10 September 2020
Change is never easy, and the transformation needed in the energy sector for us to become a Net Zero economy by 2050 is no exception.
The sector has a history of bringing forward big changes, whether it be the world’s first civil nuclear programme or switching from town gas to natural gas. The need to digitise the energy system has resulted in smart meters being rolled out across the country with systems being installed to make use of this newfound capability such as turning up/down an industrial user to provide flexibility to the grid. But there’s still a mountain to climb if we are going to meet our 2050 commitment.
One of the biggest challenges that needs to be addressed is how we build and finance the new critical infrastructure required to decarbonise the energy system as well as ensuring the current framework can support the growth in existing technologies. Large infrastructure projects are, by their nature, hard to finance due to their complexity, size and the amount of time they take to build. In the energy sector there’s an added complication as many of these projects are the First of a Kind (FOAK) making them riskier to invest in.
Hydrogen is widely viewed as necessary if we are going to meet our carbon commitments as it can replace a significant amount of carbon intensive areas that use natural gas today, such as heating and industrial processes. Hydrogen production falls into two categories:
- Green hydrogen which is produced through electrolysis; and
- Blue hydrogen which is produced through the process of steam methane reforming of natural gas with Carbon Capture and Storage (CCS)
There have been several demonstration projects built around the world. Although the technologies work, there is a big step up to full commercial deployment. There’s no doubt the Government will need to play a significant role in providing direct funding (capital expenditure support) as well as providing a support framework for these projects. But that’s only one part of this puzzle. CCS requires a carbon transport and storage facility to remove the carbon. Even if green or blue (or probably both) get Government support to go ahead, there’s still the problem of upgrading the UK gas network to accept hydrogen, as well as modifying every gas appliance to burn hydrogen – no small task as the companies currently installing smart meters will tell you.
Negative emissions have really come to the forefront of decarbonisation policy this year. Bioenergy with Capture and Storage (BECCS) is the front runner in terms of technologies that promise to remove carbon from the atmosphere. BECCS does this by burning biomass and capturing the carbon emissions (similarly to blue hydrogen production). This technology is in the demonstration stage in the UK (with other projects also in operation around the world) but has significant potential to decarbonise the electricity sector as well as helping to offset the emissions created by other sectors. Many of the issues that hydrogen will need to overcome are also true for BECCS projects such as the transport and storage of carbon. Therefore, this will be another FOAK UK plant needing support from government.
The last technologies that fall into this category are new nuclear projects. Although the science behind fission reactions is mature each new generation of reactor is effectively a FOAK. The level of complexity surrounding the building of a new nuclear reactor is huge and without special regulatory treatment these would never be built. While the previous nuclear power stations were built by the Government, the new structure means that private companies will build the power station with revenue being guaranteed by the Government.
It’s fair to say that the business case behind all of the projects listed above would be near impossible to finance without some sort of guarantee from the government, whether this be the production of electricity or hydrogen. A Regulated Asset Base (RAB) can be used to provide certainty that the owner will recover the cost of the asset over its lifetime. This structure is already used for electricity and gas network infrastructure, while a Contracts for Difference (CfD) may be more appropriate to manage the production of the electricity/hydrogen. There are a number of ways mechanisms can be designed but, ensuring that investors have enough certainty to invest is crucial if the government is to progress these large infrastructure projects. These can work effectively, for instance for renewable developers who compete for CfDs and power providers that bid for Capacity Market (CM) contracts – both of which have been very successful in reducing prices and attracting finance.
There’s lots of capital that’s ready and willing to invest in the UK but the market mechanisms and incentives must be right. If the UK wants to be a world leader in Net Zero, then it also needs to be a leader in attracting the finance for these large infrastructure projects. The missing money that is currently holding back the deployment of these projects needs to be filled with a government strategy and crucially market mechanisms that give investors the confidence to invest.
For more information on LCP’s energy market services please contact Kyle Martin by clicking here.