Nesta’s response to the Net Zero Review
The UK government asked Chris Skidmore MP to conduct a review of Net Zero policies, with a focus on how they can support economic growth. Below is Nesta’s submission to the review’s Call for Evidence, which answers six questions on how Net Zero can best contribute to economic growth.
Our responses draw heavily on our work on decarbonising home heating and on productivity and Net Zero.
How does Net Zero enable us to meet our economic growth target of 2.5% a year?
Reducing gas imports
Key Net Zero changes — such as renewables, heat pumps and energy efficiency — reduce the UK’s imports of gas, which would directly boost the economy. The UK imports around 60% of the gas we use. At current gas prices, that is around £50 — £70 billion, around 3% of GDP, flowing straight from UK households and businesses to overseas companies and businesses. This is a huge drain on the economy, and one of the key reasons why the energy crisis has weakened the UK economy.
Our main uses of gas are heating homes (37%) and electricity (30%). Increasing renewable energy production saves gas directly, and reduces our imports. Installing heat pumps, which use electricity instead of gas, cuts gas use by 70% assuming the electricity grid remains constant. Every heat pump installed saves the equivalent of £1,100 in wholesale gas costs to the UK economy.
Greater efficiency / lower costs
Many Net Zero technologies are more efficient than the fossil fuel ones they replace. Electric vehicles use far less energy than petrol or diesel ones. Heat pumps use three to four times less energy than a boiler. For businesses, industry and agriculture, the switch to electricity should also involve a greater focus on efficiency, while the circular economy required to cut emissions from waste will also cut resource use.
Being more efficient is one of the key drivers of productivity growth. Where energy efficiency reduces costs — as it currently does wherever gas is involved — it directly boosts Gross Value Added (GVA). Because GVA is the sum of all outputs in the economy minus the sum of all inputs, if you reduce input costs without reducing output, GVA rises. The push for efficiency required by Net Zero gives us the chance to repeat this productivity boost across the economy.
Higher value industries
Many of the industries involved in Net Zero are higher value than their fossil fuel counterparts, and will grow the economy. This is true for electric vehicles and heat pumps, and is likely to be for many other Net Zero technologies.
The economist Anna Valero has shown that the UK has a likely comparative advantage in many clean tech industries, including offshore wind and nuclear. Net Zero is also likely to require new tech-enabled services, such as for home energy flexibility or electricity grid balancing, which should play to the strengths of the UK economy. These high value industries, if properly supported, offer a major opportunity for the UK to grow its economy.
What challenges and obstacles have you identified to decarbonisation?
Price of electricity
The UK’s electricity is among the most expensive relative to gas in Europe, and this seriously limits the nation’s progress towards Net Zero. Eric Lonergan and Corinne Sawers estimate in their book Supercharge Me that around 70% of the challenge of reaching Net Zero is about electrifying activities currently powered by fossil fuels.
The ratio of electricity to gas and oil prices is crucial, because it determines the running cost of electric systems, such as electric vehicles and heat pumps, compared to fossil fuel alternatives. To use heat pumps as an example, if the electricity-gas price ratio is below 3, heat pumps will almost always be cheaper to run than a gas boiler. This then opens the door to financing for upfront costs, as monthly finance payments are offset by lower energy bills.
The UK’s electricity-gas price ratio has consistently been well above 3, rising as high as 5 before the energy crisis. This holds back electrification of the economy. This is exacerbated by two issues:
- Levies on electricity bills but not gas bills, which act as an artificial anti-carbon tax.
- The coupling of electricity prices to gas prices, caused by gas acting as the marginal unit of electricity.
The UK government should permanently shift the levies on electricity bills (the Energy Price Guarantee temporarily removed them), and should pursue market reforms to decouple the price of clean energy from gas.
Supply shortages
The UK needs many more skilled workers to deliver Net Zero, and businesses to employ them. There are supply constraints across the Net Zero landscape, with demand for items such as solar panels far outstripping supply.
On heat pumps, Nesta estimates there are currently between 3,000 and 4,000 heat pump installers currently trained in the UK. To achieve government’s Net Zero targets, this needs to grow by more than 4,000 every year after 2024, raising skills levels at the same time.
Electricity grid
As well as increasing the supply of renewable electricity, the UK also needs to invest urgently in upgrading its electricity grid. Demand for electricity is due to increase by around 2.5 times by 2050 according to the Climate Change Committee, as more parts of the economy switch to electricity. However , there are already signs that a lack of grid capacity is holding back the switch to electric devices (as well as building new homes). While it is important to deliver as much flexibility in energy use as possible, there is no route to Net Zero without significant upgrades to the grid.
