A draft Energy Bill was announced by the UK’s Secretary of State for Energy and Climate Change at the end of May but has been heavily criticised by the House of Commons Energy and Climate Change Committee in a report published on 23 July.

The draft Bill is the latest stage in the UK Government’s planned electricity market reform (EMR) which will radically reform Britain’s electricity market which has been largely de-regulated and open to competition since privatisation of the electricity industry over 20 years ago.

The stated purpose of EMR is to deliver secure, affordable and low carbon energy by establishing price mechanisms designed to support investment in new generating capacity and an improved transmission network.

There has been relatively little investment in generation in the UK since the so called “dash for gas” (construction of a large number of combined cycle gas turbine plants) in the 1990s.  As a result, there is a great deal of old plant which needs to be replaced – perhaps a third in the next decade – and additional capacity is required to meet projected increases in electricity demand.  At the same time, the UK Government is committed to reducing greenhouse gas emissions by decarbonising generation and to having 15% of the country’s energy needs (around 30% of its electricity) met from renewable sources by 2020.   

The International Energy Agency puts the investment needed at £110 billion by 2020 (£75 billion in new generating capacity and £35 billion in improvements to the transmission network).  This compares with current investment of around £4 billion a year.

Against this background, the UK Government decided that radical reforms were necessary and, following a consultation process, a White Paper on EMR was published by the Department of Energy and Climate Change in July 2011.   

The Energy Bill will set out the proposed primary legislation which the UK Government plans to have in place by the end of 2013 but this will only provide the broad legislative framework for EMR with many details needing to be implemented through secondary legislation and changes to codes and licences.

EMR will consist of a number of key measures, including:

  • Low carbon generation support through “Feed-in-Tariffs with Contracts for Difference” (CfDs) to provide stable and predictable prices for companies investing in low-carbon generation;
  • Introduction of a capacity market providing incentives to ensure the availability of sufficient generating capacity to provide security of electricity supply;
  • Introduction of an Emissions Performance Standard (EPS) limiting carbon dioxide emissions from new fossil fuel power stations.  The effect of this will be to prevent construction of new coal-fired plants unless capable of carbon capture and storage (CCS).
  • Transitional arrangements.
  • Appointment of the System Operator, National Grid plc, as the EMR delivery body (to administer CfDs and the capacity market) and arrangements regarding possible conflicts of interest on the part of the System Operator.

The UK Government’s original EMR proposals contained another key measure – introduction of a carbon price floor, but this has already been covered in the Finance Act 2011.

Contracts for Differences (CfDs)

The CfDs are intended to provide generators of low carbon electricity with stable prices for the electricity they generate by setting a “strike price”, with the generator receiving (or paying back) the difference between the strike price and the market reference price.

The draft Energy Bill proposes a “multiparty payment model” whereby the liability to make payments to a generator under a CfD would be borne collectively by all electricity suppliers.

It is envisaged that there will be a minimum strike price for each technology (with strike prices up to 2017 to be announced next year) but some strike prices, particularly for nuclear and CCS, will be decided on a project-by-project basis.

Although the UK Government will initially set strike prices administratively, it proposes a move to auctions at least for some renewable energy technologies, from 2017 and seems determined to influence the generation mix by having different strike prices for each technology (at least until 2020), with offshore wind and nuclear likely to get strong support notwithstanding concerns as to their cost.

Prior to introduction of auctions or some other tendering process, it is proposed that prospective renewable energy generators should be awarded their CfDs through participating in allocation rounds, with the volume of contracts on offer reflecting both the UK Government’s renewable energy targets and financial cost caps (reflecting the Treasury’s cap on green levies) to be established through secondary legislation.

It is proposed that CfDs for renewable energy projects will have a duration of 15 years while those for CCS projects will only be for 10 years and those for nuclear are likely to be for more than 15 years.

