Memorandum submitted by ESB International |
1. ESB International (ESBI) welcomes the opportunity
to provide views in response to the Committee's inquiry on electricity
market reform. The challenges facing the energy markets over the
forthcoming years are significant and the structure of those markets
will play a major role in achieving Government policy objectives.
The points raised in the Committee's call for evidence are therefore
timely and particularly pertinent.
2. This response provides a brief introduction
to ESBI and a summary of our views, followed by more detailed
responses to the specific questions posed by the call for evidence.
3. ESBI has been a developer and operator of
independent Combined Cycle Gas Turbine (CCGT) generation projects
in the GB market for over 15 years. We currently have equity interests
in Corby power station and in the 850MW development at Marchwood,
which commissioned late last year. We are highly advanced with
our latest 860MW development at Carrington which is intended to
become commercially operational in 2014. We are also developing
further large-scale CCGT developments at other locations across
4. In addition to increasing our conventional
generation fleet, we continue to grow our position in the UK wind
market. We operate the 24MW West Durham Wind Farm in Northern
England, as well as the 20MW Hunters Hill and 15MW Crockagarron
projects in Northern Ireland. We are currently also constructing
what will be England's largest onshore wind farm, at 66MW, at
Fullabrook in Devon. Further, we expect to start construction
of our 38MW Mynydd y Betws Wind Farm in South Wales later this
year. We are also active in the tidal energy sector.
5. This section is a high-level summary of the
views expressed in the more detailed responses to the Committee's
- The proposals contained in DECC and Treasury's
consultation documents comprise fundamental changes to the operation
of the GB electricity market. The introduction of a package comprising
of a FiT, EPS, carbon price support and a capacity mechanism will
support the delivery of the Government's energy policy objectives,
however the success of the package will depend on its specific
- The delivery timescales are challenging and come
at a time when investment needs to be made, if environmental and
security of supply targets are to be met. In order to limit investor
uncertainty, Government must provide clarity on the intended solutions
at the earliest opportunity, clearly define transitional arrangements
and must demonstrate consistency of purpose over the long-term.
- There remain questions as to how the new arrangements
would work in detail and also interact with existing market mechanisms.
In particular, we are uncertain as to how the tariff levels would
be set under a new FiT mechanism and how any new mechanism would
interact with a grandfathered RO mechanism in support of low-carbon
- ESBI welcomes the Government's commitment to
maintaining competitive wholesale markets and its recognition
that the market reform proposals need to be underpinned by significant
improvements in wholesale market liquidity. We would seek for
Government or Ofgem to publish further thoughts and proposals
at the earliest opportunity.
- Any market intervention must be introduced to
remedy specific market deficiencies. Each element of the package
must be developed and introduced as a compatible and complementary
suite in order for the high-level objectives to be achieved. For
example, capacity mechanisms should be used to ensure future security
of supply and should not be used to drive low-carbon generation
This section provides ESBI's views on the specific
questions raised in the Committee's inquiry.
What should the main objective of the Energy Market
Reform project be?
6. Energy market mechanisms should be designed
to facilitate the achievement of Governmental policy objectives.
As such, the aims of the Energy Market Reform (EMR) project should
be consistent with Government's stated objectives of affordably
meeting the legally binding carbon reduction targets, whilst ensuring
security of supply. We are strongly of the view that, wherever
possible, this should be done within the context of competitive
markets which provide opportunities for independent and new entrant
players, hence minimising the overall cost to consumers.
Do capacity mechanisms offer a realistic way of
achieving energy security, low-carbon investment and fair prices?
7. Capacity mechanisms, in varying forms and
to varying degrees of success, have been used in electricity markets
across the world and are generally adopted on the premise of securing
supply. This is by providing specified price and/or investment
signals to generators to provide appropriate levels of capacity
in the future. The Committee's question suggests that it is perhaps
of the view that a capacity mechanism could be used to deliver
a range of policy objectives, rather than focus on security of
supply. We strongly believe that the purpose of each policy intervention
should be well-defined and focused. The call for evidence discusses
other market interventions such as Feed in Tariffs (FiT) and Emission
Performance Standards (EPS) which are more appropriate tools for
reducing carbon intensity.
8. The low carbon generation technologies that
will deliver the required reduction in carbon emissions will be
primarily renewable (in particular onshore and offshore wind),
new nuclear and carbon abated forms of thermal generation. Although
these technologies are low carbon, they are all also inherently
inflexible and therefore unable to react to demand variations.
An effective capacity mechanism could ensure that sufficient flexible
generation is available to meet peaks in system demand in a market
providing significant support mechanisms to low carbon technologies.
By this role, an effective capacity mechanism can facilitate the
objectives of lower carbon generation, security of supply and
What is the most appropriate kind of capacity
mechanism for the UK?
