Memorandum submitted by Ofgem
ABOUT OFGEM
1.1 Ofgem welcomes the opportunity to provide
evidence to your inquiry on Emission Performance Standards (EPS).
We are the Office of the Gas and Electricity Markets. Protecting
consumers is our first priority. We do this by promoting competition,
wherever appropriate, and regulating the monopoly companies which
run the gas and electricity networks. The interests of gas and
electricity consumers are their interests taken as a whole, including
their interests in the reduction of greenhouse gas emissions and
in the security of the supply of gas and electricity to them.
EXECUTIVE SUMMARY
1.2 The evidence we have gathered suggests
that there are many ways of designing an EPS in order to achieve
different objectives, but that any EPS has to be designed very
carefully in order to:
— complement existing and future policies
in reducing CO2;
— manage any effects upon EU wide CO2
emissions and the carbon price;
— limit its effect on the level and volatility
of domestic energy prices;
— encourage the development of carbon capture
and storage (CCS) technology;
— minimise the costs associated with reducing
CO2; and
— manage its impact on security of energy
supply and investment, especially with regard to flexible capacity.
Designing an EPS which addresses all of the
above will be difficult and it is inevitable that there will need
to be some trade-offs throughout the policy development process.
What are the factors that ought to be considered
in setting the level for an Emissions Performance Standard (EPS)
and what would be an appropriate level for the UK? Should the
level be changed over time?
1.3 Before discussing the factors to be
considered in setting the level of an EPS, it is important to
clarify what is meant by an EPS. In essence an EPS is a limit
on the amount of CO2 that can be emitted during the
generation of electrical energy. Within this basic definition,
an EPS can take a variety of different forms according to what
the EPS is attempting to achieve and what the existing policy
and market framework is like.
1.4 Firstly, there are options for the timescale
over which the emissions are measured. An EPS could be designed
such that the amount of CO2 per unit of electrical
energy generated is restricted on a half-hourly basis, which is
the approach currently being used in California.[28]
Alternatively, it could be applied on an annual basis (an emissions
"bubble"), which was adopted in the UK to reduce other
gas (SO2 and NOX) emissions from large power plants during the
1990s.[29]
1.5 Secondly, there are options for how
an EPS is targeted across the power sector. One possibility is
to apply the EPS to every plant (or even generating unit), which
would effectively prohibit the construction (or constrain the
running hours) of particular types of power generation that emit
relatively large amounts of CO2 for each unit of electrical
energy they generate. A further possibility is to apply an EPS
across a company's fleet or across the whole of the UK's power
fleet. This would allow high emitters to operate for limited periods,
provided that the average emissions over the year are below the
EPS level.
1.6 Thirdly, an EPS can also be applied
to either new or existing plant (or both), which could have implications
that are discussed later on.
1.7 Finally, these limits can be static
or change over time. While the CO2 limit in California
is fixed at 500 kilos of CO2 per megawatt hour, the
SO2 and NOX limits under the European Large Combustion Plant Directive
(LCPD) became tighter throughout the 1990s.
1.8 Each of these designs imply very different
flexibilities for both Government and energy companies, with a
range of associated benefits and costs. Therefore, before setting
any EPS design or level, it is important that clear objectives
are considered. Possible objectives include:
— The limiting of CO2 emissions
from new, existing or all plant.
— Preventing the construction of certain
types of generation plant (eg specific technologies such as unabated
coal).
— Encouraging the development of low carbon
technologies, such as CCS.
— Encouraging more carbon efficient plants
within existing technologies—eg designing an EPS to make
all gas plants meet a certain EPS for gas plants.
Once the objectives are set, it is then possible
to consider the other factors to be considered when setting the
EPS. These include:
— The effectiveness of the EPS for achieving
emissions reductions—there could be unintended consequences
as a result of generators' decisions and through interactions
with other policies.
— The need for new flexible plant on the
system and security of supply issues—see sections 1.22 to
1.26 for further information.
— The existing policy framework for emissions
reduction and the interaction of the EPS with these policies—see
sections 1.9 to 1.14 for further information.
— The future policy framework, such as
a carbon price floor.
— The availability of technology to operate
within the EPS—the EPS has to take account of what is technically
possible or should be designed to drive technology development.
— The costs associated with meeting the
EPS—see sections 1.27 to 1.36 for further information.
— The effect of the EPS on investment decisions.
What benefit would an EPS bring beyond the emissions
reductions already set to take place under the EU ETS?
1.9 Before discussing the extra benefits
of an EPS beyond EU ETS it is important to highlight the overlap
between the two policies. As the EU ETS is primarily designed
to reduce the quantity of CO2 emissions over time,
any sort of EPS that does this too will clearly overlap with it.
For an EPS to reduce CO2 emissions in the UK by more,
it will have to set limits on generators that are stricter or
more specific than those implied by the EU ETS.
1.10 However, a UK based EPS will not necessarily
reduce total emissions across the EU unless further steps are
taken. Because total EU power sector emissions are capped at the
EU wide level, and the EU ETS allows trading of carbon across
member states, any emissions reductions undertaken in the UK could
still be emitted elsewhere in Europe.
