Economic Affairs Committee
Corrected oral evidence: UK energy supply and investment
3.05 pm
Watch the meeting
Members present: Lord Bridges of Headley (The Chair); Viscount Chandos; Lord Fox; Lord Griffiths of Fforestfach; Lord King of Lothbury; Baroness Kramer; Lord Monks; Baroness Noakes; Lord Rooker; Lord Skidelsky; Lord Stern of Brentford.
Evidence Session No. 5 Heard in Public Questions 55 - 73
Witness
I: Professor Sir Dieter Helm CBE, Professor of Economic Policy, University of Oxford.
USE OF THE TRANSCRIPT
21
Professor Sir Dieter Helm CBE.
Q55 The Chair: Good afternoon. Welcome to this hearing of the Economic Affairs Committee. Thank you very much for joining us. Would you like to introduce yourself?
Professor Sir Dieter Helm: I am professor of economic policy at the University of Oxford and author of the Cost of Energy Review.
The Chair: I think a number of us are very familiar with your work, so it is great to have you with us this afternoon to discuss a very pertinent topic. All of us have a lot of questions to ask you, so I would be grateful if you could possibly try to keep your answers as precise and short as possible. I am sorry to sound rude but we have quite a lot to get through.
Let me start with a very basic question. In a piece in the Financial Times today you are quoted as saying that this is the first “net zero price crisis”. In light of that, the big picture question is: should the UK change its energy policy and, if so, how?
Professor Sir Dieter Helm: And you would like a short answer. The short answer is that I set out in the Cost of Energy Review how to pursue security of supply and decarbonisation simultaneously. It is fair to say that the attention that has been paid to security of supply has been very limited. It has been neglected, and the attention that has paid to the system to deal with the important issues of managing the intermittency of particularly the wind renewables has also, in my view, been neglected. In the Cost of Energy Review, I set out how they can be dealt with. I do not think it is rocket science; energy policy does not need to be particularly complicated but, my goodness, they have made it fantastically complicated.
The Chair: Yesterday the Times quoted a spokesman for the Government saying, “The Prime Minister is interested in giving the gas industry a climate pass in the transition to nuclear and renewables”. Would you think it right if he were to do that? I am not entirely sure what they mean by a “climate pass”, by the way, but I am interested in what your view is on that.
Professor Sir Dieter Helm: I hoped you were going to inform me. We have an economy that is 80% fossil fuels, like the world economy or thereabouts; Germany is about 78% fossil fuels. The idea that you can go from an economy that is saturated with fossil fuels to one where we have vastly diminished that role instantly is just naive or utopian. We have to get from here to there and that means we need a pathway for the gradual exit of fossil fuels. We can argue about the timetable.
As we have discovered in the last three or four months, because it is pre-Ukraine, neglecting one bit of that, the gas component, can end up creating so much disruption and cost that it leads people to question whether they should be pursuing net zero at all. That, to me, is a price crisis for the net-zero trajectory and is very dangerous.
The Chair: Before the invasion of Ukraine, was there not an underlying problem with rising energy demand, certainly from the developing world for oil and gas, and depleted investment in oil and gas? This crisis has accelerated, or at least brought to the fore, the problem that that was creating.
Professor Sir Dieter Helm: That is partially correct, but you have to ask why the investment cycle has not kept pace. The recovery of demand—is it a surprise that after the coronavirus lockdowns are over we go roughly back to the status quo ex ante? We do not yet have over 100 million barrels a day, but we are getting pretty close. Nobody should have found that surprising. If you ask why the investment has not kept pace, part of the idea that I regard as utterly naive is that you simply solve this problem by disinvesting from any fossil fuels. That has clearly put enormous pressure on what the independently owned companies do.
Part of it is also the incredibly naive belief that caught on, and has been there for quite a while, that the price of gas was always going to go down and, therefore, we could have everything on a spot market, do away with long-term contracts and relationships, and simply go on the spot market. Clearly what happened in the supply market reflects that. They all thought the price would go down. A little inspection of the requirements for gas for the system now, whether you think they are good or bad, and what has happened to the investment cycle and the pressure for them to disinvest from gas—add up that lot and not to have noticed this is to have been asleep at the wheel.
The Chair: I will bring in Lord Stern as I think his question flows directly from this.
Q56 Lord Stern of Brentford: Thanks very much for coming, Dieter. It is good to see you here. I want to pursue this line of argument but a bit more specifically around Russian gas. What effect can Europe have and how effective can Europe be in the move away from Russian gas dependency on the issues that you raised, quite rightly, and the subject of this review—security and affordability? Within that, are there any specific risks from rising demand for LNG and other sources that could create bottlenecks in responding quickly to the challenge that is likely to come, one way or another, in moving away from Russian gas?
Professor Sir Dieter Helm: Okay, and you wanted a quick answer to that as well. I will try.
Lord Stern of Brentford: No, but I do recognise that you have to do lots of things. It is your judgment, your assessment, of the role of those different things.
Professor Sir Dieter Helm: The first thing to say about the Russian invasion of Ukraine, apart from how evil and terrible it is, is that it requires both crisis management and thinking about longer-term implications for energy policy. Five-point plans to build all sorts of stuff will take years and you have to look through the crisis to the world after the crisis. It may not be after the crisis for the poor people of Ukraine, but in the immediate issue of what happens in energy markets. There is no assumption in my mind that energy prices will go up. I do not know that, but politicians seem to. They seemed to know that they would come down this autumn because otherwise they would not have turned the £200 into a loan on the assumption that customers could pay it back. We do not know what those prices will be.
The long-term lesson, which relates to short-term crisis management, is getting Europe to a position of, first, depending on spot pricing and wholesale markets almost exclusively and, secondly, allowing the dependency on Russia to build up, specifically in respect of Germany. The German-Russian relationship in energy terms is at least a century old. There are many historical moments in that relationship that should have struck fear into people a long time ago.
