HC 742 Electricity Market Reform

Comments on Proposed Electricity Market Reforms

Dr Barrie Murray Dec 2010


This memorandum advocates the establishment of a centralised procurement agency for low carbon energy sources as the only viable option to secure an optimal least cost development whilst managing the many new and diverse issues associated with alternative energy sources.

The previous efforts to promote competition in the electricity sector have moved the country into a position where we no longer exercise control over a key part of our national infrastructure. We are left with attempting to seduce potential generators with incentives under the guise of market reforms to build new capacity. The industry is controlled by foreign utilities whose only interest is profit and they use the threat of future shortages to extract more subsidies and are in a position to blackmail us. This contrasts with our neighbouring European partners who have retained national champions that have enabled them to thrive whilst maintaining an ability to exercise control. Given the wide range of issues that the sector faces over the coming years it will not be possible to effect an optimum development strategy through market mechanisms and some form of central planning and control needs to be implemented. End users and industry have to be able to input their needs and concerns. It is likely that the escalation of energy prices associated with the proposed EMR will put some companies out of business and reduce electricity demand. The proposals can only lead to higher end user prices and the government has to evidence why it believes prices will be lower than they would otherwise have been. How reliable is this assertion without knowing what investors plan to do when they will seek to maximise profit? Can we be certain what the rest of Europe will be doing during this period and why investors in new plant would choose the UK? Where are the academic economists that said that the market would solve all including the provision of adequate levels of investment? It is naive to believe that the targets and the required optimal outcome will all be delivered through manipulation of a carbon floor price. Nuclear must be the most cost effective way of meeting requirements to reduce emissions because of its high load factor producing three to four times more energy than the equivalent wind capacity. Nuclear should form a dominant proportion of the future plant mix and its contribution to reducing emissions should be recognised. But, how will its provision be made competitive when we purposely and openly disadvantage the alternatives of coal and gas generation. A further consequence of the proposed CCL on fuel will be to encourage energy intensive users to locate outside the UK. The current government agencies that exercise authority to commit the nation to crippling subsidies were not constituted with the necessary skills for their current engagements in negotiating and establishing an optimal way forward.

1. What should the main objective of the Electricity Market Reform project be?

a. The aim has always been to minimise the overall energy cost to end users whilst maintaining accepted levels of security. The end user payments also include a significant proportion to cover transmission and distribution as well as metering, administration and regulation and they can be expected to add significant extra costs to accommodate renewable sources. What’s missing in the current debate is how the optimum development is supposed to be established. The procedure prior to restructuring was to establish optimal coordinated generation and transmission development plans that took account of all the requirements including cost minimisation security, fuel diversity, operational efficiency and minimum risk. This was achieved using large scale LP formulations of the problem which over the years had become highly developed. It is to retain this ability to coordinate development that many informed countries have chosen the Single Buyer market model where a central procurement agency acts on behalf of all customers to establish supplies and facilities to meet their agreed needs. This enables overall government strategy to be incorporated with competitive tenders for new capacity aimed at developing an appropriate plant mix. It is difficult to see how this can effectively be managed by tinkering with current market arrangements were each player has the option to pursue their own plans. The long lead times for development confound the problem and introduce risk that has to be covered through market prices. It is a delusion to think that DECC or Ofgem are going to establish an optimal way forward by tinkering with market arrangements and CO2 prices. The costs involved and implications of failure are too great to rely on ad hoc trials of different market arrangements and someone needs to take control of the situation. A centralised market to coordinate the development of low carbon sources offers the best approach to deal with the many abnormal issues surrounding renewable development. This approach offers more scope and flexibility to address some of the technical problems associated with renewable integration and has parallels with the centrally managed balancing market. It must be arranged to foster competition through competitive tender in all time frames. Amongst the many other issues that need to be addressed are:

· Should renewable energy sources receive special treatment related to balancing?

· Should this balancing treatment be differentiated by renewable energy sources?

