HC 742 Electricity Market Reform

National Grid submission to the House of Commons Energy and Climate Change Committee inquiry on Electricity Market Reform


National Grid owns and operates the high voltage electricity transmission system in England and Wales and, as Great Britain System Operator (GBSO), we operate the Scottish high voltage transmission system. National Grid also owns and operates the gas transmission system throughout Great Britain and through our low pressure gas distribution business we distribute gas in the heart of England to approximately eleven million offices, schools and homes. In addition National Grid owns and operates significant electricity and gas assets in the US, operating in the states of New England and New York.

In the UK , our primary duties under the Electricity and Gas Acts are to develop and maintain efficient networks and also facilitate competition in the generation and supply of electricity and the supply of gas. Our activities include the residual balancing in close to real time of the electricity and gas markets.

Through our subsidiaries, National Grid also own s and maintain s around 18 million domestic and commercial meters, a Liquid Natural Gas importation terminal at the Isle of Grain , and 50% of IFA and BritNed (the electricity interconnectors with France and the Netherlands respectively) .

National Grid will be contributing to the DECC consultation on Electricity Market Reform launched on December 16th . As such , the responses set out below express our initial thoughts and will be subject to review during the course of the DECC consultation.

Executive Summary

National Grid is fully supportive of electricity market reform (EMR). In order to assist in the decarbonisation of other sectors, early large scale investment in low-carbon, electricity generation infrastructure will be a priority. EMR has the potential to ensure that the necessary investment in appropriate, low-carbon technologies is made in an affordable, secure and sustainable manner.

We are supportive of the principles of a carbon floor price, feed-in tariffs and an emissions performance standard.

We do also agree that it is important to consider whether an additional intervention to bring on sufficient "back-up" generation is necessary. However, there is more work to be done before we can conclude that further intervention in the form of explicit capacity payments is required. It may be that adjustments to existing market mechanisms will be sufficient to facilitate the investment. For example, imbalance prices could be "sharpened" to encourage suppliers to make the appropriate investments in order to avoid being exposed to the true cost of imbalance. The extent to which such amendments could be successful in providing comfort that sufficient generation will be available requires further assessment. National Grid will provide more detail on what such amendments could look like when formulating its response to the DECC consultation on EMR.

Finally, in order to maintain security of supply, it is crucial that Electricity Market Reform is carried out in a coordinated way with other energy policy and planning policy development. If EMR is to drive GB down a certain "energy path", then it is important that other policy, legislation and regulation support the delivery of that.

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

The main objective of the project should be to encourage efficient and timely investment in low carbon generation, energy efficiency and network/interconnection technologies while maintaining security of supply.

The measures recommended by the EMR project should fully take into consideration EU objectives and initiatives such as the development of the internal energy markets (including the third package and relevant legislation on state aid).

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

It is important to define what is meant by a capacity "mechanism". A "capacity mechanism" should not necessarily be regarded as synonymous with pure capacity payments. Capacity payments, even if made via an auction which could help to find the best "market" price, could prove unnecessarily expensive to consumers if inappropriately designed.

It might be that a package of subsidies and incentives to encourage the development of generation capacity could ensure that sufficient capacity is available without the need for an explicit pure capacity payment. The measures already proposed as part of DECC’s EMR consultation (e.g. feed-in tariffs) will, by themselves, result in some new generation capacity being built. This, along with additional market-based measures (e.g. sharper imbalance prices) to incentivise generators and suppliers to "self-insure" against the intermittency associated with increased volumes of renewable generation, could constitute a "capacity mechanism", ensuring that the risk remains with the market (where it is best able to be managed) rather than with the consumer. The mechanisms currently employed by National Grid as System Operator to procure "balancing services" could also be extended or amended to provide additional "back-up" capacity. National Grid intends to work up these alternatives with DECC over the coming months to identify how such a package of mechanisms could work to provide the government and the industry with the necessary confidence that security of supply will be maintained.

Capacity Payments and Capacity Auctions

Given the focus in the DECC consultation on capacity payments, we thought it would be helpful to set out our views on this option which needs to be considered alongside other capacity mechanisms.

Capacity payments have the potential to encourage investment in generation and may thereby facilitate a transition to low carbon electricity while delivering security of supply. Whether capacity payments can deliver such outcomes at fair prices very much depends upon the design and operation of the mechanism.

Although we can see the benefits of a capacity auction which could be designed to bring on certain types on generation technology at a fair price, there is a risk that such interventions will disrupt other segments of the market. For example, interventions for just low carbon technology might reduce market investment for establishing or maintaining back-up generation. However, extending support to cover certain backup generation will reduce incentives for interconnection and enhanced demand side measures. In this way, it is possible that more interventions are then required for increasingly larger sections of the market. We are very keen to understand DECC’s views on how this risk could be mitigated.

We also have a concern about who would decide on what needed to be auctioned. Some careful thought is needed on this issue as this mechanism is likely to result in a much more prescriptive approach to the balance of the energy mix.

There are a number of other issues which need to be considered when designing capacity interventions. Some of these issues are:

· The potential for distorting effects if additional revenues are unduly focused on capacity without regard to its effectiveness in terms of reliability and flexibility of energy production.

· Similarly, if revenues are unduly focused on energy delivery from certain sources there is the potential for distorted scheduling and consumption decisions (for example, in extreme, those conditions observed in some markets when negative prices result).

