Time to shift energy spending - Andrew Warren

Fascinating research from Schroders reveals that capital spending in the energy sector will need to move from energy production to energy saving.

Ever since the Conservative Party returned to government in 2010, it has been determined to see a minimum component included in the price charged for each unit of electricity, to (at least vaguely) reflect the carbon footprint of the input fuel.

The “floor price for carbon” policy has been a consistently “nice little earner” for the Treasury. But this carbon tax has ended up as neither fish nor fowl. It has been high enough to be the largest public policy contributor to rising household bills – the “green crap” as former PM David Cameron so memorably called it.

It has also been high enough to cause concerns to energy intensive companies, sufficient to cause the introduction of a series of tax exemptions to be introduced ostensibly to shield exporters from becoming disadvantaged.

The policy was introduced in order to augment the impact of the European emissions trading scheme (EU:ETS). This had been set up five years before to help deliver a low-carbon economy using the most established commercial mechanism of all. Subsequently, due very largely to the vast superfluity of allowances in circulation, the trading price has been a fraction of what the economic modelers had predicted.

Now it seems very possible that Brexit may have to lead to a decoupling from the scheme for the 1,000+ UK based units currently participating. Whether this will lead to a recreation of the UK-only carbon trading scheme that operated early on in the century remains to be seen.

But one point is being made crystal clear. The mammoth Clean Growth Strategy documents, issued by the Government last autumn, are littered with statements stressing that UK policy henceforth is “firmly committed to carbon pricing.” The conclusion must be that implementing this absolute pledge will lead to higher prices per kilowatt hour consumed - with the important corollary being that the more energy efficient any activity is, the fewer kilowatt-hours will need to be consumed.

That being the case, it is instructive to examine precisely which sectors of the business economy are most likely to be affected by exposure to these higher carbon prices. On the face of it, this may seem to be the easiest calculation to undertake. It must be those sectors that are the most intensive users of energy.

In practice, it isn’t quite as simple as that. The global asset and investment managers, Schroders, have undertaken some fascinating calculations, assessing which product areas are most or least at risk from higher carbon prices.

They have considered both the direct operational, and the indirect supply chain emissions. They have considered the relative degree of dispersion in carbon exposure within the sector. They have calculated the price elasticity for specific products – if all costs can readily be passed onto customers, the impact upon volumes sold will be limited. And of course the percentage change upon current profitability levels remain pertinent.

The results are decidedly counter-intuitive. Yes, of course among the most exposed sectors are iron & steel, commodity chemicals, specialty chemicals and mining. But building materials are deemed the worst exposed sector of the lot, whereas one of the least exposed sectors is heavy construction - the differentiation being that the former include cement and concrete, while the latter are mostly engineering oriented.

Least affected are service sectors like banking, life insurance and investment services, given their limited use of energy per unit of wealth produced in their offices.

Software developers are far less exposed than, say, computer services, recognition of the latter’s heavy server footprint. But the airlines industry is ranked among the most vulnerable. Interestingly, the defence-manufacturing sector is reckoned to be one of the least affected, possibly a reflection of the ease with which higher input prices can be passed on to purchasers like the Ministry of Defence.

Crucially, the same Clean Growth Strategy emphasises that most of the lowest hanging fruit within the business sector is to be found by improving buildings, rather than improving process plant. Five-sixths of the cost-effective potential savings identified within business over the next decade are to be found there - the sectors least likely to be exposed to change from higher carbon prices.

Schroders stresses that there will need to be a major shift in capital for energy infrastructure over the next two decades. The absolute amounts invested need not alter. Where it is spent will. Currently energy efficiency receives just 10 per cent of such investment monies, whereas half is devoted to gas and coal power and fossil fuel production. To meet even the least ambitious of the international climate change targets, those percentages will need to be reversed.

All this demonstrates clearly one important conclusion. To meet the government’s declared objectives, concentrating upon carbon pricing will be a necessary component within its policy armoury. But reliance upon that alone will almost certainly exclude action within precisely that part of the economy where the big savings remain to be made: the commercial sector. We shall need other sticks, other carrots, other tambourines to succeed.

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