Five steps to ‘Net Zero’ levels of innovation

The Government’s commitment to a ‘net zero’ economy will mean profound changes to the British economy. Changes to the way we move around, to how we heat our homes, to what we eat, to how we grow our food, to our landscape, to the way industry works, to what we throw away. While the public supports action on environmental protection and to reduce carbon emissions in general terms — and credibility on the issue appears a key hygiene factor for political parties, particularly for younger voters — it is not evident that most people are aware of or ready for the pace or scale of changes (See this by Public First’s James Frayne).

If moves to a low carbon economy go against the grain of human behaviour or deliver worse experiences for households, it is likely to face resistance or revolt. The les gilet jaunes anglaises may not be far away. Street confrontations with activists, such as Extinction Rebellion, are not inconceivable. If the transition is dependent on hair-shirtism or self-sacrifice or even putting up with a slightly poorer service, it will struggle or could require more and more authoritarian measures.

Luckily, it is not clear such an approach is necessary. The potential for innovation in new products and services that people want, are low cost and, oh, happen to be low carbon is significant. At the same time, digital technologies and data are beginning to disrupt the energy sector in the same way they have transformed so many other parts of our lives. As a result, change is coming to energy, even without the imperative of climate change.

The UK is well-placed to capture the industrial and economic benefits of this transition in many sectors. But it will require imagination and bravery from politicians and businesses. That includes an honest recognition that, despite all the progress of recent years, we do not yet have all the technologies or products (and, crucially, the service that join them all together) that we need to get to net zero. And that there are real trade-offs that need to be managed, particularly about who pays for all this low carbon stuff.

So how can we unlock the innovation we need to get to net zero, while being mindful of the risks of failing to maintain popular support? What does a serious net zero strategy look like? The below are five important (but not exhaustive) measures that could form part of that strategy.

1. Devolution. If the only part of the economy we had to decarbonise was electricity, we would be patting ourselves on the back for a job (nearly) well done. Last year, the UK got 53 percent of its electricity from low carbon sources, up from 26 percent in 2005. The cost of renewables, such as offshore wind, has fallen dramatically. Onshore wind and solar are now being deployed, at admittedly small quantities, without any Government-backed contracts, as a result of tumbling costs. The cost of new storage technologies, such as batteries, are on a similar trajectory. There is still much to do, not least getting the cost of nuclear power down (see below), but the level of innovation and progress is staggering. There have been significant costs on the way, which have pushed up people’s bills[1] (although this has been offset, in general, by improvements in efficiency of products and buildings). But decarbonising power is easier than other sectors because it does not mean a significant change for consumers. I go home, I turn the light on, the lights comes on. Does not matter to me if it is from a coal-fired power station or a solar panel on my roof. The experience is the same.

But the next phase of decarbonisation will be profoundly different. It is about largely about decarbonising transport, which will mean a lot of electric vehicles bolting on to our power system, and decarbonising heat. The latter could mean a system based on a new heating vector (hydrogen) or the mass take up of electrified heating, such as heat pumps. It will probably mean plenty of both (including, in some cases, in the same properties). And managing that shift in a sensible way firstly means understanding local conditions. What is the potential for district heating? What is the condition of the housing stock, and what changes need to be made to improve the thermal efficiency of the properties to make them heat pump-ready? Could the local power network take a sudden influx of EVs and heat pumps? Is the local gas grid ready for hydrogen and will it require local production and storage? Is there significant sustainable biogas feedstock available? Do you have enough charging points to give people confidence to make the switch to EVs? These decisions profoundly change people’s day-to-day experiences. And they are systems questions. You need to understand how the whole system fits together, to understand the range of costs and trade-offs. They require political consent and planning. But in the UK we do not have a set of institutional arrangements that allow us to do the kind of detailed planning at a local level that would allow us to identify trade-offs and choices. Such an approach would also allow you to build political consent for action (taking advantage of some of the, er, ambitious commitments to decarbonising made by local authorities). It would create a serious plan, with a set of priority, low-regrets projects based on detailed, data-driven analysis, not a high-level consultant report, and proper consultation. This is not about community energy — although it could help identify where community schemes are of most value to the wider system — it is about developing an actionable plan at the right scale, based on a consistent approach across the country.

