3% of total costs for the industrial sector, the impact of projected energy bill increases on the total costs and final prices of goods and services provided by the sector is small (e.g. increased energy costs as a result of low-carbon policies to 2020 will add around 6 pence on average to every £10 spent on goods and services produced by the industrial sector).

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• Energy efficiency opportunities. Opportunities exist to reduce energy consumption and therefore costs by at least 8% overall, potentially offsetting a third of the increase due to low-carbon policies. However, DECC’s recent energy efficiency strategy estimates that less than a fifth of the energy efficiency potential will be realised under current policies, implying the need for additional incentives.

• Projected bill impacts for energy-intensive industries: Increases in energy prices will have a larger impact on costs of energy-intensive industries (i.e. given the higher share of energy costs in total costs for these industries).

There is therefore a potential concern about competitiveness impacts of low-carbon policies for a small number of energy-intensive industries, which may be addressed through a combination of energy efficiency and direct measures to offset low-carbon costs (e.g. the Government has made compensation available for energy-intensive industries to 2014). We will provide a detailed analysis of competitiveness risks and potential mitigating measures in our competitiveness report in spring 2013…

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