9. Were a capacity mechanism to be introduced,
it must provide appropriate signals for capacity that is required
to meet peak system demand in the future market containing significant
amounts of inflexible, low-carbon generation; the signals would
need to be sufficient to support investment in new capacity as
well as for retention of relevant current capacity. As such, we
are strongly of the view that any mechanism must recognise fully
the value of flexibility, as well as capacity. Further, it must
provide sufficiently long-term and secure financial returns to
generation developers. Investment decisions would be affected
if the signals were short-term or if the signals contained any
inherent instability. As a company with existing generation and
development projects, we would be particularly concerned if the
capacity mechanism eroded the vital role that flexible, high efficiency,
lower-carbon, gas-fired generation plays in the generation mix
now, and in the future.
10. The GB energy markets are some of the most
liberal in the world. We believe that any GB capacity mechanism
should be complementary to the current liberalised bilateral market
arrangements and, wherever possible, better promote liquidity
in the wholesale energy markets.
11. We welcomed the Government's initial proposals
in the EMR consultation regarding its preferred option for a future
GB capacity mechanism. In general, given the current GB market
design we see merit in the Government proposals for a capacity
payment mechanism that:
- is targeted, rather than offering payments to
- is based on a market derived price for a given
volume of capacity, rather than a price established by a regulatory
- contains a volume for capacity that is derived
by a coordinated administrative process.
12. In order that a competitive, bilateral wholesale
market can thrive, we welcome Government's preference to keep
the generation contracted within the capacity mechanism separate
from the existing wholesale and balancing markets. We recognise
that this option will require careful market design but believe
that it could be a workable option. The Government's EMR consultation
does not specify what types of plant the mechanism would incorporate.
We are of the view that the mechanism should be open to both new
and existing generation plant and would seek for Government to
provide clarity on this point at the earliest opportunity.
13. The so called "last-resort" model,
whereby the capacity mechanism is only called upon when all other
market options have been used, would preserve market-based investment
signals and would produce more efficient, economic outcomes. To
this end, we very much welcome Government's recognition of the
existing problems with liquidity and its requirement for Ofgem
to address them in timescales consistent with the EMR. We would,
however, seek that Ofgem or Government provide proposals as soon
as possible, in order that respondents to the EMR consultation
are able to take a more informed view on the full range of possible
Should the system of Feed-in Tariffs be focused
on particular technologies or maintain a wider-technology-based
14. In our view, Feed-in Tariffs (FiTs) should
contain technology differentiation. The level of each FiT should
be determined by the costs specific to each type of low-carbon
technology being supported by the subsidy. They should not, however,
be further differentiated by location as this could result in
less efficient outcomes by promoting yet higher cost generation
at the expense of more economic outcomes.
15. In setting the FiT for each technology, we
would seek that Government undertakes a transparent and robust
process. We are concerned that an opaque process for determining
the FiT, undertaken between Government and generators, could lead
to inefficient and costly outcomes whereby the FiT produces inappropriately
high rewards for certain technologies or for specific projects.
This is particularly the case for technologies in which there
is currently uncertainty in the development and operational cost
bases, due to the nascent nature of those technologies (such as
the next generation of nuclear plant and offshore wind generation).
16. Whilst the EMR documents contain some information
on the Government's views of which FiT it believes would best
suit the requirements of the GB market, there is a further level
of detail required before industry is able to decide on the most
appropriate model. In particular we look to Government to further
elaborate on how the FiT strike price or premium will be set.
In particular we would recall the experience of the later rounds
of contract auction under the Non Fossil Fuel Obligation process,
which led to undeliverable projects securing contracts and hence
precluding deliverable projects from securing contracts.
We would therefore seek for the Government to give careful consideration
to the methodology for deriving the strike price or premium for
whichever FiT model is chosen.
Will it be feasible to deliver EMR in one go,
or will regulations and implementation be spread over time?
17. We envisage the changes to be delivered by
EMR to be wide-ranging and fundamental. If the goals of the reform
are to be met (ie the delivery of an affordable, secure and lower-carbon
generation mix), the changes must be completed as soon as possible,
in order that investors have the clarity and stability they require.
As such, we would seek that the EMR be introduced in one go or
at the very least against a clear and defined timetable which
matches the requirements of Government and industry. If phased,
Government could choose to recognise the build processes and timings
for new technologies, such as the new nuclear fleet and deployment
stage of carbon capture and storage. However, Government must
ensure that an expeditious timetable does not compromise the integrity
and rigour of the final model.
Will market reform increase political risk for
investors or create certainty?
18. If political risk is to be defined in terms
of political intervention in the market, then EMR has introduced
material, albeit hopefully short-term, political risk. As previously
stated, we would seek that Government introduces any reforms quickly
and for those changes to be robust and able to deliver the challenges
the energy markets face over the forthcoming years. If these requirements
are met, we would expect the risk of future political market intervention
to be significantly reduced.
