The power industry has had its say over the UK Department of Energy and Climate Change’s landmark Electricity Market Reform proposals. The consultation closed in March of this year to a mixed response. Is the reform all it promises to be: a quantum leap in securing Britain’s low-carbon future? Or merely a leap of faith?

Chris Webb, UK

UK Energy Secretary Chris Huhne’s ‘seismic’ plans for Electricity Market Reform (EMR), announced last December, were in hindsight trumpeted with a few ill-chosen words. Just three months later a very real seismic event in Japan was to violently shake efforts to redraw the map of power provision for a low-carbon future including nuclear power.

The UK government maintains that the EMR remains on course, with the promise of securing investment in cleaner, greener power, while delivering diversity and security in the supply of affordable energy for decades to come.

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OUT – Wylfa nuclear power station in North Wales, commissioned in 1971, is due to be shutdown in 2012
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IN – the 842 MW Marchwood combined-cycle gas turbine power plant, which was commissioned in 2010

But industry is not quite so sure. Opinion is split into two distinct camps with the demarcation clearly defined between proponents of renewables and conventional sources. And events in Japan are not the only cause for dissent.

Volker Beckers, CEO of RWE npower, believes the coalition, less than a year into its term, has set its sights too high and has missed a trick or two along the way. “The EMR proposals risk trying to fix everything at once – increasing uncertainty for long-term investments rather than minimizing it during this critical time.

“[The government] wants to pull a lot of levers all at the same time. I would say pull only one at a time. That way, you remain in control. We believe that the overriding concern must be to create the right investment conditions to support the delivery of large-scale, low-carbon generation, such as Round Three offshore wind farms and the first wave of new nuclear power [plants]. This is what the UK will need to meet its energy challenges.” 

Sticking to nuclear guns 

Beckers made his comments on 10 March 2011, the day which saw closure of consultation on the EMR proposals that will pave the way for a White Paper on the future of Britain’s energy policy before the summer recess, and the very day before the devastating earthquake in Japan.

Any consultation is, of course, destined to highlight individual vested interests and the EMR is no exception. RWE npower, which shares a joint venture with E.ON in Horizon Nuclear Power, a company which is chasing a potential £15 billion ($24 billion) worth of new plant, is sticking to its nuclear guns.

Alan Raymant, Horizon’s chief operating officer, acknowledged the earthquake and tsunami in Japan had shocked the world and that problems with the Fukushima Daiichi nuclear plant had to be taken very seriously by the nuclear industry. But, he said, pursuit of “safe, clean nuclear power generation” remained the company’s goal. Horizon is considering building a new power station at Wylfa on the Isle of Anglesey.

Nuclear problems aside, important though they will prove to be in light of the events still unravelling in Japan, returns to the EMR consultation have highlighted a raft of concerns shared by many key operators. The government’s plans to introduce a carbon price support mechanism have received a particularly unwelcome response.

Many regard the move, effectively setting a ‘floor’ price for carbon, as a tax to raise revenue rather than an incentive to build low-carbon plant. Other unpopular proposals include replacing the Renewables Obligation scheme with long-term government contracts for difference (CfD), which some have likened to power purchase agreements for low-carbon technologies, and an Emissions Performance Standard (EPS) for fossil plants.

Yet few deny that a major shake-up in the electricity market is necessary to push forward the scale of investment necessary to meet government’s low-carbon objectives. Unveiling the Department of Energy and Climate Change’s (DECC) ambitious EMR plans to Parliament last December, Huhne said they would require a whopping £110 billion of infrastructure investment by 2020. 

Once in a generation opportunity? 

Huhne described the proposals as a “once in a generation” opportunity on the scale of privatization in the 1980s. There was no time to spare, he continued, as Britain faces a looming energy crunch. By 2020, a quarter of all generating capacity must be replaced and 30 per cent of all electricity will need to be low-carbon, compared with just 7 per cent at present. The shake-up was necessary, he said, because of the way the market currently works – effectively encouraging suppliers to build low-cost, low-risk, gas fired power stations. The reforms aim to address investors’ concerns about the long-term payback from low-carbon generation with higher upfront capital costs, such as wind farms and new nuclear power stations.

So, what exactly is proposed in the EMR? The EMR sets out four key proposals:

  • A carbon price floor – a tax on fossil fuels supplied to all electricity generators, including CHP stations, to be introduced from April 2013;
  • Feed-in-tariffs (FiT) – to provide greater revenue certainty for low-carbon generation, either in the form of a two-way CfD (the government’s lead option) or a premium FiT (PFiT- the preferred alternative);
  • Targeted capacity payment – an incentive to encourage the construction of reserve plants or demand reduction measures to ensure there is an adequate capacity safety cushion as the amount of intermittent (e.g. wind power) and inflexible low-carbon generation increases;
  • An EPS – a limit on the amount of carbon any new generating plant can emit, particularly coal fired power stations (encouraging the inclusion of carbon capture and storage). 

