HC 742 Electricity Market Reform

Friends of the Earth England, Wales and Northern Ireland welcomes the opportunity to submit evidence to the Committee’s inquiry into Electricity Market Reform.

14th January 2011

Introduction

Electricity Market Reform (EMR) offers a once-in-a-generation opportunity to set Great Britain on a path that might allow it to meet its carbon budgets as required under the Climate Change Act 2008.

Reform is desperately needed. In order to remain on a plausible pathway to the UK’s 80% cut in carbon emissions by 2050, the Committee on Climate Change has said that the electricity system must be "substantially decarbonised" by 2030 – to around 50gCO2/kWh. Yet, as the Government and Ofgem have both clearly identified, this will require unprecedented levels of investment in low-carbon generation, transmission and distribution networks, smart grids and other demand side response measures, storage, European interconnection and energy efficiency.

We are not responding in detail to all of the questions posed by the Committee, but set out below our thoughts on the key priorities for EMR and the proposals set out in the twin DECC and Treasury consultations.

Summary

· The 2020 and 2030 objectives need to be strengthened and centre-stage.

· Demand reduction should be a fundamental principle, and EMR proposals strengthened accordingly.

· A FIT is welcome, but this should be targeted at new and emerging technologies: nuclear should not be included.

· The FIT should include clear degression rates, as for the small FIT, so it is not an ongoing subsidy, but will gradually reduce as technologies mature. This will reduce the overall cost of the programme.

· The Government should set the level of the FIT; an auctioning system is likely to benefit big and existing players and shut-out new or smaller entrants.

· The EPS needs to be strengthened, so that new gas plant has to have CHP.

· The carbon floor price, at the levels proposed, will have a relatively minor effect on investment decisions. It should not be seen as a justification for weaker policies in other areas. It needs to be reformed so it does not provide a financial benefit to either existing or new nuclear, which receive major subsidies already on liabilities, insurance and decommissioning.

· The reforms should include a greater focus on decentralised energy as a means to smooth demand spikes.

The objective of EMR – meeting the 2020 renewables target and a 2030 target of 50gCO2/kWh

Creating a low-carbon electricity system, while ensuring that the ‘lights don’t go out’, and doing so in the most affordable way (the Government’s stated aims) are reasonable and appropriate goals for EMR.

However, there must be clarity on the definition of a low-carbon electricity system, and a timetable consistent with achieving the UK’s carbon budgets, in order to drive the requisite scale and pace of investment. Friends of the Earth believes, in line with the recommendations of the Committee on Climate Change (CCC)’s Fourth Budget Report, that the Government must adopt a 2030 target for decarbonisation, with the system having a carbon intensity of no more than 50gCO2/kWh by this date. Missing this date and target puts the longer term 2050 target in jeopardy and means that cumulative emissions in the period to 2050 will be far greater. We note that the CCC’s 2030 target of an overall 60% economy-wide cut, from which the electricity sector’s decarbonisation target is based, is in the CCC’s view the minimum effort consistent with the 2050 target.

The EMR consultation document makes no commitment to a 2030 deadline for decarbonisation (referring to decarbonisation during the 2030s), and the policies in the consultation are supported by modelling on the basis of a carbon intensity of 100gCO2/kWh. This is understandable given that the EMR document came out only a week after the CCC’s report, however the final EMR proposals must reflect the tougher 50gCO2/kWh 2030 target.

The legally binding EU 2020 renewables target is also critical.

Reducing energy demand should be the fundamental principle

Reducing energy demand is the most cost-effective way of reducing carbon emissions from electricity. This means focusing on delivering long-term energy efficiency, as well as mechanisms to enable short-term load shifting, to smooth demand peaks. Doing so reduces the need for new generation plant, cutting cost and the burdens of obtaining planning and other consents.

The consultation gives limited recognition to the policy change s needed to deliver a transformation in energy efficiency. It is welcome that there is consideration of a capacity mechanism which would support both long term energy efficiency and demand side measures, and this must be retained in the White Paper.

However, this will be insufficient to deliver the scale of energy efficiency measures needed, and the other policy proposal referred to, the ‘Green Deal’ in the current Energy Bill, is equally inadequate in its current form .

The Green Deal will succeed or fail depending on critical factors such as the interest rates on the loans, the strength of any accompanying suite of incentives and regulations to drive take-up, and whether the scheme can be made to work for the millions living in fuel poverty or on low incomes. Huge amounts of detail are currently missing from the Government’s proposals.

