HC 742 Electricity Market Reform

Energy and Climate Change Select Committee inquiry into Electricity Market Reform

EDF Energy’s response

Ke y points

· EDF Energy plans, with its partner Centrica, to build up to four nuclear power stations, creating thousands of jobs and providing enough low carbon electricity to meet 40% of the UK’s domestic customer demand; the first unit, at Hinkley Point, would be commissioned by 2018. This will add to our existing, diverse generation portfolio, which includes renewables, coal, gas and nuclear.

· Our final investment decisions for new nuclear generation have yet to be taken, and are reliant on receiving the necessary consents and to a robust investment framework being in place.

· We therefore welcome the Government’s proposals for market reform , which we believe can be developed into a robust market framework which is capable of underpinning the low carbon investment required .

· We believe there is a need to recognise the difference between instruments used to correct the defects of the existing market arrangements and additional measures such as Contracts for Difference ( C f Ds ) that can mitigate risks for both customers and investors , and the final package of reforms must be coherent and sustainable .

· Instruments such as CfDs will be settled against a reference price in the wholesale market and this places a high premium on ensuring that market arrangements deliver wholesale prices that more accurately reflect the underlying cost of delivering low carbon electricity.

· We therefore welcome HMT’s proposal to provide a carbon price floor and we believe that this along with a capacity mechanism will play an important role in ensuring that future wholesale prices more accurately reflect the underlying cost of delivering low carbon electricity.

· T he carbon price floor should start low and increase gradually to encourage new investment while minimising the impact on existing plant.

· The ETS was set up to encourage a switch to low carbon energy. It has not yet delivered an enduring price at the level required to do this. The carbon floor price mechanism aims to restore the price signal that the ETS was intended to provide.

· Much work will need to be done to develop the detail behind the proposals and establish the necessary institutional arrangements to implement the reform.

· We will evaluate the proposals that Government has put forward and intend to provide a full and constructive response to the Government’s consultation s .

· It is imperative that Government move s quickly in establishing the new market arrangements , to enable investors to move forward with their plans for low carbon investment and minimise the need for any new unabated fossil fuel plant.

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

1. The existing electricity market framework is being stretched in an attempt to deliver outcomes that were not envisaged when it was originally established; there are a number of reasons why the current market arrangements are unlikely to be fit for purpose over the next decade, including:

· the inability of the EU ETS to provide a strong, long-term carbon price signal for investment in low carbon generation;

· the significant increase in the proportion of the market that will be supported by subsidy and the consequential distortions in wholesale electricity prices. These compromise the effective operation of the competitive market;

· the large increase in the proportion of high capital, low marginal cost plant required on the system to deliver the UK’s decarbonisation objectives, and the need to deliver stable and adequate returns to investors in these plants;

· the significant projected increase in the level of intermittent generation on the system, and the need to ensure that there is adequate capacity of short term response and standby plant to provide back up for variations in wind output.

2. EDF Energy does not believe that the current electricity market arrangements will be able to secure the investment required to decarbonise the electricity sector by the 2030s in an efficient manner while delivering secure energy supplies at least cost to consumers. EDF Energy called for electricity market reform in 2009 and this view is now generally accepted by Government, industry players and other key stakeholders such as the Committee on Climate Change (CCC) and the Confederation of British Industry (CBI).

3. EDF Energy plans, with its partner Centrica, to build up to four nuclear power stations over the next 15 years, creating thousands of jobs and providing enough low carbon electricity to meet 40% of the UK’s domestic customer demand. EDF Energy is already investing hundreds of millions of pounds in new gas and renewable electricity capacity. This will add to our existing, diverse generation portfolio, which includes renewables, coal, gas and nuclear.

4. Our final investment decisions for new nuclear generation have yet to be taken, and are reliant on receiving the necessary consents and on the Government implementing proposals to introduce a carbon price floor and reform of the wider electricity market. The Electricity Market Reform project must therefore deliver a coherent and robust set of market arrangements that allows market participants to invest with confidence in the generation capacity that is needed to deliver the UK’s energy policy objectives.

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

5. We believe that delivering energy security and investment in low carbon generation capacity requires a coherent set of complementary measures. In line with this view, we believe a balanced package of reforms should include both a carbon price floor and capacity payments.

6. A carbon price floor will help ensure that fossil fuel generators pay a fair price for the pollution they emit. A floor price could start at a low level, and rise over time, ensuring the true costs of carbon are reflected in market prices, as new generation comes on line. However we would agree with DECC’s view that a carbon price floor is unlikely to be sufficient on its own.

7. In EDF Energy’s view the future market arrangements must provide a framework to bring forward sufficient generation capacity to meet electricity demand and have a sufficient margin to deal with the projected scale of intermittency that the UK system will have to deal with by the end of this decade. The existing market arrangements, where the market price is largely based on marginal production costs, are unlikely to provide a credible market signal to bring forward the required capacity; nor do they provide sufficient reassurance to underpin investment in capital intensive low carbon plant. We therefore believe that some form of capacity payment is required to achieve the levels of security of supply that customers expect.