Crucially, such an approach might challenge the argument that at some point in the 2020s, the central Government is going to choose, like the giant hand of old National Lottery adverts — “It could be you” — either a hydrogen or an electrified heating system. I have always been sceptical about such a choice either in practical (how do you have enough information to make the choice) and political economy terms (deigning how an entire country heats its homes is a choice that no politico is keen to make).

A better alternative would be to devolve the decision. If Yorkshire wants to become a hydrogen economy, make them test if it is the cost-optimal path with some proper, data-driven planning. If they want to do it anyway, even if it is not a cost-optimal path (I have no idea if it is), because they think they can capture local economic benefits and build companies that can change the world (ITM Power an obvious example), let them. The plans need to add up to a national whole, of course, and national level action is needed for things like creating the supply of low carbon H2, CCS infrastructure and funding. But understanding the local context is essential, not least for building the political support you need for action[2].

2. Heat. If I woke up tomorrow and decided I wanted to ‘low carbon my home’, who would I call? I could call up some suppliers and ask them if they have a green offer. On power, it would be OK. My consumption could be matched to some real wind farms or nuclear power stations. My conscience is clear (for a bit of an extra price[3]). But if I said I wanted to decarbonise my heating supply, what would they offer? If they offered anything at all, it would likely be offsets either to biogas production, or planting trees in Mozambique or somesuch. They might offer a bit of a discount on a smart thermostat, or see if I was eligible for a Government-backed insulation grant.

But at the end of the call, my (very efficient) natural gas boiler would still be spewing out CO2. So I could call up someone to sell me a heat pump (backed by a generous public subsidy, at least for now). But is the heat pump suitable for my home? What changes to the fabric of the building do I need to make? Do I need a bigger radiators? Will the heat pump heat my draughty home enough when it is the middle of winter? I am pretty knowledgeable about energy, but I would find it very hard to know what is the best thing to do. I would quickly have to become my own chartered surveyor/built environment engineer/heat pump expert/project manager (and shell out quite a lot of money) with no guarantee I will get the same warmish home. Frankly, I can’t be bothered.

At the moment, as far as I can see, there are very few options to do this (please let me know if I have missed any). If we took the same approach for a new car, I would have to source all the parts and build it myself. I know some people like doing that. Most just like going to a showroom, pointing at one, paying for it and driving it home (and knowing it will be fixed if it does not work properly).

If we are to decarbonise heating in our buildings at the pace we need to (about 1 million homes a year, up from about 20,000 a year at the moment), we need to make it not just easy for people, but also desirable. The reason electric vehicles are taking off is because they are, in many cases, a better product that their rivals. The are fast, cheaper to run, quieter and cool. That has been driven by brilliant innovation, particularly by Tesla, in strong regulatory and innovation policy contexts.

Consumer desirability should be the starting point for heating systems in the UK, particularly for the 24 million odd homes with natural gas boilers. We need services which are, as good, or better than current offerings. This is, it goes without saying, going to be really hard. The current offering is pretty good. Boilers are efficient, cheap (obviously the pollution costs are not reflected in the running costs, which helps a bit, and many policy and system costs are loaded onto electricity) and we all know how to find a plumber who can install one. They generally heat our homes pretty well — which is why hydrogen boilers are promising — although it is fair to say most of us currently suffer from draughts, damp, or struggle to get rooms to the right temperature, or fight the thermostat, or suffer from overheating (even in winter, in some cases). In other sectors, this would spur greater innovation, but this is limited in the consumer experience of heat.

So the aim of policy should, to some extent, be help develop a supply chain mature enough so that I can phone up someone and tell them I want a low carbon home and they take care of all of it, and guarantee the same outcome. Just like I do if I want my loft converted or a new kitchen. The service would make the right changes at the right time. I might not even have to pay for it all up front, but pay it back through my energy bills.

How to we get to that nirvana? First, the good news. Digital technology and control is improving at a pace. Companies like Nest, Tado, Hive, Passivsystems and many others are all building the controls and tech that can make this possible. And thanks to better kit and data, there is potential new business models where consumers can buy an outcome (living room at 21 degrees between 7 and 10pm every evening, thanks very much) rather than just pay for the units of gas they consume. That is a really smart home. And if a service provide can guarantee an outcome and give people much greater control of their heating experience, do they care if they have a natural gas boiler, a heat pump or a hydrogen hybrid system? Do they bollocks.

