UK Electricity Market Reform
This article sets out why the UK’s Government’s approach, and previous industry experience of contracts for differences in the energy sector, may yet deliver early benefits and encourage new market entry.
By Rajan Phakey & Jeremy Chang
THE UK GOVERNMENT’S Electricity Market Reform (EMR) White Paper was published in July. Following on from its December 2010 consultation, the reform package proposed gives industry much of what most players lobbied for. Market reaction has accordingly reflected cautious optimism. Commentators have questioned whether there is enough detail in the White Paper (particularly in relation to contracts for differences) to enable investment decisions in low-carbon projects to be made immediately.
Key Proposals EMR sets out an ambitious reform package specifically
designed to unlock the huge scale of investment required to achieve the government’s policy objectives of cleaner electricity from more reliable sources at more stable prices. The scale of the challenge is clear: the Government estimates more that £110 bn of investment is required in generation and transmission infrastructure to mitigate against roughly a quarter of UK’s generating capacity retiring over the next decade, with many coal plants due to retire shortly owing to the requirements of environmental legislation. The Government’s EMR policy comprises a package of four key proposals to meet the objectives:
• A carbon price floor (announced in March’s Budget), which puts a price on the cost of carbon from April 2013. The aim is to increase the cost of fossil fuel generation, thereby helping drive investment in low- carbon generation.
• New long-term contracts for low-carbon generators, which are likely to be effective from spring 2014. The
aim is to stabilise revenue streams for investors and reduce other risks to support investment in all forms of low-carbon electricity generation. The White Paper confirms that these contracts will take the form of feed-in tariffs with contracts for differences (FiT CfD).
• An emissions performance standard (EPS) for new fossil fuel plant of 50MW and above. EPS is likely to
be effective from autumn 2014. The aim is to act as a backstop to limit how much carbon new fossil fuel plants can emit. It will initially be set at an annual limit equivalent to 450g CO2/kWh, with an exemption for projects with ‘carbon capture and storage’ technology.
• A capacity mechanism, which is likely to be effective from spring 2013. The aim is to create a new
contracting framework for capacity, to provide security of supply of electricity.
A Different Perspective on DECC’s Approach Criticism of the White Paper has focused on the lack
of detail around some fundamental questions on the FiT CfD arrangements and concerns that we are arguably no closer to knowing what the proposed design of the capacity mechanism will be than when these measures were consulted on in December 2010. There are, however, some clearly identifiable reasons
for DECC’s approach. With nearly 250 separate responses to the 2010 consultation to take into account, it was always a stretch to expect the Government, in the time available, to deliver a White Paper that both reached firm conclusions in all major areas of policy and give detail of how they would be implemented. A number of respondents to the 2010 consultation
expressed strong concerns about DECC’s preferred option for capacity mechanism (strategic reserve). DECC’s decision to open a new consultation (on whether there should be a targeted mechanism in the form of ‘strategic reserve’ or a market-wide mechanism in the form of a ‘capacity market’) shows that it is listening to the industry, albeit at the expense of formulating detailed implementation policy within the original timetable.
Criticism of the White Paper has
focused on the lack of detail around some fundamental questions on the FiT CfD
The delayed decision on the capacity mechanism has implications for the level of detail that can be provided on the FiT CfD proposal. In particular, there are a number of possible interactions between a market-wide capacity mechanism and the proposed FiT CfD. There are, however, some areas of the White Paper
that provide a good level of certainty. The policies for the carbon floor price and the EPS are largely settled and it is unlikely that finer details will significantly alter investors’ risk assessment. In addition, DECC’s policy on the transitional measures
for the Renewables Obligation (RO) is resonably clear and comprehensive. For example, existing accredited generation will continue to receive support under the RO; the RO will close to new accreditations on 31 March 2017 and – until then – new projects will have a choice of support under the RO or the FiT CfD (when it is introduced). The RO announcements alone should give investors certainty for the next 15 years (at least) for planned projects that are designed around receiving subsidies under the RO.
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