8. The need for capacity payments is further emphasised by the increase in the proportion of high capital, low marginal cost plant required on the system to deliver the UK’s decarbonisation objectives. Under the current market arrangements this plant is never likely to set a marginal price that is capable of recovering its full costs.

9. We believe these components of market reform will deliver what is required by all low carbon generation technologies, and are in the interests of all market participants.

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

10. We believe that a long term low carbon capacity payment would provide a reliable incentive to invest in low carbon generation. It would help ensure that enough of the right, reliable, low carbon capacity is built. In a market which will have increasingly high levels of intermittent supply from renewable sources, security of supply will be increasingly valued by customers. Investors should therefore be able to gain income from providing secure, available low carbon generation, alongside earnings from wholesale prices. We would expect such low carbon capacity payments to:

· Be paid on availability of plant at times when capacity is needed most, i.e. times of peak demand;

· Be paid on capacity (kW) rather than energy output (kWh), in order to provide protection against reduced load factors resulting from market operation;

· Provide long term certainty for new low carbon investment, i.e. guaranteed for 20 to 30 years depending on projected lifetime and typical financing requirements for particular technologies;

· Be set at the level needed for the lowest cost low carbon generation to recover upfront capital costs that may not be fully recovered over its operating lifetime from wholesale prices.

11. DECC acknowledges the potential distortions to wholesale prices that could be created if a capacity mechanism targeted solely at peaking plant is implemented. The distortion would manifest itself in depressed wholesale prices, with the additional costs of providing adequate capacity being recovered outside of the wholesale market. EDF Energy believes that the costs of the targeted capacity payments should contribute to the composition of the wholesale electricity price and that this would provide a more efficient outcome for consumers with lower overall costs. We would seek further reassurance that these distortions can be avoided. If not, then EDF Energy believes, alongside low carbon capacity payments for new investment, the Government should consider a flat capacity payment that would be payable to all available generation capacity, and potentially to reliable demand reduction capability.

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

12. It is very important that new arrangements to provide revenue certainty are available equally to all low carbon technologies, since renewables, nuclear and carbon capture and storage (CCS) will all need to make contributions to the required decarbonisation of electricity production. EDF Energy recognises that a single flat payment is unlikely to provide sufficient returns to deliver all of these technologies and that some renewable technologies in particular will require higher payments until they become mature. However we believe there is merit in having a uniform set of consistent arrangements that will provide greater transparency to market participants and minimise distortions in the formation of the wholesale electricity price.

13. Work done by DECC on its analysis of potential pathways to meet the 2050 climate change targets has demonstrated that new nuclear power will be essential in an affordable future energy mix. The need for new nuclear is also recognised in the draft National Planning Statements that have been republished for consultation.

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

14. Much work will need to be done after the EMR consultation to develop the detailed implementation of the proposals, including establishing the necessary institutional arrangements. This may take some time but it is urgent to establish sufficient certainty for investment to proceed without delay. We are therefore pleased with the government’s statement that it will seek to ensure that implementation of the reform proposals will proceed on a timetable that enables investors to bring forward the low carbon projects they are proposing.

15. In practical terms we believe this means that the carbon price support must be implemented by the 2011 Finance Act, the market reform White Paper must be published in Spring 2011, and proposed legislation to implement it must be presented to parliament also during 2011. New nuclear projects in particular have long lead times and, if we are going to achieve commercial operation of the first reactor in 2018, which is important for security of supply, final investment decisions will need to be made soon, based on certainty about the new market arrangements.

16. While drafting of new regulations may take time, in our view there needs to be sufficient detail in new legislation to provide certainty for investment. Government also needs to be willing to engage with investors on the basis of its policy decision, in order to provide investors with sufficient comfort to proceed with their proposed investment in a timely way.

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

17. We welcome the Government’s proposals for market reform and we believe the proposals can be developed into robust market arrangements in which investors can have confidence ; robust arrangements w ould be less subject to political risk. We look forward to taking these forward with Government to ensure that we achieve the right mix of instruments so that we have a coherent and sustainable package of reforms.

18. We believe that ‘ Package 3’ in the EMR consultation represents the most balanced set of proposals that are capable of achieving the government’s policy objectives , provided our concern about potential market distortions created by targeted capacity payments can be addressed . If not, we would advocate a revision to package 3 to incorporate universal capacity payments. We are currently evaluating these proposals in greater detail and will include a summary of our analysis in our response to the consultation.

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?

Market Arrangements

19. We believe it is important to be clear about the potential role of each of the measures and recognise the clear difference between correcting the defects of the existing market arrangements and additional measures such as CfDs that can mitigate risks for both customers and investors. Instruments such as CfDs will be settled against a reference price in the wholesale market. This places a high premium on ensuring that market arrangements deliver a credible price. Therefore CfDs should be adopted as part of a wider range of measures.

20. This is why we welcome HMT’s proposals to provide a carbon price floor, and we believe that this, along with some mechanism that recognises and rewards the value of capacity, will play important roles in ensuring that future wholesale prices more accurately reflect the underlying cost of delivering low carbon electricity.