The crucial mistakes in this frame were to go for Nord Stream 1 around the outside of Poland and the Baltic states. My understanding is that that was the specific request to Putin, when it would have been a quicker and more direct route to take it straight through fellow EU member states and NATO members. Then they held up the prospect of Nord Stream 2 as essentially a signal to the Russians that the Germans would not be too belligerent in respect of Ukraine for fear of loss of their gas supplies. It is utterly stunning and remarkable how big the change in Germany has been and it is extremely exciting. I am half German, east German, and I did not think I would see this moment, but I did not think I would see the fall of the Berlin Wall either.
On what to do from that immediately, thank goodness we are going into spring. There are immediate things people can do, like they did with the oil price crisis in 1979, such as to cut speed limits. People can do all sorts of things to instantly cut demand because there is nothing much you can do about supply in the short run. On supply, we will be forced—and I think this is a good thing—into trying to strike some long-term LNG arrangements. The Prime Minister apparently, I understand, formed some agreement with the Kuwaitis about providing LNG. The question is price. You can always get a tanker to turn around, having gone through the Panama Canal, as we did, by offering a price higher than anybody else. You will get the tanker, but that is not security of supply as I understand it. We need to put those bits in frame.
In the EU—something I was deeply involved in when I was a special adviser at the Commission—the Donald Tusk energy security proposal for an energy union was essentially one for all and all for one, and a single bargaining point with the Russians. It was an extremely good idea at the time. My understanding is that the British in particular were hostile to that because of the belief that spot markets and spot pricing were the way to drive these markets forward. There are lots of lessons there. Further out, there are lessons about making sure that one does not get oneself in that position again.
Lord Stern of Brentford: If I understand it, it is very important for each action, and there will have to be many, to have with it some understanding of the time to its effectiveness: how long will it take to do X? We should also, if I understand you well, think through the long-term consequences. If it takes us 10 years, it cannot be justified as a short-term crisis response. It has to be justified in an overall strategy that combines net zero, security, affordability and so on.
Professor Sir Dieter Helm: Absolutely, and the context is one in which there is an explicit assumption that you do not know what future prices will be. The danger this time around, as happened at the beginning of the 1980s, was to assume that oil prices would go ever upwards. This time around the assumption is for oil and gas. On timing, whenever you have a crisis, you know how serious it is by the intensity of the lobbying that takes place. Every vested interest sees this as a wonderful opportunity to say, “I told you so”. For example, people think that the response to the current crisis is to build more nuclear power stations. There may be a very good case for building more nuclear power stations, but they are not going to make much difference to the position we are in for a decade. It might have been helpful in the past to realise how fast the existing nuclear power stations were coming off and make some provision for what fitted instead, but we had no option but to close nearly all the nuclear power stations bar one. Ironically, now the Greens have taken the position they have in Germany, we may get out of nuclear faster than the Germans will.
Lord Stern of Brentford: Would you say the same thing applies to fracking in the UK: it could never produce fast enough to make any real difference?
Professor Sir Dieter Helm: On fracking, I think that there is a coincidence of things. If anyone thinks that we will solve our immediate gas problems by getting out and fracking immediately, they are on another planet. It will not make much difference. The Secretary of State made that point and is absolutely correct, but there is a broader point. There are lots of people in favour of fracking who have been to the United States or seen some film clip of the United States and think that is where we are. We have an immensely complicated geology and we have dense populations.
Lord Rooker: And no prairies.
Professor Sir Dieter Helm: We do not have the Permian Basin, the Bakken fields and so on. I have never thought it makes economic sense, full stop, but it does not make any extra positive to be a short-term palliative.
Offshore oil and gas is a different issue, because the fracking technologies have great roles to play in getting more resources out of existing wells, if that is what you want to do. In oil, mostly wells are abandoned before 50% of the oil is used, and a well is not just a nice sealed vessel. It is porous and there are lots of abilities for horizontal and other drilling to be applied, but onshore I very much doubt it.
Q57 Lord Fox: I agree with you on the role of fracking in increasing recovery in existing fields. What is the capacity to do that quite quickly, and what would be the speed to increase outflow from the British side of the North Sea?
Professor Sir Dieter Helm: I guess that it is a less clear-cut answer than people would expect to have automatically. You do not really explore what you can do with existing wells unless you think you will have to or you think the price is high enough. My guess is quite a range, but we are producing 40% of our gas and I have estimates that suggest we could produce 50% of our gas for a while longer. It is like the estimates for future reserves of oil; they are always only a few decades ahead and then we will run out. That is because it is not economically worth finding out.
Lord Fox: I was going to say that there is also a price factor here in that the higher the value of the gas the more you can get out.
Professor Sir Dieter Helm: Yes, but it is also true that, particularly as oil prices came down, people found that they could get existing resources out that they thought were uneconomic when they tested the cost. That is true of the tar sands example in Canada: people assumed that you needed $100 oil to produce the stuff and it turned out you could make a profit at $35. It is about quick changes of cost.
Q58 Lord Stern of Brentford: I have one last question in my set, Dieter. What do you see as the role of renewables in energy independence and security, say, 10 to 15 years from now?
Professor Sir Dieter Helm: I do not have in my head that it should be X or Y gigawatts. Clearly renewables will be an incredibly important part of the frame. I am not convinced that the costs will fall as much as some people think they will, but they might. There is a lot of carbon-intensive stuff in a wind turbine and the costs have risen very sharply in the short term. I think that the cost to the system of intermittency goes up as the proportion increases, until we get some other technologies that might crack those problems, and in the long run I suspect we probably will. It is an important part, but I am not with those who think that we will solve all this with renewables. It is a question of balance.
