HC 742 Electricity Market Reform

GE Submission to Energy and Climate Change Select Committee Inquiry into Electricity Market Reform

January 2011

Summary

GE Energy is one of the world's leading suppliers of power generation and energy delivery technologies.

The businesses that comprise GE Energy - GE Power & Water, GE Energy Services and GE Oil & Gas - work together to provide a broad portfolio of product and service solutions in all areas of the energy industry including coal, oil, natural gas and nuclear energy; renewable resources such as water, wind, solar and biogas; and other alternative fuels. In the UK, GE’s installed technology meets 18% of UK electricity needs and we also supply to 13 of the 14 transmissions & distribution networks in Great Britain.

GE Energy is part of General Electric, a global infrastructure, finance and media company. GE is proud of its presence in the UK since the 1930s. We currently employ over 18,000 people across the UK and have invested over £10 billion in our UK-based businesses since 2002.

This submission provides an initial assessment of the Government‘s December 2010 Electricity Market Reform (EMR) announcement and we look forward to providing our full response to the consultation in due course. GE is keen to be part of the current consultation which we believe provides a tremendous opportunity for the UK to develop a world leading supply chain in low carbon technologies.

Key comments:

· GE welcomes the Energy and Climate Change Select Committee Inquiry into Electricity Market Reform which provides a tremendous opportunity for the UK to build a world leading supply chain in low carbon technologies. The Committee Inquiry can help to clarify the overall narrative of the EMR project and consider the practical considerations of policy change, so as not to undermine the basis of existing investments or create unintended consequences.

· Last year GE announced its intention to invest £99m in a new wind turbine-manufacturing facility in the UK; however the right policy framework is required to support the investment. Current proposals to transition away from the current Renewable Obligation (RO) are based on efforts to secure long-term project finance for renewables but could risk delaying the pace of investment in offshore wind unless properly implemented. The Inquiry can helpfully explore the potential for combining a price-based incentive with a continued form of volume based obligation to support the operational characteristics of offshore investment together with the implications on long term trading arrangements.

· More widely, all fuel sources, including gas, will be vital ingredients in the transition to a diverse low carbon mix. EMR can help to lower the long-term costs of decarbonisation, primarily by ‘future-proofing’ and ‘de-risking’ investments in low carbon technology, however a coherent, stable policy framework is needed to allow manufacturers and utilities to invest for the long-term.

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

As a major UK manufacturing company GE wants to invest and innovate for the long term. As a part of this we support the view that reform is required to ensure that UK power markets remain fit for purpose during the low carbon transition. The UK is the only EU country to have set legally binding CO2 emissions targets, however a range of recent reviews (DECC, the Industry Regulator Ofgem and the Committee on Climate Change) have concluded that current power market arrangements are unlikely to deliver the necessary investments required to help meet them.

The current market structure encourages low capital cost investments such as thermal power plants and has many features that make low carbon investment (where returns on investment accrue over time) unattractive or more expensive than necessary. The result is that most of the new electricity generation plants built under current arrangements tend to be gas-fired and that important investments in wind, CCS, decentralised generation (CHP) and smart grid have tended to be slow and overly expensive.

The EMR must therefore provide a more coherent market and regulatory framework to address the fundamental problems associated with investor risk and capital cost of investment is reduced. Government can reduce investor uncertainty by removing investor risk away from the market and thereby enable developers to more effectively manage the operational risk of low carbon investments.

For reforms to be successful a central aim should be to ensure that the implications of policy change are fully considered and do not undermine or reduce the certainty for current investments in low carbon technologies. Meanwhile, any new arrangements are unlikely to deliver the quantity of low carbon generation needed unless they are implemented quickly in order to meet the tight timescales involved.

Do the proposed policy instruments offer a realistic way of achieving energy security, low-carbon investment and fair prices?

Actions to tackle energy efficiency have tended to focus on demand-side opportunities to improve efficiency of buildings and seek alternative forms of transportation; however they should also focus on supply-side opportunities in the electricity generating sector.

While there are undeniable tangible gains to be made by focusing on the habits and choices of energy users, they can be complex to address. Meanwhile the number of power providers is considerably smaller than the number of consumers; supply-side solutions can be found, agreed and deployed more quickly. As part of a serious effort to increase efficiencies, it is important to recognise the continued role of gas as part of the energy mix. Gas offers half the emissions of coal and, with continued investment, can provide important back-up to support the growing penetration of renewable energy.

