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Uncertainty of future costs remains at forefront of Treasury Net Zero Review

The Net Zero Review follows on from last year's interim report. Image: HM Treasury.

The Net Zero Review follows on from last year's interim report. Image: HM Treasury.

The difficulty of forecasting the costs of decarbonisation has dominated the Treasury’s Net Zero Review, carrying on a theme from the interim review, published last year.

Overall, the review concluded that the costs of global inaction significantly outweigh the costs of action, with higher temperatures and an increased prevalence of extreme weather events potentially leading to reduced productivity growth in the UK and significant damage to UK capital stock.

However, the step change in investment required to reach net zero could provide a boost to the UK’s economy, although it will contribute to structural change as resources and jobs move from high to low carbon industries.

Additionally, there will be significant co-benefits, such as cleaner air, which could deliver £35 billion worth of economic benefits in the form of reduced damage costs to society, reflecting for example lower respiratory hospital admissions.

Ultimately, the way in which the economy and policy respond to the changes required over the next thirty years, will determine the scale, distribution and balance of opportunities and challenges, the review found.

The difficulties in forecasting costs

The government estimate of the overall additional capital expenditure required for net zero shows additional net zero investment peaking at over £60 billion by the mid-2030s. But these estimates do not capture the entirety of net zero investment, only the additional investment required i.e. the additional cost of investing in an electric vehicle (EV) over what it would cost to purchase a petrol or diesel vehicle prior to reaching cost parity.

However, there is also “significant uncertainty” over the precise mix of technologies and costs that will make up the transition, with the eventual net impact of the transition on output being “highly uncertain and challenging to estimate”. It will depend on the policies used to catalyse the change and technological progress that has not yet occurred, the Treasury said.

When it comes to households, it’s impossible to forecast the impact, the Treasury found. This is due to the transition being dynamic and taking place over thirty years. It is also “inherently difficult” to predict future technology and innovation costs, with previous forecasts for renewable technology costs being overestimated.

Projecting future electricity prices was also described as challenging as there are several key uncertainties that will influence them. There is technological uncertainty, with the future role of hydrogen unknown, policy uncertainty with decisions made by the government and regulators to have an impact, price uncertainty such as Contracts for Difference strike prices and wholesale prices and energy demand uncertainty.

However, the cost of decarbonising power can be reduced though a smart, flexible energy system, which utilises technologies such as storage, flexible heating systems, smart electric vehicle (EV) charging and interconnection. BEIS estimates that increased flexibility could reduce system costs between £30 billion to £70 billion between 2020 and 2050.

The updated Smart Systems and Flexibility Plan - published in July - set out how the government will facilitate the take up of smart technologies, including energy storage, to help reduce peak demand.

The costs of the electric vehicle transition

The EV transition was also looked at in the review, which found that different households are to be exposed to the EV transition at different points in time. As higher income households drive more and are likely to adopt EVs earlier, the costs and benefits of EV adoption are likely to fall on higher income households first. Meanwhile, any changes to the cost of running an internal combustion engine (ICE) vehicle will fall disproportionately on lower income households.

Earlier this year, Current± explored the disparities present in EV adoption between income brackets, and how on-street charging is helping to bridge that gap.

How drivers choose to charge their vehicle and the charging that is available will influence the costs and benefits of EV adoption, the Treasury's review stated. Looking ahead, there are at least two major sources of uncertainty in this area to account for:

  • Charging segments, behaviour and technology, with a range of ways to charge including off-street, on-street, destination and rapid charging hubs. These will vary in costs, but the degree to which the costs vary will be dependent on technological change and the variable cost of electricity.
  • Variable electricity prices, with overnight at-home charging enabling households to make use of cheaper off-peak energy prices. Shifting charging away from peak times can significantly reduce costs by avoiding the need for network reinforcement and additional generating capacity, while vehicle-to-grid can provide additional flexibility.

Private investment in the UK charging market is rapidly increasing, with the private sector leading on the development of the charging network. However, the review did make reference to the £950 million committed by the government to futureproof grid capacity to enable the private sector to rollout rapid charging hubs at motorway service areas and key A-Road service areas.

Overall, reaching net zero will involve some costs, the Treasury found. Policies needed to drive investment and behaviour change can lead to an upwards pressure on consumer prices of goods and services that are more carbon-intensive and can weaken the profitability of the companies that produce them.

This shift in relative prices and impact on demand, as well as higher costs of supply, is likely to bring major structural changes in the economy as existing industries adjust or face decline.

Policy instruments required

The Net Zero Review found that multiple policy instruments will be needed to address multiple market failures as businesses and households transition from high carbon technologies to low carbon ones.

The policy instruments used to facilitate the transition can reduce the magnitude of transition costs and affect the distribution of them across businesses and households, with the successful growth of the EV market showing the role that policy can play to support market expansion as well as bring down costs for households.

The review went on to state that competitive markets are likely to deliver the most efficient transition across the economy, with widespread and increasing carbon prices able to create a strong incentive for the private sector to invest and innovate, while giving firms flexibility as to how to abate emissions.

In addition, innovation will be vital in the 2020s, and policy can support private investment to ensure the UK increases the pace of decarbonisation, and has access to new cost-effective technologies.

Supporting innovation was one of a number of key areas outlined in the government's Net Zero Strategy, published yesterday.

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