OBR: UK’s current gas reliance likely to be as costly as net-zero transition

The Office for Budget Responsibility (OBR) has stated that continued dependence on volatile gas markets “could be as expensive fiscally” as reaching net-zero emissions, or even twice as costly if no action to decarbonise is taken.

OBR: UK’s current gas reliance likely to be as costly as net-zero transition

The OBR, which produces forecasts for the economy and public finances, has this week published its latest update assessment of fiscal risks in the UK.

The analysis finds that “significant investment” is needed in the power sector over the next decade if the UK is to reach its net-zero ambitions. The OBR cites investments in renewable energy sources alongside the electrification of sectors like transport, heating and buildings as areas where more public finance is required.

The OBR warns of the risk that the UK economy “remains relatively highly dependent on imported gas” and that a dependence on these imports “could be as expensive fiscally as completing the transition to net zero, were periodic upward spikes to global gas prices to continue to occur”.

The OBR adds that the UK “remains one of the most gas-dependent economies in Europe”, which has left the nation “more exposed economically and fiscally to sudden changes in global gas prices”. The report also notes that the UK’s reduction in gas usage in response to the spike in prices was less than the European average.

The OBR warns that a “continued reliance on gas” would result in the UK being more than 40% more exposed to price spikes in the late 2020s, unless gas usage can be reduced in line with the Government’s own pathways listed in the Net-Zero Strategy. The UK would be more than twice as exposed to price spikes in the late 2030s; and more than five times more exposed to spikes in the late 2040s.

The OBR states that if gas price spikes occur every decade, it could cost the UK between 2-3% of GDP annually, adding 13% of GDP to public debt by 2050. Under these scenarios the dependence on gas could be twice as costly as the net-zero transition.

In contrast, the OBR’s 2021 scenario estimates the net effect on public finances that the net-zero transition would have. It found that taking early action to reach net-zero would reduce the primary balance of GDP by less than 1% and add 21% of GDP to public sector net debt, which is around £20bn annually.

The pricing estimates include the loss of receipts from fuel duty as fewer petrol cars are on the road and also a higher carbon tax. The OBR’s current report states that the imposition of a carbon tax is unlikely to offset the loss from fuel duty.

The OBR’s March 2023 forecast also stated that half the cost of the UK’s support to household and businesses to respond to rising energy costs could be recouped by windfall taxes on energy producers. However, with North Sea output declining, the OBR is now unsure as to what extent policymakers will be able to recoup future support costs via windfall taxes on oil and gas producers.

Research from green groups has estimated that wholesale gas prices will remain at least twice as high as they were before the price crisis until 2030 at the earliest.

The OBR notes that the volatility of gas prices will likely continue into the future, even as more renewables come online and Europe attempts to grow its own gas markets to further reduce reliance on Russian imports. As such, volatile price spikes similar to what the UK has experienced over the past 18 months are a likely possibility moving forward.

At the start of the year, Ofgem introduced its latest intervention to respond to spiralling energy costs. The regulator set an annual level of £3,280 for a dual-fuel household based on typical consumption, down from £4,279, as part of the Energy Price Guarantee which runs until March 2024.

But, given that the Guarantee currently caps bills to £2,500, and that the cap is increasing to £3,000 in April, most homes will still see their bills increasing by at least 20% between March 2023 and April 2023.  The Trades Union Congress (TUC) has stated that the year-on-year increase for April bills is around 52%.

low-carbon alternatives

The UK is exploring alternatives to gas in a bid to reduce costs and reach net-zero and one technology that has been touted is hydrogen. The OBR findings come as Energy Secretary Grant Shapps has indicated that plans to replace gas boilers with hydrogen variants could be scrapped.

The Guardian has reported that Shapps looks set to reel in plans to switch home boilers to hydrogen alternatives. Trials have already started as part of a wider vision to phase out natural has boilers by 2035 to decarbonise heating, but Shapps feels the technology is better suited to energy storage.

“It’s not that we won’t do trials,” Shapps said. “We will. But I think hydrogen will be used for storing energy. You won’t have to switch off windfarms when you don’t need the power because you can turn it into hydrogen and use it later.”

Gas prices have fallen in recent months, but the OBR expects them to remain around twice as high as pre-pandemic levels through to 2025 at the earliest.

The OBR also states that higher gas prices might “sharpen” private investments and incentives to low-carbon alternatives that could reduce the need for some levels of public spending. However, the OBR also states that it is working off its pricing estimates from 2021 – currently the only published estimate of the fiscal cost of getting to net-zero in the UK – and that the Climate Change Committee’s recent progress report has indicated that the UK is off-track to deliver its near-term climate commitments. As such, inaction from Government “increases the risk of higher public investment being needed in future,” the OBR notes.

The report summarises that as these complexities continue to manifest, achieving the Government’s net-zero target by 2050 “will become increasingly difficult”.

“Although completing the energy transition to net zero is likely to generate some significant fiscal costs, maintaining the UK economy’s current reliance on natural gas would not be costless either,” the report states. “Exposure to volatility in the price of gas can, as the past two years have shown, have wide-reaching implications for the UK economy and public finances.”

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