The large devaluation of the last few days will have significant effects on UK energy, from electricity to motor fuels. Other changes are also likely to slow decarbonisation of the economy.
Hinkley Point C is even less likely to be built. As at the point of writing, the pound is down about 16% against both the dollar and the Euro compared to twelve months ago. That means that all the components for the power station purchased outside the UK will be 16% more expensive.
EdF has indicated in the past that ‘up to 57%’ of the cost of Hinkley will be spent on UK goods and services. Let’s be a little sceptical and say that only half the cost of the new nuclear plant will be incurred in the UK. The last estimate we saw was that constructing Hinkley was going to absorb £18bn. If half of that cost is derived from imported components and other charges the exchange rate decline over the last year has added over £1.4bn to the bill. Much of that has been in the last few days.
The electricity that Hinkley generates will be no more valuable to EdF than before. The strike price of £92.50 a megawatt hour does not rise in the event of a UK devaluation. So the prospective financial return to EdF and the Chinese shareholders has fallen sharply. Perhaps as importantly, the position may get worse if the decline in the value of the pound continues but nobody can know this in advance, nor can it be fully hedged against.
The same argument applies to all other prospective nuclear construction in the UK. Put at its simplest, the components for nuclear power stations will largely be shipped into the UK and then assembled here. The rapid devaluation that is going on has made all future projects more expensive. Nuclear fuel (costing about $5 for a megawatt hour’s worth of uranium) will also become more costly.
There is a counter-argument. If Brexit pushes interest rates in the UK even lower - and the signs are that this is happening – EdF may be prepared to take a lower return on its capital than would previously have been the case. Rumours have suggested that EdF’s financial projections were based on a 9% cost of capital. We could argue that this number is too high; UK utilities generally run on a 6% estimate. However there is no sign yet that either EdF, the French government, or Hinkley’s Chinese backers are prepared to accept a lower return. I
Lastly, as at Monday midday, EdF’s shares have fallen 20% since the Thursday referendum. EdF’s total stock market value is now less than the cost of Hinkley, a position seen earlier in the year but from which the company had been climbing out of. Investors see profoundly bad effects on EdF from Brexit.
Gas fired power stations are relatively cheap to build and operate. (Perhaps £600-£700m for a gigawatt of capacity, or about a tenth the price of new nuclear). Fuel is the most important part of the costs they face. The price of gas is set in an increasingly international market. Although contracts in the gas market are set in sterling, the underlying global price set in US dollars feeds into the UK’s auctions. Devaluation will therefore add sharply to the cost of buying gas for power generation. This will force up the long-run price of electricity because developers of new power stations will need guarantees of higher prices before they build their plants. My rough calculation is that the wholesale price of electricity will need to be about 10% higher as a result of the events of the last few days. The price that homes pay for gas will be equally adversely affected.
If these increases do directly feed through to household bills, the immediate impact will be about £100 per home. People will also see inflation in the costs of goods and services they buy because their suppliers will also face higher costs of energy.
Those of us over fifty will remember this phenomenon clearly: large devaluations push up prices. The referendum decision will significantly affect the least prosperous because more of their income is spent on heat and electricity than wealthier groups. Fuel poverty will probably rise, possibly sharply. This will tend to affect worst those most likely to have voted to leave.
The oil price has been gradually recovering after the sub $30 lows seen earlier in the year. Today, the cost of a barrel is bobbing around $50. But a dollar is now 15% more costly to those buying in British pounds than it was a year ago. The price of petrol will therefore also rise although the percentage impact is softened by the fact that more than half the cost of a litre of fuel is composed of duty, VAT and UK denominated costs. Nevertheless, we'll see a visible jump in fuel prices in the next few weeks.
The cost position of the UK North Sea will be improved, making it slightly easier for offshore oil and gas rigs to stay in business.
Will the rise in the price of oil help the sales of electric cars? It depends. In my view, the rise in renewables will in the longer run force down electricity prices all around the world. The economics of buying and operating an electric car will tend to get better as time goes as by, Brexit or not. Short term relative prices changes in petrol and electricity costs have little impact.
The impact here is slightly more nuanced. In the case of solar, withdrawal from the EU would mean that the UK could escape from the ‘Minimum Import Price’ facing Chinese companies. The price of solar modules would fall in Euro terms. But because the Euro is now more valuable than it was a week ago, the impact in pounds would be much less. Perhaps the price of Chinese panels will be higher than it would have been without the devaluation and prospective exit from the EU. Other system components, such as inverters, will also rise in price. Because over 80% of the cost of a large solar field is imported (my guess – better estimates welcome), PV will become much more costly, at least temporarily.
In the case of wind, more of the manufacturing value is added in the UK than in the case of solar. Perhaps they now regret it, but some of the large offshore turbine makers have factories and installation operations here. The UK should become an even more important centre for wind turbine construction as a result of devaluation. However this optimism is only justified if we believe that the UK will be able to export to major markets without substantial tariff impediment. As of today, this is no certainty.
A large fraction of the total costs of offshore wind farms are denominated in Euros. The fall in the value of the pound will make developing large wind areas, such as those on Dogger Bank, more expensive. This will reduce the pace of offshore wind development, perhaps substantially.
Places like Culham and Harwell, the UK’s energy research centres in Oxfordshire, will diminish sharply in size and importance. The nuclear fusion lab at Culham gets £55m a year from the EU, a large fraction of its budget.
As importantly, research into the conversion of surplus electricity into gas and liquid fuels that can be stored for months will be slowed. As PV and batteries becomes ever cheaper globally, this is the last remaining challenge for the clear energy revolution and the UK had been in a commanding position because of its world-leading role in biochemistry. The Brexit vote is a huge setback for research in this area.
More generally, of course, any new Conservative government will be profoundly sceptical about climate change. The part of the human brain that determines whether one is a denialist or a climate alarmist is the same as that which provided the opinion on the EU. So renewable and low-carbon energies of all types will be under threat as a result of the likely rightward shift of the government.
For example, the Vote Leave campaign literature railed about wickedness of the Large Combustion Plant Directive, the EU’s coordinated plan for reducing air pollution by forcing older coal-fired power stations to close. (The LCPD was one of the undoubted successes of the EU energy and environment policy). The implication is that the Leave people will be happy to see coal back as a major contributor to power supplies even though they also threw about the accusation that the EU had ‘tied our hands on decarbonisation’. That last complaint is about as far from the truth as is possible to get.
The primary conclusion I take from the events since the referendum is that energy is going to become more expensive in relation to household incomes, at least for a few years, and that the low-carbon transition in the UK will be slowed, partly by the impact of devaluation and loss of funding but also because of the rise in uncertainty over the future direction of energy policy.
Chris Goodall's new book on the global rise of solar PV and energy storage, THE SWITCH, will be published next week.