You could combine such a data-driven, consumer-friendly approach with the local area energy planning set out above, and you have the start of a serious response to the challenge of heat. You are aiming to develop low carbon products and services that people actually want and are willing to pay for (which is also going to help you with you ‘who pays’ question). Focusing any available subsidy (perhaps the replacement for the RHI) on developing an innovative market like this (including training up the people with the skills needed to deliver such a service) should be a priority for any Government hoping to inspire the kind of new industries that will tackle the hardest net zero challenges[4].

But none of this innovation is going to be low carbon on the scale we need without policy. That means regulation for new buildings and thinking carefully about what you are going to do for the millions of off-gas grid properties. And it means getting serious about low carbon incentives in heating. The economists will reach for a carbon tax. Allez les gilets jaunes, is the risk. Perhaps a better approach is a carbon standard obligation on suppliers. This is similar to the tightening carbon standards on automakers which has driven such significant innovation in that sector, to the huge benefit of consumers and society. The chicken and egg problem for heating is that you cannot get to robust policy intervention without having confidence that the market is going to provide something better. Setting a date for banning boilers now would be politically, er, brave. And this is HEATING. People really, really care if their home is not warm. It is only because of electric vehicle innovations that we are now confident enough to argue about dates for banning ICE cars. We need to start the same journey for heating in people’s homes, which means you have to start with the consumer.

3. Digitalisation. Energy talks a good game on digitalisation, but compared to other sectors it is nowhere. This partly reflects the reality of the physics and the legacy systems — it is not easy to change 53 million analogue meters to smart ones, as we are seeing. Large parts of the networks have no telemetry at a sub-station level. Settlement needs to be carefully managed and half-hourly (or shorter) settlement periods are still a long way off. Switching still goes wrong too often and take too long. But there are signs that the transformational potential of digital technology and data are beginning to disrupt this most laggard of sectors.

This is partly manifesting itself as the kind of smart home heating technologies are becoming more ubiquitous, although there is still a long way to go before they are combined with brilliant new consumer propositions (see above). Electric vehicles, because of home charging, are likely to spark (haha) further change, if there is drive (haha) from the energy system. Government took a massive step forward on system data with the Energy Data Taskforce (although the midata programme on consumer data is still struggling to deliver what many innovators need). But the sector is hardly mobile telephony, is it?

The potential is massive. Flexible load could help reduce the need for generation and network capacity, and improve the efficiency and reduce the carbon intensity of the energy system (ideally without consumers even noticing the difference). Perhaps the greatest uncertainty facing the power market over the next 10 years is how much of flexibility, of various types, there is in the system. Some, such as the National Infrastructure Commission, are optimistic. Others less so. Crucially, digitalisation could lead to a richer understanding of consumer desires and behaviours, allowing companies to sell them better, low carbon products and services.

So how do we unlock the potential of digital? First, the Government and Ofgem is doing lots of sensible things which will help: Smart Systems and Flexibility Plan, Energy Data Taskforce, greater independence for the system operator[5], elective (and eventually mandatory) half-hourly settlement, which is already leading to new products on the market, such as Octopus’s Agile tariff, the smart meter roll-out (although it is obviously tough going).

But we need a recognition that some markets are missing for the kind of services that a more flexible, smarter system might provide. As a result, the incentive to innovate and invest is limited. These are likely to have locational, as well as temporal, elements. The work of the Prospering from the Energy Revolution Challenge, is helping to identify some of the barriers and potential action at this scale.

But the shift to a digital system also create new risks. Cyber security is one obvious one. But perhaps just as important, and much less well understood is the risk of new monopolies appearing. Very quickly a tech giant could come in and own the space between consumers and suppliers. A decision you could make in the future to buy a smart fridge bundled in with an energy contract could see you locked-in to that supplier until you want a new fridge (or a heat pump, or a hydrogen-ready boiler etc etc).

