Merlin Weekly Macro: A question of energy security

It’s mid-January. It’s cold and miserable. The days are gradually getting longer but it’s still two months until the spring equinox; we all still have the lights on, possibly the heating too, for longer than we don’t. Access to electricity at the flick of a switch is something we take for granted.

Behold! Let there be light!

As your correspondent in these miscellaneous ramblings sits bashing his keyboard in Jupiter’s Victoria office, looking out through the dank, stygian gloom towards Buckingham Palace and Green Park midway through a wet Thursday afternoon, the National Grid Live website tells me that total current UK demand for electricity is 41.3 gigawatts (GW), met by 20.9GW (50.6%) from natural gas, 10.3GW (24.9%) from renewables (wind, solar, biomass), 5.4GW (13.1%) from others (nuclear, hydro) and 4.7GW or 11% is coming from “transfers” i.e. imports from neighbouring France, Holland, Denmark etc. Go back 12 hours to the dead of night when demand was slack at 30GW and the sun wasn’t shining (mind you, it isn’t now either), the gas was turned right down (2.4GW, 8%), wind was able to do the heavy lifting (16.8GW, 56%) but only thanks to a stiff breeze, nuclear was rock-solid steady at 3.9GW (13%) while the balance came through transfers.

We are neither self-reliant in electricity nor in the natural gas needed to fuel our base load generating capacity. Gas is highly versatile and efficient as a fuel, able to be turned on and off at will and nothing is wasted. At best at this time of year, the sun shines for much less than half the day and sometimes is mere ambient light rather than providing maximum energy from direct sunlight (whatever the weather conditions and the number of hours between sunrise and sunset, at this time of year the sun’s azimuth—the angle at which light strikes the earth-- is also sub-optimal for solar power generation). Finally, wind is variable: today the wind is blowing in the right places but during periods of high barometric pressure giving windless days, even the most efficient onshore turbines struggle to rotate.

UK: betting it all on red

The government is developing an unenviable record for handbrake turns with major policy initiatives (benefits reform, winter fuel payments, mandatory digital ID profiling for employment, farmers’ IHT etc). One policy, however, despite its obvious potential structural flaws, has proved enduring. Step forward Secretary of State Ed Miliband’s national energy strategy. Even if he now has a more constructive attitude to nuclear power both in regard to delaying the decommissioning of the obsolescent fleet of power stations and commissioning new capacity, Miliband remains dogmatic that he will fully decarbonise UK electricity generation by 2030. Despite the change of attitude towards nuclear, in the absence of gas it will largely be variable, unreliable renewables which he intends will power the UK beyond 2030.

USA: betting it all on black

It is a statement of the obvious that energy literally powers and drives the economy. Donald Trump has clearly identified that energy is a fundamental national asset; control, security, reliability and self-reliance are vital for growth and national resilience. “Drill, baby, drill!” is an unfashionable, controversial but very unambiguous national energy strategy: little did we know that it included not only the exploitation of the US’s own on- and offshore oil and gas capacity, but also taking control of Venezuela’s. But he is preoccupied with the future: he is not blind to the transition towards carbon net-zero; he is acutely aware of the potentially exponential demand for electricity as AI, quantum computing etc fulfil their potential. Hence his laser focus on control of or access to the rare earth minerals and ores in places as diverse as Greenland, sub-Saharan Africa, Siberia and south-east Ukraine. Trump fully recognises four aspects of economic wealth, growth, technological innovation and development: you need permanent, consistently available energy capacity; you need full control over it; you need lots of it; and you need to invest in even more of it (or pinch it). 

The UK is still the world’s sixth biggest economy. It remains an act of faith that Miliband and industry leaders are able successfully to reconcile energy security, generating capacity, the expected structural surge in demand and the significant changes in consumption patterns (we will all be plugging in our electric cars to charge overnight turning slack demand time to an oxymoronic state of perpetual peak usage; data centres do not rest) with a system reliant substantially on unreliable renewable generating sources. Battery storage technology is developing but is still technologically nascent on a national industrial scale.

Wind auction: fruitful but at a price

This week saw the latest annual licence auction for new off-shore wind projects in the UK. Unlike Auction Round (AR) 4 in 2022 (poor take up) and AR5 in late 2023 (zero bids) industry bids in AR6 in 2024 were better and AR7 announced in January 2026 were good with 8.4GW of theoretical capacity being awarded for development.

The wind auction works on a contacts-for-difference system under which the government underwrites a guaranteed backstop electricity price for developers over a fixed contract period. The idea is that it attracts private capital for national infrastructure leaving private contractors taking some but not all of the risk. If the wholesale market price for electricity rises above the strike price beyond which the contractor is making excess profits, consumers are reimbursed; if the market price is below, the government stumps up the difference which is eventually recovered from consumers through their bills. The developer’s financial risk is essentially defined by its ability to manage large infrastructure projects to time and budget, and in terms of the two components of revenue, limited to how accurate its forecasting models are at predicting generating output (i.e. volume) given the security offered by the backstop tariff (price).

