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COP27 and the UK energy sector – between a rock and a hard place

10 November 2022 | Insight

The UK's climate change agenda will be complicated by an energy market under intense pressure and policy in flux 

UK CLIMATE COMMITMENTS

In 2021 the UK enshrined in law a pledge to reduce emissions by 78% by 2035 (compared to 1990 levels), with an overarching commitment to reach net zero by 2050. The UK Government has stated that its strategy for net zero is to "lead the world in ending our contribution to climate change".

The Net Zero Strategy includes commitments to:

  • generate 100% of the UK's electricity from low carbon sources by 2035 (subject to security of supply). This is to be achieved largely by incentivising investment in offshore wind power, with a target of delivering 40GW of offshore wind power by 2030 and, secondly, introducing a new regulatory framework to improve coordination in offshore electricity networks;
  • deliver 5GW of low carbon hydrogen capacity by 2030, to be achieved primarily through a £240 million Net Zero Hydrogen Fund;
  • regulate the oil and gas sector in a manner that reduces greenhouse gas emissions, including by addressing regulatory barriers to the electrification of oil and gas production and cutting routine flaring and venting; and
  • deploy at least five megatonnes of engineered greenhouse gas removals a year by 2030, to be delivered through £100 million in innovation funding for Direct Air Capture and the development of a strategy and business model to incentivise investment into carbon capture, use and storage technologies (CCUS).

The UK is also taking steps to review certain climate-related policies and regulations to ensure they align with overall climate targets. For example, in March 2022 the UK Emissions Trading Scheme (ETS) Authority consulted on a package of proposals to develop the UK ETS, which aimed to align the scheme's cap with the UK's net zero target.

On the other hand, the UK Government continues to support oil and gas production in the North Sea following a review in March 2021, which concluded that doing so was compatible with the UK's climate change objectives.

RECENT LEGISLATIVE AND REGULATORY DEVELOPMENTS

The Russian invasion of Ukraine and the UK's ongoing cost-of-living crisis has created intense political pressure on energy prices. In response, the UK Government introduced several measures to mitigate the effects of these events. In July 2022, the Energy (Oil and Gas) Profits Levy Act 2022 (the Act) was passed, which aims to raise an estimated £5 billion in its first year by imposing a 25% surcharge on extraordinary profits from oil and gas production in the North Sea (referred to as a 'windfall' tax).

Russia's invasion of Ukraine, and the subsequent phase-out of imports of Russian oil and gas, raised fresh concerns about the security of the UK's energy supply. The former Secretary of State for Business, Energy and Industrial Strategy Jacob Rees-Mogg noted that "strengthening [the UK's] energy security is an absolute priority".

Determined to increase domestic sources of energy to reduce reliance on foreign imports, the UK Government has announced a new licensing round, which is expected to lead to over 100 new oil and gas licences. In September 2022, the UK Government also formally lifted the moratorium on shale gas production in England, which was originally introduced in November 2019 following analysis of the environmental impact of shale gas production. The temporary suspension of the moratorium proved controversial in the UK, with the effective ban reinstated in October by new Prime Minister Rishi Sunak.

October also saw the UK Government publish the Energy Prices Bill, which covers measures previously announced in response to the energy crisis, including:

  • the Energy Price Guarantee for domestic consumers which, depending on use, will cap certain elements of household energy bills, including the price per unit and the daily standing charge, for two years from 1 October 2022; However, the Government on 17 October announced a revision of the policy, saying the full guarantee would now last for just six months, with more targeted support to be unveiled following a review by the Treasury.
  • the Energy Bill Relief Scheme for businesses and non-domestic properties, which will enable the Government to provide eligible non-domestic customers with financial assistance on energy bills from 1 October 2022; and
  • a Cost-Plus Revenue Scheme, which will be a periodic payment scheme for electricity generators that are not currently covered by a Contract for Difference, although the scope of coverage is still being finalised. The mechanics of the scheme are subject to an upcoming consultation. It is anticipated this will be a temporary measure to address exceptional market conditions, notably unprecedented wholesale price rises.

In addition to measures adopted in response to the energy crisis following the invasion of Ukraine, the UK Government is also progressing other policies that could have a significant impact on the energy sector. For example, on 18 July 2022 the Department for Business, Energy and Industrial Strategy launched a consultation on reforming non-retail electricity markets in Great Britain (GB). The proposals range from incremental changes to revolutionary reforms, which could impact all investors in the GB electricity market.

THE FUTURE DIRECTION OF THE UK ENERGY SECTOR

The UK's energy mix has changed dramatically over the last 20 years. Coal consumption has fallen from 108 million tonnes in 1990 to just seven million in 2020, while demand for petroleum products fell from 79.8 million tonnes to 51.8 million over the same period. Half of the UK's power now comes from low carbon technologies. Renewable capacity, meanwhile, has grown fivefold since 2010, which has been driven by the deployment of wind, solar and biomass. For example, the UK had 10GW of operational offshore wind by 2019, compared to just over 1GW in 2010. The UK Government aims to increase this to 40GW of offshore wind, including 1GW of innovative floating offshore wind, by 2030.

While investment in electricity from renewable sources (primarily wind) has increased over the past decade, overall investment in the energy sector has been stagnant. Investments in 2020 totalled £15 billion, the lowest level since 2010. Despite positive progress, significant capacity will be needed to achieve the UK's climate change targets. Many of the commitments relating to renewable energy and CCUS outlined in the Net Zero Strategy hinge on incentivising dramatic private sector backing. It is expected the offshore wind sector alone will see over £20 billion in private investment by 2030.

However, recent measures introduced by the UK Government (including the windfall tax and the Energy Prices Bill), combined with the wide-ranging consultations underway, may disincentivise investment in various areas of the UK energy sector. Moreover, ongoing reviews of existing policies to reflect climate change commitments could lead to further regulatory changes, potentially discouraging investment.

Some of the recent measures to protect energy supplies have also been criticised for running contrary to the UK's long-term climate commitments. These measures may therefore undermine the UK's ability to push its agenda at the COP27 UN climate conference, as they may be seen to reinforce existing tensions between developed and developing countries regarding priorities for COP summits.

In sum, the UK and its major energy players face this month's summit in Egypt while attempting to strike a singularly difficult balance between short-term demands and long-term imperatives.