The bigger picture though is that the Green Deal could only ever do part of the job. What is really needed is a comprehensive strategy to both eradicate fuel poverty and radically cut carbon from homes. Such a strategy is conspicuous by its absence.

Demand reduction – both long- and short-term – will be supported by the possibility of new entrants, with new business models , and less of a vested interest in simply selling as many megawatts as possible, into the retail market. Yet the EMR consultation does little to tackle the key barriers to entry into energy supply, not least the lack of transparent wholesale pricing for electricity.

The measures being developed by Ofgem to increase market liquidity and transparency in parallel with the EMR work are welcome, but it is unclear that these will be sufficient to challenge the domination of both generation and supply by a handful of vertically integrated companies, with limited incentive to invest in dema nd reduction .

Consideration should be given to how the distribution network operators – and other players, such as local authorities – might be well placed to help deliver investment in energy efficiency and the smart technologies which will help with switching the time of electricity use.

Providing long-term certainty on price

Renewables generation has wholly different investment profiles to fossil fuel plants, lacking the in-built hedge that the current market creates for gas, and requiring high levels of capital investment, but having low short-run marginal operating costs. Uncertainty around long-term prices for renewable electricity creates barriers for investors and increases the cost of capital for those that are prepared to back new low-carbon plant.

The Renewables Obligation has had a mixed track record in bringing forward investment in renewable technologies; it has had limitations in terms of cost and complexity. Following the success of Feed-in Tariffs in significantly boosting the deployment of sub-5MW renewables, Friends of the Earth support the proposals to create long-term contracts using a form of Feed-in Tariff to provide investors in renewables with price certainty.

The choice of type of FIT is important; we feel that the consultation may offer a too negative opinion of the merits of a fixed FIT. Price certainty is a key goal, and we think that a fixed or CfD FIT is preferable to either the premium FIT or RO. However a more important issue is the level of FIT support. Here there is very little information in the consultation on this – we advocate that the committee scrutinise this crucial issue in depth. We suggest that the Committee take evidence from German parliamentarians, who have had great success in driving renewables investment using a fixed-tariff system.

The Government’s lead preference is for the level to be set by auction. We have a major concern with this, which is that it is likely to skew the FIT system in favour of big and existing players, who will be better resourced and able to understand and operate in an auctioning system. There is also a concern that auctioning may lead to speculative bids which do not end up being build. It appears to be more effective for the Government to set the FIT level. This is how the sub-5MW UK FIT works, and also how the successful German system operates. The Government can set a FIT for different technologies consistent with a certain return on investment, with appropriate degression rates.

We are concerned that the level of ambition for renewables beyond 2020 as set out in the consultation is extremely low – FIT levels should be consistent with both the EU 2020 renewables target and also necessary renewables investment to meet the 2030 decarbonisation target of the Committee on Climate Change.

Support for renewable energy not nuclear

The current mechanism for supporting the development of low-carbon electricity generation, the Renewables Obligation, is rightly focused on supporting renewable energy technologies, and on providing differing levels of support for different technologies in relation to their maturity. The EMR consultation suggests a different approach, treating electricity from renewable energy and from nuclear as interchangeable, placing them together under the innocuous heading ‘low-carbon’.

Friends of the Earth believe that this is disastrous. Doing so runs the risk of nuclear 'crowding out' investment in renewables, even to the extent of placing existing investment (such as the Crown Estate Round 3 windfarms) at risk. If nuclear gains at the expense of renewables, the electricity system is likely to decarbonise less quickly (since nuclear plants take much longer to construct than, e.g. windfarms); we risk lock-in to a highly centralised electricity system, with concomitant inefficiencies in transmission and distribution; we will fail to support emerging technologies in which UK could be world leader, e.g. wave, tidal, and the jobs that would accompany such leadership. In addition, the nuclear industry’s waste problems remain unresolved.

Providing Feed-in Tariffs for nuclear is effectively a subsidy, contrary to Government commitments. These incentives are only appropriate to help newer technologies compete with existing players in a system which currently heavily favours older technologies. Nuclear power has had six decades to stand on its own feet. It should not continue to get its existing heavy subsidies (on insurance and decommissioning), let alone get new support.