The best defence against such monopolists is ensuring the energy system is as interoperable as possible. This is not just about your fridge being able to talk to your electric car, although that is, of course, important. This is about being able to switch energy supplier if you have got an energy-as-a-service contract which came with a new hydrogen-ready boiler, without the boiler being ripped out. And it is about the service provider being confident it can get its money back for any capital investment. It is about making it easy to compare different energy offerings, even though one may bundle in an EV and the other is a no frills energy supply contract. A lack of interoperability is already limiting innovation: SMETS1 smart meters are, for now, perceived as a barrier to switching between suppliers; If you buy an electric car, you have a boot full of different cables and potentially a dozen different charging cards for different points (thankfully the Government is already taking steps to rectify this, as well as the work of the Electric Vehicle Energy Taskforce, due to report in the autumn). But if we do not bake in interoperability, in its widest sense, across the energy system now, we risk branching to digital future that stifles innovation and makes consumers rightly nervous about getting locked in to bad contracts.

We need to learn the lessons from other sectors. Telecoms, with a hefty lean from Government, got its act together in Europe and developed the GSM set of standards. It helped create a common rulebook on which the mobile handset manufacturers could innovate. Cue one of the biggest waves of innovation ever (also helped by brilliant innovations like the iPhone, of course) and Europe and many European companies benefiting economically from that innovation. Getting ahead of this in energy is important. You need to send a clear signal to industry that you are taking digital interoperability seriously, and to provide a test environment where people can test the standards and the consumer protections that will be needed in the future energy system.

This could also enable a different approach to policy development. One practical example is the future of suppliers. New technology and innovators, many driven by a better understanding of the potential of data and digital than incumbents, are keen to try out new ideas that will improve the efficiency of the system and cut carbon (and make money). But doing so without becoming a supplier or partnering with one is difficult under our supplier hub model. Ofgem and BEIS recognise this risk (and the opportunities) which is why they have released the recent consultation on Flexible and Responsive Energy Retail Markets. But how do you test if particular changes will lead to undesirable consumer outcomes? It will be very hard in a paper-based consultation exercise. You need to understand how consumers and market players really respond. So if the Government is serious about unlocking the potential and managing the risks of a digitalised energy market, it should think about creating a telecoms-style kind test facility that allows industry to explore these issues[6]. The prize for the UK is significant. We have a thriving tech sector, consumers who are early adopters, and a regulatory regime which has led the world in driving innovation for 40 years. These are some of the reason the UK is home to so much FinTech innovation. We now need to do the same with for digital technologies in energy (not least to support out net zero ambition).

4. Nuclear. Despite the industry’s best efforts to prove the contrary (at least in the West), nuclear power does not have to be expensive. But current UK policy seems almost designed to make it that way. The developer-led model, designed when it was thought that mighty European utilities could finance almost any investment off their balance sheet, has been tested to destruction. The UK is not a big enough market for six different reactor designs. We need a new approach.

The consultation over whether future plants could be financed under the Regulated Asset Base (RAB) model is an important step. The financing for nuclear power should become more like a utility-style infrastructure investment, so that it can attract more private sector money (and accompanying rigorous scrutiny). While some will be attracted to other suggestions made by the NAO, including direct Government procurement, none of the options are simple, or remove some of the tortuous politics evident on recent UK projects.

But better financing is a necessary, but not sufficient, measure. It needs to be accompanied by a programmatic approach to the constructing of new reactors. Cost reductions have been evident internationally (South Korea most recently), but they are based on building the same reactor again and again, and learning each time. Basically, nuclear needs to follow the pattern of every product in the history of the world that has demonstrated cost reductions, including renewables. Nuclear needs to become a product, not a series of bespoke projects. But this means Government needs, to some extent, to drive the programme.