1.11 This "waterbed" effect could,
however, be mitigated if suitable quantities of EU Allowances
(the currency of EU ETS representing the right to emit) are removed
from the system. The Government could "retire" or "purchase"
EU Allowances but this process is complex to get right. It should
also be noted that the auctioning of EU Allowances brings in substantial
Government revenues which would be forgone. Further, the legality
of the UK government effectively reducing the quantity of EUAs
available within an EU-wide agreed cap and trading scheme would
have to be explored.
1.12 There is also the question of how widely
an EPS could be applied. For example, as noted above, a UK applied
EPS could reduce UK emissions, but would have little wider impact
on EU emissions. For an EPS to have a significant impact on EU
emissions, it would also have to be implemented by a number of
European countries either independently or co-ordinated together.
However, this would imply that two schemes are in place with similar
purposes and possibly working against one another in certain areas.
1.13 The overall impact of an EPS upon EU
Allowance availability and the CO2 price is unclear
since this depends on the interaction between lower demand—generators
wanting fewer EUAs because they cannot emit as much carbon—and
reduced supply—Governments retiring EUAs to prevent the
waterbed effect. However, it is possible that an EPS could reduce
the price of CO2, which would act as a disincentive
for investment in low carbon technology.
1.14 However, if an EPS helps to force a
technological breakthrough in CCS or other emissions performance
innovations in generating plant then this could encourage cheaper
ways of decarbonising the power sector than those that would otherwise
have emerged as a result of the EU ETS. This could mean that the
cost of using these technologies is reduced in future relative
to what they would have been had an EPS not been introduced and
could also mean that the EU ETS cap could be further tightened
to take advantage of this technological development in order to
reduce emissions further.
1.15 In addition, an EPS could ensure that
there is an insurance policy against the construction of higher
carbon plant that could occur if the EU ETS were to be weakened
in the future. We understand that there is some stakeholder concern
that once higher carbon plant have been built, their developers
may have some "bargaining power" with which to later
broker a way to run for more hours with future Governments.
1.16 Lastly, an EPS that affects existing
coal plants might also encourage further switching to biomass,
which has started to occur due to the subsidies offered by the
RO. For example, the Drax and Tilbury power plants have both moved
from pure coal-firing to biomass co-firing, with plans to increase
the amount of biomass that they use as their fuel source.[30]
This should reduce emissions in the short-term, with the provisos
about the EU ETS cap that were noted earlier, but as the use of
biomass increases so does the importance of sustainable sourcing
and life cycle emissions.
How effective is an EPS likely to be in driving
forward the development of CCS technology? Should the UK's CCS
demonstration programme cover gas-fired as well as coal-fired
power stations?
1.17 There is no simple answer to this question
as different types of EPS have varying impacts on the development
of CCS.
1.18 If an EPS means that power generators
using fossil fuels cannot operate without CCS, this may provide
an incentive for them to invest in this technology.
1.19 However, at present, CCS technology
is unproven at a large scale both technically and economically.
Correspondingly, a developer may choose to make an alternative
investment decision to meet the EPS, rather than necessarily explore
CCS. For example, if an EPS rules out unabated coal plants, a
developer may choose to invest in a gas plant (assuming that would
meet the EPS) rather than a coal plant with CCS.
1.20 There is an additional risk that some
EPS types may actually deter investment in CCS. For example, a
developer may not invest in a new plant with CCS fitted if it
believes that it will be left with a stranded asset in the eventuality
that CCS does not work and the station cannot meet the required
EPS.
1.21 All in all, most EPS variations are
unlikely to provide a sufficient incentive by themselves to push
a developer towards CCS.
Could the introduction of an EPS pose any risks
to the UK's long-term agendas on energy security and climate change?
1.22 Once again, there is no simple answer
to this question as different types of EPS have varying impacts
on energy security and climate change.
1.23 In the energy market there is always
a requirement for flexible plants to be able to be switched on
quickly when energy demand is high, or when output from other
forms of generation is lower (eg when renewable output is low
or when base-load plants fail). Flexible capacity is likely to
become of greater importance as increasing amounts of variable
renewable generation, such as wind power, comes onto the power
system. Currently fossil plants provide a lot of this flexibility.
1.24 If an EPS ensures that fossil plants
are to be restricted in some way then flexibility will be needed
to be provided from somewhere else. This could be provided by
increased use of sustainable biomass and through innovations in
electricity storage and demand side response, as well as extra
interconnection. However, these possibilities face a number of
current challenges. Correspondingly, any EPS will need to carefully
consider what impact it would have upon peaking and balancing
plant during the time before these alternative options can be
developed and deployed.
1.25 For example, if an EPS prevented the
construction of any new coal-fired plants, then alternative generation
(eg new gas plants) would need to be built in their place. We
have analysed in the "Discovery analysis tool" the most
extreme case, ie the impact of building neither any of the coal-fired
plants that we had projected would be built between now and 2024-25,
nor any alternative plants. Although this is a crude analysis
as it is likely that the market would invest in alternative generation
(eg new gas plants), the tool showed a potential shortfall in
generation capacity. If this shortfall is filled primarily by
gas plant, then the UK will lose some diversity in its generation
capacity, which could pose a risk to security of supply if there
are gas supply blockages.