One of the reasons why security of supply is an important component is that you want a bit of cushioning. No market will produce sufficient security of supply margins, because it depresses the marginal costs and the returns of the existing assets. It is a public good to the system and that is why policy has to think about the level of the margin and incentivise it, and about storage, and it has to think about how to facilitate that happening.
Lord Stern of Brentford: The margin for the geographical unit, for example, if we had a better European grid all round, would be another view of what margin means.
Professor Sir Dieter Helm: The great advantage of interconnection, and part of the vision of what the internal energy market was all about, is that the portfolio effect of connecting up more bundles of power in different parts is very powerful. There were some estimates done way back at the Commission about how much less capacity you would need for any level of security of supply.
It has to be said that the vision of an integrated grid is another missed opportunity when we were members of the EU, because we pushed the early British model of a liberalised electricity system and regarded it as en route to peeling back the onion so they could all be competitive—meters, networks—so there is no monopoly left at the core. Of course, that rules out any serious system thinking about the integrated network you need. We could have been miles ahead. Even the links between France and Spain are primitive still and I hope the Europeans learn that lesson. I hope that the UK realises that, having put so much interconnection in place and now being so reliant on the marginal supplies of electricity from Europe, it matters a lot to us how much that grid is interconnected in Europe.
Lord Stern of Brentford: I am speaking in Paris tomorrow morning with Bruno Le Maire and I will make exactly that point.
Professor Sir Dieter Helm: Excellent.
Q59 Lord King of Lothbury: Dieter, as ever your arguments are very compelling, so at the end of this session perhaps you could spend one minute telling us why you think policy has been so naive. Why has it gone off track? Is it lobbying pressure? What other reasons are there for that?
My main question is: assuming that gas will be very important in the short and medium term as part of this gradual switch away from fossil fuels, could you sketch for us what your strategy would be for gas for the UK in the short and medium term? In particular, what do you think needs to be done to ensure sufficient investment to make that gas available?
Professor Sir Dieter Helm: It needs a tiny bit of framework context. In my Cost of Energy Review, I have equivalent firm power as being the principle of bidding capacity into an electricity system. Firm power will definitely turn up at the time provided; wind and other renewables are intermittent power, and they would be derated in that system by the costs of bringing in whatever alternative you need to make sure that they are firm. The great thing about this is that it gives an enormous incentive to the new decentralised and intermittent technologies to go into the market to do deals and arrangements to increase their firmness. It is flippant to say a wind turbine with a battery at the bottom, but you can think about that as a simplistic version of how you make something intermittent firm. You need that firm power frame and that will reveal the costs of the intermittency. That is why the renewables industry is so opposed to equivalent firm power; at the moment they quote their costs without any system component added. That is a perfectly legitimate thing to do when you are lobbying, but it is not a true reflection of the cost that is there.
Gas comes into that frame. Gas markets kind of work, as long as we think about gas markets where there are incentives for people to sign long-term contracts and do spot trading as well. To give you an example, if the price cap that we have on final consumers was a more sensible one year rather than six months—I am a customer; I would like my price fixed for a year, please, and certainly do not want it for three months, which is what Ofgem is proposing—the supplier will have to contract to make sure they cover that position and stay in business. Part of that contracting will be for gas too. Then you start to put in place a structure in which, yes, you have a spot price doing the things that spot markets should do, but not driving the market.
In the very old days of British Gas, it was all long-term take-or-pay contracts. That is how British Gas built the network, which was one of the most effective infrastructure projects Britain has ever seen in cost, delivery and specification. It built it against long-term contracts to build out customer supply. You have to create the incentive on the player to have some long-term contract frame. All those suppliers, the 28 or 29 that went bust, did not even have cover for six months and they were able to hide behind the bankruptcy constraint with the failure of regulations.
You put that in place but then you need a few more things. Given that we will have to take quite a lot of LNG from international markets, there has to be a political framework around those arrangements. It is relatively straightforward in the United States, but is a bit more complicated with Qatar. That is the policy element and it is naive to think these can be purely commercial arrangements.
That needs to be put in place and then storage. In the old days we used the take-off from the North Sea to increase or decrease—this is what British Gas did—and be our storage. It was fantastically economic but we ended up with Rough and closed it. It is true that Rough is not that big but, going forward, we have to think about lots of storage options, and they are not just gas storage options, by the way. There are options in other technologies that can step in when you would have needed gas instead. But storage requires policy, long-term contracts in the geopolitical sense require a political framework and the final customer does not want—I assert this and I could be proved wrong—spot pricing all the time. They would probably prefer what they used to have, dare I say, under the bulk supply tariff, to know what is ahead. That would change the incentives from a purely spot market driven forward.
Sorry; there is one further thing. This is in a context in which most of the generation that is non-fossil fuel is capacity not energy. A wind farm has zero marginal costs. It is like building electricity cables or building pipes; it is infrastructure. A nuclear power station is basically infrastructure and, in that world of infrastructure, we are perfectly happy to spread those costs in five-year reviews for the networks, but we are trying to drive the supply market in the current proposals back to a spot-spot-spot market, as if that will make it any good.
As an aside—it is not my world—I would be slightly alarmed, if I were in the political realm, and someone was announcing price increases every three months for the next few months. I think that would give you pause for thought, but for customers it is just a nightmare. How can they adapt in that timeframe?
Lord King of Lothbury: If storage is an important component of this in the medium term, how long does it take before the storage could be put in place if we decided to increase it now?
Professor Sir Dieter Helm: That depends on two other things. First, how fast are you prepared to do CCS? CCS is a storage technology, just a carbon storage technology, but these units can be used for storing gas as well. Hydrogen as a second element is very important too. The Germans are building two new LNG plants, or they have announced that, but they are yet to be hydrogen ready. Remember that hydrogen will probably be a very important part of the storage story.