I tend to be more optimistic that commentators like Michael Liebreich in his recent excellent post, who say that such an approach will never work with the large-scale reactors that are being built today. More by accident than design, we have fallen into a situation where the learnings from Hinkley could be applied to the same reactor at Sizewell. If the timing is right and the Government does not dither on a decision on the later reactor, the same workforce can be redeployed and learnings captured into real savings. If the Government is to pursue a more programmatic approach, it needs to focus on both financial engineering and real engineering (and develop the expertise to assess the latter). And the industry needs to demonstrate it is prepared to learn from proximate industries who have experience of cost-falling engineering and look on in slight bemusement at the nuclear industry (shipbuilding is one example). Government should also be tougher on setting out a necessary cost-reduction path, as they did with offshore wind. If the lower prices in construction are not met, the Government must be prepared to walk away. Remember the offshore wind industry said a cap of £105/MWh could kill the industry when it was introduced. The next auction came in at £57.50/MWh.

I am also, like Liebreich, optimistic about the potential of small modular reactors (SMRs) to develop into products, with many components made in factories. But we should only move forward if we are clear there is a good chance of a significant market, both in the UK and internationally (this includes standardising nuclear regulation where possible). And we should think carefully about the types of more advanced reactor we want to develop; what are the characteristics of the system it is likely to need to fit into? Flexibility and heat are likely to become more important in a future net zero world.

But hold on, I hear you ask? Is the case for nuclear not irreparably damaged? Will ever-cheaper renewables and storage make it irrelevant? ESC’s analysis, which is supported elsewhere, is that the strategic case for nuclear remains robust in the UK, such is the likely huge increase in demand for electricity (although the case has weakened somewhat in recent years). Completely ruling out such reliable forms of generation, in my view, demonstrates a lack of understanding of the size and seriousness of the net zero challenge. The power sector faces some huge uncertainties:

· how much flexibility and of what type will be available. There remains significant doubt about how much consumers are prepared to use their cars as an add-on to the power system, for example;

· how quickly electrified heating and transport will come onto the system;

· how do you create the quantity of low carbon hydrogen you need to meet demand in even a moderate-hydrogen scenario (ie not domestic heating).

When faced with that level of uncertainty and the scale of net zero, you need to be hard-headed about developing options. Withdrawing nuclear from that list of options would be premature, although the success of renewables and storage is weakening its case at the margin. But, of course, nuclear’s strategic case is strengthened if costs fall safely, which is why it must be the focus of efforts.

The need for options also means that support for innovations like nuclear fusion remains strong. There are not too many industries where the UK is a genuine world-leader. Fusion, thanks to the brilliant team at Culham, is one of them. We are now, for the first time, starting to see private money investing in the technology. Progress in adjacent fields like big data, materials science and robotics is helping solve many of the barriers to the development of commercial fusion. The risks of climate change are too high to give up on such a technology.

5. Architecting markets. Since 2008, or probably since Project Discovery, the UK’s energy markets have changed significantly, particularly in power. New instruments have been piled upon new instruments to create a policy alphabet soup: ROCs; CFDs, FITs, CM, SEG, CCAs, ETS, CPS, CCL, ECO, WHD, WFP, RIIO piled on top of balancing markets and ancillary services markets and plenty more that only the likes of Nigel Cornwall will have heard of. But no-one has really stepped back and tried to work out how all these markets fit together, and what unintended incentives they are creating. The last attempt was probably the reforms that moved from NETA to BETTA, around the turn of the century. Dieter Helm, in his Cost of Energy Review, highlighted the problems such complexity created, and rightly called for simplification. In my experience, ministers have certainly felt frustrated when trying to balance decisions between whether to support large-scale or small-scale generation, and struggling to see how the different policy mechanisms fit together as part of the same system.

At the heart of this is a need to understand the architecture of the energy system, how all the pieces fit together. Such an approach (essentially a systems engineering approach) is not unusual in other complex industries, but for some reason it is absent in energy (apart from in specific activities, like the construction of nuclear power stations). I confess when I first heard the term ‘systems architect’ in an energy context, all sorts of ‘Return of the CEGB’ alarm bells started ringing. But, as on many things, I was wrong. Systems architecting, properly understood, is not about central planning or a return to the CEGB. Rather, it is about designing the architecture of the whole system, its markets and incentives, and understanding how the various bits fit together.

The reality is that BEIS is now the closest thing we have to a systems architect, although I imagine many occupants of 1 Victoria Street would baulk at such a description. But, despite all the brilliant people who work there, it is not really set up organisationally to think about the integration of the various markets, or to run a process that could move towards a better set of arrangements. Such systems thinking is unusual in Government, and systems engineers and their set of skills are as rare (with the possible exception of the MOD) as an MP unlobbied by Tidal Lagoon Power.

