What will happen to our energy bills over the next 20 years?

Over recent months there has been a rash of media articles and TV programmes highlighting the rapid rise in energy bills and the potential causes.  A BBC Panorama programme pointing the finger squarely at ‘green policy initiatives’ has been widely criticised as inaccurate.

Rising energy prices are a major concern for most people particularly those in fuel poverty.  They also have a huge impact across the green energy sector.  At the heart of almost every decision to invest in energy efficiency or renewable energy generation by a household or organisation lies the ability to make long-term SAVINGS.  The higher the price of energy, the bigger the SAVINGS, the stronger the motivation to cut your consumption..and potentially generate your own energy more cheaply.  The basis of the case for investing in energy efficiency measures and, to some extent, green energy generation solutions, is driven by how much you can save..or, at the very least, the ability to control your future energy costs. The whole underlying basis for the new government's flagship green energy policy, the Green Deal, relies on the ability to generate greater savings over a period of years compared with the up-front cost of making the improvement.

But underlying all this are major assumptions around the future price of energy.  These are very often glossed over yet make a huge difference to the case for taking action.  Do we actually know what energy prices are likely to do over the next 10 or 20 years?  Unless we do, how can we make any sort of accurate prediction of potential savings?

Over the last year I’ve been looking at some of the discussion on this topic and trying to come up with some suggestions.  I’ve asked some awkward questions to senior energy economists and I;ve exchanged emails with specialists at DECC tasked with looking at projections for energy prices.  And I’ve read lots of reports by industry experts.  The views below are, of course, mine..not theirs.  And I am not an energy economist, just an amateur looking for some answers.

The crux question – as a household or company that’s currently paying 10-14p/unit for electricity right now, what will you be paying (in current prices) by 2030?  [There are also other important questions I don't try to address here like how volatile prices could become over this period and how high prices might ‘spike’.]

Predicting energy prices is a highly complex inter-connected issue impacted by global trends and unpredictable events.  For example, even 5 years ago no-one predicted the real impact of the arrival of shale gas on the US energy scene.  We do know that the major factor influencing what we pay is the global wholesale price of oil and gas - and the degree of competition in the global market for these diminishing resources. We also know that some of the major exporters of oil and gas are located in areas of instability and therefore it is wise to ensure that we, as UK energy consumers, are less dependent on these areas – even though this means we have to pay higher prices.  Unfortunately, as the useful OfGem Factsheet (http://www.ofgem.gov.uk/Media/FactSheets/Documents1/Why%20are%20energy%20prices%20rising_factsheet_108.pdf) points out, in recent years we have actually become more dependent on imported gas and therefore our energy prices are more susceptible to international factors we cannot control.

There appears relatively broad agreement that energy prices in the UK are likely to rise over the next 20 years although we are seeing a 'dampening effect' as a result of the global economic slow-down and the associated reduction in overall energy demand. The DECC report (http://www.decc.gov.uk/assets/decc/11/about-us/economics-social-research/3593-estimated-impacts-of-our-policies-on-energy-prices.pdf) states..

"Global fossil fuel prices (particularly gas prices) are the main drivers of retail energy prices in the UK (and elsewhere) and if, as expected, they continue to rise over the coming years, energy bills will likely continue on an upward trend with or without policies."

If you want to read more about medium term global energy price projections I'd recommend the IEA publications like http://omrpublic.iea.org/omrarchive/mtogm_2011.pdf, or watch their video at http://www.worldenergyoutlook.org/name,27000,en.html.

Before we go any further we should differentiate between short-term and long-term trends. Prices can rise dramatically over 12 months as they did in 2011 (when household electricity prices will have increased by around 16% and household gas prices by 25%). But this doesn't mean they will continue to do so for the next 20 years and, indeed, it would be unlikely. Prices are relatively volatile and can go up and down over short periods - it is the long-term trend we are focusing on here.

Many of the experts provide 'projection scenarios' depending on a wide range of global factors, in particular the future international price of fossil fuels.  See the International Energy Authority global scenarios and projections at http://www.iea.org/publications/scenariosandprojections/.

The recent draft McKinsey Report for DECC (http://www.decc.gov.uk/assets/decc/11/cutting-emissions/5776-capturing-the-full-electricity-efficiency-potentia.pdf) talks about an annual percentage rise from 2010 to 2030 in UK electricity of 3.65% (which, by my calculations, puts the cost per unit of electricity at 28.4p in 2030, so electricity bills would be roughly double what they are now).

The DECC 2011 Projections for electricity retail prices offer 5 scenarios (see 'Annex F: Fossil Fuel and Retail Price assumptions' at http://www.decc.gov.uk/en/content/cms/about/ec_social_res/analytic_projs/en_emis_projs/en_emis_projs.aspx#2011-projections. Their 'Central Scenario' suggests electricity prices for UK residential customers rise by approximately 50% from current levels (14p/unit) to 21.5p/unit by 2030. This is more like a 1.5% annual increase.  DECC also provide analyses of the impact of their policies on energy prices at http://www.decc.gov.uk/en/content/cms/meeting_energy/aes/impacts/impacts.aspx.