We are worried about immediate storage to deal with intermittency of wind but, in some sense, that is pretty straightforward compared with the big issue, which is what happens for two months in winter when you have a high-pressure cold system over Europe and the skies are dark. The sorts of technologies you then turn to are big and lumpy and that is where hydrogen comes in. Hydrogen, particularly this green ammonia, is basically a storage technology. None of that will work any time soon, although I do not know how long it would take to refurbish the Rough field, but they are not too far out either. That comes back to my point about—
The Chair: Can you just be a bit clearer, sorry? When you say “not too far out”, what does that mean?
Professor Sir Dieter Helm: I do not know the answer.
The Chair: Is it a decade or is it—
Professor Sir Dieter Helm: It might be within a decade. It depends whether we get a policy together. To give you an example, if we are going to use blue hydrogen, we will use CCS for it. For 14 years the Treasury has promised £1 billion as a subsidy to get it going. They fought it off, including even the competition to win that sum, for 14 years. We have no regulatory regime for offshore CCS; we have no agreement about integrating the pipelines; we have no agreement about how the pricing will be done; we have no agreement about the legacy liabilities and the bonds, et cetera. If you really had to do this, it might be more than doing it tomorrow morning, but you would have a plan to get from here to there and you would get on with it.
In the context of the UK, we have this target to decarbonise the power sector within 13 years, thinking about the question you asked me about whether it is a decade. If you are going to use a lot of gas between now and then, even if you might not need the gas beyond that point, and you are going to decarbonise the power sector, your CCS regime has to be up and running and in pretty good shape. It absolutely is not.
My guess is that it is not the physical issue of how long it will take to build this thing. It is the framework within which it is set. I have to say that the history of UK energy policy is not one that is full of optimistic cases of doing this stuff fast and effectively, except the British Gas transmission system, which was done fast and cost effectively, because there was a national imperative to do the conversion to natural gas.
Q60 The Chair: On the investment in gas and LNG, last week we had a representative from the International Energy Agency here and we asked about the scenarios that it has for net zero. One of the scenarios is, “No new natural gas fields are needed beyond those already under development. Also not needed are many of the liquified natural gas liquefication facilities currently under construction or at the planning stage.” Those scenarios are now being used by financial institutions globally as they map decarbonisation paths for their businesses. How much is this just a complete lack of joined-up thinking? If it is a lack of joined-up thinking, how much of an impact will it have if those financial institutions follow the IEA scenario?
Professor Sir Dieter Helm: I have virtually no faith whatsoever in the IEA scenarios. A while back we did an analysis of all the oil price projections of the IEA from its early incarnation onwards and I think we found that the spot price at any time was better than any of its forecasts. The IEA has lots of very good people in it, but remember what it was set up for, what brings its budget, and note how it swings from the golden age of gas to the golden age of this to the next golden age of something else. I think that any financial institution should look very carefully, and there is a more fundamental reason too, as those scenarios are only as good as the assumptions that go into them. We should be very careful in energy policy and net-zero policy not to run away with the prize we would like to believe, as opposed to recognising that our world is one in which there will be lots of surprises. I bet this gas price rise is not in an IEA scenario, but it needs to be taken into account. I am not confident in that kind of framework.
Q61 Lord Rooker: This is a new area for me and I basically want to get on to green finance. As I understand it, the EU will be including nuclear and gas in their taxonomy, but the UK is not; should we not be aligning? Is it possible to burn gas in a way that we force the capture of carbon, as an incentive for investment? Would we be better aligning nuclear and gas rather than having a separate system from the EU?
My final point is on Norway. I have never understood this. Norway is in the single market and I just assumed that, if something goes wrong in the EU, its requirement as members of the single market to deliver their gas will overshadow anything it has committed to supply to us. Is that the case or not?
Professor Sir Dieter Helm: Let me try to unpack these component parts. On the taxonomy, I understand why people like these things, but I would love to live in a world where something is either green or not green. It is simplistic to imagine that we can just decide that these are good and those are bad technologies. One has to look at how the technologies combine to take us on the pathway we want to go down. You end up with this immensely sterile argument about, first of all, whether gas is part of the frame.
When I was at the Commission as a special adviser to the Commissioner and I did the 2030 road map, I had never seen a wall of lobbying like those that were put forward against anything to do with gas or anything to do with nuclear power. I do not know how many tens of thousands of lobbyists there were in Brussels, but pressures were exerted because these people were absolutely certain that they knew the path to righteousness. It is not like that in energy. You cannot get to net zero without gas for some time. There is no way you could do that. What is the point of vilifying it and saying, “We will not invest in independent oil and gas companies so that the other 90% or 80% that are all state-owned can just supply us instead”? That seems naive.
It is absolutely right that you might want to engage and discuss whether the methane leakages are being managed or the component parts, but calling one green and one not green is nuts. It seems similar if you look at the hydrogen story. Green hydrogen is—particularly the way the Germans are pursuing it—a very interesting route to go down, but everybody accepts that we will do blue hydrogen first. Well, that is gas, right? You have to consider how that is put together.
I am not in favour of these taxonomies at all. The battle that has gone on to get nuclear in or out—I am sure a very large number of lobby firms, PR companies and all sorts of people have been paid lots of money to do this stuff—does not get you one iota nearer to doing these things in a coherent way.
Should we align with what the EU is doing? My guess is that, in nearly all climate change and energy things, the idea that we want to experiment in one country differently from our neighbour, given that we are interconnected to it with all those cables and other component parts, and we are trading a lot with them, and deviate in energy, carbon pricing, network components and all those things, seems not to be a good idea. You may well want to deviate from the common agriculture policy and the common fisheries policy, but the internal energy market has enormous benefits to us and we have benefits to offer it. We are only one bit-part player in the global carbon story and that is why we should be linked.
