Memorandum submitted by the Association
of Electricity Producers |
- 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
- 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.
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.
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.
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
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
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.
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
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.