On 12 July, the UK Government published its much anticipated White Paper on Electricity Market Reform, alongside its Renewables Roadmap.

The proposals set out in the White Paper represent the biggest shake-up in the UK electricity market since privatisation in the 1980s.

Announcing the package, Chris Huhne MP, the Secretary of State for Energy and Climate Change claimed that the measures would kick-start investment of £110 billion in energy infrastructure over the next 10 years: more than twice the rate of investment seen in the past decade.

The proposals aim to tackle the 3 “Cs” of the UK’s new energy policy: carbon, cost and continuity of supply. In other words, the framework aims to achieve the Government’s objective to transition the UK into a low-carbon economy, including by meeting the EU target of 15 per cent renewable energy by 2020; and to do so in an affordable way whilst ensuring continuity of supply.

The key elements of the reform package are set out below:

Carbon Price Floor

The introduction of a Carbon Price Floor to reduce investor uncertainty and to provide a stronger incentive to invest in low-carbon generation.

What form will the CPF take?

At the moment, the supply of electricity (amongst other things) to non-domestic consumers is subject to the Climate Change Levy (CCL), that is a tax. The supply of fossil fuels to generators is currently exempt from the CCL.

It is proposed that, from 1 April 2013, supplies of fossil fuels to generators would become liable to the CCL. The rate of CCL would reflect the carbon content of the fuel in question.

The precise rates would be determined 2 years in advance based on the difference between a target carbon price and the market carbon price.

The current target price is £15.70/tCO2 in 2013 rising to £30/tCO2 in 2020 and £70/tCO2 in 2030.

Feed in Tariff with Contracts for Difference (FiT CfDs)

New long-term contracts, Feed-in Tariff with Contracts for Difference, are to be introduced to provide stable financial incentives to invest in all forms of low-carbon electricity generation. A FiT CfD is a long-term contract between a low-carbon electricity generator and a central counterparty under which payments are made by reference to a strike price specified in the contract and a market reference price.

The contract is two-way: where the market reference price is below the strike price, a payment is made to the generator. However, where the reference price is above the strike price, the generator makes a payment to the contract counterparty.

No electricity is traded under the FiT CfD and key to its success is the mechanism under which the market reference price is set. Problems will arise where the generator cannot achieve the reference price in selling the electricity to third parties.

Emissions Performance Standard (EPS)

An Emissions Performance Standard set at 450g CO2/ kWh per annum is to be introduced at baseload as a cap on the carbon dioxide which new fossil fuel power stations can emit; and

Capacity Mechanism

A Capacity Mechanism is being considered, including demand response as well as generation, which is needed to ensure future security of electricity supply. The Government is seeking further views on the type of mechanism required and will report on this around the turn of the year.

Next Steps

The Government is aiming to introduce legislation to implement the key elements of the package in Spring 2012. The CPF will come into effect in April 2013 and the first FiT CfDs are expected to be signed in 2014.

The form of Capacity Mechanism has not yet been determined: a further consultation will be issued at the end of 2011.

Our Views

The White Paper represents a massive shift in UK energy policy and it is not possible in this Alert to provide a comprehensive analysis. Indeed, the Government is still working on the detail associated with these changes. That said, the following themes are emerging:

  • the scale and urgency of investment required in new low-carbon generating capacity in the UK is unprecedented. What investors want, above all, is clarity and predictability. Paradoxically, the need to spur investment has resulted in a wholesale policy shift: with the abolition of the UK’s main renewable incentive, the Renewables Obligation, and its replacement with a wholly new mechanism, the FiT CfD. Not only is there a shortage of detail on this key proposal, but implementing it (with the need for new institutional arrangements) will be no mean feat;
  • in an attempt to allay concerns over policy certainty, the White Paper makes clear that incentives under the existing regimes will be protected for plant which has already been commissioned. This principle will also apply moving forward so that investors are to be insulated against future policy changes. The precise way in which “grandfathering” and, in the case of the Renewables Obligation “vintaging” will work, however, has not been determined;
  • the changeover from the Renewables Obligations to FiT CfDs may, depending on the particular drafting, trigger change in law provisions in existing Power Purchase Agreements or finance documentation. Investors in existing projects should be checking this now;
  • the White Paper makes clear that the level of support available under the FiT CfD is fiscal expenditure: as such it is (subject to grandfathering) subject to the short-term consideration of Budgets and Spending Reviews.