The policy shift toward a net-zero United Kingdom continues to emerge, given strong momentum by the recent 26th United Nations Climate Change conference in Glasgow. With a bold target of a 78 percent reduction in economy-wide greenhouse-gas emissions by 2035, now enshrined in law, and the UK government putting the Green Industrial Revolution at the heart of its plans for a stronger post-COVID-19 economy, there is impetus for change.
Beyond environmental benefits, the energy transition will mean the growth of significant value pools in renewables (in particular, offshore wind), grid, flexibility and operability services, and new downstream. Among industry players, there is excitement about the opportunities within the sector, and investors anticipate a new wave of growth. However, unlocking potential value will not be easy and will involve addressing issues regarding security of supply, costs, demand stimulation, and pressure on returns.
In this article, we draw on modeling contained within the United Kingdom’s Sixth Carbon Budget.1 We consider the implications of the Committee on Climate Change’s modeling on the Balanced Net Zero (BNZ) Pathway, the central route to achieving net-zero emissions by 2050. Looking at electricity demand, technology, and the grid, we discuss options available to investors, regulators, policy makers, and energy companies as they consider how best to support the United Kingdom’s transition to net zero.
What Balanced Net Zero means for the energy sector
The BNZ Pathway anticipates a decrease in overall energy demand and a rapid switch away from fossil fuels (Exhibit 1). In this scenario, the majority of UK energy consumption will shift from fossil fuels to electricity (Exhibit 2).
In the BNZ Pathway scenario, electricity will experience a steep reduction in emissions by 2035, to 88 percent below the 2020 baseline, with the carbon intensity of generation falling by 93 percent between 2020 and 2035. Meanwhile, electricity demand is set to increase by approximately 50 percent by 2035 because of a shift from fossil fuels to electricity as the primary fuel in the transport and building sectors.
The expected increase represents a fundamental change in the trajectory of electricity demand, from flatlining over the past 20 years to growth at over 2 percent annually over the next two decades.2 Managing the twin objectives of decarbonizing supply and supporting demand growth poses a significant challenge (Exhibit 3).
The shift outlined in the BNZ Pathway described in the Sixth Carbon Budget highlights rapid scaling of new technologies for dispatchable generation (carbon capture and storage and clean hydrogen), likely as much as 7 gigawatts (GW) by 2035. The BNZ Pathway also highlights unprecedented growth of renewable electricity, with offshore wind power set to quadruple to 40 GW by 2030. In addition, there will be a material buildup of nuclear electricity, with 8 GW expected to come online by 2035. Further, new technologies will support grid flexibility and operations on the supply side (for example, synchronous capacitors and batteries) and demand side (such as demand-side response and vehicle-to-grid).
On the demand side, the BNZ Pathway will see nearly 25 million battery-electric vehicles on the road by 2035, and 600,000 heat pumps being installed annually by 2028. In parallel, electricity demand will increase with green hydrogen production. By 2025, 5 GW of low-carbon hydrogen is to be introduced—of which part will be green hydrogen.3 This will also require significant expansion, decentralization, and modernization of the grid to cater to higher demand, shifts in the peak load, and distributed and smaller generation.
The opportunity is real
Beyond the environmental benefits, successful execution of net zero—in particular, the electrification of transport and low-carbon heating—can support a more energy-efficient system. For example, electric vehicles (EVs) and heat pumps have intrinsically higher efficiency than internal combustion engines and gas heaters, holding out the potential for long-term affordability gains and unlocking new financial value pools.
Successfully transitioning to net zero, as laid out in the BNZ Pathway, projects a significant shift from traditional oil and gas to electricity and hydrogen. In this scenario, demand for conventional fuels will drop over time by 50 percent by 2035 and then decrease by 70 to 85 percent by 2050. Within power, profits will shift at a greater rate toward renewables, network, and new downstream; there will be pressure on conventional generation and, to some extent, traditional retail.
For renewables, the BNZ Pathway will result in significant growth, particularly in offshore wind, where the United Kingdom looks to be one of the world’s two biggest markets, with 40 GW planned for by 2030.4 Under this scenario, the grid will need significant investments and changes, as the role of the grid—and in particular the distribution grid—will shift toward an enabler of the energy transition and active energy manager (for example, distributed energy-sources integration, demand-side response, marketplace for flexibility services, and peer-to-peer transactions).
