Energy Report 2022
Investment
How can the level of investment needed, be achieved?
Nearly 30% of survey respondents have noticed increased activity and/or confidence in the energy sector since the strategy’s launch. However, only one in ten think that there is sufficient government support to achieve the objectives set.
Data from the Office for National Statistics (ONS) demonstrates the enormous impact of the COVID-19 pandemic on public finances. UK public sector net borrowing for the financial year ending 2021 is estimated to have reached 14.4%, the highest ratio since the end of World War Two when it was 15.2%.
The energy price guarantee support from the government is expected to lead to further significant borrowing, along with the tax cuts announced as part of the mini budget on 23 September.
High inflation is also affecting the cost of servicing central government debt, with ONS data showing significant increases since mid-2021.
Analysis from the ONS shows that the rising costs are largely a result of higher inflation, with the interest payable on index-linked gilts rising in line with the Retail Prices Index (RPI).
The data for July 2022 shows that the interest payable on central government debt was £5.8 billion, with £4 billion of this reflecting the impact of the RPI.
Despite inflationary challenges, various factors will require government spending.
The Office for Budget Responsibility (OBR) outlined the following areas in its ‘June 2022 Fiscal risks and sustainability report’:
Rising geopolitical tensions
- Increased defence spending \ The Russian invasion of Ukraine has led to a reassessment of the sustainability of current historically low levels of defence spending across Western countries
- Cyber attacks \ The increased likelihood of a large-scale, disruptive cyber incident with significant economic and fiscal repercussions
- Global economic fragmentation \ Rising geopolitical tensions have also impacted economics with growing global trade policy frictions, the increased use of trade restrictions, including sanctions to achieve broader foreign policy aims and fears of a return to global economic fragmentation.
Higher energy prices
- Fossil fuel price shocks \ High and volatile fossil fuel prices can be very disruptive economically and fiscally, as in the late 1970s and early 1980s
- Long-term changes to the UK’s energy mix \ Investment and alteration of the energy mix to reduce dependence on fossil fuels and meet the ambition to reach net zero carbon emissions by 2050.
Long-term fiscal pressures
- Updated demographic projections \ Demographic pressures have eased since the 2018 Fiscal and sustainability report due to a lower birth rate, slower improvements in life expectancy and lower migration
- Latest policy, economic and environmental changes \ However, in the longer term, the pressures of an ageing population on spending and loss of motoring taxes in a decarbonising economy leaves public debt on an unsustainable path in the long term.
There is a challenging outlook. The OBR’s long-term projections show debt rising to 100% of GDP by 2052–53 and reaching 257% of gross domestic product (GDP) in 50 years if it accommodates the upward pressures on health, pensions and social care spending and the loss of motoring taxes.
The OBR highlights that compromises will be required to bring debt back to 75% of GDP — the level at which it stabilised in the government’s pre-pandemic March 2020 Budget. Namely, taxes to rise, spending to fall, or a combination of both.
Making allowance for “inevitable” periodic shocks would push debt to 100% of GDP by 2047–48 and nearly 320% of GDP in 50 years.
There is a possibility of geopolitical tensions escalating further, leading to increased defence spending commitment. Energy prices could spike even higher or persist at elevated levels, although both of these scenarios would lead to higher levels of debt.
The UK's challenges are generally not unique, with governments worldwide announcing massive investments in energy and infrastructure to overcome energy and climate change risks.
Mobilisation of $600 billion is targeted by 2027 for The Partnership for Global Infrastructure and Investment. Launched by the G7, it’s intended to deliver “game-changing” and “transparent” infrastructure projects to developing and middle-income countries.
Supporting the transition to net zero with nuclear is likely to require more public investment in constructing and decommissioning nuclear facilities. Construction costs of the additional capacity, targeted in the British energy security strategy, potentially approach £170 billion if the price of Hinkley Point C was a sensible guide.
Renewables will also require more public investment in storage capacity to overcome intermittency in wind and solar power generation, forecast to cost tens of billions.
More than half of the replies to our survey question below said that private project financing is “very important” to deliver a pipeline of energy projects.
The government has committed to pay for half of the development costs of Sizewell C, until external investors are brought in, pledging £700 million of investment to fund ongoing development work.
However, only one in five of survey respondents felt that there is sufficient appetite from the private sector to be involved with energy projects.
Though government commitments have been forthcoming in recent times, it is clear that more is needed to meet demand with a cleaner energy mix.
Government support is needed to increase confidence in investment.
Funding totalling £210 million has been provided by government towards small modular reactors (SMR) as part of ‘The Ten Point Plan for a Green Industrial Revolution’.
Rolls-Royce is developing its small modular reactor business, hoping to offer a reliable, sustainable, low-cost and scalable product that can be rolled out globally.
Their approach would deliver an entirely factory-built nuclear power plant which would be transported as modules and assembled on-site.
According to Paul Stein, Chairman of Rolls-Royce SMR, “The UK SMR heralds a new approach to the cost of nuclear power by broadly rethinking manufacturing and construction methods and by the extensive use of digital twinning whilst keeping the physics package exactly the same. This is a pressurised water reactor of a type we know and love.”
In the long term, the SMR will provide investors and lenders with a degree of confidence that will enable future customers to access a range of capital options.
As part of the mini budget, the Chancellor announced new measures intended to unlock private investment. Changes to regulations will increase investment by pension funds into UK assets, incentivising investment into science and tech companies.
Overall, to encourage private investment in the energy sector, there will need to be confidence in the return on investment, which may lead to increased energy prices. However, attractive return on investment levels encourages competition, creating a market and increasing supply.
Some respondents suggested that a reduced pay-back period will be required to align with non-energy projects.
Others suggested that penalties and regulations are needed to prevent the continuing use of fossil fuels.