· The practical issues associated with specifying the required functionality of the capacity (for example, ensuring appropriate reliability and flexibility). These are particularly challenging if the characteristics of particular low carbon technologies (such as variable wind) are addressed independently of the wider portfolios in which they will operate.

· The issues associated with ensuring appropriate settlement of technology specific revenue streams (for example, ensuring payments are not made where contracted services have not been delivered).

· A risk that incentives on the demand side may be dampened at a time when new opportunities from SMART metering, demand scheduling and energy efficiency technologies are increasingly important.

· The potential for additional obligations or complexity to dissuade new entrants and so reduce competitive pressures that protect consumers.

· The need to ensure consistency with capacity limitations in the network.

· The timing for the application of capacity mechanisms is crucial in tackling security of supply issues. The implementation needs to target the period when security of supply becomes a major issue (e.g. in 2016 following closure of Large Combustion Plant Directive generation assets).

· Affordability to consumers should remain at the forefront of all considerations.

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

As per our response to question 2, we think there is a requirement to undertake further analysis and discussion before taking any decision on capacity mechanisms.

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

While National Grid has a duty to remain neutral and non discriminatory in its dealings with all generation technologies, we observe that experience from other countries suggests Feed in Tariffs offer a means of bringing new technologies to market readiness with lower financial risks and hence lower costs than the approach embodied in the Renewables Obligation. They also potentially offer a better deal for consumers in so far as they offer improved sunset arrangements for situations where technologies have reached market readiness or it has become clear that certain technologies are unlikely to ever reach such a state.

We would however recommend that FiTs are structured so that they do not insulate recipients from appropriate market imbalance and network locational signals. These signals will remain important in guiding efficient market development and facilitating competition such that consumers can be assured fair prices. This factor must be taken into consideration in the development of any capacity mechanism discussed above.

Similarly, FiTs should also be structured so that appropriate locational signals, concerning the relative merits of connecting close to consumption within distribution networks (as so-called embedded generation), are balanced with the costs of accommodating generation in net surplus areas which will require strengthened transmission links.

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

We recommend that, regardless of whether the implementation of EMR is staggered or delivered in one go, firm policy decisions need to be made as early as possible to remove uncertainty for investment decisions.

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

The market reform has the potential to enhance certainty and increase investment provided appropriate policy decisions are made and suitable implementation arrangements are chosen. We suggest clarity on how policy interventions will address specific market short-comings will help avoid unintended consequences and improve certainty for the industry and the financing parties/institutions.

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?

The combination of different mechanisms should provide the required incentives to drive transformation to achieve climate change goals.

It is important that EMR is not carried out in isolation from other energy policy and planning policy development. If EMR is to drive GB down a certain "energy path", then it is important that other policy, legislation and regulation support the delivery of that. For example, if there is to be greater reliance on flexible gas generation, then it is important that the industry has a clear vision of the requirements for gas infrastructure to support this transformation

In parallel to work on gas policy, it is also vital that we continue to develop CCS so that we can reduce emissions further and perhaps provide access to coal generation as well as gas. The CCS demonstration programme should be continued and extended to include at least one gas plant. A n acceptable regime for storage and incentives for investment in CCS infrastructure should be developed with a view to the future wider scale roll out of CCS when commercially and technically proven .

The EPS should not be set at such a level as to prevent the further build of unabated gas generation.

FiTs – See question 8

Capacity mechanisms – see questions 1, 2 and 3

Carbon Price floor – See questions 3 and 9

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

We have mentioned above a number of interrelations between different mechanisms and the existing market, and also the importance of how the implementation of the measures is timed. In addition:

Conflicting signals between a UK carbon floor price and the EU ETS incentive could lead to a "carbon leakage" scenario (see question 3 and 9)

Interaction between the development of cross border electricity markets as recommended within the EU third package and the changes brought to the UK electricity market through the EMR needs to be considered.

We believe that support for investment decisions made under the RO regime should be grandfathered if FiTs are expanded to cover all scale of renewable generation replacing the RO regime.

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

We are supportive of the establishment of an appropriate and stable carbon floor price. An unstable or low carbon price has hindered delivery of the potential benefits of the EU ETS. A UK carbon floor price is feasible provided the level is set so as to increase the wholesale price of fossil fuel used for generation to a level that makes low carbon generation feasible. We believe the carbon floor price will be a welcome interim measure in the medium term to provide certainty for UK investors in the absence of an EU wide carbon floor price. However we need to carefully assess the level to which it is set and its potential interactions with an EU and international carbon price. Too low a level will again fail to drive investment whereas a high level could lead to "carbon leakage" with investors offsetting their carbon emissions elsewhere in Europe. It is also important to consider whether to apply a carbon tax on power sector/electricity generation only or on a wider scale across industries. The latter solution could exacerbate the "carbon leakage" problem and drain investment.

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?

We do not believe there will be a material impact at this stage; however the impact of a low carbon generation fleet with low marginal cost but a need for flexible albeit low load factor backup/top up may be conducive to the development of new forms of electricity storage, "quasi-storage" from the demand side (e.g. electric vehicles charging network) as well as increased interconnection to other markets..

If the government ends up with a more prescriptive approach to the energy mix, then it will be vital to ensure that interconnection with Europe is taken into consideration when determining appropriate generation requirements. Even with a more market based approach, it is important that the market understands the appetite for greater interconnection so that this can be factored into the investment decisions.

Much greater coordination with Europe is required than currently exists.