Efficiency opportunities exist along the entire energy value chain in the form of gas turbine upgrades, smart grid technologies and decentralised generation, and can be readily implemented. In fact, as energy efficiency leads to a growing emphasis towards electrical consumption supply side solutions will become even more important.

For the electricity market to be attractive to the full range of investors, it is therefore necessary to ensure that there is a long-term price signal against which long-term investments can be assessed. Current market interventions do not set sufficiently long-term volume targets in any of the low carbon technologies outlined above. The process must also be complemented by reform of other systems that currently add delay or cost to infrastructure investment including the planning system, grid connections and combine with the rapid establishment of appropriate institutional or governance arrangements that will need to be in place.

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

- Proposals for Low Carbon Generation Revenue Support (Feed-In Tariffs)

Last year GE illustrated its belief that the UK has a unique opportunity to become a global centre of excellence for offshore wind by announcing a £99m investment in a new wind turbine-manufacturing site in Britain. It is hoped that this investment could provide up to 1,900 clean energy jobs by 2020. Over the next decade the UK has the potential to create a thriving low-carbon sector delivering jobs, domestic sales and export opportunities, particularly in offshore wind.

To support this intended investment the right conditions must be in place to maximise the UK’s wind resource, namely policy certainty. The current Renewable Obligation for example has to-date proven to be an effective policy for encouraging the deployment of renewable energy technologies by incentivising utilities with strong balance sheets to invest in higher risk technologies such as offshore wind. Whilst we understand that the proposals to transition away from the RO are intended to make renewable projects easier to finance in the longer term, there is a risk that the move could have the reverse effect without the right financial support mechanism in place.

The Electricity Market Reform process should consider the continued use of both price-based incentives and volume based obligations to support the operational characteristics of offshore investment together with a technology-specific ‘multiplier’ that specifies an appropriate level of support to encourage offshore wind investment and other technologies. In the case of offshore wind, deployment is largely driven by operational costs with maintenance for offshore about three times the cost of onshore and therefore financial support mechanisms must have a multiplier effect, for technologies which deliver electricity at a higher cost to provide additional support for offshore investors.

There is also a need to fully understand the implications of any new financial support mechanism on long-term trading arrangements as a requirement to trade into the same pool as less intermittent generation could create unintended consequences. Since offshore wind reflects higher operational risk, premiums of investors will be higher and therefore require a higher tariff than may be provided through a new mechanism. The RO motivates utilities to compromise on project profitability in return for renewable generation; however the risk profile of offshore wind is not compatible with investors attracted by steady returns provided by private equity and pension funds.

Should a decision be taken to move away from the RO, GE is also keen to ensure that sufficient measures are taken to ensure a smooth transition. This will include a greater understanding of what basis Government will propose to grandfather the RO to ensure some kind of ‘tailing’ of the current 2 ROCs towards the 2017 end date for accreditation.

- Emissions Performance Standards (EPS)

In the UK, GE is a leader in the development, application and design of IGCC power plants which employs gasification as a key technology for pre-combustion carbon capture. We view the concept of an EPS for coal plant as a viable regulatory supplement and recognise the potential of this policy instrument to be introduced as part of a broader process of power market reform.

The EPS can also deliver targeted outcomes by increasing the future market opportunity for low carbon generation and CCS in particular, by ensuring low carbon options are not undercut by high carbon generation. This is particularly important as it allows suppliers of CCS equipment, such as GE, to support investments in the technology development and supply chain capacity now that is necessary in order to begin deployment in 10-20 years’ time.

Before an EPS can be introduced, the level and timing must be carefully considered in order to take account of differences in fuels and technology options and further detail on implementation will need to be understood during the consultation process. Whilst policy-making remains at an early stage, we would recommend that the design of EPS should seek to be consistent with Best Available Technology (BAT) at the time of implementation. For example, we would be opposed to an initial standard that goes beyond the 360g CO2/kWh as any standard set higher risks penalizing fuel advantages provided by natural gas by unnecessarily increasing capital and operating expenditures.

- Carbon Price Support Mechanism(CPS)

We consider that a stable EU Emissions Trading Scheme (EU ETS) is the most appropriate mechanism to achieve the UK’s long-term energy goals. However, low carbon technologies are disadvantaged by low prices; they are capital intensive and require long term visibility of the carbon market that values low or zero emitting technologies.

