What do we need to do to solve the simultaneous energy and climate crises?
What do we mean by the energy crisis?
There are various energy crises (high prices, unstable suppliers, resource depletion?). One possibly serious energy crisis is the potential shortage of electricity generation capacity.
For example, by 2015, the UK might have only 80% of the generating capacity that it needs.
What are the reasons behind this ’energy gap’?
Firstly there is a closing of existing capacity: both of old nuclear power stations coming to the end of their lives and of dirty coal power stations being closed down due to EU regulations: see this report p11-13.
Secondly, there is large uncertainty in the market.
Uncertainty leads to:
a) returns need to be higher or else investment won’t take place 
b) investment may be delayed, especially if a delay will lead to the resolution of uncertainty 
The problem now is that there is severe uncertainty over the future of the energy in this country. The government has assuaged some of the regulatory uncertainty by making strategic statements about the future of nuclear, renewable and fossil fuel energy. But there remains great financial uncertainty.
Each power source has its’ own uncertainties
a) Gas: the fuel is now hugely expensive, making this source uneconomic if such prices were to be maintained
b) Nuclear: nobody has built a nuclear power station in the UK since Sizewell: there are considerable price escalation and legal risks. A power station can be built in 7 years but with all the regulatory and public opinion hurdles new power is unlikely to come on stream before 2020. The government was 5 years too late in it’s decision.
c) Renewables: the Renewables Obligation, unlike the German system of ’feed-in tarrifs’ provides a highly uncertain return
d) Carbon Capture and Storage (coal or gas): again we don’t know the exact cost until the plant has been built. Any plants built by 2015 would be ’demonstration’ plants.
e) Coal. The dirtiest energy source of them all. The price of energy in the form of coal is a lot lower than the price of energy in the form of natural gas or oil. However, is the European Emissions Trading Scheme carbon price sufficient to control the price?
In this sitution, gas is ruled out as too expensive. renewables may happen if they can get through planning, nuclear is too late for 2015 but could make a significant impact from 2020 onwards. We are stuck between the rock of our climate change ambitions and a hard place of the investment response of low-carbon electricity to current ambitions. What we need is strong incentives for investment and in particular strong incentives for low carbon electricity. My next post will explain how this can be done.
 uncertain cashflows will lead investors to require a higher return in order to compensate for the risk. in otherwords people will invest but only if the price is right.
In otherwords, uncertainty may lead to less investment and the prices of that investment may rise to compensate investors for the extra risk incurred.
The relevant theory of this is known as certainty equivalent. Under certain conditions, an investor’s aversion to risk can be represented by a higher or ’risky’ discount rate. For a full account of the relation between the various ways of representing risk in investment decision see Rothwell and Gomez (2003) "Electricity Economics", IEEE press, NJ, USA pages 53-74
If governments make investing more risky than it needs to be, then electricity consumers (industry and the public) are likely to have to pick up the bill in higher bills or blackouts.
 If investment is irreversible there is a further effect. Real options theory shows that a combination of irreversibility and uncertainty can lead to investments being delayed. See for example Dixit and Pyndyck ’Investment Under Uncertainty, Princeton.