Lukewarm response from utilities

Energy companies responded with a warning that they alone cannot achieve everything on the EMR’s challenging agenda, and external investors will be needed. Beckers summarized the mood: “We will need investment from third parties not used to investing in energy projects, and it is what they make of the government’s proposals that will really matter.

“The contractual incentive arrangements for large-scale, low-carbon generation proposed by the Government, either as a CfD or a PFiT, should therefore be the principal focus of the EMR. Other concerns should not interfere with this focus and risk delay in implementation.”

On the question of low-carbon generation incentives, Beckers believes any low-carbon support mechanism should be targeted at getting Round Three wind, new nuclear and CCS retrofit to demonstration projects delivered.

“A contractual revenue support mechanism is best suited to satisfying the requirement of investors to have stable predictable and transparent returns commensurate with project risk, independent of the exact mechanism (CfD or PFiT) chosen,” he said.

“Both a CfD and a contractual PFiT could be designed to deliver investment in large-scale, low-carbon generation. As currently framed in the consultation, a CfD appears to most closely offer the regulatory certainty our investors are seeking.”

The continued delivery of renewable projects is also highly important, says Beckers. “We believe it is therefore critical that government provides early clarity about transitional arrangements, in particular the provision for grandfathering and the future operation of the Renewables Obligation [RO].”

On the third key point outlined in the EMR, Beckers was sceptical about its plans for capacity mechanisms. “We do not believe that the case for considering a capacity mechanism as part of the EMR has been made. The introduction of a capacity mechanism now will undermine the capability of the market to deliver an efficient combination of generation capacity and demand response at the lowest cost to consumers. Experience around the world suggests that capacity mechanisms have a number of undesirable effects on the economic and efficient operation of electricity markets; [in effect] they undermine the efficient development of demand-side response, storage, interconnection and energy efficiency.”

On the subject of carbon price support, he is equally scathing: “Support through this mechanism will not provide the necessary certainty to drive investment in new large-scale, low-carbon generation. The mechanism will in effect end up as a tax to raise revenue. RWE continues to support the European Union’s Emissions Trading Scheme [EU ETS] as the principal mechanism for setting a carbon price.

“The timing of its introduction will also send a critical signal to external investors, particularly if its introduction is not coordinated with the incentive mechanisms for low-carbon projects, and will simply produce a windfall for those companies with legacy plant that gain from it.”

He added: “The introduction in 2013 will not encourage investment in new low-carbon generation which will not be commissioned until 2018, and yet will hasten the closure of current fossil fuel plant that is vital for security of supply.”

On the fourth key element of EMR, the introduction of an EPS, Beckers said the proposals only served to duplicate existing government policy for new coal plant, and that it was unlikely to provide any additional certainty or incentive for investors in low-carbon generation. “It could potentially also discourage investment in flexible gas fired generation [that is] needed to maintain security of supply and provide flexible back-up generation to enable further investment in renewables.”

Sara Vaughan, director of regulation and energy policy at E.ON, said much still depended on the coherence and sustainability of the overall EMR policy package if it is to be successful and achieve all the government’s aims.

“It is now generally accepted that the existing market won’t deliver sufficient large-scale investment in new low-carbon generation in the timeframe needed to meet our climate change targets,” she said. “We need a market framework that not only fairly rewards those willing to invest but also provides opportunities for energy companies like E.ON to engage [with] customers so that they can play their part in achieving this country’s aims.” 

Don’t forget the consumer 

She said electricity market reform went “right to the heart of the trilemma” facing policymakers. “As well as ensuring we meet the country’s targets on carbon reduction, it’s vital that no-one forgets the needs of the customer; they have a right to expect reliable and affordable energy alongside lower carbon energy.

“Ensuring our homes and businesses are energy efficient and properly insulated is critical to help consumers manage the additional costs that new investments imply.” Overall, she added, E.ON was “pleased” with the progress made to date on EMR and “looked forward to more detailed proposals in the White Paper. By making energy cleaner for the environment we don’t want to make it worse for consumers. We need a market that recognizes the additional costs connected with investing in low-carbon generation, but it is vital that the customer is not forgotten in this process.”

Vaughan said a CfD would provide more certainty for investors with a consistent, known payment and could help reduce market risk, providing more security to make long-term investment decisions. But carbon price support was not E.ON’s favoured mechanism to deliver cleaner energy. “It is a tax not an incentive,” she told PEi. “It risks increases in consumer bills and low-carbon investment can be driven by a CfD without a floor price.”

Moreover, she said: “An EPS is unnecessary. It could substantially increase the risks associated with new investments. It’s also not necessary to prevent unabated new coal – existing consenting policies already guarantee this.

