HC 742 Electricity Market Reform

ELECTRICITY market reform (EMR)

IET Evidence to the Energy and Climate Change Committee

Ref: S884/hf, 20 January 2011

About the IET

1) The Institution of Engineering and Technology (IET) is one of the world’s leading professional bodies for the engineering and technology community and, as a charity, is technically informed but independent of network company, equipment supplier or service provider interests. This submission has been prepared on behalf of the Board of Trustees by the IET’s Energy Policy Panel.

What should the main objectives of the EMR be?

2) The Electricity Market Review needs both to facilitate the rapid move to deployment at scale of new large scale generation to avoid supply shortfalls over the next ten years and also to enable the transition to a low carbon energy system. It would be undesirable to have to introduce further large scale reform to achieve the latter.

Requirements of Future Electricity Markets

3) In the short term, the main requirements are:

a) To encourage demand reduction

b) to advance construction of mainstream technologies: nuclear, gas, wind and biomass; and

c) to facilitate large scale demonstration of coal (and perhaps gas) with carbon capture, and also newer renewable technologies.

d) to facilitate the development of low carbon energy solutions at community scale

4) Key aspects of the longer term requirement of the EMR are:

a) Full participation of all aspects of demand in the market to allow the opportunities for management of demand to balance supply to be fully realised.

b) Anticipation of massive scale-ups of controllable demand (such as heat pumps, electric vehicle charging)

c) Incentivising reduced demand through efficiency and time shifting of loads

d) Providing sufficient clarity to allow a smart grid to be deployed with confidence

e) Dealing with a much more volatile generation market with large amounts of highly variable wind generation, and potentially significant contributions from sources such as solar and tidal barrages

f) Dealing with increasing amounts of both nuclear and carbon capture-fitted thermal generation, whose dynamic performance is currently untested

g) Moving renewables and other low carbon technologies from special support regimes towards the mainstream as carbon becomes properly valued

h) Enabling the build of significant amounts of low cost peaking generation to provide cover for renewables shortfalls and exceptional demand peaks

i) Being adequately robust to both improvements and further degradation in the funding climate

j) Enable the wider integration of storage in the electricity supply chain

k) Adequately incentivise new interconnectors with other European states where these can be shown to be economically attractive

l) Delivering all this at costs acceptable to consumers and in ways that give sufficient confidence to investors.

Capacity Mechanisms

5) Capacity mechanisms are used successfully in many countries to provide incentives for the construction of power plant, and give confidence to investors by reducing or eliminating dispatch risk [1] . The plant typically earns enough money to pay its fixed costs, service its debts and produce a commercial return simply by being available for service. Rewards for actual operation are typically scaled for the marginal costs of so doing (typically fuel plus hours-dependent maintenance).

6) This arrangement works best when the requirements for capacity are centrally determined such that an optimal amount of plant is built. The disadvantages of such a capacity mechanism are (a) that it limits the extent to which competition can bring innovation into the types of plant built and their operation in a market, and (b) potentially also provides capacity payments to fully depreciated generators who do not really need them.

7) The proposals currently being consulted on by DECC seem to see a more limited role for capacity mechanisms. They are to be used only when a proposed central body foresees a shortfall of capacity being provided by the market, thus avoiding the costs of making payments to all generators. The risk of this arrangement, recognised in DECC’s consultation document, is the distortion it could introduce into the rest of the market. (For example, will owners close plants deliberately to precipitate a decision to make capacity payments available for getting new plant built quickly?). The subject is complex and more work is clearly needed. However whatever arrangement is adopted needs to be transparent and sufficiently simple to send clear signals.

Feed-in Tariffs

8) Ideally the market should determine the least cost renewable solution, however there are wider issues to consider such as:

a) technical maturity (mature technologies are cheaper generally)

b) available land for onshore renewables

c) the desire to create new green industries and employment through supporting certain technologies, and

d) the different generation characteristics (for example wind has certain intermittency characteristics, solar different intermittency characteristics, and that biomass is dispatchable).

e) The desirability to pursue solutions at a range of scales (large plants, community energy schemes, building scale schemes), to maximise the opportunity for decarbonisation and to explore alternatives to find best options

9) Given the scale of renewables deployment implied by the EU 2020 targets, all technologies will need to be pushed hard, and as such there seems little alternative to a technology banded approach to the FIT.