The carbon price on its own does not currently provide a sufficient incentive to invest in supply chains for low carbon generation as it has primarily been influenced by policy decisions and requires supportive instruments to drive deployment of specific technologies. This has reinforced an expectation of low carbon prices caused by the system for allocating permits or the link between carbon price levels and the current challenging economic environment.

For this reason we believe that using the Climate Change Levy (CCL) to create a carbon floor price will broadly improve the prospects of low carbon technologies and the way business invests. As with other aspects of the EMR, the implementation of a CPS will need to consider the practical implementation issues that arise, particularly by way of example for ‘small emitters’ such as CHP installations that currently fall under the 20MW ETS threshold and for which clarity over future policy is required to support investment decisions taken today will be affected by changes post 2013 when such a policy instrument is likely to take effect. As such, GE looks forward to contributing the HM Treasury consultation in February 2011.

- Capacity Payment Mechanism

Significant penetration of renewable generation, primarily wind and solar power, the retirement of fossil fuelled generation and expanding demand-side participation, will necessitate increased operating flexibility from the balance of the generation portfolio that is secure, economic and maintains low emissions. Current power market operating rules likewise need to evolve with power system requirements.

Most notably, proper incentives must be provided to market participants to encourage modified operations and investments in flexible resources required. Included in this category are capacity markets and payments.

While grids with increasing renewable penetration will require more flexible thermal generation capacity, there are insufficient market mechanisms to encourage and incentivize the addition of flexible generation. The addition of such mechanisms targeted upon specific types of low emissions technologies that have peaking and/or flexibility capabilities would help to accelerate growth in renewable penetration and would in turn contribute to a cleaner energy future.

Currently, it is common practice for owners and developers of thermal power plants to evaluate projects predominantly on the combination of output, efficiency and maintenance costs to arrive at a levelized cost of electricity. Given today’s shift to more cyclic operation of these assets, fewer plants are operating in base load mode. Owners and operators can generate electricity more cost effectively if they include high efficiency flexibility and efficiency considerations in their evaluation models.

A form of capacity payment that places a value on the availability of capacity will be critical to achieving secure, economic operation of power grids in the near future, while ensuring environmental targets are not compromised. This can help identify a future sales volume whilst encourage investors to develop or purchase the low carbon solutions to meet this market need and provide innovative opportunities to encourage the demand-side to bid into the electricity market. For capacity payments to be effective, coherence with other area of policy such as Ofgem’s Review into the Liquidity of the Electricity Wholesale Market will be essential to ensure the policy instruments is effective.

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

At GE, it is important for us to be in a position to offer our customers a range of power generation and energy delivery options. Underlying this is the regulatory certainty that will allow us to take investment decisions and have the confidence to take long-term view over the next 30 to 40 years.

Our customers have to be able to have the right regulatory framework in terms of business and technology proposition that would allow them to invest. We feel that the DECC EMR proposals that combine market principles with "prudential oversight" form a good basis on which to ensure the UK’s security of energy supplies but must fully consider the practical implementation issues so as to avoid unintended consequences.

Long-term policies will be critical to encouraging investment throughout the value chain as they demonstrate a clear commitment to the deployment of renewable energy technology. Projects such as offshore wind have a development cycle ranging from under a year for smaller solar projects to ten years or more for large scale projects. Meanwhile investments in manufacturing also have a long development cycle. It can take several years to fund, build and tool a plant, and a number of years of operation are required to justify the investment.

A long-term incentive policy will foster a robust project pipeline and supply chain that will ultimately reduce the cost of low carbon technologies, such as renewables. This will also increase the associated benefits of economic development as more manufacturing forms around natural local clusters.

EMR in the international context

GE recognises the development of the UK’s low carbon economy will benefit from the ready availability of renewable energy and coal clusters that are prevalent in the UK if the appropriate policies are in place.

The UK has often led European thinking in electricity market design, from privatization to liberalization which means it is well placed to drive the innovation required to meet its energy challenges. The current reform process will be keenly observed in other member states; however, these benefits will only arise if the UK system has sufficient regulatory arrangements in place with Europe.

At the same time that the UK Government is considering electricity market reform, the European Commission also has a role to encourage Governments elsewhere in Europe to review their electricity markets to ensure the market reform process in the UK is more coherently aligned with other markets. The costs of meeting UK Government objectives are likely to be significantly reduced over the longer term if policy objectives are more integrated with the single European market.

January 2011