19. We note, and welcome, that there are elements
of the Government's proposals that (if implemented) would reduce
the amount of risk associated with investments recently and currently
being made. In particular, statements made on the grandfathering
of RO arrangements for existing and soon-to-be developed projects
and the non-retrospective application of EPS provisions were especially
Will the Government's proposed package of carbon
price, EPS, FITs and capacity mechanism provide sufficient transformation
to achieve goals on climate change, security of supply and affordability?
20. The package is both wide-ranging and fundamental.
The proposals have the scope to deliver sufficient change to facilitate
the delivery of Government's goals for carbon reduction and security
of supply. We are uncertain, however, whether they will result
in a more affordable energy future. The amount of investment required
to deliver the carbon reduction necessary to achieve Government's
objectives, is significant. It consists of both generation and
infrastructure investment, which will have to rise to unprecedented
levels, widely estimated to be in the region of £200billion.
Coupled with this are the support mechanisms proposed within the
EMR, which will result in increasing wholesale prices resulting
from additional energy taxation and consumers having to fund various
direct subsidy payments. We are of the view that Government should
further address affordability as the EMR process continues through
its various stages.
21. For the package to deliver its goals, Government
must state what its intentions are for each element of the EMR
and ensure that those intentions are not confused or diluted.
Each element of the package (carbon price support, FiT, EPS and
capacity mechanism) must be developed and introduced as a compatible
and complementary suite in order for the high-level objectives
to be achieved. We would seek that Government ensures this happens
as a priority.
22. Further, there is a significant level of
detail that must be developed before we are able to judge whether
the reforms will deliver the intended outcomes. We welcome Government's
commitment to implementing changes by April 2013 but would urge
for more details of the mechanics of the proposals to be published
at the earliest opportunity, along with well-defined implementation
timescales. This will reduce uncertainty investor uncertainty
and ensure help ensure there is no investment hiatus.
What synergies and conflicts will there be between
proposed mechanisms and policies already in place?
23. As discussed previously, we strongly support
the maintenance of the liberalised, competitive wholesale market.
Government rightly raises liquidity in the wholesale market as
an issue that must be addressed for its proposals to be successful.
As an independent generation company, we are acutely aware of
the impacts that low liquidity brings and welcome Government's
statements on improving it within the timescales of the EMR. The
"FiT with contract for difference" mechanism that is
favoured by Government relies on a transparent and robust wholesale
price, driven by generation cost. We would support any initiatives
that help deliver this and believe it is a key interaction/requirement
of the Government's proposal.
24. We welcome Government's intention to grandfather
the arrangements for existing and current development projects
that are accredited under the RO. However, for this to work, thought
needs to be applied to how projects receiving support under the
RO interact and are kept "whole" relative to those that
will be supported under a future FiT. It is essential that these
arrangements are clarified as quickly as possible to ensure that
uncertainty is minimised for projects negotiating, and entering
into, power offtake agreements now.
25. The carbon price support proposals (based
around the removal of Climate Change Levy exemptions currently
applied to fossil fuel generation) must be compatible and consistent
with the existing EU ETS arrangements. We would seek that Government
ensures that the levels of taxation within the new levy on fossil
fuel generation are consistent with the price of carbon being
Will a carbon floor price be feasible in the context
of EMR and at what level should it be set?
26. The proposals for supporting the carbon price
contained within in the Treasury consultation published alongside
the EMR appear feasible.
27. It is for Government to determine the level
of carbon price support that will encourage investment in low-carbon
technologies. It is crucial, however, that the aggregate level
of support from all the reforms is considered, in order that inappropriate
levels of financial support are not granted to developers. We
would also seek that the process for determining the level of
support is transparent and robust.
28. We note Government's proposal to introduce
carbon price support through taxation, by removing existing exemptions
from the Climate Change Levy, and as such will impact generation
in both GB and Northern Ireland. Northern Irish generation participates
in the Irish Single Electricity Market and we will be monitoring
Treasury's proposals with interest to better understand the consequent
impacts on both UK and Irish generation.
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?
29. We welcomed Government's recognition of the
possible role that increased interconnection could play in the
future generation mix. Interconnection between markets has been
shown to deliver significant benefits to other European markets.
These benefits relate in particular to security of supply in areas
of high renewables penetration and economic price discovery as
price arbitrage occurs between the markets. As a company with
generation assets in other European markets, we are particularly
interested to explore how interconnector flows into and out of
the GB market will be treated under the envisaged GB capacity
30. I hope the Committee finds these comments
useful. Should you have any questions or wish to discuss any of
the issues raised in more detail, please do not hesitate to contact