There are other reports by 'industry experts', particularly those highlighting the global pressure on demand for oil as it becomes a more scarce resource ('Peak Oil') - see for example http://peakoiltaskforce.net/download-the-report/2010-peak-oil-report/ - that suggest energy prices could rise faster within these timescales. The 'Peak Oil' debate is majory hampered by a lack of transparency over data - no-one really knows for sure what reserves remain and the energy multinationals are unlikely to be telling anyone too much of the detail.

Historical data on energy bills suggests much faster rates of increase.  Since 2004 uSwitch research suggests the average dual fuel bill has more than doubled (http://www.uswitch.com/gas-electricity/guides/household-bills/).

Domestic fuel prices 1990-2011

Source: DECC Quarterly Energy Prices June 2012

The DECC’s Quarterly Energy Prices publication indicates that since 2004 energy bills have risen in real terms (accounting for inflation) at around 9% annually.  A 9% annual increase turns a current £500 electricity bill into something nearer £2,500 by 2030!  I’m guessing some would argue that this is not a long-term trend on which you can assess likely prices in 2030, this is a relatively short-term pattern.  However the obvious response is "at what point is this going to stop?" I am told there are some very senior analysts at the World Energy Council and executives at the International Energy Agency who use the logic of approximating a projection using the past. 

Can we be sure of anything?  The price we pay for our energy does depend on a range of factors that we can be fairly sure about. 

The UK currently has a looming ‘energy gap’ as a third of our power generation capacity goes over its 'sell-by date'.  This will require major investment by energy companies to replace or refurbish this capacity. Likewise major investment is needed in the UK grid transmission network over the next 20 years. There are also other policy initiatives like new green energy initiatives to make us less energy dependent on others plus the roll out of smart meters which introduce additional costs to be passed on to the 'bill payer'.  Globally there are trends like the increasing competition from developing nations like China and India that are likely to lead to increased competition for global energy resources.  In the UK surely our demand for energy is likely to decrease by 2030?  Well, unfortunately it appears not – our demand is likely to continue to increase for reasons laid out in a new draft report by DECC at http://www.decc.gov.uk/assets/decc/11/cutting-emissions/5776-capturing-the-full-electricity-efficiency-potentia.pdf (even without a mass move to electric vehicles).

Some would even contend that the UK is facing a ‘perfect storm’ on energy prices as a result of these numerous national and international pressures.  Would the Government provide us with long-term warnings of any serious trouble ahead?  Do Governments have to care too much about offering information about the next 20 years when they are re-elected every 4 years?  You might also argue that it’s not in the best interest of the Government to tell its citizens the whole truth on this issue.  It would obviously be deeply unpalatable...indeed even political suicide. So wherever possible they may seek to play down the implications.  Certainly their recent statements on energy prices have given no indication of the potential for steeper rises and the 'spin' always seems to play down likely increases.

When it comes to predicting future energy prices very few people have mastered the crystal ball (here's one example). My hunch, and that of the experts I've talked to, is that the DECC estimates are too low and prices will increase faster than they are suggesting.  

Treat what you read in the mainstream media (and on many websites) with caution - certainly the media will continue to sensationalize the whole issue very often by over-looking basic statistical principles in favour of a more enticing headline.  It seems fairly clear that there will need to be a substantial investment required by all those involved in the UK energy industry to meet our future energy needs.  Personally I believe this is likely to lead to some hefty increases in energy bills.  I suspect these increases may happen in painful ‘jumps’ rather than gradual iterations.  

It’s impossible to say exactly how much your bills might go up over the next 20 years - whether it will be an annual increase nearer 3% or nearer 6-9%?  This makes a huge difference of course.  If you are able to think about your future in a way that is long-term (and I believe only a minority of people are in a position to do this) then the principle of investment to ensure your home and lifestyle is as energy efficient as possible seems sound.

Comments

The Future Cost of Energy and Energy Rationing.

As an old hand at Energy Policy I cannot help but feel that the debate on renewable energy has become bogged down in rhetoric and is missing the point with regard to explaining why renewable forms of energy are vital to our future and why we can no longer rely on Fossil Fuels to sustain our energy hungry society.

Back in the 1970’s the principle argument against the continued reliance on Fossil Fuels was that they were finite, a secondary issue was the pollution they caused. The first point occurred as a result of the 1970’s oil crisis which caused a major economic crisis and brought the world’s attention to the fact that the USA had become a net importer of Petroleum and could not increase production due to resource depletion. This brought about the realisation that because products like Petroleum were in finite supply and there would come a point, at some time in the future, when there would be an economic crisis where supply of all fossil fuels would no-longer meet global demand. This crisis is now upon us in the form of a bank solvency crisis; however the role of energy and energy supply issues in creating this crisis are largely ignored.

Part of the problem is that the secondary issue of pollution in the form of CO2 emissions and the connection with global warming, or manmade climate change have come to be seen as the primary and sometimes the only justification for renewable energy. There is nothing wrong with this argument except that it is not the best argument for the need to greatly increase the amount of renewable energy we are able to effectively generate. Of course we would all like to prevent global warming but if in the process we suffer hardship in order to prevent some hypothetical future problem many will complain about the cost and point to the real hardship some will experience in the process and use this as an excuse not to make hast to utilise renewable energy. The reason why the connection between the banking crisis and energy supply provide a better justification for renewable energy is best explain in broad economic terms based on the primary observation about the finite availability of fossil fuels.

