HC 742 Electricity Market Reform

Additional memorandum submitted by Ofgem (EMR 22B)

1. Ofgem is the Office of the Gas and Electricity Markets. Protecting consumers is our first priority. We do this by promoting competition, wherever appropriate, and by 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 gases and in the security of the supply of gas and electricity to them.

2. In February 2010 Ofgem’s Project Discovery reported to Government that under certain scenarios there were concerns over both security of supply and environmental objectives beyond the middle of this decade. Discovery also highlighted that around £200 billion of investment will be needed in the energy industry over the next decade.

3. Ofgem’s Project Discovery used scenario analysis to test the current energy arrangements to see if they could cope with the unprecedented combination of the global financial crisis, tough environmental targets, increasing gas import dependency and the closure of ageing power stations. It concluded that all these factors combined to cast reasonable doubt over whether the current energy arrangements will deliver secure and sustainable energy supplies.

4. Our analysis revealed five key insights:

i. Unprecedented levels of investment (estimated at £200 billion before 2020) need to be sustained in difficult financial conditions and against a background of increased risk and uncertainty.

ii. Uncertainty in future carbon prices could delay or deter investment in low carbon technology and lead to greater decarbonisation costs in the future.

iii. Short-term market price signals at times of system stress do not fully reflect the value that customers place on supply security (for both electricity and gas), which could result in insufficient incentives to invest in peaking capacity.

iv. Interdependence with international markets exposes GB to a range of additional risks that may undermine GB security of supply.

v. Higher energy costs may mean that increasing numbers of consumers are unable to afford adequate levels of energy to meet their requirements, which may harm vulnerable consumers, and affect the competitiveness of industry and business.

5. These five factors still hold and the Government’s energy policy as a whole will need to tackle these issues. Correspondingly, the Government’s stated objectives of Security of Supply, Decarbonisation and Affordability (with its four broad principles of cost effectiveness, durability and flexibility, practicality and coherence to judge the effectiveness of different market design options) seem to us to be correct.

6. Ofgem therefore welcomes the Department of Energy and Climate Change’s Electricity Market Reform Consultation Document. Ofgem looks forward to working with DECC to help change the electricity market to meet consumers’ long-term interests for affordable, reliable and low carbon energy supplies. When taken together with Ofgem’s review of gas market arrangements, [1] the document addresses all the key issues of concern that we identified in Discovery and puts forward reforms that are potentially capable of meeting these challenges. Ofgem believes that starting the reform process promptly is the best way to keep investment costs & energy prices low for consumers.

7. The Energy Minister has recently commented that there will inevitably be a period of uncertainty in laying the framework for the new system. Ofgem recognises the importance of a stable regulatory and competitive framework in energy markets, but believes that the Government is right to act in this instance. As Project Discovery highlighted, there were concerns over both security of supply and environmental objectives beyond the middle of this decade, and there is a window of opportunity to rectify the situation.

8. Industry has criticised previous changes as piecemeal. Tackling the issues together and creating a framework that can then be maintained for some time thereafter will improve investor confidence.

9. Now that the Government has published further details of the proposals, we will be examining these from a consumer perspective in accordance with Ofgem’s duties. In recognising that action needs to be taken in relation to meeting the challenge of reducing greenhouse gases and ensuring secure supplies, it is likely that these proposals will result in increased costs. It is essential that the design of the instruments included in the EMR seek to minimise costs for consumers as much as possible, while still achieving the very important objectives of the EMR.

10. As the Consultation points out, market reform alone is not necessarily sufficient for meeting Government objectives if other parts of energy policy are not aligned. Correspondingly, the work which Ofgem is undertaking to improve electricity market liquidity, which will conclude in the Spring, will be aligned with DECC’s wider reform package. In addition, Ofgem’s ongoing work on delivering the necessary £32 billion of network investment and transforming the energy networks through our RIIO model (which will help to ensure that the networks get smarter, while continuing to be reliable, at low cost), Project TransmiT (which is looking at transmission charging and some aspects of connections to the transmission system) and our work connecting offshore wind farms to the onshore grid are so important.

[1] Ofgem launched the Gas Security of Supply Significant Code Review (‘Gas SCR’) on 11 January 2011 with the release of an initial consultation paper.