Electricitymarkets Striking the right balance


The first of this year’s series of Energy Briefings published bythe Energy Institute in partnership with Deloitte* takes a close look at the current proposals on the table for UK electricitymarket reform.


T


he UK government has accepted that the existing measures to decarbonise the UK power sector – the European


Union Emissions Trading Scheme (EU ETS) and the Renewables Obligation pro- gramme – are insufficient to achieve current targets. Accordingly, the Department of Energy and Climate Change (DECC) has initiated a period of statutory consultation on the government’s pre- ferred electricity market framework. The consultation period closed on 10 March 2011, and is to be followed swiftly by a White Paper, with legislation to implement the proposed new market arrangements expected soon after. Essentially, as the government sees it, there are three imperatives to achieving


successful reformof the electricitymarkets:  ensuring an appropriate, effective mixture of low carbon generation technologies;


 ensuring the security of electricity sup- plies when the current nuclear fleet goes offline; and


 ensuring affordability of supply for consumers and generators of elec- tricity.


In this article, we look at these objectives


in turn, outlining the government’s pro- posed interventions and providing a brief analysis of their potential effects.


Ensuring a low carbon generation mix At present, there are two main incentives for the development and operation of low carbon generation in the UK. The first of these incentives is ‘the carrot’ – the addi- tional revenue available to renewable elec- tricity generators under the Renewables Obligation scheme. The second of these is ‘the stick’ – the imposition of significant carbon costs on fossil-fuelled generators under the EU ETS. However, these two factors by them-


selves are simply not enough to deliver the scale of investment required to meet the UK’s lowcarbon generation targets. Factors such as uncertainty around electricity prices, low prevailing levels of EU ETS allowance prices and uncertainty around future policy all serve as disincentives to investing in low carbon generation.


Security of electricity supply 2020 is less than a decade away, and by then around a quarter of the UK’s existing generating capacity is expected to close


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due to a combination of ageing plants and equipment and ever-tightening environ- mental regulations. While its true capabili- ties remain disputed by some, a significant share of the new capacity is expected to be supplied through wind power. As more wind power comes online, there will be an increased requirement for flexible generat- ing plants that can power up and power down on demand to offset fluctuations in wind output. Given that future base-load electricity supply is envisaged to come from a combination of nuclear, renewable and coal-fired generation fitted with carbon capture and storage (CCS), and as none of these technologies are particularly adapt- able, flexible plants will have to recover a return over alimited number of operating hours. However, the current UK electricity mar-


ket fails to adequately reward peaking and flexible plants – a situation which places security of supply at risk.


Affordability of supply The simple truth is that, at present, lowcar- bon generation is more expensive than marginal fossil-fired generation such as combined cycle gas turbine (CCGT) technol- ogy. So, as the sector decarbonises, electric- ity prices will inevitably rise. Ensuring the supply of affordable electricity is set to become a significant challenge. Therefore, the UK government has to introduce meas- ures to incentivise low carbon generation at the same time as it supports measures to promote energy efficiency.


DECC’s proposed solutions The DECC consultation, which is running in parallel with a consultation on a floor price for carbon, is intended to set out potential changes to the UK market arrangements that will resolve all three issues above, crit- ically, without requiring public subsidies for nuclear projects. The proposed interven- tions and our assessments are summarised below.


A form of feed-in tariff for low


carbon generation, including nuclear This option would see top-up payments made to low carbon generators under long-term contracts, in order to achieve an aggregate revenue appropriate for their technology. The top-up payment would be determined by the difference between a benchmark index for wholesale electricity


Electricity market reform – feed-in tariffs, emission performance standards and tar- geted capacity payments are on the table


prices and a pre-determined revenue requirement for each technology. If whole- sale prices rise above the agreed price, gen- erators would pay back the difference. Low carbon generators would continue to sell their electricity through the existing bilat- eral electricity market. The consultation paper also opens up the option for this tariff to be set by periodic auctions. For lowcarbon generators, the proposed


system will largely remove the wholesale electricity price as a risk – ensuring that the low carbon generation incentive delivers an acceptable revenue stream regardless of fossil fuel and carbon prices. This is to be achieved through contracts-for-differences, which at the margin still leave the genera- tors exposed to incentives based on whole- sale market prices. The question is whether this system will produce asufficiently liquid UK wholesale electricity price index which will be areliable reference price; which provides a reasonable estimate of the rev- enue that low carbon generators would otherwise earn; and which is not open to uncompetitive distortion. Large trades can skew sluggish


exchanges, and thiswould become an issue if the UK government is expected pay com- pensation on the basis of these prices. The requirement for low carbon generators to sell their output through the bilateralmar- ket under aspecified process would increase liquidity, but would also transfer significant risks onto supply markets.


An emissions performance standard


(EPS) for new power plants Under this proposal, a maximum carbon dioxide per megawatt hour limit would be set for new UK power stations. This devel- opment would effectively rule out the con- struction of new unabated coal-fired power stations, but it would allow the establishment of new gas-fired plants and coal-fired plants with at least partial CCS.


Energy World April 2011


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