Retail value pools may be increasingly disrupted by technology and digitalization, which may both reduce costs to serve and decrease barriers to competition. New downstream products and services, such as low-carbon heating and EV services, are projected to grow, even as the path to a profitable and scalable business model remains unclear in some areas. Hydrogen is expected to be another significant area of opportunity, as a critical enabler to decarbonize industry, heating, transport, and (to an extent) electricity supply, with potential opportunities across the full value chain (Exhibit 4).
The challenges are real too
Achieving net zero in the electricity sector will require dramatic shifts, which may help address the simultaneous challenges of attaining financial sustainability, energy security, cost efficiency, and affordable and equitable tariffs. This is likely to require new forms of system-wide optimization.
Managing supply chain pressure. The scale of development needed may put the supply chain under pressure. The renewables value chain will need to scale up. For example, in the BNZ scenario offshore wind will need to be delivered at 3.0 GW of new capacity each year, twice the historic rate, while solar installations will need to increase 30-fold, to 4.7 GW per year. Delivering 8 GW of new nuclear on time and on budget is likely to represent a significant challenge. New interconnections may be needed for security of supply and flexibility, and significant investment in grid stability and modernization is likely to be required to manage a largely “nondispatchable” and noncontrollable supply. Long-duration energy storage can mitigate renewable variability, and virtual power purchase agreements with hydrogen or wind plants can offer low-carbon power 24/7.
Meanwhile, the UK economy, facing supply disruption from other factors, is experiencing shortages in key personnel, materials, and construction capacity. Ongoing nuclear projects are consuming large parts of the engineering and construction workforce in specialized roles, such as welding.
Investing significantly. Substantial investment will likely be crucial to help bring new technologies to cost-competitive prices. Emerging technologies such as carbon capture and storage, and hydrogen, which are currently unproven at scale, will be required. For example, there are not yet large-scale (more than 50 megawatts [MW]), operating combined-cycle gas turbines using hydrogen or carbon capture, utilization, and storage (CCUS), and the cost of CCUS abatement for natural-gas power generation is still in the range of $60 to $120 per ton of CO2.5
Considering cost efficiency. Because reduced electricity operating costs may not fully offset capital investment in supply and network infrastructure, cost efficiency will be a crucial area to consider. In addition, the cost structure is likely to become increasingly fixed (that is, renewables do not have fuel costs) while demand remains uncertain. A scenario with full (or prevalent) electrification of heating may lead to the creation of stranded assets, such as gas pipelines with low utilization, with operating and maintenance costs that will need to be addressed.
Stimulating demand. To get to scale, demand stimulation may be needed, with thought given on how to fairly allocate net-zero costs and overcome consumer reluctance. To appreciate the scale of the challenge, consider that achieving net zero will most likely require shifting 30 million households and thousands of industrial and commercial players to become active adopters of the new technologies, such as electric heat, hydrogen fuel, and EVs. As an example, the economics of low-carbon heating leveraging heat pumps are challenging compared with gas-based solutions, with a potentially long payback period. The UK government’s recent announcement of a financial incentive for installing heat pumps is one such example.
Addressing uncertainties. Finally, maximizing private investment is likely to require addressing significant uncertainties. In our discussions with industry players, it is clear that attracting capital at favorable terms fast enough to fund the BNZ Pathway will require addressing remaining uncertainties in the pathway choices and building confidence around the new business and commercial models. No one wants to “take venture capital risk with infrastructure returns,” in the words of one interviewee.
Addressing uncertainties and building confidence will likely require a range of measures. One potential element is to get clarity around the technology choices for heat decarbonization (through electricity or hydrogen or hybrid options) and hydrogen production (blue hydrogen versus green hydrogen, and standards for “clean” hydrogen). A second potential element is to map out the future for potentially stranded assets, such as gas pipelines, and consider how to allocate these costs. A third is to decide how to finance carbon capture and storage—recognizing potential broader systemic costs and benefits—and how to compensate carbon pipelines.
Delivering on the aspiration
Successfully meeting the 2035 carbon budget and setting the United Kingdom on a clear course for net zero will require all stakeholders to start thinking about what actions they will need to take now. Action can be considered in five areas.
Increasing access to affordable financing. Delivering the energy transition may necessitate unlocking significant new investment from the private sector. The government can help by considering how to create policy and regulatory certainty. In particular, the government may reflect on remuneration models for new technologies, and a financial framework that ensures fair returns to investors and fair allocation of costs to consumers, as anticipated by the new net-zero strategy. Investors may need to be comfortable committing capital to new business models with novel risk profiles and with building the relevant capabilities.
