Electricity Market Reform - Energy and Climate Change Contents

Conclusions and recommendations


1.  The Government must reverse the downward trend in "clean" investment. It must create more attractive returns and reduce the risks of investment in order to reduce the cost of capital in the electricity sector. (Paragraph 20)

DECC's high level objectives

2.  It is important that the Electricity Market Reform package is geared to deliver our renewables targets as well as our decarbonisation objectives. (Paragraph 37)

3.  The Electricity Market Reform package must deliver 50gCO2/kWh carbon intensity by 2030 instead of 100gCO2/kWh. We recommend that the White Paper sets out an indicative carbon intensity pathway for the power sector to 2030, aiming to deliver a 40-60gCO2/kWh carbon intensity in the electricity by 2030. DECC should set out its carbon intensity trajectory on the advice of the Committee on Climate Change. (Paragraph 40)

4.  We recommend that the White Paper addresses directly the problems associated with greater intermittency. It should plan for electricity storage and interconnection and how that will help to meet demand in the light of increasingly inflexible and intermittent supply. It must show how the development of smart grids and demand side responses can contribute to managing demand. (Paragraph 48)

5.  "Affordable" electricity in the short term cannot be achieved at the expense of meeting the other objectives of Electricity Market Reform. Lower prices cannot be a primary driver of energy policy, but developing greener and more secure sources of electricity needs to be accompanied by sound social policy to protect vulnerable consumers. (Paragraph 54)

6.  The White Paper must set out a range of possible price impacts of the reforms and how these impacts would be mitigated for the fuel poor and vulnerable businesses. Government must also assess the price impacts of other low carbon policies outside of the EMR package. (Paragraph 55)

7.  The White Paper should include a demand reduction objective. (Paragraph 58)

8.  The White Paper must set out a second tier of objectives, following a strategic view of the energy sector in decades to come. This should include a specific pathway for reducing electricity consumption through demand side measures. It should set an explicit decarbonisation goal for 2030, with a trajectory for reaching the target. It should focus on dealing with intermittency and inflexibility on the system as a key energy security challenge. It should also set clear objectives for improving support for vulnerable consumers. (Paragraph 59)

The electricity wholesale market

9.  The current market arrangements do not facilitate a fully functioning wholesale electricity market which transmits the price information necessary to attract investment. We recommend that the Government incorporate a review of the present trading arrangements and liquidity in the forthcoming White Paper. (Paragraph 70)

10.  DECC must consider the future evolution of the electricity wholesale market as part of the Electricity Market Reform process. The review of Ofgem is an opportunity to ensure that it delivers decarbonisation and security of supply alongside affordability for consumers. (Paragraph 80)

11.  DECC should investigate the full range of options for improving liquidity in the wholesale market. DECC must also consider its options for making the wholesale market fit for a low-carbon future. We would recommend an evolution of the System Operator's role and a reform of the "balancing mechanism". (Paragraph 81)

12.  The Government must acknowledge the direction of travel of the electricity market in future, which may well include increasing interconnection with other European markets. The Government should explore how this will affect the Electricity Market Reform package in its White Paper. Electricity Market Reform needs to be accompanied by a strategic vision of the shape of the market in coming decades, including the European dimension. (Paragraph 85)

Long term contracts

13.  The Committee recognises that different levels of Feed-in Tariff ("banding") are required to support technologies at different levels of maturity and with different financing needs. In the short term, levels should based on technological and economic considerations. This process must be transparent and levels must be set for a defined period, with clear triggers that would activate a review if levels need to be reassessed. (Paragraph 108)

14.  In its White Paper, the Government should acknowledge the problems of relying on auctions to set Feed-in Tariffs for most technologies in the short term, but it should set out conditions under which it would shift to an auction-based process in the future. (Paragraph 109)

15.  The main argument for the Contract for Difference is the Government's desire to achieve the investment certainty offered by fixed prices while maintaining the efficiency of a competitive market. However, this approach is not appropriate for all kinds of low-carbon generation. Different kinds of low-carbon generation are at very different stages of technological maturity, with very different operational and financing requirements. Feed-In Tariffs should recognise the unique characteristics of different low-carbon technologies. Proper discussion of these possibilities is a serious omission from the consultation. (Paragraph 121)

16.  The Government must recognise more clearly the different financing requirements of low-carbon technologies and investigate the possibility of different kinds of long-term contract for different kinds of low-carbon technology. The Government should consider Contract for Difference for nuclear, but it should recognise that some technologies such as wind generation cannot easily respond to market signals under a Contract for Difference and may be exposed to lower than average prices. We also believe that Carbon Capture and Storage and electricity storage should benefit from Feed-in Tariff support, but that a Contract for Difference may not be the best model. These technologies are likely to require bespoke contracts. The White Paper should offer a flexible solution to meet these different objectives. (Paragraph 122)

17.  If it is the Government's policy objective to develop large amounts of new nuclear generation, then it is almost certain that it will require policy or financial support that will amount to forms of subsidy. While a Contract for Difference Feed-in Tariff may be the best option for nuclear generation, it may not be the best for all low-carbon generation. The Government must not go down the route of Contracts for Difference for all low-carbon generation just because it does not feel able to differentiate between nuclear energy and other low-carbon technologies. The White Paper should address the advantages, risks and challenges of promoting new nuclear generation head-on and honestly; it should not distort the market merely to save political face about the precise meaning of the Coalition Agreement for Government. (Paragraph 132)