Friends of the Earth believe that Feed-in Tariffs should apply only to genuinely renewable energy technologies.

In addition, the proposals for a carbon floor price through reform of the Climate Change Levy will, as currently set-out, deliver a de facto windfall to not only new nuclear plant, but to existing nuclear generators too. If the Government is to proceed with this measure, it should consider levying an additional tax on nuclear fuels set at a sufficient level to remove this unfair benefit, and which could make a partial contribution towards the currently heavily subsidised costs of dealing with nuclear waste.

The right mix

There is necessarily some degree of uncertainty about the ideal generation mix in the electricity system of 2030, and also uncertainty about the appropriate balance between spare generation capacity and storage, interconnection and demand side measures in providing security and stability.

However, it is disingenuous of the Government to suggest that it does not have a preferred mix and that the measures suggested in the EMR consultation are not predicated on any particular mix. The Government's policy package appears to assume particularly large roles for nuclear and gas, with renewables getting squeezed. The illustrative modelling underpinning the work assumes that renewable deployment actually slows down in the 2030s (renewable energy represents 29% of electricity generation by 2020, and 35% by 2030), at a time when currently emerging – and less intermittent – technologies, such as tidal, might be expected to become commercially viable.

Emissions Performance Standard

We have discussed nuclear above; but the framing of the proposed Emissions Performance Standard (EPS) as merely a ‘backstop’ against new unabated coal, illustrates how committed the Government remains to fossil fuel plant, and with no signal that unabated fossil fuel plant will be unacceptable at a future date. With both the proposed EPS standards extremely weak, we risk being locked-in to a fossil-fuel dependent system, with a new 'dash for gas' imminent.

We support WWF and Greenpeace’s central recommendation in their evidence to the Committee’s 2010 inquiry into EPS, of "a plant-based EPS set at a level of 300gCO2/kWh for all new generating plant from now on, tightening to less than 100gCO2/kWh in 2025 (from which point it should also apply to existing plant)."

This will ensure that any new gas plant has to have some degree of CHP. We note also the major potential for biomethane to supply heat and power, the new plant built by Thames Water and British Gas, the major use of biomethane in other countries such as China, and the National Grid’s estimate that 50% of the UK’s household gas needs could be met by this source by 2020.

This should be complemented by reforms to National Policy Statements currently out to consultation, where the NPS set a limit to the amount of new non-renewable capacity allowed. This safeguard is absolutely essential if the EPS is not strengthened and stays at the proposed levels in the consultation, otherwise there will be a new dash-for-gas which will stifle renewables investment.

The carbon floor price is relatively insignificant

The carbon price, at the levels proposed in the Treasury’s consultation, plays a relatively small role in total electricity prices, as illustrated in the Treasury’s document. The level of investment risk created by low and volatile carbon prices is therefore quite limited, when set against the gas price, or major non-price barriers such as the need to obtain planning consents. We note that the three options are all under the level modelled in the DECC consultation.

As such, and particularly given the proposed low starting rates for the fuel duties that will create the 'floor', the carbon floor price is, in comparison with other measures, trivial in bringing forward low-carbon investment.

The proposals to create a floor price at these levels should be seen as only a very minor issue, with little positive effect. It creates a strong argument for tougher proposals in the DECC consultation. It also has the current undesirable effect of creating an effective new subsidy for both new and old nuclear plant, in conflict with the Coalition agreement.

Capacity payments

The need to 'keep the lights on' dictates the need for the maintenance of an appropriate capacity margin, but this need not simply mean the availability of Combined Cycle Gas Turbines or other fossil fuel peaking plant. We therefore welcome the Government's stated intention to design a capacity mechanism that will support storage and demand side measures. Appropriate investment in these measures and in interconnection with other European countries can obviate the extent to which a continued reliance on gas is necessary.

The Government’s focus still appears to be heavily on supply-side measures to deal with demand spikes, although the smaller focus on demand-side responses to spikes is welcome. This demand-side focus needs to be strengthened.

However, the Government should also introduce measures to prevent spikes in the first place. We note the growing evidence from Europe and the USA that increasing decentralised energy can have a major impact in smoothing out demand – turning demand ‘spikes’ into ‘waves’. We urge the Government to have a much greater focus on decentralised energy as ways to tackle demand spikes.

Contact:

tony.bosworth@foe.co.uk

simon.bullock@foe.co.uk