On the Norwegian side, I do not know the precise legal details about where Norway fits in this, but it was very revealing that BEIS thought we had no problem about security of supply because we get a lot of our gas from Norway. Norwegian prices are driven off European prices for a very good reason. The naivety that was reflected in that discussion is this notion that there is no problem about physical supplies; it is just a problem about price: “I can make supply equal demand; you give me a price I will do it for you. I can close the fertiliser factories, steel mills and all the other components, and down will go demand and supply will equal demand”. The notion that BEIS is pursuing that these two things are distinct is strictly nonsense, and a little 101 economics might help to understand that security of supply, as I put it in the Cost of Energy Review, is about affordable security of supply.
We can always outbid a tanker on the high seas. One went through the Panama Canal and came back again, as we paid a higher price than anyone else. You have to remember in the UK’s case that we were hit worse by the gas price crisis in the run-up to Christmas than any other major European country, despite the fact that the Government claim we take only 4% of our gas from Russia.
Q62 Lord Griffiths of Fforestfach: You argue convincingly that gas is key in the short to medium term. What about oil?
Professor Sir Dieter Helm: Gas, oil—not coal in our case, thank goodness—renewables, wind, solar, the existing nuclear, the building of nuclear and all these things are part of the mix. There is no “If we only have that it is the right answer”. There is one that we ought not to have in the answer, which is coal. The great success of the British policy is to have largely got out of coal.
Oil is incredibly important. We use a great deal of it; we produce some in the North Sea and we import a great deal too. We are subjected to global energy markets and the price effect of oil will be significant. The advantage we have in oil is that we have been there at least once before in the 1970s. Jimmy Carter thought it would be a great idea to put a couple of solar panels on the roof of the White House and take a couple of other inconsequential crisis management steps, but we did have strategic stocks and so on. I think the lesson we should learn is that it was rather silly to release strategic stocks to try to keep the motoring costs down last summer in the United States, when those stocks should have been used right now when they are not as they should be. Storage is part of that frame too.
Q63 Lord Rooker: This is a minor point—it is not trivial—on coal. We started railways. There are 123 heritage railways in this country and, at some point, their plan was to buy the coal they need to keep going from Russia. That clearly will not happen. It is nothing to do with energy, but the fact is there will be some lobbying on that.
Professor Sir Dieter Helm: The international coal market is very well supplied everywhere. Sadly, we are burning more and more of the stuff globally, primarily in China and India. I am talking about coal having been 80% or 75% of our energy mix in 1985 when nuclear was the other 20% and a world where it is close to nought in the energy mix. Climate change is not going to be affected much by a small amount of coal around the edge, neither will world markets. Frankly, Putin is not going to mind either way, as he does his evil deeds in Ukraine, about the locomotives and the vintage heritage ones in the UK, with due respect. It is a different story for me.
Q64 Lord Skidelsky: Do you think the UK’s introduction of mandatory financial disclosures will be effective? After all, the object of the whole exercise is about getting industry to adopt sustainable policies towards net zero. Is it enough for the Government to make a material contribution or does there have to be serious financial monitoring? If so, can it be made effective?
Professor Sir Dieter Helm: In general, and I am using those words deliberately, shining the torch on what people are doing is a good idea. Why would you not want to know? In practice, it is very selective and is not free. There are armies of people producing this stuff and the crucial thing is to make sure it is effective by asking the right questions and getting the right things disclosed. That links to the stampede of companies declaring they will be net zero by a particular date.
Whether a company is net zero or not is not an easy thing to establish, even if it gets there. I would rather it be net zero excluding imports rather than territorial domestic production. But the difference between scope 1, scope 2 and scope 3, as they are known, is very great. You can do lots of things in scope 1 that do not make much difference. Scope 3 is very serious and is about the whole supply chain. You have to see that in the context that 80% of the world depends on fossil fuels for its energy. For example, a wind turbine developer in the North Sea should be declaring the steel and the carbon content of that, the petrochemicals that are going into it, the copper wires going into the connecting cables and the diesel that is being used in the ships to support them. It is not as black and white as you start to open this up. I would rather the questions are clear. That is a job for the state. It is a regulatory job and not a job for private firms to take forward.
I add a caveat that in lots of these net-zero targets that companies have set, they blindly assume they are just going to buy offsets. I am told you can buy an LNG cargo from the Gulf that is net zero because a number of trees have been planted in America. Hopefully they have not burned down, caught diseases or had any deer, squirrels or other things to help them along the way. I am not against offsetting at all. Offsetting is a very important part; to me, sequestration is half the story of climate change. But what is actually going on out there is closer to the wild west than a genuinely torch-shining exercise. It is for the state, with the accounting bodies and others, to start to get really clear about what is being done on the accounting side.
As I did when I was chair of the Natural Capital Committee, I think it is incredibly important that natural capital is properly accounted for in this frame and the assets in perpetuity, as opposed to the historic-cost ways in which many of these assets are dealt with. It is a complex problem. It needs regulation and what is actually going on at the moment is lots of people jumping on, dare I say, an ESG requirement to say that they have come up with something. What I would like to see is some practical reflection of that in outcomes.
Lord Skidelsky: The danger is that, as the purely financial attempt to get firms to adapt policies runs into all these problems you have talked about, the temptation would be for Governments to do more and more directly.
Professor Sir Dieter Helm: If you will the end—net zero and carbon production in territorial terms by 2050—you have to will the means. Industry is an incredibly important component in getting us from here to there. There is no way around it. On the financial pressures and ESG, first, ESG was very clear: these things are in and these things are out. Then, as people pointed out, is Saab the defence company ESG because it is defending the personal liberty and freedoms of people in Ukraine? It is a bit difficult that one. Is Shell, if it is developing gas that is helping provide the back-up for intermittent supply in electricity, ESG or not?