Innovating. The most successful organizations will be those that can develop granular market insights to identify and capture opportunities. Many companies are already investing in these capabilities. For example, critical success factors in building a heating business include micro-segmentation of customers by type of building, and identification of the trigger points across the customer life cycle for the adoption of low-carbon heating.
Capturing the net-zero opportunity will involve new business models, technology choices, and the ability to develop customer and market insights. Developments from innovative companies include new contract structures to integrate onshore and offshore wind, models to optimize offshore wind-farm connections, and partnerships to develop end-to-end hydrogen businesses (from green hydrogen production to demand stimulation). On the technology front, companies are starting to experiment to find the most effective solutions for meeting new needs, including long-duration storage and inertia services.
Bringing down costs. Delivering the transition is likely to require significant efforts on operating and capital expenditure, both to bring down the cost of new technologies to eliminate the “green premium” and to reduce the overall cost of construction and manufacturing, given the sheer scale of capital investment involved.
- Achieving capital execution excellence. Given the scale of capital investment, it will be essential to bring down the cost of project development and execution. A holistic approach to the modularization and standardization of projects can enable as much as a 30 percent improvement in productivity and cost efficiency. This will include not only engineering, but also project delivery, interfaces, supplier ecosystem, and personnel and resources planning.
- Accelerating adoption of technology. Technology trends, such as next-level process automation, next-generation computing, applied AI, and cloud and edge computing, have the potential to disrupt traditional cost structures in the energy sector. Leading adopters are already able to achieve significant cost and quality advantages, such as excellence in the adoption of platforms and end-to-end data management.
- Redesigning the operating model toward higher cost efficiency to deliver at scale. For example, delivering at-scale low-carbon heating may benefit from adopting standardized design, investing in R&D to accelerate development of new lightweight and highly insulating materials, preassembling products, automating and digitalizing construction, and optimizing logistics (for example, via regional distribution hubs to preassemble and store materials).
- Getting to minimum viable cost of early-stage technologies. Many of the technologies likely to be necessary to achieve the energy transition still have a high green premium. Governments around the world are beginning to target investment to bring these costs down.
Uplifting capabilities and transforming operating models. Incumbents may also need to uplift the capabilities of people and systems to optimize solutions within a much more dynamic distributed energy system and develop more agile operating models that will help them thrive as the market continues to evolve.
Building these new capabilities will involve both significant talent acquisition and reskilling across the board. For example, achieving the energy transition in buildings will require a major scale-up in workers skilled in retrofitting, including a significant increase in general installers, specialist heat-pump installers, and associated managerial and professional roles (Exhibit 5). Companies and the government may need to look to reskilling programs and proactive talent pipeline management to ensure the skills system is delivering necessary capabilities.
Recognizing the more dynamic market environment, one key reflection for companies is whether they have the right organizational operating models in place to move at the speed needed to capture opportunities and to build new businesses while retaining deep expertise, operational excellence, and delivery focus.
Shifting customer attitudes. For customers, the transition to net zero may involve increasing comfort in adopting new technologies—in particular, on low-carbon heating and transport—and a shift toward consideration of whole-of-life energy costs. For example, adoption of EVs may reduce the overall energy bill, as EVs are more efficient than conventional internal combustion engine vehicles, but EVs will raise the pure electricity bill, while heat pumps deliver a significantly different heating experience.
To help encourage customers in moving from compliance to consent to championing the transition, companies can provide open and transparent communication on risks and safeguards of new consumer-facing technology, on topics such as hydrogen blending into home gas supplies.
Regulators can consider how customers receive trusted information on issues that are harder to understand, such as the expected payback period of solar, heat pumps, etcetera. Just as consumer information on diet can enable people to make better choices, information on energy options can benefit customers as they consider adopting new practices.
Finally, companies can also help with consumer uptake by making the journey as smooth as possible, such as providing one-stop-shop solutions for low-carbon heating replacement or EV adoption.
Delivering on the stated aspirations of the Balanced Net Zero Pathway will involve unprecedented changes to the energy system. The environmental and economic opportunities are exciting and potentially transformative, but the risks and challenges to security of supply, cost efficiency, financial sustainability, and affordability are also significant. Stakeholders—including investors, regulators, policy makers and energy companies—have choices that may help unlock these opportunities and mitigate risks. These include increasing access to affordable financing, adopting innovative business models and technologies, bringing down costs, raising capabilities, and turning customers into champions.