The first observation to make is that most of the comments that appear on the subject of renewable energy development focus on two issues that is the global availability of energy, and ideas like peek oil or alternatively focus on the internal micro economics of renewable energy development in the process they tend to gloss over the macro economics of the UK as a whole and as such do not address one key issue which underlies bank liquidity which is the overall solvency of the British economy. Put simply we have a long term structural balance of payment deficit, the UK always spends more buying everything we need than we make from selling and the goods and services we export and all the capital assets we sell, or even more simply our expenditure exceeds our income. Historically this was the nature of all post war economic crisis in the 1950’s, 60’s and 70’s. In the 1980’s the situation was changed by North Sea oil but this short term boom in oil and natural gas output disguised the fact that UK manufacturing was struggling with a high value pound and none oil exports were declining. The result was that on the balance of payment account even at the height of the oil boom expenditure always exceeded income and Britain rarely broke even. Up to 2008 this insolvency was effectively disguised by a hyper active banking sector which of course then went bust in 2008.

As for energy the simple facts are; Britain imports 75% of the coal we use, 80% of the steam coal used in power stations, in a cold winter Britain imports 70% of all gas consumption for domestic heating power production and industry, only in the case of petroleum does Britain breakeven importing as much as we export. The consequences of importing such a high proportion of the basic energy we consume, in the form of fossil fuels, is that Britain has a structural balance of payments deficit in energy trading and since energy is fundamental to our whole economy a structural balance of payments on all trading. The fact that there is also pressure on the international price of energy only helps to enhance the overall deficit. This deficit is structural in two senses, most obviously because it is always there, but also because if we wish to increase exports we would have to increase energy consumption, which would increase our energy trading deficit. One of the few ways to break this vicious circle is to generate more energy from indigenous sources, in particular those energy sources which are freely available like renewable energy, energy collection technologies which collect the suns energy directly or indirectly from our environment. This prescient argument about the fundamental ability of the UK economy to fund the levels of energy consumption we presently enjoy and about the basic economic vulnerability of the British economy are pertinent concerns which if explained greatly enhance the arguments in favour of renewable energy, it is all about economic survival.

One of the fundamental problems when dealing with the subject of renewable energy is one of definition, what exactly is a renewable form of energy. This is partly the direct result of government policy which is confused and lumps dubious technologies like waste to energy incineration alongside technologies like wind power. This is done to encourage competition but it may be observed that co-operation is a better way to developed renewable energy, competition certainly leads people into strange places for example the recent criticism of Government support for the gas industry in this blog. It should be clearly understood that amount of wind power generating capacity which can be accommodated on the grid is directly linked to natural gas supplies and its use in Gas Turbines. A gas turbine can be cold started, run up to speed, synchronised and placed on line in less than 5 minutes which means that there is always standby capacity to compensate for a reduction in wind power without the need to keep dirty and expensive steam plant as running standby. In actual fact there is a synergy between wind power and gas as when there is plenty of wind it is possible to save gas which is expensive to buy, so co-operation is probably a better option.

Gas turbines have other advantages; a closed cycle gas turbine is the most efficient heat engine we have, with a thermal efficiency of about 44% and they can also be run on renewable fuels like Bio-gas without a loss of this high efficiency. This point highlights one of the largest failures of renewable energy policy in Britain, we have failed to pay any attention to renewable fuel production, which is the best technique we have for storing energy, for when it is actually needed; and anaerobic technology in particular can be used to reduce our present dependency on imported Natural Gas. Improving the energy efficiency of electrical production is one of the best techniques we have for reducing our fossil fuel dependency and also helps reduce CO2 output, over the last 20 years most of the actual advances in CO2 reduction have been achieved by adopting more efficient gas turbine technology, advances which can be threatened by an escalating international gas price and a depreciating pound.

It should be clear by now, with new attention being drawn to our ballooning balance of payments deficit by another round of bad quarterly figures that Government economic policy is failing to address the real weaknesses of our economic position. It is also clear that by their discouragement of the whole renewable energy industry as demonstrated by their planned reduction in FIT and ROC, which resulted in an immediate reduction in hydro-electric investment, that they have not yet grasped the desperate economic need to develop more renewable energy. However judging by present performance it is unlikely that the present overall economic policy can be sustained for much longer and also the Government that created it. However when government policy does change it is important that amongst other things that change should be a greater openness to energy rationing and on the subject of this rationing. At present we have energy rationing by price, were by the VAT and Excise duty on Petroleum are meant to reduce demand and the electricity and gas markets are highly regulated, also to decrease demand. Unfortunately all these measures are hurting the most vulnerable people and parts of society most; it is the poor and pensioners on fixed income who are suffering most from escalating energy costs and it is our rural population who suffer most from high fuel costs. More openness and honesty on this subject in particular with regard to restructure our economy to reduce the balance of payments deficit which can only be done by reducing overall energy consumption will become increasingly vital.