Electricity markets Market reform – the EI responds
In December 2010, the UK coalition government outlined four pillarsof reform for the electricity market to ensure the required investment in low carbon, secure energy supplies. Gareth Parkes, Energy Institute (EI) Knowledge Manager, summarises the EI responses to the consultations.
T
he EI responses are the outcome of a build-up of engagement with govern- ment, with EI members participating
in scene setting briefings with key govern- ment figures prior to a consultation launch. The EI is responding to two consultations – the Treasury’s on carbon price support and the Department of Energy and Climate Change’s (DECC) on electricity market reform (EMR) – whose ‘four pillars’ consist of a carbon price support mechanism, feed-in tariffs (FiTs), capacity payments and an emis- sions performance standard (EPS). EI mem- bers and government officials were invited to attend a stakeholder workshop to discuss the impacts of proposed measures, consider any unintended consequences and identify opportunities that may have been over- looked. The intentions of the session were
two-fold: ToallowDECCand Treasury officials the opportunity to listen to the debate. It is important for the consultation teamto hear stakeholder opinion directly and before it is diluted, as is often the case due to the volume and diversity of writ- ten consultation responses.
Secondly, to use the EImember’s contri- butions as the basis for a peer reviewed EI written submission.
The session was followed up with a break-
fast briefing between EI Fellows and Charles Hendry, the Minister of State for Energy. This provided a platform for discussion for representatives of many EI stakeholder groups affected by the proposed reforms. Present were representatives from power generators (incumbents and new entrants), suppliers, carbon capture and storage and renewables industries, the oil and gas sector, independent consultancies and academia as well as consumer groups. EI members were quick to agree that, at
current electricity prices, changes to the existing market arrangements are urgently needed to deliver the required £200bn investment to provide energy security in the UK and meet targets for the decarbonisa- tion of power, whilst simultaneously coping with increased electricity demand. The changes must bring with them increased certainty and stability.
The four pillars of reform EI members agree that the introduction of carbon price support is a reasonable and robust measure, providing long-term sup- port for investors. Crucially though, this must be seen by the investment community to be a bankable option. Certainty, the long-term price of carbon plays an impor- tant supporting role to the EMR proposals, enabling a lower cost of capital for develop-
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ers whilst reducing the burden on the consumer. There is consensus amongst EI members
that a low carbon incentive in the form of a FiT is the most important measure to encourage new investment in the energy industry. Whilst there is cautious support for government’s preferred option, a FiT with contract-for-difference (CfD), the lack of clarity as to how the mechanism would work in practice and interact with the other reform proposals is a concern. As a result, there is differing opinion amongst EI mem- bers as towhich of the three-tabled FiT pro- posals (FiT with CfD, premium and fixed rates) would best serve investors, the energy industry and, importantly, the consumer. In order to explore the practicalities and
increase confidence in the FiT with CfD model, the EI has offered to host a work- shop session for DECC economists to work through case studies of CfD scenarios for particular technologies. This would provide stakeholders with a better understanding of the FiT with CfD in action, whilst also acting to probe the model for any unintended con- sequences. Whilst recognising the benefits of intro-
ducing a capacity mechanism, EI members do not see this as important a measure as the FiT or carbon price support mechanisms. A capacity mechanism that rewards flexibil- ity would foster innovation and be a natural compliment to the intermittent generation joining the grid. However, EI members are cautious of supporting a targeted capacity mechanism as there is the potential for this to remove the scarcity rent and reduce the prices for the peak power product, thus dis- incentivising investment in new capacity and accelerating end-of-life for generation assets not included within it. EI members recognise that the govern-
ment has attempted to put forward a bal- anced package and that there is a risk of losing that balance if one or more legs were to be taken away. However, whilst under- standing the government’s reasons for introducing an EPS, EI members are con- cerned that this measure has the least influ- ence in meeting the objectives of EMR.
Analysis and implementation ToEI members, the issue of sufficientmarket liquidity is of critical importance, especially for the FiT with CfD model, which would need a reference price to allow the market to function properly. The outcomes of the market liquidity review currently underway by Ofgem will be important to the success of this proposed policy. Other key factors raised by EImembers as to whymarket price signals are vital include the need for optimal
plant dispatch, the need for demand-side response and the need for optimising the location of new plant, particularly the loca- tion of peak load capacity. Amongst EI members, there were many concerns about auctioning, from the differ- ent characteristics of projects, locations and technologies to the significant investment which could be exhausted competing for auctions. Only once low carbon generation technologies become more established could competition between different gener- ators make auctioning work. In order to enter auctions, very skilled operators would be needed, which is contradictory to the objective of reducing complexity and encouraging new entrants. It should be noted that consumers are
more interested in the cost of electricity than the provider – incumbent or new entrant. However, some EI members do not see the alternative to auctioning as attrac- tive either. Negotiation between govern- ment and generators is unlikely to produce a good deal for consumers. EI members do agree that further definition as to the roles and responsibilities of the proposed central coordinating body is needed. EI members feel particular attention
should be paid to practical issues during the transitional period fromthe existing market arrangements to any new ones. For exam- ple, there is a need to knowhowthe renew- ables regime will work after the Renewables Obligation has been phased out in 2017. In summary, there is recognition from EI members that investment is needed across the energy system, not just in low carbon generation technologies. Investment will be needed in demand-side response, user technologies and energy infrastructure – particularly smart meters and networks, distributed energy and combined heat and power to achieve government targets, as well as training and development of the personnel required.
In response to both consultations, the EI has attempted to reflect the views of EI mem- bers from across the energyindustry– from generators, suppliers, consumers, independ- ent consultants and academics. As a learned society, the EI does not promote specific technologies or options and instead seeks to assist the policyprocess byhelping to clarify the keyissues and by improving the evi- dence base on which decisions will be made.
To read the full EI submission or to assist in future energypolicyconsultation responses,
visitwww.energyinst.org/energy-policy or e:
gparkes@energyinst.org
Energy World April 2011
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