Electricity Market Reform - Energy and Climate Change Contents


Memorandum submitted by the Association of Electricity Producers

EXECUTIVE SUMMARY

  • The Association welcomes the Government's recognition of the issues surrounding investment decisions in the electricity industry and its efforts to address them. We are still in the process of assessing the benefits and risks of the wide-ranging proposals presented by the Government on 16 December 2010 in its consultation on Electricity Market Reform (EMR).
  • The EMR work must provide clear, stable and achievable proposals that will demonstrate that the UK offers an attractive environment in which to make energy investments. The aim should be to reduce political risk and create greater long term certainty for investors.
  • The Association wishes to see the continuation of a robust, competitive and liquid wholesale electricity market, which should provide a reliable and credible wholesale price where the investments required to meet the Government's energy policy objectives are fully rewarded.
  • The Committee is aware from our evidence to its recent Inquiry that the Association is not convinced of the benefits of introducing an Emissions Performance Standard, which it believes would further undermine the EU Emissions Trading Scheme and add to investors' risks.

INTRODUCTION

1.  The Association of Electricity Producers (AEP) represents the many different companies, both large and small, that make the electricity upon which the UK depends. Between them, AEP members account for more than 95% of the country's electricity generation capacity and embrace all generating technologies used commercially in the UK - coal, oil, gas, nuclear power and a range of renewable energy technologies. A list of our members can be found online at www.aepuk.com

2.  Members accept the principle that, to achieve longer-term carbon reduction ambitions, short and medium term investment decisions have to be on the low-carbon path. However, the sums of money required to replace ageing plant and, more significantly, to meet the requirements of the Renewable Energy Directive and the UK's own target for the reduction of carbon emissions mean that the energy industry has to attract significant new investment - £200 billion for new power production and networks and gas infrastructure by 2020 and another huge sum in the following decade. In the present financial climate, there is a serious risk that this investment will not be available if investors do not have confidence in the UK electricity market arrangements. If these huge sums are to be attracted to the UK, there must be a clear, credible and stable political and regulatory environment which delivers appropriate rates of return. We do not have that today, because a) the current design of the electricity market will not bring forward the full range of low carbon technologies needed to meet the UK's highly demanding low carbon agenda in an economically efficient manner and b) the emission limits applied by the EU Emissions Trading Scheme do not offer the visibility and confidence of longevity beyond 2020 that would help to bring forward the diverse low carbon investment required to meet those UK targets. There is a fundamental need to align the policy framework with the investment timescales and payback periods for large scale low carbon technologies.

3.  We welcome the government's recognition of these issues and its efforts to address them. The changes proposed in the Electricity Market Reform (EMR) consultation would be the most significant to the industry since privatisation and could have a substantial influence on the unprecedented level of investment required to achieve a transition to a low carbon electricity supply industry. It will also be important to ensure that investments already made in the industry are appropriately protected. The Committee is asked to note that the Association is still in the process of evaluating the impact of the proposals which were announced by the Secretary of State on 16 December 2010 and that this evidence should be treated accordingly.

PROCESS

4.  Our hope is that the EMR work will provide clear, stable and achievable proposals that will demonstrate that the UK offers the best environment in which to invest. Whatever the conclusions of this review there should be an assessment of whether a speedy and radical implementation delivers the best result, compared with an option which delivers a number of quick wins followed by slower more evolutionary change.

5.  This reform will be, in effect, the fourth set of trading arrangements (the Electricity Pool, NETA, BETTA) to be applied to the electricity industry since it was privatised and liberalised in 1990-91. The industry has considerable experience of change, but, it is not yet clear at which stages it will have the opportunity to contribute to the work developing the proposals further. The Electricity Market Reform consultation envisages the publication of a White Paper in the late spring of 2011 which is expected to include final proposals. We assume that there is to be a period of activity when industry expertise will be put to good use and the Association would like to make clear that its members would be willing to input to any Working Groups that may be established to develop and assess the various proposals.

6.  The Committee will be aware that, for many years and with few exceptions, the Association has been consistent in its support of market principles and in the importance of market-driven prices. Although the EMR presents the Association with difficult issues, many of which we have not yet been able to resolve, it is already clear that members want to see the continuation of a robust, competitive and liquid wholesale electricity market, which should provide a reliable and credible wholesale price where the investments required to meet the Government's energy policy objectives are fully rewarded. We have also stated consistently that, given a clear and stable policy and regulatory framework, the industry is capable of managing risk.

RESPONSE TO SPECIFIC QUESTIONS

Do capacity mechanisms offer a realistic way of achieving energy security, low-carbon investment and fair prices?

7.  Our members have different views on the need to reward capacity. Some can see merit in such an approach while others will reserve judgement until further detail is available about the design of such a mechanism and there is greater clarity about which plant would be affected among existing plant and/or plant yet to be commissioned and about how to avoid potential distortions to wholesale prices. Members note, however, that the consultation states that "... because of the increasing risks to security of supply arising from the transition to low-carbon generation, the Government is consulting on introducing a capacity mechanism to explicitly reward the provision of capacity ..." The implication could be that the problem is seen as the potentially large amount of wind power which will be on the system when the EU target is met (requiring more "back-up" than other plant), but, the consultation is not entirely clear about which problem the government is attempting to address (eg. peak demand, flexibility, or both) and we shall therefore seek clarity on the rationale behind the proposal.

Should the system of Feed-in Tariffs be focused on particular technologies or maintain a wider technology-based view?

8.  The Government wishes to accelerate the transition to a low carbon electricity industry and "low-carbon generation revenue support" appears to be a key facilitator of that. Experience of the Renewables Obligation suggests that there is a need for support to be banded by technology in order to incentivise a wide range of technologies.