Confidence that Net Zero is happening
Most Net Zero policies are popular with the public, and demand for many Net Zero technologies is on the increase. However, in order for people and businesses to commit to switching to low carbon goods and services, they need confidence that government will not change course from its Net Zero goal and approach. Future regulatory signals, such as the phase out of electric vehicles and gas boilers, play an incredibly important role in influencing people’s behaviour, and government must be consistent in setting and keeping to such policies.
Rising interest rates
Net Zero is generally a capital-intensive undertaking, requiring investment in wind farms, low carbon heating systems and new industrial and business equipment. A rise in interest rates increases the cost of this capital, and can greatly increase costs to businesses. Enabling businesses to access lower cost borrowing may play an important role in moving towards Net Zero.
What opportunities are there for new/amended measures to stimulate or facilitate the transition to Net Zero in a way that is pro-growth and/or pro-business?
Decoupling electricity markets and further reducing price of electricity
Renewable electricity is generally the cheapest form of electricity, and has scope to become even cheaper in the future. However, its wholesale price is normally tied to the price of gas, which is currently far more expensive than renewables. Reforming electricity markets to reduce the long-term cost of electricity is a huge opportunity for Net Zero and for the economy. Possible opportunities to do this include:
- Increasing clean electricity capacity enough so that gas is needed less often to balance the grid.
- Making wider use of Contracts for Difference to keep renewables prices at steady levels (note — these prices may need to be higher in future to account for higher interest rates).
- Separating the electricity market so that gas and other forms of energy are traded separately (though this may be difficult to implement).
Support for low cost finance
Borrowing costs will be a key determinant of the success or otherwise of Net Zero. The UK government can typically borrow more cheaply than anyone else in the UK economy. By offering its balance sheet for Net Zero investments, either by underwriting investments or through bodies like the UK Infrastructure Bank, it could keep borrowing costs as low as possible. This should ideally extend to consumer finance — for items like electric vehicles and heat pumps — as well as to business investment.
Planning policy
The planning system in England can be a barrier to Net Zero technologies. This can be true for large scale infrastructure — high speed rail, onshore wind and solar are all made more complex and expensive by planning constraints. It also applies to home-level changes — the planning regulations around heat pump installations can make it impossible for some homes to switch to a heat pump, even though the case for planning restrictions (eg noise) appears to be outdated. Moving towards a presumption in favour of Net Zero development could accelerate the transition to Net Zero and grow the economy.
Where and in what areas of policy focus could Net Zero be achieved in a more economically efficient manner?
Government’s key policy to support heat pumps is the Boiler Upgrade Scheme, a subsidy for installing heat pumps which is intended to operate on a fairly small scale. This subsidy is important, and may need to be extended in the coming years.
However, in the longer term it may be more effective to use a combination of lower running costs (secured via reforms to make electricity cheaper) and financing to make heat pumps a financially attractive proposition. Nesta’s research found that over a third of home owners would choose a heat pump over a gas boiler if both lower running costs and finance were on offer.
Government should also focus carefully on the efficiency of heating devices, which have a huge impact on energy efficiency and fuel poverty. Government should: a) require open monitoring of all heating devices, via systems built in by manufacturers; and b) set minimum efficiency standards, holding installers to account if these aren’t. This would greatly benefit consumers and the economy by reducing wasteful energy use.
How should we balance our priorities to maintaining energy security with our commitments to delivering Net Zero by 2050?
There is no real trade off between energy security and Net Zero in the current energy crisis. The most secure and economically beneficial form of energy is that made in the UK — typically renewable energy. More renewables — and more heat pumps and electric vehicles — means less reliance on fossil fuels from overseas.
The challenge with renewables, though, is to manage the variability of supply, a role which is currently performed by gas-fired power plants and which has wrought havoc in the UK energy system. Variability is not an insurmountable problem. The UK should:
- Continue to increase renewables capacity, to reduce the amount of time gas is needed. We may need to create uses for excess energy to enable this.
- Reduce gas use for home heating (via heat pumps and other low carbon heating) — this enables gas to be used for electricity backstop where unavoidable.
- Invest in storage of all kinds. This includes batteries, pumped storage, hydrogen, thermal storage within homes and businesses, and any other viable and affordable storage option.
- Support flexible energy use, so that households are incentivised to use energy only when it is abundant and clean. Re-introducing widespread time of use tariffs should be a priority, and should spur significant innovation among businesses.
What export opportunities does the transition to Net Zero present for the UK economy or UK businesses?
While the UK has some advantages in some clean technologies, it is an economy that specialises in high value services, especially technology- and internet-enabled services. There are many services that will be required to make a Net Zero economy work — from helping households use energy at the right times, to running devices efficiently, to storing energy and balancing the grid. The UK already has a number of start-ups emerging in these areas, and should go all out to support their growth into export champions. Key actions will include getting the regulatory environment right for these services, supporting skilled workers in these sectors and enabling the market in flexible energy to grow early in the UK (eg by ensuring time of use tariffs are widely restored).