There are positive moves towards elements that such an architecting approach would need: the move to reform code governance is about as unsexy a topic as there is, but it is essential to improve the plumbing of the energy system; greater independence for the System Operator is another step in the right direction, which already appears to be having a positive influence that was hard to imagine a few years ago; and the Smart Systems and Flexibility Plan, which I mentioned earlier, will make a massive difference, if the key parts of legislation can find a brave enough politician to wade through the current Parliamentary quagmire. But much more needs to be done, if we are to unlock the potential of new technology and services to improve the efficiency and reduce carbon of our whole energy system. Setting up a process, either within BEIS or in an independent institution, to ‘architect’ the future energy markets, starting with power, could unlock lasting value and help reduce reliance on subsidies[7].

One area that needs early focus is the economic incentives to reduce carbon emissions. As ESC work has found, there is a complex and inconsistent set of effective carbon prices at different parts of the economy. In many cases, this means we are incentivising high carbon activity. At this point, the economist reaches for the economy-wide carbon tax. But the political economy of such taxes is, to say the least, not straightforward. So a sensible net zero approach will be flexible on the selecting the best instrument for different sectors. In some cases, perhaps in domestic heat, this could mean standards, which have been so effective in reducing emissions in transport, without damaging outcomes for consumers. To stress, carbon incentives on their own are not enough, but they are an essential driver of the innovation we need.

Of course, if we were really serious about net zero globally, we would be thinking hard about carbon border adjustments to ensure UK manufacturing and heavy industry are not disadvantaged by robust UK climate policy. I am not sure any idea I raised had such a strong reaction from officialdom when I was in Government, with talk of trade retaliation and diplomatic fallout. But times have changed. If we are going to have a trade war — as seems increasingly likely — we may as well have one over something important. Emmanuel Macron has raised the possibility of carbon border adjustment at a European level. Drawing on behavioural science, the late energy guru Sir David Mackay saw it as an essential part of a successful international agreement. Perhaps one to consider for London 2020….

This is not an exhaustive policy list, not even close. Net Zero will require action in every part of the economy. I have barely mentioned energy efficiency, or fuel poverty or industrial decarbonisation, all of which are huge issues and require renewed policy ballast. I have only touched on CCUS, which is probably one of the most important technologies to keep the overall cost of decarbonisation low, particularly when coupled with sustainable biomass. But while there are potential important innovations in CCS, deployment of existing technologies realises most of the system benefits. And that is about the commercials, as it has always been[8]. Government just needs to get started.

The overall approach for policymakers should be about creating an ecosystem where you give innovators the best possible chance of creating low carbon products and services that people want, and from which they can make a reasonable return. So there is consumer pull for the transition, not just Government push. Creating that ecosystem is about using markets, innovation support, regulation, pricing, subsidy, and competition so that the different instruments work together, depending on the specific characteristics of the challenge. Only such a whole system approach can meet the net zero challenge.

[1] A radical Government could always shift some of these essentially legacy innovation costs to general taxation…

[2] This also needs to join up with the network regulatory framework — and a real whole system approach would ensure interactions between gas and power are well understood and managed.

[3] We need to fix the green tariff system too, as well, but that is a blog for another day.

[4] You also need an environment where industry can test new ideas, without necessarily having to become suppliers. Luckily, the Government has supported Energy Systems Catapult to build a Living Lab, which can do some of this stuff (but we want to be able to do more). Get in touch if you want to work with us.

[5] Which was a big priority for the new Secretary of State, Andrea Leadsom, when she was an energy minister in DECC.

[6] Declaration of interest: we at ESC are proposing the development of such a facility, an evolution of our current , heat-focused Living Lab.

[7] Huge credit must go to the team at IGov at Exeter University, which has been looking at systems architect-type institutions as part of its energy governance work in recent years. Their latest summary paper is here (I stress that I do not agree with all aspects of its proposed reforms, but it is perhaps the most serious attempt to grapple with the governance of the future energy system).

[8] Local area energy planning as described in step one could be an important enabler of action here.