ESG is going the way that sustainability did in the past. It is becoming largely meaningless as investors discover, first, that performance is much worse than the sin stocks, particularly commodities and fossil fuels and, secondly, that what they should really do is engage with the boards of these companies. That is just what fund managers do. I do not think that is the route that will get there, whereas accounting for your emissions in scope 1, scope 2 and scope 3 is highly educational to the companies themselves and a bit more of the torch that one might want to shine.
Q65 Baroness Noakes: Could you say what you think the role of the Bank of England could or should be in achieving net zero? Slightly linking to the conversation we have just had, could you link that to whether the data exist to allow the Bank of England to work out for the financial system as a whole, let alone individual financial institutions, where the risks lie?
Professor Sir Dieter Helm: At the outset you asked for short answers, so the short answer to the first part of your question is almost nothing at all. It is not the role of the Bank of England to distinguish a particular component part. That is the job of the regulatory framework, the carbon price and the component parts of policy. I think the direction it went in the last five or six years has not been particularly helpful, and I also have that view about so-called green bonds.
You have to ask what question the data are supposed to be the answer. I am as clear as mud about that. I thought that the Bank of England had a pretty demanding job to address inflation. Given where we are at the moment it seems that, if the Bank of England were to move to distinguishing which investments are good and which investments are bad, it would be outside its role.
Should it assess climate risk as a systemic risk to financial institutions? Yes, of course, if it thinks that in its time horizon and with the instruments it has it can do something about them. I am probably in a small minority in thinking that the climate risks to the systemic macrostability of the UK, over the next 10 to 15 years, are significantly less than the risks of inflation, interest rates, economic recession, asset market rebalancing and so on. That is not to downplay climate change at all; it is just that everybody wants to be in on the act and doing their component part.
It is quite important—I will be careful to say this with a former governor here—to try to get the day job right and leave it to the climate policies to address the other component. The instrument that you really want to reflect this is a carbon price. Of course, the Government are willing to mimic or try to mimic the EU ETS but have ruled out extending carbon pricing to agriculture, which is by far the largest emitter relative to its size in the UK, and heating, which is up there as well.
By the way, agriculture is 0.5% of GDP and measured at 11% of emissions before properly measuring emissions from soil and peat. Soil has four times the carbon of the atmosphere, so this matters. The economic costs of doing that are quite low.
Baroness Noakes: You said that over the last five or six years the Bank had been doing the wrong things. It has not done very much, although it has said quite a lot.
Professor Sir Dieter Helm: I retract. Thank goodness it did not.
Q66 The Chair: Professor Helm, I have here what Frank Alderson from the ECB said last week and he reflects central bank thinking to quite a considerable degree. He said that “2022 will be the year that climate and environmental risks become integrated in the day-to-day activities of our joint supervisory teams … These risks will come to form an integral part of our ongoing dialogue with supervised entities, and the supervised review and evaluation process … This will ultimately influence banks’ minimal capital requirements.” That is the direction of travel as far as I can see among some central bankers’ thinking. Do you think it would be wrong to introduce capital requirements of either a penalising kind on fossil fuels or a supportive kind on renewables?
Professor Sir Dieter Helm: I am with you entirely if you say that a job of a central bank is to look at the banking system and see where institutions face risk that might damage them, but particularly systemic risks to the whole.
Right now, if I was sitting in the ECB, which of course I never will, and I was thinking, “What shall I do tomorrow morning?” the possibility of inflation being at 10%-plus would exercise me remarkably more than worrying about whether the banks within my regulatory remit are about to go down because there is going to be another flood in Germany. Further into the future, of course that is part of the frame, but this is about relative importance. The worry is that the central banks are struggling to do their day job and moving between a line of what is important for Governments’ regulation, policy and framework, and their job within the remit of a central bank. When central banks get political about recovery funds that must build back green better or whatever the latest slogan is, to me that is a political judgment and not a judgment for a bank.
Q67 Lord King of Lothbury: I would like to put on record that I agree with every single word that Professor Helm said.
Professor Sir Dieter Helm: That must be a first.
Lord King of Lothbury: It is immensely sensible. I want to go back to the question I dropped in earlier, because this is another example of where common sense has gone out the window. Do you think it is because people in particular positions of authority have decided they want to be politically popular, even though they are not elected? It goes back to this question of why so many mistakes have been made in policy in this area. Is it an intellectual failure? Is it a question of lobby groups? Why have things gone so wrong? You have been making a compelling case.
Professor Sir Dieter Helm: I have thought a lot about that. There is no perfect energy policy and, as is the essence of government policy, there will always be mistakes. I should say as an aside that the Treasury’s net-zero review and the Climate Change Committee assume that government policy will be perfect in coming at the 1% GDP estimate. Government failure is widespread, we know that, but that does not mean government should not act.
There are different kinds of intervention that elicit more or less lobbying. Once you go down the detailed complex regulatory structures and regulatory interventions, capture multiplies. One of the reasons I am so keen on carbon pricing is that it is quite hard to capture the carbon price. The farmers cannot do anything about lobbying for red diesel, which is their half-price subsidy for fossil fuels, in a world where there is a common price.
I have an illustration that I made some time ago, but I am redoing, which is what I call the optician’s slide test. Those of you with glasses know when you read the letters up there and try, in my case, to be stupidly clever and remember them, so you can get them correct. If you write down the Government’s main energy and climate policies on a piece of paper and hold it at the distance of the optician’s slide, can you read any of it? I go slightly further: can any official list all the main energy interventions at the moment? I doubt it. It is so complicated, but that enables lobbyists to go for it.
That is why, right now in the crisis moment, you have an absolute avalanche of lobbyists all coming forward with their pet solutions. How does government sort out between them? How does it know when it is told that renewables are the cheapest form of electricity production, other than that they are not campaigning to get rid of the subsidies? You would do if they were the cheapest form, because you would not need to intervene to do this stuff. The fact is you do not know.