18.  The White Paper should identify which institution will be given power to create appropriate contracts and set this up as quickly as possible. If this role is not taken on by Ofgem, a shadow body should be set up in advance of legislation. Government should concentrate on the powers of this institution rather than the detail of the contracts and clarify its role, objectives, composition and funding as soon as possible. The agency must be totally independent and not susceptible to political influence. (Paragraph 135)

Carbon Price Support (CPS)

19.  We have heard no justification for the departure of the final proposals on Carbon Floor Price from those modelled in the consultation. We would welcome such a justification from HM Treasury. (Paragraph 139)

20.  The Carbon Price Support was introduced as one of the four "pillars" of Electricity Market Reform and will interact significantly with other measures. We are disappointed that the Government chose to introduce the Carbon Price Support before the Electricity Market Reform process is complete. (Paragraph 142)

21.  A UK Carbon Price Support is a necessary compromise to support low-carbon electricity generation in this country. The Government must continue to push for a European greenhouse gas emissions reduction target of 30% by 2020 in order to strengthen the effectiveness and credibility of the EU Emissions Trading System. The White Paper must include a persuasive strategy for achieving this aim. (Paragraph 148)

22.  We acknowledge the contribution to decarbonisation that a high and reliable carbon price could make in the long-term. We also recognise the good intentions of the Government in attempting to underpin the carbon price. However, we are aware that when it comes to low-carbon investment, the effect of the Carbon Price Support will depend on the confidence of investors in the long-term reliability of the Carbon Price Support. (Paragraph 160)

23.  We recommend the Government explains how it plans to deal with the problem of potential windfall profits arising from the introduction of a Carbon Price Support in its White Paper. The White Paper should set out under what circumstances the Government would take action to address windfall profits resulting from the introduction of the Carbon Price Support. If such measures involved a tax, then any revenues should be matched by an increase in the budget of the Green Investment Bank. (Paragraph 167)

24.  Reporting carbon consumption figures alongside production figures would help provide greater transparency about the UK's impact on climate change. We recommend that the Government should consider this option. (Paragraph 173)

25.  We believe that the Carbon Price Support will not influence investment decisions until 2018 at the earliest. We would have preferred the Government to establish a nominal Carbon Price Support level until 2018 and then set a long term trajectory based on advice from the Committee on Climate Change. Until then, the Carbon Price Support represents little more than an additional energy tax, which will be passed on to consumers. (Paragraph 175)

26.  We suggest that Carbon Price Support tax revenues should be matched by increased budget for the Green Investment Bank. (Paragraph 176)

27.  The Carbon Price Support must not systematically distort electricity prices between the UK and other countries. In an increasingly interconnected market, this could mean significant transfers of capital abroad and the "offshoring" of UK generation. (Paragraph 177)

28.  Carbon Price Support is a short-term solution to the failure of the EU Emissions Trading System to deliver a meaningful carbon price. It poses risks to UK energy security and the UK economy more widely. The White Paper needs to justify its costs and benefits and provide a persuasive plan for its integration with the EU Emissions Trading System. (Paragraph 178)

Capacity mechanism

29.  It is too early for the Government to specify what capacity mechanisms might look like. Legislating for capacity mechanisms now may restrict the scope to take account of future technological developments and the success or otherwise of interventions such as long-term contracts. (Paragraph 191)

30.  The Government needs to analyse more fully the nature of the problems of increased intermittency, and in particular, the potential need for flexible capacity and demand side measures at all times, not just at times of peak demand. Capacity mechanisms would need to be able to deal with this wider problem, rather than focusing solely on meeting demand at times of peak usage. (Paragraph 192)

31.  It is clear that designing effective capacity mechanisms is complex and cannot be rushed. The White Paper must set out plans to avoid the "slippery slope" problem. While it is too early to legislate for the detail of future capacity mechanisms, it is not too early to prepare for the design of capacity mechanisms which are accurately calibrated to meet the future need at minimum cost. The White Paper should pave the way for the creation of a new independent agency that would have responsibility for designing and administering both long-term contracts and capacity mechanisms. (Paragraph 202)

Emissions Performance Standard (EPS)

32.  We conclude that neither of the Emissions Performance Standard options proposed in the Electricity Market Reform consultation would promote decarbonisation of the power sector and that introducing regulation in the form proposed would not only be pointless but could even create uncertainty among investors. (Paragraph 210)

33.  We recommend that if the Government is to introduce an Emissions Performance Standard, it should be used to provide an early indication of the desired emissions intensity trajectory for the power sector, in line with recommendations from the Committee on Climate Change. (Paragraph 215)

34.  The Government's proposals to grandfather an Emissions Performance Standard at the low levels set out in the Consultation Document risk encouraging a "dash for gas" which could lock the UK into high carbon emissions for years to come. If the Government is concerned about investor certainty, a better way to achieve this would be to signal Emissions Performance Standard levels in advance by setting out a clear long-term Emissions Performance Standard trajectory. (Paragraph 216)

