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UK power reforms: Whatever happened to the free market?

The UK has unveiled sweeping energy market reform proposals to incentivize the à‚£110 billion ($173 billion) investment in new power stations and grid upgrades that is needed by 2020. Nuclear power is a clear winner, but the proposals sound the death knell for Britain’s free market model.à‚ 

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Twenty years after introducing a pioneering privatization programme, the UK Department of Energy & Climate Change (DECC) has unveiled radical changes to its electricity market structure, as the current model will not deliver the estimated à‚£110 billion ($173 billion) power industry investment needed by 2020 to replace aging plant. These changes mark the end of the UK’s long-held adherence to an ideology that states the market knows best and in effect returns the country to a state-directed power generation mix.

Britain’s electricity market is an ‘energy only’ market: generators are paid only for the electricity generated and not for also making generating capacity available to the market as in Ireland’s and Northern Ireland’s Single Electricity Market, for example.

This ‘free market’ model was designed to increase competition between generators to drive power prices down. To this end it has had some limited success, but it has offered the dominant ‘Big Six’ utilities (British Gas, Scottish Power, E.ON, RWE, EDF and Scottish & Southern Energy) insufficient incentives to invest in new capacity to replace Britain’s aged fleet of power stations.

Left to its own devices, the industry will, and is, building a few CCGTs. And why not? CCGTs are quick, easy, relatively cheap to build and rising fuel costs can be easily passed on to the consumer.

As intermittent sources of generation are ramped up, however, even the building of low-risk gas plants is under threat. An increasing volume of wind will push real-time power prices negative at times of high output/low demand and the inherent uncertainty with volatile power prices has made the existing ‘energy only’ model untenable.

Under the new proposals, the UK will return to a capacity payment mechanism to incentivize the construction of back-up plant such as gas fired power stations in order to handle surges in demand and intermittent supply from wind and other renewable sources. Generators will be rewarded for the availability of plant, even if they are not generating electricity.

The capacity payments would also pay to import electricity from European countries whose peaks differ from the UK, thus saving on the need for new plant. Utilities could also contract to generate ‘negawatts’, i.e. provide reductions in demand at peak times, for example by temporary switching off appliances such as fridges or the suspension of industrial processes. Payments would also support off-peak storage schemes.

Another proposal is for the state to introduce a guaranteed minimum price for carbon to offer greater long-term certainty to investors around the greater cost of running polluting plant. The consultation document proposes introducing a floor price of à‚£20, à‚£30 or à‚£40 per tonne of CO2 in 2020, with the final decision to be taken by the UK Treasury as part of its 2011 Finance Bill.

More radical is the proposal to rip up the existing Renewables Obligation subsidy scheme in 2017 and replace it with a feed-in tariff with long-term contracts to give low-carbon investors, including in nuclear power, a guaranteed power price. Under this scheme the UK government would pay low-carbon generators if wholesale prices fell below the contracted price, but it would also recoup money if prices rose above the agreed price.

These long-term capacity contracts could be awarded by the government via “regular”, possibly annual auctions, says DECC. The investor building plant at the lowest cost could win the contract, it says.

UK energy secretary Chris Huhne has unveiled sweeping electricity market reforms

Needless to say, these proposals are far removed from the current ultra-liberalized model where the market is left to decide what power plants are built with the minimum of market interference by the state. While energy secretary Chris Huhne was at great pains to stress nuclear is not being given special treatment, it is obvious these measures effectively comprise a state subsidy programme for the construction of a new fleet of nuclear power plants.

Time will tell whether or not Britain will witness construction of the 8″10 nuclear plants it wants to see. While the reforms would negate power price risk, major doubts persist over the construction risk of new build nuclear, as the commercial disasters at Flamanville 3 in France and Olkiluoto 3 in Finland testify. As generous as the UK is being to nuclear developers, Huhne says the project developers will bear the brunt of any construction over-runs and absolutely not the consumer.

While power prices may be fixed, Chris Huhne is a firm believer in competition, and the UK’s reforms have been designed to attract new investors in the power industry. Pension funds, insurance companies and other institutional investors are likely to be tempted by the new measures to build power stations and sell electricity in the wholesale market, he says.

Extra competition should loosen the stranglehold on generation the Big Six have enjoyed for too long in Britain. This may be the most radical change of all.

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