Memorandum submitted by CHPA |
1. The Coalition Government has recently published
its consultation on reform of the electricity market. Whilst Government
has a clear overarching objective; affordable secure, low carbon
electricity, there is an absence of a clear narrative of how the
Government will seek to achieve this. The consultation sets out
four "tools" for reforming the electricity market but
does not set out the detailed issues which it is seeking to address
through the EMR. The CHPA recommends that the scope of the EMR
be clarified with Government identifying the key issues within
the market that it wants to see addressed. Once these have been
identified, the Government can then determine how the chosen policy
measures (tools) can be deployed for delivering the energy system
that Government envisages for the future.
2. The key issues of market performance that
need to be considered in greater detail are:
- What is the scope for demand reduction, embedded
generation and actively managed network infrastructure to take
excess power at times of negative power prices, to provide cost-effective
system services and limit the requirement for the construction
of additional generation and network capacity?
- How does the market currently value these services
and what changes (if any) need to be made to ensure that these
services can play a role where they are cost effective.
3. The CHPA believes that there is a significant
potential role for new business models that can respond to emerging
system requirements and arbitrage opportunities, and that through
encouraging the development of this market the Government could
limit some of the cost increases associated with a move to a low
carbon economy. Whilst the consultation mentions demand-side measures
there is a strong focus on new generation which may lead to the
potential for demand response from being underexploited.
- What are the barriers to new market entrants
both on generation and supply? What changes to the market are
necessary to facilitate new market entry.
- What are the key points of contestability in
the current market - are these sufficient or should the reform
facilitate greater contestability.
- Is low market liquidity limiting new entrants
through an inability to determine forward prices?
4. The CHPA believes that the current market
structure limits the ability for both new market entrants and
smaller, independent parties to compete effectively with the established
market participants. Although experience suggests that the greatest
impact has been upon new suppliers, the scope for generators existing
outside of the highly-insulated, Renewables Obligation-subsidised
market has been limited since the NETA and BETTA reforms of the
early 2000s. The principal barriers to new market entry in the
UK market today arise from:
- a lack of liquidity and transparency in forward
- considerable and unpredictable imbalance risk;
- the two factors noted above combine to inhibit
the formation of a reliable reference price for both investment
and operational dispatch decisions;
- a competitive advantage in addressing these risks
for vertically-integrated market participants; and
- high regulatory costs and overheads, which afford
considerable economies of scale to larger market participants.
5. The Government's consultation mentions new
support options but makes limited mention of the mechanism by
which these would be funded or administered. It is vital that
the political acceptability of the move to a low carbon economy
is retained and strengthened as increasing prices and new generation
assets will inevitably cause some concern. The CHPA believes that
there is a need for a clear narrative for consumers about the
impact of these actions on their energy bills. More importantly,
there should be greater focus upon those mechanisms that will
help to insulate customers from the increased costs of new generation
investments, most notably through improved energy efficiency and
enhanced competition at appropriate, contestable elements of the
supply chain. For example, aggregating demand response and small
scale- or micro- generation through Energy Services Companies
(ESCos) may provide a mechanism for consumers to become more actively
engaged with energy issues and help them to benefit financially
from the services they can offer. A fundamental commitment to
encourage these options within the scope of the EMR may help to
limit future public concerns over the costs of the low-carbon
6. An EMR process occurs once every 10 to 20
years and it is vital that Government seizes the opportunity to
examine the successes and weaknesses of the current market before
proposing how it will facilitate a change in the generation mix.
The CHPA would encourage the Committee to examine the options
for reforming the market fundamentals to help crystallise some
of the issues that need to be addressed
What should the main objective of the Electricity
Market Reform project be?
7. The Government has correctly set out overarching
objectives for the future of the electricity market; affordable
secure, low carbon electricity. Whilst this is helpful, it is
too broad to inform the range of interventions that may be needed
to deliver on those objectives. The EMR consultation moves from
this suite of high level objectives and lands upon the focused
target of facilitating new investment in low carbon generation
assets, without considering the wider structural market issues.
8. The CHPA recommends that in taking forward
its programme of reform, the Government should adopt a more forensic
and comprehensive approach in addressing the barriers or limitations
that are evident in today's electricity market place. This should
include consideration of:
- Price transparency and the availability of a
recognised "reference price" against which new investments
can be appraised.
- The openness of the market to new entrants on
both the generation and supply sides of the market.
- Wholesale electricity market liquidity.
- Imbalance risk.
- Consumer engagement.
- The pricing signals for demand-side measures
and embedded generation.
- Practical points of contestability in the supply
9. Whilst the consultation mentions some of these
issues, there is an absence of a clear in-depth analysis of what
issues exist and, vitally, how structural market reforms could
address these. By placing these issues as the central point of
market reform, the Government would be better placed to develop
proposals for new interventions, such as a Feed-In Tariff. The
need for the scale of the interventions proposed may be due to
areas of market failure. Addressing the causes of any points of
market failure first will clarify what additional tools may be
needed to ensure that the overarching objectives are achieved.