35.  We recommend that the government produces argued proposals on the use of biomass in future power stations and their effect on Emissions Performance Standard targets at an early date. (Paragraph 218)

Investment: risks and returns

36.  We have concluded that Feed-in Tariffs are an effective way of creating adequate returns for investors in new low-carbon generating capacity especially when combined, in the long term, with a realistic and stable carbon price. (Paragraph 222)

37.  It is vital that the Government creates a market structure that inspires confidence in investors. In order to bring forward the huge sums of capital that are needed, the market must be certain that risks and returns will remain stable in the long run. In the White Paper, the Government must set out its long-term intentions for each of the four pillars of Electricity Market Reform: long-term contracts; Carbon Price Support; Emissions Performance Standard and a capacity mechanism. It must explain how these instruments may evolve in the run up to 2030 and under what conditions revisions will be made to the levels set for each instrument. It should also guarantee that revisions will be signalled and consulted on with sufficient warning periods and guarantee that any changes will not be made restrospectively. (Paragraph 225)

38.  Potential investors were concerned that the current Electricity Market Reform proposal will not win their confidence. The inclusion of four "pillars", while trying to address real and different problems, may in fact create an overly-complicated bundle of measures with considerable overlaps between instruments. Each extra measure creates new political risk that the terms of the incentives for low-carbon generation will change in response to future short-term political pressures. (Paragraph 237)

39.  The consultation has been an opportunity for the Government to test out a number of ideas. In the White Paper, however, the Government should aim for greater simplicity and clarity. The Government should create a framework for Feed-in Tariffs and for a capacity mechanism, but leave the details to an implementing, independent and expert agency. It should either abandon its half-baked Emissions Performance Standard proposals or replace them with a much tighter option, with a long-term trajectory for tightening the standard progressively over time. (Paragraph 238)

Energy consumers

40.  The potential negative impacts of the Electricity Market Reform on fuel poverty and on those on low incomes must be acknowledged. However, tackling fuel poverty cannot be the driver of energy policy and therefore should not be the preserve of DECC alone. Departments across Whitehall should work together, particularly including the Department of Work and Pensions and the Department for Communities and Local Government. (Paragraph 244)

41.  The Electricity Market Reform proposals are unlikely to have a major impact on UK competitiveness except in the case of electricity intensive industries that are exposed to international competition. (Paragraph 249)

42.  The aim of the Electricity Market Reform is to remove barriers to investment in new energy infrastructure. It is therefore extremely worrying that some investors find the Government's commitment to managing the cost impact of the proposals insufficiently credible. A lack of awareness among consumers that bills are likely to increase over the next decade may hamper take up of domestic energy efficiency schemes such as the Green Deal. The Government should explain clearly the likely impacts of Electricity Market Reform on energy bills and the ways in which consumers can mitigate this through energy efficiency. The roll out of smart meters could trigger consumer engagement and be one means of communicating this message. (Paragraph 252)

Demand side measures

43.  The Government should undertake more thorough analysis of the role that demand side measures could play as part of the UK's electricity system in future. More thorough modelling and cost benefit analysis of the scope for demand side measures is required and the White Paper should clarify how such measures can cut demand and provide flexibility to the system. (Paragraph 260)

44.  There is a risk that a capacity mechanism that provides support for backup generation could undermine incentives for demand side measures. The White Paper should outline how this effect would be mitigated. (Paragraph 264)

45.  The White Paper must also specify for which demand side measures the capacity mechanism will be available and clarify whether it is intended to support demand reduction, demand-side flexibility, or both. (Paragraph 265)

46.  The proposed Contract for Difference mechanism should be expanded to include rewards for guaranteed demand side measures. The White Paper should examine this possibility. (Paragraph 270)

47.  Demand side measures do not receive sufficient consideration in the Electricity Market Reform proposals. Demand reduction is the cheapest way to meet decarbonisation, security of supply and affordability objectives. The White Paper must explain the expected impact of the reform package on the three different types of demand side measures: demand reduction, demand side response and decentralised energy. (Paragraph 271)

Transition period and implementation of the new regime

48.  We recognise the risk of making poor policy decisions if analysis of potential Electricity Market Reform packages is conducted too hastily. However, we are also mindful of the Government's legal obligation to achieve 15% of energy from renewable resources by 2020 and the significant role renewable electricity will play in meeting this objective. We therefore believe the Government's proposed timetable of producing a White Paper in "late Spring" must not slip and we recommend that it introduces an Electricity Market Reform Bill before the end of this Parliamentary session. (Paragraph 276)

49.  Government needs to explain fully how the transition from the Renewables Obligation to a Feed-in Tariff will work in practice. In particular, greater clarity is needed how DECC plans to ensure that existing investments are not undermined by the Electricity Market Reform. The White Paper should set out proposals for an effective transitional regime. (Paragraph 281)

50.  We recommend that the Government publishes a proposed Electricity Market Reform implementation plan as part of or alongside the White Paper. (Paragraph 284)

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Prepared 16 May 2011