21. The proposals for C f Ds in the new market frameworks provide an opportunity to allocate risks to those best placed to manage them and to allow investors to earn fair returns. Getting this right will ensure that consumers do not have to pay any more than is necessary to deliver the UK ’s decarbonisation targets. We believe these reforms are capable of providing the platform for the UK to achieve its goals on climate change, security of supply and affordability.

Emissions Performance Standard

22. We support the principle of emissions performance standards (EPS) and believe that this could be a useful instrument in the future to close out residual emissions from fossil fuelled plant. However CCS technologies have not yet been proven at scale and this makes it difficult at this time to be specific about the long term rules and frameworks within which an EPS would be applied.

23. While a progressive EPS may be needed in the future to close out residual carbon emissions, our immediate focus should remain on delivering new low carbon generation capacity by implementing the proposals for a carbon price floor and electricity market reform.

Other Factors

24. It is important that Government moves quickly to establish the new market arrangements, to enable investors to move forward with their plans for low carbon investment and minimise the need for any new unabated fossil fuel plant.

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

25. As stated earlier, EDF Energy believes that the Electricity Market Reform project must deliver a coherent and robust set of market arrangements that enable market participants to invest with confidence in the generation capacity that is needed to deliver the UK’s energy policy objectives. It will be important to provide an effective transition from existing policies measures, such as the Renewables Obligation and the planned CCS levy. We believe that the Government’s proposals for carbon price support in conjunction with the proposals for electricity market reform can represent a coherent and sustainable package.

26. We recognise that some renewable technologies may require additional support for a time, and believe that having a more uniform set of arrangements for all technologies will provide a better platform for achieving the UK’s energy policy objectives. We are considering the potential implications for our renewable investments and will provide a full consideration of the issues that we believe need to be considered in any transition from the current mechanism for supporting renewables to the new arrangements.

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

27. EDF Energy agrees with DECC’s analysis that the carbon price floor can sit comfortably alongside the other proposals for market reform and will help ensure that the wholesale price revealed by the market more accurately reflects the true cost of providing low carbon electricity.

28. Putting a price on CO2 emissions is not new policy. The intention of the EU ETS, which is supported by the Government, is to provide a robust carbon price signal that would drive decarbonisation. However, there is widespread recognition that the EU ETS does not yet provide a long term carbon price adequate to inform investment decisions on new power stations.

29. A carbon price floor can help correct this failure by providing certainty for low carbon investment and by ensuring that those who choose to emit carbon will incur a minimum cost. The carbon price floor mechanism should be introduced early to provide regulatory certainty so that investors can plan low carbon investments with confidence. However the floor could start at a relatively low level to reflect existing market conditions and this would increase over time, reaching its target price around the time that we expect new low carbon investments to be operational. It is worth noting that the carbon floor would only be triggered if the market price fell below the floor price. In other words, if the market produces a robust carbon price, as intended, then the floor would not have any additional impact on customer prices.

30. The level and trajectory of a carbon floor price should be aligned with views expressed by independent experts and institutions such as the CCC in their price forecasts, which they believe are consistent with achieving the long term aspirations and targets to reduce CO2 emissions. Hence the floor price will only be underpinning the minimum price that the ETS was expected to create and should not be adding any additional costs.

31. The Government, Ofgem and many others have set out figures showing the likely scale of the investment Britain needs to make in low carbon energy infrastructure. Most recently, Ernst and Young said £234 billion of investment by 2025 is required.

32. We agree with the analysis presented by DECC and HMT in the consultation on the carbon price floor which suggests that these policy measures will help ensure that UK customers benefit from competitive energy supplies over the long term.

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

33. Electricity storage provides the opportunity to reduce the overall costs of electricity generation, by storing energy during periods when wholesale prices are low and releasing the stored energy when electricity prices are higher. Storage typically operates over relatively short timescales, e.g. a daily cycle. Therefore the main commercial driver for storage is the difference between low and high prices that are revealed by the market. EDF Energy believes that this is a further reason for ensuring that the wholesale prices that emerge from the reformed market arrangements represent a true reflection of generation costs, which should include any costs paid for by the system operator to secure standby and reserve capacity, as well as the costs required to keep the electricity system in balance. Such arrangements will allow the market to make optimum investment decisions in choosing between electricity storage options and building reserve capacity, as well as stimulating demand side response.

34. Interconnection can be used to improve the efficiency of the system by balancing natural peaks and troughs in demand across national systems and interconnection might also be used to import or export power if there are structural deficits / surpluses in the power sources. To date the UK system has generally operated in a way that has ensured there is sufficient capacity to meet domestic demand and we believe that this will continue into the future. Therefore, the main reason for investing in increased levels of interconnection is likely to be the reliability and predictability of domestic generation sources, which will in turn depend on the choices we make regarding our future generation mix. Similar to storage, the important outcome for the market reform project will be to ensure that the wholesale market reveals a price that is an accurate reflection of the underlying generation costs, since this will ensure that market participants can see a reliable market signal to inform investment decisions.

EDF Energy

January 2011