Less offshore wind = more CO2, even more £££

Extra gas burn would boost UK power emissions by a quarter at a cost of £1 billion every year

A couple of weeks back, Energy Flux calculated that the UK’s failure to hit its 2030 offshore wind target could cost £2-3 billion per year. That calculation covered only the cost of burning more gas to replace an assumed 10GW wind shortfall; it did not account for the carbon cost of this unplanned gas power generation. When you add the cost of CO2, the ‘lost wind’ penalty on consumers looks even uglier – to the tune of tens of billions of pounds sterling.

No time to read? Here’s a quick summary:

• A 10GW shortfall against the 2030 offshore wind target would cost £2-3 billion per year in extra gas burn and lost CfD repayments

• This would boost UK power sector emissions by a quarter and add an extra £1 billion per year to consumer bills

• Added together, the 10GW shortfall could cost £60 billion over the 15-year tenure of a Contract for Difference

• Leaning on gas makes the UK’s fifth carbon budget even harder to meet, meaning carbon prices and gas generation costs would rise further

• Investing in CfD-backed offshore wind is a hedge against spiralling power costs that is probably worth paying a slight premium for, all things considered

OK, here’s the long version. First up, let’s remind ourselves of the (deliberately conservative) assumptions used in the original calculation. A 10GW shortfall against the 2030 target of 50GW means 35,040,000 MWh less power generation every year. If replaced entirely by combined cycle gas turbines (CCGTs), the UK would burn an extra 6.8 billion cubic metres of gas (245,280,000 MMBtu) every year from 2030. The fuel cost alone would be in the region of £2.1 billion. Depending on wholesale power prices, the lost ‘payback’ from offshore wind generators under the Contract for Difference regime could amount to £855 million per year (or more). That gives us the £2-3 billion cost range.

Now, let’s factor in the carbon. To simplify matters, we will only consider emissions at the point of combustion at the CCGT power plant, not the embedded emissions along the gas value chain (which can be considerable, especially since the UK is becoming ever more reliant on LNG). A baseload CCGT emits roughly 360g of CO2 per kWh, or 0.36tCO2/MWh. Multiplied by the 35,040,000 MWh of generation required to replace the lost 10GW of offshore wind, and that’s 12,614,400 tonnes (12.6 mtCO2) of extra CO2.

That’s a fair chunk of carbon. In 2022, UK power sector CO2 emissions were 53.7 mtCO2 (source), so we’re talking about a 24% increase on that baseline. As a proportion of total UK emissions from all sectors of the economy, 12.6 mtCO2 represents an increase of 4% on 2022 levels.

The gas plants generating this electricity will need pay the UK Carbon Price Support (CPS), a top-up carbon tax that is currently a flat £18 per tonne, and buy UK emissions allowances (UKAs) under the UK Emissions Trading Scheme (UK ETS). Interestingly, the price of UKAs has dropped significantly in recent months to around £34 per tonne of CO2, opening a huge discount against the European carbon market, the EU ETS, where allowances (EUAs) trade at between €80-85 per tonne.

The UK ETS is relatively new, having been launched in 2021 following the UK’s self-flagellatory departure from the European Union. As such, there is not yet a deep liquid market for financially traded UKA futures. So, we will have to make some broad assumptions about where the UKA price might be in 2030.

Let’s be conservative and assume that the UKA price flatlines at £40 per tonne in 2030 and the Treasury holds the CPS at £18/tonne. The cost of covering 12.6 mtCO2 at these prices implies an additional cost of £730 million every year from 2030, which utilities would pass through to consumers via higher bills. Add this to the £2-3 billion extra gas fuel and lost CfD payback cost, and the cost of not building those 10GW of offshore wind is starting to stack up.

But it gets worse. The assumption that UKAs can retain their deep discount relative to the EU carbon price for several years is not credible.

Brexit redraws carbon borders

With a lower carbon cost, UK gas-fired power generation is becoming competitive against gas plants in continental Europe. A window has opened for British CCGTs to export power along subsea cables into France, Belgium and the Netherlands at the expense of marginal generation in those markets. Depending on how gas and carbon prices evolve in the coming months, this dynamic could see the UK become a net exporter of electricity this winter.

