Lessons from Carbon Budget 7
Getting to Net Zero is harder than you’d think. Governments need to be advised so they can legislate accordingly. The Climate Change Committee (CCC) is the advisor of choice for the UK government. The CCC is an independent advisor, that reports to the UK and regional governments on how to reduce emissions and on how to adapt to climate change.
Now, the UK has legally binding targets: Net Zero by 2050, and a 89% emissions reduction by 2040. To help the UK hit this, the CCC publishes five-year carbon budgets, and these interim targets define the glide path to Net Zero. The benefit of this approach is that each new budget can use the most recent information about technology, prices, consumer behaviour and public finances. The CCC has published seven budgets to date, the most recent of which was published last week and covers the period 2038 - 2042.
Looking at the UK’s glide path, we see that we’re on track so far. We’ve halved our net emissions from 1990. This is a great accomplishment, especially when you consider GDP and population growth. If net emissions have halved, emissions per unit GDP and emissions per capita must have increased even further (as both denominators have increased).
So what’s new? And what are the key takeaways for us?
Firstly, the focus on the built environment is growing. The majority of emissions reductions from the first three budgets (2008 - 2022) came from decarbonising energy supply (53.5% of emissions reductions). This notably culminated in the UK being the first G7 economy to go coal free, only 142 years after the world’s first public coal power station opened in London. But, decarbonising energy supply is the “low hanging fruit”. Over the next three carbon budgets (2023 - 2037), the focus shifts. By the seventh carbon budget (CB7), buildings are the most important sector, responsible for 25% of all emissions reductions.
We can see this in the CCC’s sectoral emission analysis. Electricity supply was the highest emitting sector until 2015, where surface transport took the lead. Today, residential buildings and industry take second and third place (with non-residential buildings in 9th place).
Their advice for buildings is simple. Heat pumps. They confirm that hydrogen for domestic heating is dead, and heat pumps are the way forward. This doesn’t come as a surprise to anyone - we said the same in Jan 2024 - but hopefully government will listen. CB7 states that we need 50% of homes in the UK using a heat pump. Today, we’re at 1%. This growth rate seems untenable, but they claim that other European countries have managed it (Ireland and the Netherlands).
CB7’s view on heat pumps seem realistic to me. Their modelling is based on people switching when their current heating systems reach the end of their natural lifecycle. This reflects the reality: most people don’t actively think about changing their heating system. Instead they react when their current system stops working.
However, CB7 are concerned about the economic argument for heat pumps and here’s where I disagree with them. Their price forecasts for heat pumps have air source heat pumps priced at £10.9k today, and falling to £7.3k by 2050 due to economics of scale, established supply chains, and learning-by-doing. They don’t give new technology enough credit. In the last few months we’ve spoken to heat pump hardware and software plays who can already give material price and cost savings for heat pump installs. Some of these startups are even claiming that their heat pumps will reach price parity with gas boilers in the next year. This would be revolutionary.
But, say their price forecasting is correct. What does that actually mean for capital required to decarbonise? Well, we can see the abatement costs for different sectors below. If CB7’s abatement analysis shows that electrifying transport and bringing on renewables have net savings. Actions higher up the abatement curve (going right) transition from net savings to net costs (with the transition point just before industrial electrification). Buildings (resi and non-resi) are firmly in the net costs camp. Again, CB7 says that decarbonising buildings will require a lot of CapEx, that may not necessarily lead to net savings. I see this is a win. Legally binding targets require us to fix these sectors. Doing it today would destroy value. And so, innovation can fill the gap. If I were a founder, I would target industries on the right of that graph. I would avoid electric cars entirely, because one could argue the problem is “solved”.
CB7 is a lot - I could spend weeks unpacking everything there. But, to keep things brief, my call to founders would be the following: if you’re building anything to electrify industry, decarbonise buildings, or our supply chains, reach out. The tailwinds are only going to get stronger.