Delivery in one go or over time

10) The proposed EMR introduces further uncertainty for investors, who will tend to wait to understand clearly what their project returns would be before committing. A key objective should therefore be clarity over the total package at the earliest opportunity, along with a very clear timeline for implementation. This should be thoroughly "road tested" with investors, noting, of course, their inevitable desire to obtain a more generous result than strictly necessary.

11) Actual implementation of the market reform process should be considered on the basis of a comprehensive risk analysis. There are market confidence reasons for doing most or all of it at once, but the enabling IT and other infrastructure will carry implementation risks that need to be recognised and managed or mitigated.

Political Risk

12) The UK has always been at the forefront of electricity market reform and has over time made a number of major market changes that have created substantial winners and losers, and thus a perception of political risk. This latest EMR proposal is no exception, although there seems to be an industry consensus that change is needed, and cross party support for it.

13) The extent to which the result decreases confidence depends on how it is implemented – avoidance of significant financial loss for disadvantaged market participants is important, as is very clear signalling of intent. As stated above, it is important that the EMR addresses long- as well as short-term issues to avoid a further revisiting of the rules and additional perceptions of political risk in the future.

14) On the positive side this reform, if carried through well, has the potential to be seen as a global template and to be creating the clarity needed to invest the large amounts necessary.

Will the proposed package deliver the security/carbon goals?

15) This will depend very much on how it is implemented. The right issues are being considered and sensible solutions proposed. The main risks seem to be excessive complexity resulting in a lack of transparency and/or unforeseen consequences. DECC is aiming to strike a balance between giving investors confidence and not over-rewarding them. In the IET’s opinion, the economic and political costs of insufficient capacity to cover times when demand is high and wind and other variable generation low seem to be rather higher than the costs of slight overprovision. We are moving into a technologically uncertain world given the high levels of intermittent renewables, demand participation and other changes and it would seem to us wise to err on the side of caution.

16) Affordability will be an issue into the future, whichever forms of generation are built. All forms of power plant, all fuels and also carbon emission will become much more costly. In addition, network infrastructure will need heavy investment to become smart and to meet new demands from heat pumps and electric vehicles. The only mitigant available is efficient use of energy, which will need continuing strong emphasis.

Storage and Interconnectors

17) Neither storage nor interconnectors seem to have been given strong consideration during the DECC work so far. Both have potentially large roles to play in the longer term, and we would suggest that a range of storage and interconnector scenarios are tested against the proposed reforms before they are firmed up.

18) Storage is essential to the secure operation of the power system and has the potential to play a bigger role in the future. It is recognised that storage can offer multiple benefits to the power system. Examples include helping to manage intermittency, meeting shorter term peak demands, reducing the need for new network capacity and enhancing security of supply. At present there is not a storage technology available that has the price/performance characteristics that will ensure widespread deployment. However, a number of technologies are under development and as the value of the ancillary services that storage can provide increases, they may well prove to offer economic solutions.

19) Storage can supply multiple services to different parties in the disaggregated supply chain. There is therefore a risk that the current market structure may make it difficult for storage owners to be properly rewarded for the services they can provide. This issue should be explicitly addressed as part of the EMR consultation process, involving the key players in the storage community. Hopefully, this will ensure that the market reforms introduced will not present any unnecessary and/or unintended barriers to the further development of storage.


20) Under the EU Third Legislative Package on Energy there is a requirement to form a single energy market but one in which the electricity supply systems of each member state will continue to have their own characteristics. Furthermore all members are obliged to significantly increase the renewable component of their generating portfolio, UK included.

21) With different levels of security of fuel supply, proportions of intermittency and cost of generation, increased interconnection within the EU seems inevitable. Interconnection with the UK is, of course, a special case because of the need for submarine connections with higher costs. Nevertheless, interconnectors have potentially large roles to play in the longer term and we would suggest that a range of interconnector scenarios are tested against the proposed reforms before these are finalised. It should be noted that both political and technical risk underlying the development of interconnectors is likely to remain low.

January 2011

[1] Dispatch risk is the risk that a particular power plant is or is not called upon to operate, which depends on the balance of supply and demand at a particular time, and on the marginal costs of operating the plant compared to other plant. As we move forward with considerable uncertainty as to how much renewable and nuclear capacity gets built and when, it is much harder for investors to be able to predict the extent to which their plant will be dispatched and therefore what their revenues will be.