Electricity Market Reform - Energy and Climate Change Contents


Memorandum submitted by InterGen UK

EXECUTIVE SUMMARY

1.  InterGen welcomes the opportunity to respond to the Energy and Climate Change Select Committee's enquiry into the future of Electricity Market Reform ("EMR"). InterGen fully supports the Government's commitment to achieving its climate change, security of supply and affordability targets. InterGen believes this can only be achieved by encouraging a diverse generation mix operating within a truly competitive environment in order to protect the interests of consumers.

2.  InterGen would sincerely welcome the opportunity to give oral evidence in front of the Committee, given it is one of the few truly independent generators left in the UK which has significant investment plans for flexible generating technology in the UK in the next five years.

3.  InterGen believes that:

3.1  Large-scale reform of the electricity market is required to support the Government in meeting its long-term three-fold objective of delivering a low carbon future, maintaining security of supply and ensuring affordability for consumers.

3.2  The current market arrangements are not sufficient to encourage significant investment in low carbon generation and the flexible back-up capacity required to support the anticipated changing generation mix in the UK.

3.3  At the conclusion of the EMR consultation process, the Government must announce a complete and coherent package of measures which will deliver its objectives, which are robust and flexible enough to work in a wide range of demand and fuel-price scenarios and are broadly supported by the industry and mainstream political parties. This will provide a stable and durable regulatory environment which is essential to secure long-term investor confidence.

3.4  The Government's proposed package of carbon price support, FITs for low-carbon generation and a capacity mechanism could form the basis of a stable environment in which its low-carbon objective can be delivered. Such a package must include support for flexible and efficient gas fired generation given that InterGen firmly believes that it will give the desired flexibility to meet peak demand and also demand requirements when renewables cannot generate.

3.5  Long-term security of supply and the lowest costs for consumers can only be delivered if a truly competitive, liquid, rational and transparent wholesale market also exists. InterGen welcomes Ofgem's continued focus on electricity wholesale market liquidity and believes that action to improve liquidity is an essential precursor to EMR. InterGen believes that vertical integration is not compatible with a competitive and liquid market and that steps must be taken to require vertically integrated companies to trade all of their generation through the wholesale market.

3.6  Carbon price support needs careful implementation and long-term clarity to ensure that market participants can continue to manage carbon and electricity market price risk and that there are no unintended consequences from interactions with the EU ETS.

3.7  The capacity mechanism should:

  • address the issue of intermittency of renewable generation by rewarding the provision of flexibility, rather than just the additional capacity required to meet peak demand;
  • ensure sufficient, though not excessive, returns for existing flexible capacity, and;
  • provide price signals to attract investment in new flexible capacity.

3.8  The proposed FIT regime should:

  • Allow low-carbon generation to be financially supported in a transparent manner.
  • Ensure such generation retains exposure to short-term price signals in order to encourage efficient generator behaviour and hence provide value to consumers.

ABOUT INTERGEN

4.  InterGen is the UK's largest and most successful new entrant independent generator, having invested £1.4 billion in the UK since 1995. InterGen owns and operates three highly efficient gas fired power stations in the UK totalling 2,490MW and actively trades in the prompt and forward wholesale power and gas markets. InterGen is currently pursuing a number of development opportunities in the UK including two further 900MW CCGTs, representing a further £1.2 billion of investment.

Question 1: What should the main objective of the Electricity Market Reform project be?

5.  Electricity Market Reform should principally support the Government in meeting its long-term three-fold objectives of delivering a low carbon future (and meeting its legally binding 2020 and 2050 targets), maintaining security of supply and ensuring affordability for consumers.

Question 2: Do capacity mechanisms offer a realistic way of achieving energy security, low-carbon investment and fair prices?

6.  An estimated 20GW of flexible fossil-fired plant will close by 2020 due to age and environmental regulations. As the penetration of intermittent renewable generation increases (assisted by proposals to support investment in low-carbon generation), existing low-carbon gas fired assets along with a significant amount of new flexible back-up generation capacity will be required to achieve an acceptable level of security of supply. Under the present market arrangements, volatile cashflows at the reduced load factors anticipated make the economics of existing and new flexible generation uncertain. In these circumstances, existing environmentally acceptable flexible plants are likely to retire early and new build is unlikely.

7.  New thermal generation such as gas-fired power stations can deliver carbon savings by replacing older, less efficient coal plants in the UK.

8.  It is possible that the Big 6 vertically integrated companies could build new generation without change to the wholesale market, relying on revenue from elsewhere in their value chain (eg some of the companies look at the whole value chain, effectively subsidising generation investment through the value achieved from their retail operations especially during periods of depressed wholesale energy prices when retail margins often increase). However, it has been widely reported that the Big 6 companies do not themselves have sufficient resources to construct all the new generation capacity required in the UK. Independent generators will also be required to construct some of this capacity and bring much needed competition to the electricity market, ensuring better value for consumers in the long term. However, the current wholesale electricity market currently does not provide the long-term robust price signals necessary to encourage independent generators to invest in back-up flexible generation with low load factors. To address this, major reform is required in the manner in which generation capacity is remunerated to ensure that the UK remains an attractive place for industry to invest. InterGen believes that a capacity mechanism is an essential part of this reform and if appropriately structured can support the security of supply objective.

Question 3: What is the most appropriate kind of capacity mechanism for the UK?

9.  InterGen is still considering the relative merits of differing capacity mechanisms, and will address this fully in its response to DECC's Electricity Market Reform consultation. InterGen's initial view is that a market-wide scheme, in which the volume of required capacity is centrally calculated but the price is determined via a competitive process, is likely to provide the best value to consumers in the long-term. Due to the predominantly intermittent nature of renewable generation, the capacity mechanism should reward the provision of flexibility rather than just that additional capacity required to meet peak demand.