Do capacity mechanisms offer a realistic
way of achieving energy security, low-carbon investment and fair
10. A capacity mechanism
is simply a tool for ensuring that generation assets or demand
reduction are available to provide net changes in power demand
during a given time period. A capacity mechanism cannot deliver
the overarching aims of the EMR. The CHPA believes that Government
needs to identify better any market issues and what may be a barrier
to energy security, low-carbon investment and fair prices and
use the evidence from that to determine what further tools are
needed to ensure that the overarching aims are met.
11. A capacity mechanism
that incorporates demand response, embedded generation and transmission
connected generation within the suite of options to manage grid
imbalance (both excess demand AND excess generation as is likely
to happen with increasing renewables penetration) will probably
be a necessary tool to manage the anticipated future power generation
mix. Well designed, a capacity mechanism can contribute to limiting
price increases (through demand management services and embedded
generation) and carbon emissions (by dispatching capacity services
on an emissions based mechanism). Furthermore, by opening up capacity
services to embedded generators and ESCos, it may be possible
to access an existing market of operators who are able to offer
capacity services but for whom the current market arrangements
do not offer value on this area.
What is the most appropriate kind
of capacity mechanism for the UK?
12. Any capacity mechanism needs to be considered
within the context of wider reforms to the market and in particular
the approach taken to the wider incentivisation of low-carbon
13. Given the deterministic approach to encouraging
low-carbon generation proposed by the Government, with contracts
struck with individual generators and with baseload or "must-run"
generation dominating the new build, consideration should be given
to a focus on availability to dispatch power rather than a mechanism
simply based on installed capacity. A system base purely on installed
capacity may see payments to generators who are unable to offer
capacity services, or who are rewarded twice for providing the
14. Furthermore, in the interests of stimulating
competition and encouraging the lowest-cost market response, any
capacity market should be opened as widely as possible to allow
the full scope of demand response options to play a part in the
market. A simple mechanism on generation assets may lead to the
development of significant numbers of open cycle gas turbine units
which would be unlikely to contribute emissions reductions and
may not be a cost effective solution. A mechanism that facilitates
the use of existing assets, such as CHP units, as well as demand
reduction may deliver far better value to consumers for the same
impact on gird balancing and frequency.
15. In the future, it is likely that negative
electricity prices will be part of the wholesale market. In cases
of excess generation, services which absorb excess generation
and use it usefully, such as charging electric vehicles and storing
energy as heat for use in heat networks, may be required. A capacity
mechanism should be designed to provide the flexibility for both
excess demand and excess supply.
Should the system of Feed-in Tariffs be focused
on particular technologies or maintain a wider technology-based
16. The proposed contract for difference feed
in tariff (CfD FiT) is an appealing mechanism for delivering low
carbon generation and with the right design can facilitate wider
market participation, with the corresponding benefit of increasing
capital flows. Recognising that there are significant technology,
construction and operating risks associated with each of the principal
generating technologies which the FiTs regime is targeting it
will be vital to ensure that each of these technologies, alongside
a wider range of demand-side measures are incentivised under the
new arrangements. At the same time it will be necessary to avoid
excessive rents, in order to maintain the acceptability of the
policy to UK consumers. These considerations would tend to favour
an approach where differentiated tariffs are offered to different
technologies or measures. The interaction of the new CFD FiT with
the current FiT also needs to be considered.
17. A further design consideration will be the
determination of the level of capacity contracted under the FiT
regime, and the corresponding extent of the capacity market. The
more FiT contracts in place, the fewer periods over which participants
in the capacity market may be required to operate, so restricting
their opportunities to recover costs through generation.
Will it be feasible to deliver EMR in one go,
or will regulations and implementation be spread over time?
18. The reform process will take several years.
Whilst this may appear a problem, a clear timetable and narrative
of what is sought by Government will be able to provide the necessary
clarity to prevent a collapse of investment or confidence. Whilst
it is important for Government to aim for a quick and efficient
resolution of the EMR process, it is vital that appropriate time
is taken to develop and examine all proposals. The EMR is a process
that occurs every 10-20 years and, as such a long term reform,
sufficient time needs to be given to ensure that it will deliver
what Government wants. The time spent in designing and implementing
a robust and enduring market framework will be rewarded through
fewer interventions to correct design flaws once the new arrangements
become operational. In this respect, the 2020 timeframes adopted
in EU legislation may be acting to compromise prospects for efficient,
long-term decarbonisation pathways by encouraging short-term,
19. There has been much focus on the need for
certainty for new investors, which is appropriate, but the impact
of a rushed reform process could be long term damage to key aspects
of a successful market such as liquidity or barriers to new entrants.
In the absence of a comprehensive approach the EMR, the CHPA is
concerned that the process may become overly-focused on bureaucratic
detail, whilst losing sight of the bigger picture.
Will market reform increase political risk for
investors or create certainty?