Indirectly, Brexit is subsidising heavy emitters. The ‘hard’ version of Brexit that saw the UK leave the EU ETS (alongside all manner of other EU institutions) raised the prospect of the UK exporting carbon-intensive products into the EU but not paying the going rate for CO2. This is the sort of thing European Commission negotiators feared might happen post-Brexit, but now there are mechanisms at their disposal to close the loophole: carbon border taxes.

While some figures in the UK government might like the idea of British CCGTs undercutting EU power generators by keeping the UKA price low, this has echoes of the risible ‘Singapore on Thames’ concept of a deregulated post-Brexit UK undercutting domestic EU industries that was flatly ruled out in the UK-EU trade agreement.

Moreover, exports of ‘cheap and dirty’ British electricity would ultimately attract import levies under the EU’s Carbon Border Adjustment Mechanism (CBAM). The intention is that, by 2030, all sectors and goods covered by the EU ETS will be within the scope of the EU CBAM. There will be a strong economic incentive for the UK carbon price to track the EU ETS to avoid tariffs and reduce trade friction.

Closing the loophole

The carbon cost of British gas generation should therefore be benchmarked against the EU carbon price, not the artificially low UK ETS. That being the case, UKAs can be expected to rise to the EUA price minus the CPA top-up to create an equivalence with Europe to the satisfaction of CBAM regulators.

All of this is a long way of saying that British CCGTs would have to pay at least €90 per tonne if hedging their 2030 carbon exposure today using EU ETS financial futures. For 12.6 mtCO2, this represents a cost of €1.13 billion (£986 million). By 2030, it could be a lot more as the issuance of carbon allowances is progressively restricted in order to meet decarbonisation targets.

At the higher end of these calculations, the gas fuel cost plus the lost CfD savings and the higher 2030 carbon cost implies an additional cost of nearly £4 billion per year arising from the 10GW shortfall against the UK’s 2030 offshore wind target. Multiplied over the 15-year term of the CfD and we’re looking at £60 billion being heaped onto consumer bills.

And remember, all this assumes the UK installs 40GW of offshore wind by 2030, which is probably unrealistic. If the shortfall is 20GW against the 2030 target, which seems entirely reasonable in light of stalling installation rates, all these costs would be doubled.

Volatility on steroids

There is a confluence of factors supporting UK carbon and power prices over the medium term. Put simply, the cap on carbon allowances must be tightened to meet legally binding carbon budgets, which drives up UKA/EUA auction clearing prices. This is added to the ‘clean spark spread’ for gas-fired power, pushing gas further to the margins of the merit order.

The more that CCGTs are marginalised, the more they must charge in the hours they are able to run to recover fixed and variable costs. And since gas sets wholesale prices under the ‘pay as clear’ price formation model, a rising carbon price increases wholesale power prices both directly (by increasing the cost of carbon-intensive generation) and indirectly (by forcing marginalised price-setting generators to charge more per kilowatt-hour).

The UK is already facing an uphill battle to meet its legally binding carbon budgets this decade. Modelling by the UK government shows there is likely to be an overshoot of 73 mtCO2e in the fifth carbon budget, which covers the 2028-2032 period. The overrun is even wider in the sixth budget, at 976 mtCO2e over 2033-2037. Failing to ramp up offshore wind (and other low-carbon power sources) makes closing this gap even harder because it means an extra 12.6 mtCO2 or more of unplanned power sector emissions.

The Contract for Difference (CfD) is a long-term hedge against spiralling price volatility. Under the CfD, low carbon generators with zero marginal costs get paid (or pay back) the difference between their ‘strike price’ set at auction and the prevailing market price, depending on which is higher.

With carbon prices expected to bite hard in the 2030s to meet emissions reduction targets, it is reasonable to assume generators with strike prices below £90/MWh will be making net repayments over the course of their CfDs.

For these reasons, investing in fixed-price clean power today makes sense on numerous economic, environmental and energy security metrics. It always costs more to lock down prices over the long term, but the balance of risks suggests it is a bet worth taking.

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