If you have a carbon price out there, it is tough. If you have an equivalent firm power auction, it is clear. I like simple interventions and I think you should resist ditching market solutions, reluctantly. Of course, there still has to be regulation. There still has to be R&D. But we have created an evolution of ever more complicated policy. The end result is where we are now.
By 2035, the electricity system is supposed to be completely carbonised—less than 13 years from now. What is missing? Any plan to get from here to there is. We have a huge lobby about CCS, we have arguments about offshore and arguments about regulation, but not a simple plan to say, “What are the main stakes in the ground that we need? What are the necessary conditions for getting there?” confronting people with the true costs of what is involved, which is the carbon price. That is why politicians resist it.
The Chair: I will bring in Lord Monks because we will come back to carbon price at the end.
Q68 Lord Monks: This follows the previous discussion we were having. We have already discussed storage problems in Britain and what has happened with Centrica, Rough and so on. Do you think there is a role for government or financial regulators to encourage investment in energy storage, particularly to address the intermittency problem? I will bracket that by specifically asking about contracts for difference: have they been successful in encouraging offshore wind development and are there any lessons we can learn and apply to other technologies?
Professor Sir Dieter Helm: On storage, there is, because it is a public good. The private market will not optimally supply a storage system and that requires the state not to do a great deal but just say, “How much risk do you want to take?” and then auction the opportunities in the market to bring that forward. It is not difficult but just leaving it to the market is a nonsense, because it is a public not a private good—full stop.
CfDs are fixing your guess at the spot price into the future, so are tied to the wholesale market. The wholesale markets are what we have had for most of the 20th century, because fossil fuels have significant marginal costs. Going forward, the renewables technologies and the nukes, in particular, have zero marginal costs, their capacity.
It is like taking a bit of national grid infrastructure and saying, “We are going to fix a CfD for that. We are going to say this is the price you will be paid ongoing, rather than having a regulatory asset base and sticking it in the framework of infrastructure assets in the normal way”. That is why my equivalent firm power is the alternative to CfDs.
Of course, if you are prepared to pay enough and have a big enough revenue stream, you can get anything you like built. For £92.50 indexed for 35 years, you can get a Hinkley built; whether it is profitable or not is another matter, but you can get it built. There is always a CfD that will build you however many gigawatts of offshore wind you want. It does not follow that that is the right way to do it. The early costs were much higher, understandably, but that is why I say in the Cost of Energy Review that they should be taken off the bills, so customers are not initially paying the higher prices for a technology the current cost of which is a lot lower. You do not pay for your latest iPhone or iPad, in equivalent technology terms, the same price as you pay for the first one. We do not say to customers, “There was a lot of R&D in Apple years ago; you now to have pay a very high price when you go and buy a particular bit of IT kit”. You take the market price. If the market price of renewables is much lower, consumers should see that. But the legacy cost was an R&D investment and I think that should come off the bills.
My equivalent firm power treats these technologies as utility-infrastructure type assets with zero marginal costs, and the future of a decarbonised world is moving away from wholesale markets to capacity markets. That comes full scale back to the gas problem of tying all our electricity price in Britain to the spot price of gas in the European market.
That seems to me nonsense. Why are we paying it? The French have an increase of 4% to their bills. EDF, of course, complains noisily about this but the fact is that the cost of electricity in France has not gone up very much. Nuclear costs exactly the same today as it did six months ago, so does hydro. Why should French customers pay the marginal cost of Russian gas? We have no strategic reserve for gas, no development of that intermittent gas market as a distinct component and no equivalent firm power market. We will get to a firm power market, I am absolutely certain about that, but it will be called everything else and resisted step by step by lots of lobbyists, who will have lots to lose if we go down that route.
Q69 Lord Monks: I have a quick follow-up, which relates to the intermittency problem. You mentioned hydrogen and one or two other things, but do you have any strong views about the best technologies to invest in to tackle that gap in the future?
Professor Sir Dieter Helm: There are two answers. The first is that I do not know, do not think the Government know and do not want a policy that picks winners, because losers will pick Governments. That is what happens.
On the intermittency side, however, I think there is a very strong case for moving towards a strategic reserve of gas plant, rather than having the price of that insurance taken as a spot price of gas in the wholesale market. That would be a big step away from wholesale markets. As I say, they have been very effective for a century, because they are fossil fuel markets and that is what they are designed for. We are trying to design a decarbonised world in which most technologies will be close to zero marginal cost. Park the gas, pay the insurance cost when we need to pay it and then we would be looking at price increases for British customers that are completely different.
In France, if EDF were charging the marginal cost of gas, there would be a massive windfall profit to EDF but, since the French state owns most of it, it would be to the French state. That is important.
The Chair: We are really under time pressure; forgive me. I know that Lord Chandos wants to ask a question and so does Lord Fox. Can we make them short, please?
Q70 Lord Fox: Very quickly, what scale of strategic reserve are you suggesting? Will it be 10% of need?
Professor Sir Dieter Helm: Let us start with how secure you want to be and what risks you want. You do not want perfect protection, but you can have a frame to get that together. Then think about how many gas plants you need through your plan to get to 2035, given that you know how much strategic gas reserve you will need only if you know how much wind you are going to auction. These are indeterminate pieces. I do not know the answer on a piece of paper, but it is not rocket science, as long as you do not want to be perfectly right. I do not want to be perfectly wrong; it is good enough for me to be roughly right, but we are a million miles from that position.
Q71 Viscount Chandos: You make a compelling economic case for treating a public good differently from stuff that is addressed by the market. But how do you move from the economic theory to good government? I was thinking nostalgically about the controversy 40 years ago about the gas-gathering pipeline, where a debate about whether a government guarantee would be brought into the PSBR stopped a project that the vast majority of experts thought would have been good. That seems to be a pattern of government policy.