1.26 Further, it is possible that if an
EPS is focused on banning new fossil plants from being built,
it might encourage existing fossil plants that are less efficient
and "dirtier" to run harder and longer than would have
been otherwise been the case. Under some circumstances this could
perversely lead to increased carbon emissions (although this effect
would be limited by the EU ETS cap). This incentive would be created
if an EPS drives higher prices for electricity (mentioned below)
and a lower carbon price.
What is the likely impact of an EPS on domestic
energy prices?
1.27 Once again, there is no simple answer
to this question as different types of EPS have varying impacts
on both the level and volatility of the price of energy.
1.28 However, an effective EPS will affect
the level and volatility of domestic energy prices. This is because
any effective EPS will restrict the choices available to generators,
which is likely to lead to higher costs that will ultimately be
passed onto energy consumers in the form of higher prices.
1.29 The most obvious source of an increase
in costs is generators having to use lower carbon forms of generation
to provide the energy needed in the UK. Existing lower carbon
energy (at current carbon prices) is generally more expensive
than using coal or gas, and the fitting of CCS to fossil fuel
power stations would also clearly increase the cost of generating
the electrical energy.
1.30 In addition, generators under any sort
of running hours restrictions will only want to use their running
hours at the point where they can make the maximum possible returns.
This means that the generators will want to sell their energy
at peak times when the electricity price is highest eg winter
demand spikes. Correspondingly, generators will not want to use
their hours at times of lower demand, when prices are generally
cheaper. If their generation was required at those times of lower
demand, then they would demand a higher price to generate, in
order to factor in the opportunity cost of them not being able
to use their hours when they can take advantage of higher prices.
The result would be that the price at those times of lower demand
would increase, thereby increasing the costs to consumers.
1.31 When restricted plant is able to demand
a higher price for its electricity, unrestricted plant can also
increase its price in the knowledge that it will still be purchased.
Therefore the price making behaviour of restricted plant to maximise
their profits also presents opportunities for unrestricted plant
to become more profitable. Unrestricted plant includes low carbon
and renewable generators, and increases in these generators' profitability
could extend their planned operational life, or increase the incentive
to invest in these technologies.
1.32 We would like to draw the Committee's
attention to an interesting example of how plant running restrictions
can affect the prices that these plant charge for the electricity
that they produce. We would like to stress that the example is
only dealing with the price of the energy produced by the specific
restricted plant mentioned below and that we are not drawing any
firm conclusions on the more complicated effect of these plants'
behaviour on other plants' pricing behaviour. While overall electricity
prices did increase during this period, there were other contributory
factors affecting the wholesale market price at that time.
1.33 The example here is the effect of the
Large Combustion Plant Directive on plant pricing behaviour. The
LCPD introduced measures to control the emission of nitrogen oxides
(NOX), sulphur dioxide (SO2) and particulates (dust) from combustion
plants. These plants must meet Emissions Limit Values (ELVs) for
the three pollutants.
Large combustion plant had the option to either:
— Opt-in: comply with LCPD's ELVs, with
existing plants being able to use a national cap and trade system
that reduces the amount of their emissions over time; and
— Opt-out: existing plant could agree by
30 June 2004 not to run the plant for more than 20,000 operational
hours between January 2008 and December 2015.
1.34 Existing plant which would not run
for more than 2000 hours a year until the end of 2015, and/or
1500 hours a year from 2016, could apply for derogation from the
LCPD. These were subjected to a fixed ELV for SO2.
1.35 From the graph below it can be seen
that the more restricted plants (opt-out and derogation) became
more expensive than the plants who fully complied with the LCPD's
emissions limits. This is mostly visible from December 2007 onwards,
where the differences between the prices asked for by plants which
have opted for the different LCPD compliance options diverges.
This is because they put a premium on their energy, factoring
in the opportunity cost mentioned in 1.30.
Prices for coal-fired generation, 2007-08,
£/Mwh
CONCLUSION
An EPS is a policy intervention with good intentions
but many potential repercussions. It is not just a case of introducing
a simple intervention to ban higher carbon forms of electricity
generation.
The policy intent of any EPS needs to be clear,
then the EPS can be appropriately designed to meet its intent.
Whatever EPS is chosen, it must be well designed
in order to ensure that it actually results in carbon emissions
reductions, while preventing security of supply threats or increases
in the price of energy.
I hope that this evidence is of use to you and
I am happy to provide additional evidence if required.
September 2010
28 California Public Utilities Commission 2010, Greenhouse
Gas EPS (set at 500g/kWh), http://www.cpuc.ca.gov/PUC/energy/Climate+Change/070411_ghgeph.htm Back
29
Crown Copyright 1991, The Large Combustion Plant (Control of Emissions)
(Scotland) Regulations 1991, Statutory Instrument 1991 No. 562
(S.47) Back
30
Drax 2010, "Drax highlights vital role for biomass",
30 June. Back
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