· The market time frames that should apply recognising the intermittency

· The degree of optionality available to market participants

· The requirements to realise competition and liquidity including, tenders and auctions in different timeframes

· Avoiding market distortions and maintaining compatibility with current market arrangements

· The potential role of capacity payments

· The importance attached to establishing an appropriate level of system security

· Avoiding undue complexity, implementation delays and operating costs

· The governance of the market

· Consideration of associated storage options

2. Do capacity mechanisms offer a realistic way of achieving energy security, low-carbon investment and fair prices?

a. The problems with capacity payments are well known in that the expectation is that they should be paid to all generators, including those that are already there, even if they are not used. The calculation of the justifiable charge to end users is usually based on the overall LOLP (Loss of Load Probability) and VLL (Value of Lost Load). The optimum arrangement is where the likely cost to end users of loss of supply is in balance with the fixed annual cost of new generation. Where these payments are spread between all generators they make only a small contribution to the fixed costs of a particular new entrant and there is no guarantee that any new plant will be built. In a Single Buyer model the exact amount of new capacity would be established through a competitive tender and contract process.

b. The suggestion of capacity payments has been prompted by the concern to retain marginal peaking generation to cater for wind output variation. With the large volumes of wind proposed mid merit and even base load generation will also see a reduction in utilisation. Any mechanism would have to recognise the different impact on generation and added wear and tear costs incurred by generation in regulating to follow the net demand. There should be the option to meet the regulating requirement from other sources like Scandinavian hydro which is likely to prove cheaper. A new North Sea super-grid extension should be actively promoted to facilitate competition between the various options. These options are best coordinated and developed as part of a centralised procurement function for low carbon energy embracing the procurement and contracts for provision of balancing energy.

3. What is the most appropriate kind of capacity mechanisms for the UK?

a. Any capacity payment should be self correcting and not encouraging new entry when sufficient capacity is already in place. In some implementations the payment has been geared to the overall plant margin (a measure of excess capacity over demand). Other implementations have proposed payments according to technology type to encourage an appropriate plant mix. The question also arises as to the credit to firm capacity that should be given to wind generation and other marine sources.

b. There are two issues involved; one is ensuring sufficient capacity is available to meet future needs recognising construction timescales; the other is securing availability in operation on the day. The requirement to manage the intermittency of generation ultimately rests with the System Operator (part of NGC). They are best placed to determine need and should be incentivised to contract for capacity considering all options including demand side management and import/export. The SO should also be incentivised to coordinate wind and marine output forecasting as part of a centralised management function. In operational time scales the original UK Pool model aimed to achieve availability through a LOLP increment to the marginal price when capacity was in danger of being short of that required to maintain security. It was considered that market spot prices provided an adequate mechanism through price spikes to secure capacity in the short term. Price spikes can be minimised by better forecasting and control. The requirements for balancing are most easily coordinated centrally.

4. Should the system of Feed-in Tariffs be focused on particular technologies or maintain a wider technology-based view?

a. The world is full of examples where long term commitments to power purchase agreements have proved a subsequent burden when developments have changed the situation. The tariffs should be linked through contracts to general market prices and available to any source to promote the least cost abatement for emissions. They should be linked to the price of CO2 to enable nuclear, coal and gas with CCS to compete on an equal basis. It is dangerous to set tariffs artificially high to promote industrial development as this sets expectations that are not sustainable.

5. Will it be feasible to deliver EMR in one go, or will regulations and implementation be spread over time?

a. There is insufficient time to agree and establish a whole set of new regulations that have to be judged and analysed by the market. It is also expected that they will be wrong given the difficulties associated with this sector. A centralised procurement agency would have the flexibility to respond and adjust on a continuous basis as issues arise and circumstances change.

6. Will market reform increase political risk for investors or create certainty?

a. Uncertainty will still surround what plant will actually get built. Claims by DECC and the Scottish Executive about the proportion of renewable energy in the future plant mix are fanciful. However, they do deter investors because of the potential impact on the utilisation of their conventional generation. There is also uncertainty about how the REFIT will vary in future. Investors prefer an unbiased market where real costs affect market potential rather than price fixes and subsidies and attendant regulatory risk that cannot be predicted. There is also uncertainty as to what new directives may emanate from the EU.