9.  Greater consideration of the practicalities of a CfD feed-in tariff is required, including who would act as the counterparty to a CfD contract and how a tendering process could work, in particular in relation to the discovery of a meaningful price and the difficulties of ensuring planning consent. We also note that a tender process does not necessarily ensure that the appropriate levels of support are guaranteed. For example, Government may be targeting support for particular technologies; however, the vagaries of a tender process do not necessarily ensure the required outcomes are achieved. The government will need to be mindful of the potential burdens that participating in an auction/tender could present to generators, in particular smaller renewables plants.

Will market reform increase political risk for investors or create certainty?

10.  It would be a very unhappy outcome for the industry and its customers if EMR increased political risk. While the outcome of some of the proposed reforms is unclear at this stage, the aim should be to reduce political risk and create greater long term certainty for investors. There are, however, elements of the package which could increase political risk. The Committee will be aware from our evidence to its recent inquiry that the Association is not convinced of the benefits of introducing an Emissions Performance Standard, which it believes would further undermine the EU Emissions Trading Scheme (EU ETS) and add to investors' risks. Similar risk could arise if the carbon floor price were to become important in terms of Government revenue. We should make clear that most of our member companies want to operate in a competitive market and that relying entirely on government direction of the market would not necessarily reduce political risk to investors - it might well increase it. Members consider that there is a need to maintain the elements of the current market that work and to protect existing investments as well as encouraging new low carbon plant.

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?

11.  The Committee is trying to establish whether this package of proposals will work without there being a serious imbalance between the long-standing political objectives for the industry. The Association is also interested in this question, not least because failure could lead to further changes in public policy and new political and regulatory risk. We shall be discussing the proposals with Government. In the meantime, it is probably fair to say that, whereas a transition to a low carbon electricity industry should be compatible with security of supply, it is less clear whether, with reduced reliance on a competitive market, this can be achieved at an acceptable price - the judges of which are ultimately the customers, domestic and commercial.

What synergies and conflicts will there be between the range of proposed mechanisms and policies already in place?

12.  The implications for the Renewables Obligation of the transition to a new support mechanism for renewables, including the proposal in the EMR consultation to fix the price of a Renewables Obligation Certificate, will need to be carefully considered. The tensions between the carbon floor price and the EU ETS are also an issue. Finally, it is paramount that the industry has certainty on grandfathering options and the length of time that "interventions" are to be applied.

Will a carbon floor price be feasible in the context of EMR and at what level should it be set?

13.  A carbon floor price is feasible, but there are differences of opinion between members on the necessity of a having a carbon floor price in addition to a two-way CfD FIT for low carbon generation, when it should be introduced and the appropriate level of the floor price. The Association will discuss with the Government the impact of the EMR proposals on the relationship between the GB electricity market, the electricity markets of the EU and the development of the single market in electricity. The impact of capacity payments and a floor price for carbon on cross-border trading demands careful examination. We wonder, for example, whether a carbon floor price in the UK could encourage increased emissions elsewhere in Europe. We shall ask the Government to continue to press for a robust, long term carbon price signal across Europe, the absence of which is a factor behind the proposed EMR.

Will it be feasible to deliver EMR in one go, or will regulations and implementation be spread over time?

14.  An initial examination of the EMR proposals led the Association to consider whether the entire package of reforms should be delivered in one step or whether it should be phased. Our preliminary conclusion is that it may not be necessary or even desirable for all aspects of the package to be implemented at once. Sufficient time will be required to implement changes to the industry codes in a robust and lasting manner and it is desirable that a clear, holistic plan be drawn up, even if it is to be implemented in stages.

OTHER MATTERS TO BE ADDRESSED

15.  The Association notes that the Committee on Climate Change has indicated that it would prefer there to be rapid deployment of low carbon plant ahead of any increase in electricity demand (arising from the decarbonisation of other sectors, such as home heating and transport) rather than allowing the market to determine the mix of generation to be built to fill a generation gap. The Select Committee and the Government, however, should be conscious of the potentially negative outcome of a surplus of generation capacity being forced on to the system. Current levels of capacity compared with demand have led to wholesale prices being depressed and in the last decade, when generating capacity greatly exceeded demand, companies were put out of business. With existing and future investment in mind, careful consideration should be given to the possible impact of the Climate Change Committee's proposal and the mitigation of risk to investors.

16.  The impact of European legislation and its application to the UK must be taken into consideration. There are a number of emerging energy-related European codes due for development in the near future. Early sight of the extended scope of a pilot connection code, for example, has caused widespread concern among our membership. We shall urge the Government to consider carefully the potential impact of European regulations on its proposals for electricity market reform.

17.  We find it difficult to assess the impact of the proposed reforms on market liquidity. While we support initiatives which deliver increased liquidity, we cannot see any specifics within the proposals which will promote this. Indeed for the CfD element of the proposals to work, liquidity is paramount. There is no "correct" level of liquidity, yet poorly considered design could actually result in reduced liquidity. We believe that additional focus on this area would be of benefit particularly around the development of longer term options.

18.  We are also aware of the Government's review of the future focus for Ofgem and we look forward to the outcome and clarification of Ofgem's future role and responsibilities with regard to electricity market reforms. This includes clarification of where current Ofgem initiatives such as Project TransmiT and review of market liquidity would be relevant to the outcome of these reforms.

19.  Finally, we should like to emphasise that a timely and business-like planning process and significant grid investment remain vitally important if the transition to a low carbon electricity supply industry is to be achieved.

January 2011



 
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