20. It is inevitable that reforming the market
will create some degree of uncertainty but it has become clear
that the current market arrangements are unlikely to deliver a
cost effective decarbonisation of the UK electricity generation
mix, in line with UK targets, whilst maintaining security of electricity
supplies. As a result, the Government should develop a strategy
for minimising uncertainty in the form of setting out a detailed
set of metrics to be addressed in the reforms and a reasonable
timetable. The lack of clarity for the direction of the EMR and
the confused nature of the consultation document has already had
a direct impact on the liquidity of the traded market.
Will the Government's proposed package of carbon
price floor, EPS, FITs and capacity mechanism provide sufficient
transformation to achieve goals on climate change, security of
supply and affordability?
21. No. The consultation does not comprise comprehensive
analysis and steps for market reform. As set out earlier, the
fundamentals of the market need to be reviewed and examined. Based
on the analysis of the function of the market fundamentals, Government
needs to determine what reforms need to be implemented to ensure
that the market will function both now and in a low carbon generation
scenario. Once these have been established that Government may
best consider what additional interventions are required to secure
low carbon investment and security of supply.
What synergies and conflicts will there be between
proposed mechanisms and policies already in place?
22. There is the opportunity to develop synergies
between new policies and existing structures but it is not possible
to define these (or the potential conflicts) without greater detail.
23. The most significant interface issue is that
which lies between the contracted FiT market and the proposed
capacity market. The greater the level of volumes potentially
contracted for under the FiT regime, so the smaller the volumes
traded in the capacity market and the greater the prices that
will need to be offered to capacity market participants to make
capacity available and respond to system requirements. In an extreme
situation, with excessive volumes of "must-run" FiT-rewarded
generation, the capacity market will be dominated by flexible
generation reducing output and by energy storage. A major challenge
for the Government will lie in achieving the optimum balance between
incentivising low-carbon generation and low-cost response.
24. The proposed level for an emissions performance
standard will have limited, if any, impact on the status quo.
The interaction of the CfD FiT and any capacity mechanism will
be vital to the effective operation of the market and delivering
value for money to consumers but this is not examined by the consultation.
Will a carbon floor price be feasible in the context
of EMR and at what level should it be set?
25. The proposed carbon floor price is a feasible
mechanism for Government although it has several key issues that
need to be considered.
- As a mechanism for providing a minimum carbon
price that passes through into the wholesale electricity market,
it is appropriate that only fuels used to generate power pay the
carbon price levy. This may appear self-evident, but it is the
case that the Government's proposals for Carbon Price Support
include proposals to impose the carbon price levy on fuels used
to generate heat in combined heat and power plants. This situation
creates an unmanageable cost risk for CHP operators which may
cause them to cease operating in CHP mode, leading to a direct
increase in UK emissions.
- The interaction of the proposed mechanism with
the EU Emissions Trading Scheme may create significant issues
for future interconnections with the continent as there will be
a carbon price disparity. This could lead to an increased drive
to import power as it may have a lower cost.
- A carbon support price mechanism will only lead
to cost pass through (to the wholesale market) during periods
when fossil fired plant is the marginal (price setting) plant.
With a predicted increase in power generation from low carbon
sources, it is likely that there will be periods when non-fossil
plant operates as the marginal plant. The result will be no carbon
cost pass-through to the market and the loss of the intended signal
from the carbon support price.
What effects will EMR have on the development
of capacity for electricity storage and the development of interconnectors
between the UK and other electricity markets?
26. The EMR proposals set out by Government set
out the value and theoretical options for both interconnectors
and storage but there are no detailed proposals on how new capacity
in these two areas will be brought forward through the EMR. In
addition, the discussion of storage is primarily limited to pumped
storage for which there is limited opportunity for expansion.
27. The CHPA believes that storage both pumped
storage and other means such as thermal storage will have an increasingly
important role to play within the electricity market but there
needs to be a clear examination of the role that it can play and
what value it can contribute. The fourth chapter of the Government's
consultation sets out a range of options that can be considered
for managing the change in generation mix but there is an absence
of analysis as to the value that these options present, the saleability
of these options and what (if anything) in the market needs to
change to ensure that these services are valued sufficiently for
them to be provided.
28. The CHPA recommends that the Government commissions
an examination of the potential for the fullest range of demand
side response measures (including embedded generation, demand
reduction, use of excess generation and localised balancing services)
and a cost benefit analysis of what these may offer a more diverse
and unpredictable energy mix. The CHPA notes that opening up of
the Danish district heating market to provide services to accommodate
variable power generation has dramatically smoothed power prices
and facilitated much needed system balancing. As part of such
a review, the potential costs and benefits of moving to a system
of actively managed electricity distribution networks (DNs) should
be examined. The CHPA believes that there is substantial opportunity
to save costs by reducing the level of infrastructure development
required for DNs by moving to a system of active management. Such
cost savings may be key to limiting the rise in customer energy
bills and hence, retaining vital political acceptability for energy