7. Will the Government’s proposed package of carbon price floor, EPS, FITs and capacity mechanism provide sufficient transformation to achieve goals on climate change, security of supply and affordability?

a. Offshore wind is unlikely to be built without a subsidy of 2 ROCs or an equivalent feed in tariff resulting in wholesale prices three times equivalent gas and coal. In addition off shore transmission will increase the capital cost around 50%. They will contribute very little to the security of supply because of their intermittency, with only 10% of their installed capacity being regarded as firm. There are also hidden costs in managing intermittency and ensuring backup capacity is available through capacity payments. Given the scale of developments in Asia the UK contribution to climate change amelioration is likely to be minimal.

b. The government should make its goals clear in terms of how they expect the target to be met. What is the optimum mixture of technology that would meet the requirement at minimum cost? How is it expected the intermittency of renewable sources will be managed and what will be the added cost to consumers? It is not acceptable to state that it will be less than otherwise would be the case without evidence. What scenarios have been advanced and studied. What assumptions have been made about fuel prices, demand side management, energy efficiency, CCS, imports/exports and electric vehicles? These require detailed analysis given the potential impact on consumers and industry and should be preceded by a statement of strategy.

8. What synergies and conflicts will there be between proposed mechanisms and policies already in place?

a. The EU has set a number of Directives aimed at promoting the development of renewable energy sources. Most countries in Europe use feed in tariffs to promote renewable development. What is proposed to ensure that the optimal level of transmission is in place to ensure timely connection?

9. Will a carbon floor price be feasible in the context of EMR and at what level should it be set?

a. It is difficult to see how this proposal is supposed to operate alongside the European Emission Trading Scheme designed to achieve least cost abatement. There will inevitably be public and political outcry from attempts to distort the market. There will be a particular problem if alternative abatement options around Europe lead to lower costs and carbon prices. The carbon price should not be fixed but developments should be promoted through a centralised competitive market for low carbon sources able to establish power procurement contracts on case by case basis.

10. What effects will EMR have on the development of capacity for electricity storage and the development of interconnectors between the UK and other electricity markets?

The development of a European wide EHV super-grid is essential to promote the pan European market and offers the best defence against the abuse of market power. It also offers the best option to accommodate renewable energy sources enabling advantage to be taken of flexible European wide hydro sources. This should be actively promoted through the EU with the North Sea as a starting point. If wind is to be built in Europe it makes sense to build it where it is windiest. The added CCL to fuel used to support generation exports will be counter-productive to encouraging trade and unlikely to be acceptable to the EU. It is likely to encourage more imports and external dependency. Why should European generators generate in the UK when they can generate abroad with no CCL charge but benefit from higher UK market prices?

The EMR proposals appear ill considered and will result in billions of pounds of extra costs to consumers and industry during a difficult financial period. More in depth analysis is required to determine the optimum strategy and then propose how it might be implemented. I would be pleased to provide oral evidence if it is considered that the Committee may derive benefit and can confirm that I have no vested interests outside of being a citizen.

December 2010

Dr Barrie Murray Electricity market Services Ltd.

Barrie is a chartered engineer with more than 30 years' experience working in the electricity energy sector and is the managing director of Electricity Market Services Limited . He has worked around the world on consultancy projects since 1998. He specialises in the provision of consultancy services to major players in deregulated electricity markets including market operators, regulators, investors and traders. Skills include the development of business processes and procedures necessary to support electricity trading and system operation, including regulations and commercial agreements associated with the Independent System Operator (ISO) function. He also analyses market operation and develops models and forecasts to support trading and investment appraisal and market development.

Prior to working as a consultant, Barrie gained over thirty years' experience in the electricity supply sector having work ed in senior positions with ABB, the Central Electricity Generating Board and the National Grid Company plc (NGC). He was the Senior Manager in NGC responsible for establishing the processes and systems necessary to support system operation at the National Control Centre. Barrie played a lead role in enabling restructuring in the UK, having been involved since the inception of the market in 1990, and was responsible for developing systems to support market operation and pricing . He has advised the Regulatory and Consumers Groups on the review of pricing and trading in England and Wales , Belgium , Oman and Ireland . He has advised on electricity restructuring and market development options in South Africa, Abu Dhabi, Sri Lanka, Namibia, Ireland, Bosnia and Hertzgovina and the UK. He has also advised banks, generators and electricity suppliers in the UK, Czech Republic, Holland , Norway, Italy and Ireland on market development and investment opportunities in Europe and Eastern Europe . He has undertaken some 50 consultancy projects around the world and has established an international reputation.

He has a first class honors degree in electrical engineering, a PhD in Energy Markets , he is the author of two book s published by J Wiley on Electricity Markets (Power Markets & Economics 2009, and Electricity Markets 1998), and is a Fellow of the Institution of Electrical Engineers.