10.  To prevent market distortion and ensure existing plant can compete effectively with new plant, capacity payments should be paid to both incumbent flexible capacity as well as new plant. If capacity payments only apply to new plant, existing flexible capacity will be forced to retire early due to the anticipated reduced long term prices in the market as the proportion of low carbon generation increases. Such artificial displacement of existing plants by new build is inherently economically inefficient and would undermine investor confidence in the UK electricity market through impairment of existing plant investments. Hence InterGen believes that capacity payments must be made to all flexible generation whether existing or new.

Question 4: Should the system of Feed-in Tariffs be focussed on particular technologies or maintain a wider technology-based view?

11.  InterGen believes that any low-carbon support mechanism (such as FIT's) should be designed to allow such generation to be financially supported in a transparent manner whilst promoting maximum wholesale market liquidity. To encourage efficient generator behaviour the support mechanism should ensure that intermittent generation retains its exposure to prompt price volatility through full participation in the wholesale market, as the preferred FIT with CFD option provides.

12.  It is appropriate to support a wide range of low-carbon technologies to ensure a diverse generation mix: making access to Feed-in Tariffs open to any low carbon technology will have the effect of a market which prioritises the most cost-effective technologies, to the benefit of energy affordability.

Question 5: Will it be feasible to deliver EMR all in one go, or will regulations and implementation be spread over time?

13.  It is appropriate for the implementation of the reforms to be delivered in two or three rounds. Support of the all-in carbon price, essential to improve the investment case for low-carbon generation, and steps to improve wholesale market liquidity can both be implemented in isolation and should be introduced relatively quickly. The remaining reforms are likely to take longer to design and implement and would best be implemented together.

Question 6: Will market reform increase political risk for investors or create certainty?

14.  There is broad consensus, backed-up by the quantitative analysis undertaken by Redpoint, that the current market structure is not capable of delivering adequate investment in low carbon generation capacity and sufficient security of supply in a cost effective manner over the long-term. As a result, there is already a widespread expectation that large-scale reform of the market will be forthcoming and this has created an investment hiatus. Accordingly it is important that, at the conclusion of the current EMR consultation, the government announces a complete and coherent package of measures which will deliver its objectives, are robust to a wide range of demand and fuel-price scenarios, are broadly supported by the industry and mainstream political parties and have a firm timetable for implementation. This will provide a stable and durable regulatory environment which is essential to secure long-term investor confidence.

15.  The Government needs to ensure that in delivering EMR it not only supports investment in new generation, but also does not undermine the value of flexible and efficient assets currently operating (or in construction) within the UK.

16.  Many generation assets in the UK have associated long-term electricity off-take or tolling contracts which will require adaptation to account for the proposals under EMR. Furthermore the government should be aware of the burden a regulatory change of this magnitude will place on smaller, independent market participants. An increase in administration costs will have a bigger impact on small players; who are also likely to have less resource available to participate fully in the development of the EMR proposals. InterGen urges DECC and The Treasury to continue to consult fully with all industry participants to ensure a smooth transition from the current arrangements.

Question 7: Will the Government's proposed package of carbon floor price, EPS, Fit's and capacity mechanism provide sufficient transformation to achieve goals on climate change, security of supply and affordability?

17.  The Government's proposed package, if broadly supported by all types of industry participants and mainstream political parties, would form the basis of a stable and robust regulatory environment in which its low-carbon objectives can be delivered. However long-term security of supply and the lowest costs for consumers can only be delivered if a truly competitive, liquid, rational and transparent wholesale market exists.

18.  New players will be encouraged to enter the market if the current low levels of liquidity are improved. Improved liquidity will make long-term price signals more robust and transparent which will assist smaller players who rely on project finance and investment from banks. InterGen is pleased that Ofgem have committed to continuing their work in this area to complement the EMR proposals.

19.  Vertical Integration is not compatible with a competitive and liquid market. InterGen believes that a self-supply licence condition should be introduced requiring vertically integrated companies to trade progressively increasing percentages (ultimately 100%) of their generation via the wholesale market, coupled with progressively greater separation between the wholesale and retail supply businesses. InterGen believes that a fully competitive and liquid electricity market will be achieved only once this process is complete.

Question 8: What synergies and conflicts will there be between proposed mechanisms and policies already in place?

20.  InterGen is currently considering the interaction between new and existing mechanisms and policies and will address this more fully in its response to DECC's Electricity Market Reform consultation. InterGen's initial concerns are that carbon price support needs careful implementation and long-term clarity to ensure that market participants can continue to manage carbon and electricity market price risk simultaneously and that there are no unintended consequences from interactions with the EU ETS

Question 9: Will a carbon floor be feasible in the context of EMR and at what level should it be set?

21.  InterGen supports the concept of a carbon price floor to promote increased investment in low-carbon generation and drive fuel-switching from higher to lower carbon emitting plant.

22.  The all-in price floor range of £20/t to £40/t by 2020 is broadly in line with market commentators views on the price needed to prompt sufficient change in operational and investment behaviours to deliver the government's long-term climate change targets.

Question 10: 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?

23.  InterGen has no specific views on this question.

CONCLUSION

24.  InterGen acknowledges that there are many challenges for both the Government and the industry in addressing the three-fold objective of ensuring security of supply whilst meeting climate change and affordability targets. InterGen believes that support of the all-in carbon price, Feed-in tariffs which are structured to ensure low-carbon generators participate in the market and capacity payments for all flexible capacity are the key elements of market reform needed to deliver the targets. InterGen are keen to be given the opportunity to give oral evidence to support the views expressed here.

January 2011



 
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