Capacity Market

The UK Government believes that a capacity market is needed to ensure that there will be sufficient plant available to prevent future blackouts.  In part, at least, this need is driven by the increased role which wind and other intermittent or inflexible sources of energy will play in the generation mix.

The draft Energy Bill does not provide the details of the capacity mechanism but a Technical Update published by the Department of Energy and Climate Change in December last year envisages capacity being contracted through competitive auctions with the cost of securing capacity being shared between electricity suppliers.  More detailed proposals will be set out in a further document towards the end of this year following which there will be a process of consultation with the industry and other interested parties.

The capacity market is likely to favour new gas-fired plant with short start-up times and a highly versatile operating response but the UK Government has indicated that existing plant will be able to bid for capacity contracts.  However, it is likely that plants benefiting from the new CfDs will be excluded from the capacity market.  .

Emissions Performance Standard (EPS)

The draft Energy Bill proposes a statutory limit on the amount of annual CO2 emissions allowed from new fossil fuel generating stations.  It is envisaged that the limit will initially be set at 450g/kWh and apply until 2045 for projects approved before it is reviewed in 2015.  Provision is made to exempt plants which form part of the UK’s CCS Commercialisation Programme or benefit from European Union or CfD funding for commercial scale CCS.

Transitional Arrangements

The Renewables Obligation (RO) is currently the main financial mechanism by which the UK Government incentivises large scale renewable energy projects.  Under this mechanism, renewable energy projects receive Renewable Obligation Certificates (ROCs) for which there is a market price.

The White Paper on EMR proposed a transition phase, between April 2014 and March 2017, during which new renewable generating stations will be able to choose between support under the RO or under the new CfDs.  Any new renewable generating stations after March 2017 will only be entitled to support under the CfDs.

The RO continues until 2037 but there are concerns as regards the income for generators during the final years of the scheme.  The draft Energy Bill therefore contains provisions whereby, from 2027, the energy regulator, Ofgem, or the Secretary of State will be obliged to purchase certificates at a fixed price which will be set by the Secretary of State and funded by a levy charged on the supply of electricity by electricity suppliers.  It is envisaged that this fixed price will be the 2027 ROC buyout price plus 10 per cent and then inflation-linked.

The Secretary of State will also be given power to issue what is being referred to as an investment instrument to a generator ahead of the introduction of CfDs.  This power is intended to address the risk that EMR could otherwise delay investment decisions and is likely to be used for the first new nuclear plant (at Hinkley Point in Somerset).  Market participants are watching these early bilateral negotiations to see the precedent set and for competition implications.  The lack of transparency of the closed door negotiations will make this a sensitive area.

Conflicts of Interest

The draft Energy Bill proposes to confer EMR functions on the System Operator, National Grid plc, a private sector company.  The UK Government considers that there is a potential risk of conflicts of interest arising between the new EMR functions which the System Operator will take on and its existing role and interests in the energy market, including its ownership of transmission infrastructure.  The draft Bill proposes to give the Government powers to manage any conflicts of interest and to confer the functions on a new delivery body if it becomes apparent that the System Operator should no longer be responsible for the EMR functions.

House of Commons Energy and Climate Change Committee Report

The Committee scrutinised the draft Bill and its Report, which draws on extensive evidence from generators and other energy companies, industry associations, environmental groups, regulatory bodies, local councils, academies and other interested parties, is highly critical of the draft Bill.  It identifies “serious concerns with the proposals as they currently stand, which could make the reforms unworkable if they are not resolved” and makes a series of recommendations, including:

  • The Government should publish draft secondary legislation, including a model CfD, prior to consideration of the Bill in Parliament.
  • The Government should set a 2030 carbon intensity targets for the electricity sector to supplement the overall carbon reduction targets set out in the Climate Change Act 2008.
  • The Government should abandon the multiparty payment model for CfDs proposed in the draft Bill and revert to a single counterparty payment model which, in the view of the Committee, should be underwritten by Government.  The Committee considered that the multiparty payment model was not bankable and the CfDs might not be legally enforceable.  Many market participants share this concern.
  • A simple fixed Feed-in Tariff would be a more appropriate form of support for smaller scale renewable energy projects.  This form of support is already available for very small projects but the Committee recommends that it be extended to renewable energy projects up to at least 10 MW and potentially up to 50 MW in size.
  • Rationing the number of CfDs under the Treasury’s levy cap increases development risk and the Committee recommends the introduction of a two-step or pre-registration process to give developers greater confidence that they will be able to obtain a CfD. 
  • The Committee notes concerns that awarding CfDs through auctions may increase development risk and does not guarantee a cheaper outcome for consumers.  It recommends that the Department of Energy and Climate Change consider setting out a planned reduction pathway for strike prices which would guarantee a reduction in the level of subsidy paid by consumers over time.  Current FIT arrangements for small-scale projects have a similar policy of subsidy reduction over time, reflecting political concerns at ongoing subsidy levels.
  • The Government should provide clarity on the strike price level beyond 2017 as soon as possible in order to help secure investment for emerging technologies, such as wave and tidal power.
  • Independent generators need to be able to sell the electricity they produce at or close to the market price if they are to get the full benefit of CfDs.  This could be difficult in the UK’s current vertically integrated electricity market and a solution to this issue needs to be identified before the Bill is introduced to Parliament later this year. 
  • The proposed process for setting the nuclear strike price lacks sufficient transparency and the Committee recommends that an independent panel of experts should be appointed to oversee negotiations with prospective nuclear generators. 
  • The Committee concluded that concerns regarding European Union state aid rules as well as political considerations have influenced the design of the CfD package and recommended that the Government differentiate nuclear from other low-carbon technologies within an overall support regime.  The Committee will consider further the building of new nuclear and its associated challenges later this year. 
  • The Government should set out a system reliability standard which, along with a decarbonisation target for electricity, would provide a clear framework for the System Operator to work within when operating the capacity market. 
  • The Government should clarify how the Energy Bill will ensure that the capacity delivered by auctions will have the appropriate characteristics, such as flexibility. 
  • The Government’s intention to review the EPS in 2015 could cause a new “dash for gas” and an understanding is needed of the likely impact of EMR on the future role for gas generation.
    • The initial EPS limit should not continue until 2045.  Instead, there should be a shorter period commensurate with decarbonising the electricity system by 2030.
  • The Energy Bill should provide support to demand-side and storage technologies similar to that given to the supply-side and should remove any legislative and other barriers preventing storage from competing fairly in the market.
    • National Grid plc should not act as the EMR delivery body and this role should instead be performed by a new independent, not for profit, company. 

How Government will respond to these recommendations remains to be seen.

Conclusion

There is a broad consensus within the electricity industry and amongst politicians in the UK that EMR is needed and the UK Government has said that it will bring the Energy Bill before Parliament towards the end of this year and expects to have the primary legislation in place by the end of 2013.

Much of the criticism of the draft Energy Bill from the House of Commons Energy and Climate Change Committee and others has been directed at its lack of detail on important issues.  However, it is on the details that there is most disagreement, with strongly held opposing views on issues such as the extent of financial support which should be provided for low carbon generation and the role of nuclear and natural gas in the generation mix.

As the details emerge, we can expect a lively debate both within Parliament and in the mass media and among the general public.  To date, there has not been much interest in EMR beyond energy and environmental circles but this will surely change as the details emerge and there is a greater appreciation of the importance of EMR and its long-term implications as regards energy policy and likely energy costs.

There is a risk that the Energy Bill will expose disagreements within the current coalition Government (formed by the Conservative and Liberal Democrat parties) and/or that parts of the Bill will be opposed by a significant number of MPs from one or both of the coalition parties.  However, now that the Government have embarked upon the process of EMR, they must bring it to a successful conclusion if they are to attract the huge investment which is so urgently needed.