Professor Sir Dieter Helm: The reason it is like that in your example is because that was essentially a non-market frame. Just because something is a public good does not mean the market is not involved. You auction it, you get the bids and you do it in two stages. In the first stage, does anybody have any ideas? You would come forward with batteries and all sorts of different technologies, which enable you to have a second round where you seriously bid for what you require. We are not a million miles from that. We have a very short-term capacity auction, in which the Government have now overruled Ofgem on the requirement, which is very expensive. I am thinking about something much more substantive for the frame.
The paradox of my way of going about this is the Government putting the stakes in the ground of what they want. What is their target for 2035? How much security do they want? They can then maximise competition to allow people to bid, which kills off the lobbying. If you say, “Minister, you should choose my technologies; they are much better than these guys’”, bid and you will see what the price is. Of course if you have a carbon price in there you are beginning to get efficient outcomes.
The Chair: You mentioned the two words that allow me to bring in Baroness Kramer.
Q72 Baroness Kramer: I have the carbon pricing question, which we should probably have started with as everything hangs on it. Let me start by saying that I am a proponent of carbon pricing. The arguments that are frequently levelled are the impacts on low-income people and on critical industries that have no potential for decarbonising, the cement industry and whatever else. Could you talk more about the key elements of carbon pricing but also cover those two issues?
Professor Sir Dieter Helm: The first thing to say is that we have loads of carbon prices. They are all inconsistent and I would argue that OPEC imposes a big carbon price and it has just gone through the roof. That is why I always want the carbon price to be inverse of the oil price or something similar.
The case for a carbon price is consistency. You have the same price across the economy and then we find out the cheapest ways of getting the emissions down. My personal view is that the net-zero path is going to be costly; I probably think it will be much more costly than a lot of other people do. Given that the consumers have a limited ability and, worryingly, willingness to pay—some of the politics of this—it behoves us to do it as efficiently as possible. It is really efficient to get emissions down in agriculture quickly, because the economic consequences are very limited; they are not in the steel industry. That is why you want it in place. I never met an economist who does not think that a carbon price is not part of the framework of taking these things forward.
On the distributional impacts, you cannot have a carbon price, because it will hurt the poor, but it depends what you do with the money. A carbon price simply raises lots of money; it changes the price of carbon-intensive things relative to low-carbon stuff. Well, the money can be used in lots of different ways, but I go back to my point that the future is a capacity world rather than an energy world. In a capacity world, you cannot switch as customers; there is just a lump of costs. It is a monopoly. It is like the electricity network is a monopoly. In a world where most of the costs of electricity in particular are fixed rather than variable, it is completely open as to who pays them. Ironically, it goes back to the days of the CEGB, in which people decided that citizens should be entitled to access basic primary goods like electricity and we should subsidise people on the periphery. The reason you can do that is that you cannot switch out of the costs.
There is a linkage here in how we allocate the costs of the electricity, including the costs of the carbon price, and what we do with the money. The idea that we should give up on the most effective component of a comprehensive decarbonisation plan, because we do not have the imagination to think of what we can do with the revenues and how we can do tariff structures on fixed monopoly costs, seems to be an example of why, if we go on like this, we are certainly not going to hit the decarbonisation targets. We can do so much better, so much more efficiently. In a circumstance where lots of people are finding it incredibly difficult to pay their energy bills, I make the assertion that it behoves us to pursue the cheapest ways of getting to these particular outcomes. Otherwise my fear is that politics will react—not my territory—we will have people campaigning against net zero and we will end up with the worst of both worlds, trying to do something but not doing it. We will have all the costs and none of the benefits.
Baroness Kramer: I can see exactly how you could manage that structure so that it works for individuals, but how do you deal with it for major industries?
Professor Sir Dieter Helm: The first thing on major industries is that my carbon price would be neutral between imports and domestic production. It would not be a subsidy to foreign steel producers to take on our British firms. It is nuts to do that. You have to have it at the border and then, if steel coming into the country faces the same carbon price as steel produced in the UK, if the demand for steel remains as it is, those companies will be perfectly profitable and able to carry out their activities. Of course, if they can find ways of making green steel, they will be even better off. The problem at the moment is that we have our UK ETS, because it cannot be a European one, and we impose it domestically but not on imports. Then we have to doctor the whole scheme to bail out all the special cases of industries that are facing international competition in that context. Again, you make it fabulously complicated and lose a lot of the bite.
You have to remember where 80% of fossil fuels in world energy comes from: steel, aluminium, fertilisers, petrochemicals, cement and electricity. That component part is now largely imported and that is our carbon footprint. That is why I do not like territorial carbon production targets. We can get our emissions down just by closing down plenty more industry, but what we actually want is to make a contribution to no longer cause climate change. We do not want to disadvantage British industry against other industry, purely because we are prepared to tax them for carbon and they are not. Just do the imports.
Baroness Kramer: Can I ask one very small question? Can you separate carbon pricing across the economy or could you just do the border tax bit?
Professor Sir Dieter Helm: No, you have to do the whole thing. If you just had border tax and did not do it domestically, you would create an incredibly inefficient incentive to do it the other way around.
Q73 The Chair: I will end by asking a very simple question about the here and now. I have read in numerous places, such as the think tank in Brussels, Bruegel, that we are looking at the prospect of rationing of energy in the next winter. Do you think that is a realistic prospect?
Professor Sir Dieter Helm: It is probably not, but I cannot rule it out. We are going into summer. There are plenty of LNG terminals throughout Europe. Whether you like it or not, there is a huge amount of US fracked gas, which is very recent but is there. Storage can be refilled. I would be surprised, but it is not impossible.
The Chair: Thank you very much indeed for answering such a wide range of questions and extremely succinctly. We covered an enormous amount of ground at pace and we are very grateful to you for coming in.