Electricity Market Reform

Memorandum submitted by Shai Weiss, Virgin Green Fund (EMR 43)

As a follow-up to my evidence given to the Energy and Climate Change Committee on February 8, 2011, please find below my responses to the questions submitted by Mr Richard Benwell on March 2, 2011 further clarifying my position on the issues relating to the Electricity Market Reform.

1. The committee noted your comments about the importance of getting

the detail of the FiT / CfD right and would like your views on what form that detail should take. In particular:

a. Do you prefer a premium FiT or CfD? Does this differ between technologies?

Based on the current proposal for CfD, we would argue for premium FiT as a simpler mechanism with smaller operating complexities. The CfD mechanism would need to be altered significantly to provide an efficient mechanism. Specific issues with CfD include lack of firm purchase obligation and price indexation to average prices vs actual prices. To indicate our final preference between premium FiT and CfD, we would need to see and understand the final detailed proposals for both mechanisms.

We do not believe differences between technologies significantly change preferences between CfD and premium FiT. In general, solutions with higher technology risk warrant simpler support mechanisms.

b. Given your comments about the importance of simplicity is the government right to exclude a fixed FiT from further consideration?

If simplicity and speed of deployment are the most important government criteria, we believe fixed FiT is in fact the most effective and the simplest support mechanism for rapid deployment of low carbon generation projects. If designed and implemented correctly with specific capacity caps and gradual FiT reductions matching the decreasing cost of low carbon deployment, fixed FiT could be a very effective tool.

c. How should the strike price for the CfD be set? The government has expressed a preference for auctions. Is this the right approach?

While auction is theoretically an appealing approach, we believe an auction system is in practice ineffective in driving rapid renewables deployment due to several factors increasing overall project and capital cost such as price uncertainty and high cost of failed bids. Most importantly, renewable energy auctions have a questionable track record as evidenced by recent experiences in Brazil, the Netherlands, or the US.

Auctions set prices well in advance of actual operation of projects without full knowledge on project economics and technology/operational risk. For example, in Brazil, many less experienced local wind developers have been successful in winning bids with extremely low prices, which is arguably why projects are slow to start. None of the 71 projects awarded at the end of 2009 had commenced construction by the end of 2010. The first projects are expected to start construction by the end of Q1 2011 and all must be completed before the end of 2012 to meet the conditions of the auction.' It is likely that these targets will be missed and capacity deployments will be much lower than expected. Auctions forced some experienced developers to sit on the sidelines and the deployment rates may suffer as a result.

The August 2010 round of auctions in Brazil has produced an even more intense competition. The scenario of limited actual construction will probably repeat itself. Please note that these issues will be even more pronounced with offshore wind, where understanding of total capital and operating cost is much more limited as compared to onshore wind.

We believe the UK government should find a mechanism that would encourage entrants to allow rapid deployment. We would prefer a government administered approach in the first stage of large scale deployment until the technology risk of some renewable solutions is minimized.

2. We have heard from some respondents to our inquiry that switching from the RO to a FIT would remove the obligation on suppliers to buy renewable electricity, thereby increasing offtake risk. Would this make investment in renewables a more risky proposition than it is under the current system?

Yes, removal of obligation to purchase renewable electricity by an offtaker creates a major investment risk. Given inherent intermittency of wind & solar, offtakers are motivated to minimize renewable capacity in order to minimize spending on storage, interconnection, demand-response mechanisms and other smart grid solutions. The reform must address this issue. Not having any guaranteed offtake for renewables would be unusual in the current EU market setting.

3. You suggested that an EPS might give concern to those who have already invested in fossil-fuel power stations. However, could a tough EPS also provide a clear sales volume opportunity for low-carbon generation, which might help encourage investment in to the UK's low-carbon power sector?

VGF does not have any investments in fossil fuel power stations so the fund is not in a position to comment on potential issues for fossil-fuel power stations. However, we believe a tough EPS should not be viewed as a tool to incentivize low carbon construction, but rather as a tool to significantly limit new fossil fuel construction and to clean up existing fossil fuel plant operations. Price support incentive scheme, whether CfD or FiT, should be the mechanism used to encourage expansion of low carbon technologies.

4. You mentioned a number of other risks that investors consider when

making investment decisions (such as construction and technology risk). How much weight would be given to these kinds of risk compared with the revenue risk that the EMR is trying to address?

All three risks mentioned - construction, technology and revenue risk - are absolutely critical risks when evaluating potential investments in renewables. The weight is individual for each specific investment and is difficult to quantify. In general, the construction and technology risk have obviously lower weight in proven solutions such as biomass generation and higher in less proven solutions such as offshore wind or CPV. However, even proven solutions carry a significant construction and technology risk given the sheer capital intensity and complexity of energy generation.

EMR will be beneficial to UK low carbon generation deployment, if set correctly. Nonetheless, addressing other risks in the UK market will be also critical to rapid low carbon generation deployment. The UK market currently has other significant barriers, specifically:

a) lack of available equity and debt financing

b) cumbersome permitting and grid connection procedures for some renewables e.g. onshore wind

c) lack of legislation support for energy efficiency and smart grid initiatives such as demand-response systems, UK/EU grid interconnection, energy storage, etc.

d) unfavourable balancing power market setup compared to other EU countries

We will be happy to discuss options to address these issues in more detail going forward.

March 2011