The assumptions and calculations behind the auction pricing are immensely complex and the modelling highly sophisticated. Consumers are told renewables are “cheap” and that wind and solar will lead to lower bills. “Cheapness” is a comparative concept. For all that sophistication, what we do know is that economic circumstances and perceptions of future risks and therefore pricing can change such that project costs can escalate alarmingly quickly; noteworthy is that in the two years separating AR5 and AR7, the administrative strike price required to attract bids and to allow developers an acceptable rate of return doubled from £44/kw hour to £91/kw hour; not only that but the fixed contract period had to be extended from 15 years to 20; the government is on the hook for longer. Note that the strike price is index-linked. The government subsidy in this round alone amounts to £1.8 billion a year. In the end, one way or another, the consumer pays.

Load factors: theoretical v actual output

We specifically mentioned the qualifying term “theoretical” in the context of capacity. Wind is variable; it does not blow all the time. The difference between actual average annual generation and the theoretical maximum installed capacity is known as the load factor (effectively the average yield on the turbine fleet). In the UK, the average load factor for offshore wind is 38.1%. Unimpressed? It’s much better than the 25.3% for onshore (sea breezes are much more prevalent).

What it means in practice is at that yield, offshore wind needs three turbines to achieve the actual output that one single turbine is designed to deliver in theory; for onshore, it needs four. It is an inefficient way of deploying capital. But even that is a spurious calculation: you can plant as many of these things as you like but if the wind is not blowing, none will turn however many there are; and when the wind is blowing vigorously there is as yet no practical means of storing the surplus in bulk (wind generators are still paid for the output even if it is unable to be used; the compensation runs to around £2bn a year). Matching supply to demand is the ultimate challenge of all variable and unreliable generating systems in the absence of mass battery storage to act as a smoothing agent.

The UK currently has 9,237 onshore turbines with an installed capacity of 15.9GW; there are 2,878 offshore units with an aggregate 16.1GW, a total of 32GW. The plan says that by 2030 the installed offshore capacity needs to be 45-50GW with for 29GW of on-shore (say 79GW in total). While the load factors are increasing all the time (bigger turbines, improved blade technology giving greater efficiency etc), even the most optimistic forecasts see the UK’s offshore yield rising to no more than 57% by the end of the decade. It is reasonable to estimate that the blended average output from both types of wind power will be no more than 40GW.

Quantifying the demand-supply challenge

That’s the immediate outlook. A decade hence, the National Grid is assuming a 50% increase in annual demand for electricity from ~300terawatt hours today to ~450TWh in 2035. That will come through a combination of anticipated GDP growth, new housing, fuel switching through electrification of transport, industry and domestic usage as oil and gas are replaced, and accelerated consumption driven by the AI revolution. Total generating capacity will need to rise 138% from 104GW at the end of 2024 to 248GW by 2035. Why the apparent big discrepancy in growth rates between the two? In addition to strategic headroom, it is largely that we move from a system today where the permanent, reliable baseload capacity provided by gas which is almost 100% efficient and is somewhere approaching half the total installed capacity is replaced by variable and unreliable renewables which are less than half as efficient but are due to provide around 85% of all supplies. There is virtually no net increase in planned nuclear (i.e. permanent generating capacity) after the current ageing nuclear fleet is decommissioned and the new projects are online in the mid-late 2030s.

Then there is the grid.  All of this new electricity must be plugged into a significantly upgraded and expanded network capable of efficient transmission from sources of production to the principal areas of consumption. It requires a massive increase in investment in pylons, interconnectors and storage to deliver electricity with minimal frictional losses over hundreds of miles and on demand. Both the generating landscape and the physical landscape are going to change dramatically. We have barely scratched the surface.

Can it be done physically and technologically in time? National Grid says that to meet the target we need to be adding 15GW of capacity every year from now. Running into hundreds of billions of pounds, is it affordable? Can we afford not to do it? Obviously not.

Political perspectives: compare and contrast

Miliband’s and Trump’s are very different approaches to a common challenge.

The UK has, and under current structures will continue to endure, some of the world’s highest energy costs; Trump wants the lowest.

Trump’s intention is absolute certainty of supply and complete control over it, beholden to no third party; the UK will be increasingly dependent on imports to plug the gaps, particularly during prolonged periods of low barometric pressure in winter when demand is seasonally high but wind and solar are deficient; that gives political leverage to those such as France when satisfying a critical British need for energy.

As the Swedes have identified, long undersea transmission cables are highly vulnerable to attack from hostile submersible drones and hunter-killer submarines; Sweden has stopped all new wind development in the Baltic.

“Drill, baby, drill” in the US translates to “Drill? Don’t you dare!” in the UK: onshore fracking is verboten and the default position on new North Sea drilling licences is “No!” with the provision to buckle under political duress. Our loss is Norway’s gain. Miliband the idealist holds the moral high ground tackling climate change; Trump the pragmatist is prepared to be a pariah to maintain US economic and geostrategic competitive advantage.

By 2035, we will know which strategy was successful. In this highly dynamic period of intense international competition, the world will be divided into winners and losers. America is determined to win; we are hoping not to lose. The two are utterly different mindsets: one brimming with confidence the other keeping every finger and toe crossed. To keep the lights on and society powered and moving, what would you do?

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