E L E C T R I C I T Y
Striking the right balance
The first of this year’s series of Energy Briefings published by the Energy Institute in partnership with Deloitte* takes a closer look at the direction of UK electricity market reform.
T
he UK government has accepted that the existing measures to decarbonise the UK power sector –
the European Union’s Emissions Trading Scheme (EU ETS) and the Renewables Obligation programme – are insufficient to achieve government
targets.
Accordingly, the Department of Energy and Climate Change (DECC) has initiated a period of statutory consultation on the government’s preferred electricity market framework. The consultation period closed on 10March 2011 and is to be followed swiftly by a White Paper, with legislation to implement the pro- posed new market arrangements expected soon after. Essentially, as the government sees it,
there are three imperatives to achieving successful reform of the electricity
market: ensuring an appropriate, effective mixture of low carbon generation technologies;
ensuring the security of electricity sup- plies when nuclear goes offline; and
ensuring affordability of supply for consumers and generators of elec- tricity. In this article, we look at these objec-
tives in turn, outlining the government’s proposed interventions and providing a brief analysis of their potential effects. Ensuring a lowcarbon generationmix
– At present, there are two main incen- tives for the development and operation of lowcarbon generation in the UK. The first of these incentives is ‘the carrot’ – the additional revenue available to renewable electricity generators under the Renewables Obligation scheme. The second of these is ‘the stick’ – the impo- sition of significant carbon costs on fossil-fuelled generators under the EU ETS. However, these two factors by themselves are simply not enough to deliver the scale of investment required tomeet the UK’s low carbon generation targets. Factors such as uncertainty around electricity prices, low prevailing levels of EU allowance prices and uncer- tainty around future policy, all serve as disincentives to investing in low carbon generation.
34 Security of electricity supply – By 2020
(less than a decade away) around a quarter of the UK’s existing generating capacity is expected to close due to a combination of ageing plants and equip- ment, and ever-tightening environ- mental regulations. While its true capabilities 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 generating 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 seques- tration (CCS) – and as none of these tech- nologies are particularly adaptable – flexible plants will have to recover a return over a limited number of oper- ating hours. However, the current UK electricity market 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, low carbon gen- eration is more expensive than marginal fossil-fired generation – for example, combined cycle gas turbine (CCGT) tech- nology. So, as the sector decarbonises, electricity prices will inevitably rise. Ensuring the supply of affordable elec- tricity is set to become a significant chal- lenge. Therefore, the UK government has to introduce measures to incentivise lowcarbon 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 the consultation on a floor price for carbon, is intended to set out potential changes to the UK market arrangements that will resolve all the above issues; critically, without requiring public subsidies for nuclear projects. The proposed interventions and our assess- ments are summarised below.
UK ProposalOne – A formof feed-in-tariff
for low carbon generation, including nuclear. This option would see top-up payments made to low carbon genera- tors under long-term contracts, in order to achieve an aggregate revenue appro- priate for their technology. The top-up payment would be determined by the difference between a benchmark index forwholesale electricity prices and a pre- determined revenue requirement for each technology. If wholesale prices rise above the agreed price, generators would pay back the difference. Low carbon generatorswould continue to sell their electricity through the existing bilateral electricitymarket. The consulta- tion paper also opens up the option for this tariff to be set by periodic auctions. For low carbon generators, the pro-
posed system will largely remove the wholesale electricity price as a risk – ensuring that the lowcarbon generation incentive delivers an acceptable revenue stream regardless of fossil fuel and carbon prices. This is to be achieved through contracts-for-differences (CfDs), which at the margin still leave the gen- erators exposed to incentives based on wholesale market prices. The question is whether this system will produce a suffi- ciently liquid UK wholesale electricity price index which will be a reliable refer- ence price, provide a reasonable esti- mate of the revenue that low carbon generators would otherwise earn; and which is not open to uncompetitive dis- tortion. Large trades can skew sluggish
exchanges, and this would become an issue if the UK government is expected to pay compensation on the basis of these prices. The requirement for low carbon generators to sell their output through the bilateral market under a specified process would increase liq- uidity, butwould also transfer significant risks onto supply markets. Proposal Two – An emissions perfor-
mance standard (EPS) for new power plants. Under this proposal, a maximum carbon dioxide per megawatt hour
(CO2/MWh) limit would be set for new UK power stations. This development would effectively rule out the construc- tion of new unabated coal-fired power stations, but it would allow the estab- lishment of new gas-fired plants and coal-fired plants with at least partial carbon capture and sequestration (CCS). The proposed EPS will halt the rise of
new unrestricted coal-fired generation. Any nervous CCGT investors,whomay be concerned that the EPS regulations will escalate through time, may be accom- modated by the freezing of EPS rates for existing and new plant, according to the plant’s online date. This proposed reform should achieve
PETROLEUMREVIEW APRIL
2011
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