“While capacity payments are proposed to provide flexible back-up to help maintain security of supply, wherever possible markets should be allowed to function without intervention and capacity payments should be considered only if there is clear evidence that security of supply is at risk.” 

EDF warms to carbon floor price 

But the proposed carbon price mechanism has not alienated everyone. Speaking as the consultation closed in March, Vincent de Rivaz, EDF Energy’s chief executive, said the suggested carbon price mechanism was a first step in the delivery of secure, affordable low-carbon energy. He said: “We must deliver, not delay, on the legislation to meet the UK’s pressing energy challenges.” Setting out what he said was a “holistic approach” to market reform, he commented on the proposed carbon price floor: “[It] will remedy the failings of today’s trading scheme. Our own analysis indicates the second price scenario in the Treasury’s consultation stands to strike the right balance for customers and industry.

“Second, capacity payments, which will reward investment in firm, available generation. They will provide the security of supply we need as more intermittent generation is placed on our grid. Finally, CfD will address risk and volatility in the market, providing greater certainty for customers and investors, and delivering the lowest possible costs.”

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Time-weighted consumer electricity prices (£/MWh, real 2009 prices) Source: DECC

Overall, said de Rivaz, the reforms the government had set out were fair and in the interests of consumers. “They will encourage investment, establish secure and low-carbon electricity and help keep future bills lower than they would otherwise be.” EDF Energy plans to build four new nuclear power plants in the UK with partner Centrica.

De Rivaz said the EMR reflected a “broad consensus” and that a robust carbon price and other market reforms were in the interests of consumers and the environment. “It creates a momentum that triggers the path to implementation in 2011. We are looking to drive about £20 billion worth of investment in new generation, working with our partner Centrica, to be on stream from 2018”.

EDF has much at stake in Britain’s nuclear future, and is keen to see it maintain its pre-Fukushima course. De Rivaz pointed to the overwhelming Parliamentary vote in support of regulatory justification for nuclear new build prior to events in Japan. It demonstrated, he said, the government’s commitment to delivering the right investment framework. 

Renewables sector gives EMR the thumbs-up 

Not surprisingly, perhaps, the EMR has been given a largely resounding thumbs-up by the renewables sector. In its response to the consultation, RenewableUK, which is the new name for the British Wind Energy Association, said it supported the government’s long-term objective of decarbonizing electricity generation.

“We also acknowledge that reform of current electricity market arrangements is required to accelerate investment in low-carbon generation. Given the government’s intention to move to a new system of support, we now hope to work constructively with DECC to forge a workable system.”

So far as its members are concerned, the RenewableUK statement said they were not opposed to a CfD mechanism in principle; however, it was essential, it said, that the implementation of the CfD addresses “basis risk and offtake risk” and that the mechanism underwrites market liquidity.

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The UK has pinned its hopes on offshore wind power in order to hit renewable energy targets Source: Vattenfall

“Of the options presented in the DECC Consultation, we believe a premium feed-in tariff provides the most certainty to renewable generators and investors; is closest in design to the RO [which its members have enthusiastically supported]; and will cause the least amount of disruption to current and planned investments. Offtake risk is also an issue with the PFiT.”

RenewablesUK added: “Sufficient liquidity in the wholesale power market is essential to the EMR’s success. It is not clear how the proposed reforms deliver it. We would prefer to see proposed changes relating to liquidity included in the EMR rather than as a parallel work programme undertaken by Ofgem.

“Neither the CfD nor PFiT includes an incentive for suppliers to buy output from renewable energy generation. Its removal from either option exposes new projects to a higher level of offtake risk than has been the case under the RO. We agree that a capacity price mechanism has the potential to offer investors greater revenue certainty, but it may also undermine the case for commercial investment in peaking capacity.”

But what of consumers – and particularly the business sector? What of their response? It is one that RWE npower has been keen to determine. David Cockshott, director of industrial and commercial markets, said his company’s poll of major energy users showed there were areas of the policy where businesses need further clarification.

“Of most concern was the proposed carbon floor price, which over half of the organizations (57 per cent) think will lead to an increase in energy bills for businesses.

“With companies already subjected to a number of ‘carbon taxes’ – the Climate Change Levy, CRC [the Carbon Reduction Commitment Energy Efficiency Scheme] and the EU ETS – there is the concern that the EMR is too ‘nationally’ rather than ‘globally’ focused, and will have an impact on the competitiveness of UK companies on a worldwide business stage.

“It is clear that businesses report very real concerns regarding the proposals in the EMR, particularly while the UK economy is still so fragile, and it is important that the impact the reform strives to achieve is promoted and incentivised to ensure businesses can see the benefits of the proposals.

“At the moment, many of our customers see the proposals as a ‘stick, not a carrot’ and it is important that this is considered seriously to get the support of major energy users.” 

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