“The government is inadvertently picking the technology winners ... though it claims to support market forces.”

This column is called ‘market forces’ yet some may well argue that it could easily be called ‘government forces’ as policymakers actively seek to plot an investment path to a low carbon economy whilst being fully cognizant of the overriding policy imperative to be austere in the face of recession-bloated debt. Faced with this deficit-investment conundrum many investors and utilities have reluctantly passed the buck to the government, reasoning that the uncertainty associated with investing in new, largely unproven, low carbon technologies carries too much risk, and believing that substantial government investment is required to placate these market concerns.

While Britain’s Confederation of British Industry’s position that the market should decide which low carbon technologies should succeed, and that the government should resist picking ‘technology winners’, is arguably right, it is a facile wish if the market remains reticent to invest. Market forces only work when the market is given a free rein to act and has the confidence to do so. Unfortunately, in many OECD markets this is currently not the case.

Take two prominent technology examples – tidal power and carbon capture and storage (CCS). Both are largely unproven technologies, more so CCS, and both require significant investment if large-scale projects are to evolve. Yet both potentially provide significant low carbon market benefits. This being so, one could argue that the investment risks with development are more than offset by the potential rewards, with both technologies expected to play a pivotal role in tomorrow’s low carbon economy. Yet investors have seemingly become unashamedly risk-averse to both technologies.

A recent survey of potential investors in CCS found that the market would only invest in this technology once it has been proven, thus requiring government to fully fund the large-scale demonstration projects that will prove the technology commercially viable, or offset the risks of any private investment. Clearly CCS provides significant investment risk – not only is the technology not proven but the time scale required to prove the technology is uncertain. Even the most optimistic proponents of CCS concede that it will not be fully proven until 2020, which means any investment today will not see any return for at least a decade. The irony is that CCS proponents argue that the timescale for proving the technology will be reduced if more large-scale demonstration projects are brought online, so by delaying investment based on the risk of a delay in financial returns the market is in effect increasing the risks associated with CCS investment.

If governments reduce CCS project funding in order to prioritise deficit reduction the risk-reward scenario looks even less appetising. And this is the potential scenario faced in the UK following October’s Comprehensive Spending Review. The Department of Energy and Climate Change requested £2 billion of funding from the Treasury for the first project and assurances for funding of up to three further projects, but it only received £1bn and no guarantee of future project funding. If the government will not commit the funding required why should the market similarly invest?

Large-scale tidal projects face similar risk-reward scenarios. Last month the UK government announced it would not fund the Severn Barrage tidal project, judging the £30 bn investment as unjustified and arguing that the funds would be better spent on other low carbon technologies. Clearly £30bn is a significant financial risk, yet proponents argue that the potential reward of 5% of UK installed capacity, equivalent to two nuclear plants, justifies the financial risk.

With some of the best tidal resources in the world the UK should be at the forefront of large-scale tidal development and the lack of support will raise justifiable concerns that the government does not have full confidence in tidal power with its preferred renewable technology being offshore wind. After all, the technologically proven offshore wind sector received £200 m of funding in the spending review, although this was justified, as investment will go towards developing the UK’s offshore supply chain, thereby reducing development costs. Nonetheless the government stands accused of picking technology winners and its choice reinforces the view that government forces are subordinating market forces.

Arguably £30 bn on one project can be viewed as ‘excessive’ but what are the alternatives? Without the Severn Barrage the UK will have to significantly increase investment in other renewable sources if the government is to achieve its objective of providing half of all new generation capacity from renewables by 2025. It may well see the alternative to the Severn Barrage as increased offshore wind capacity, yet this approach also potentially increases supply security risks by creating a non-diversified renewable portfolio that is heavily dependent on intermittent wind capacity.

The government’s preferred 2025 new capacity mix also has potential implications for CCS. If half of new installed generation capacity is to come from renewable and new nuclear, with eight sites recommended for nuclear development in the revised National Energy Policy Statements published in October, then new nuclear will account for around 20-25% of new capacity by 2025 with the balance to be sourced from clean coal and gas. Assuming CCGT development continues at the current pace, which it may do given the increasing confidence over the potential reserves of shale gas, then will there be sufficient demand for new clean coal generation to support investment in indigenous CCS technology?

To reduce emissions and meet the clean coal/renewables targets the UK government, and others, needs increased investment in large-scale non-wind plant to develop a diverse renewable generation portfolio and CCS to support the development of clean baseload generation. Yet by potentially removing large-scale tidal from the equation and skimping on CCS funding the government is inadvertently picking the generation technology winners even though it claims to support market forces.

It is generally accepted that competition leads to more secure and affordable markets, and at the heart of competition is market forces. Although the uncertainties associated with change present obvious risks it is the market that will have to make the new low carbon energy economy work. This being so the market needs a clear voice in how this will develop and must be prepared to back up its beliefs with investment. Deferring investment choices to government may appear less risky in the short to medium term, but allowing the government to effectively pick technology winners now could conceivably increase longer-term risks if the government backs the wrong technology winners. Market forces have to reassert their authority.