Memorandum submitted by RWE npower|
1. RWE npower welcomes the opportunity to submit
our views on the Electricity Market Reform inquiry to the ECC
Select Committee, but are still in the process of assessing the
implications for our existing and future investments of the proposed
Electricity Market Reform package set out in the Government consultation
published on 16 December 2010.
2. The package of proposals set out in the EMR
consultation represents a radical departure from the competitive
market. The Government acknowledges the importance of competitive
markets to deliver objectives efficiently and with minimum cost
increases to consumers and states that markets should be allowed
to function where effective. However, the reduced exposure to
the wholesale price as a result of the introduction of a Contract
for Difference (CfD), the intervention on the carbon price and
the potential distortion through the introduction of a new capacity
mechanism all amount to a radical move away from the competitive
3. We note that although all existing players
have said that they are capable of and willing to manage wholesale
price risk, the EMR proposals place significant emphasis on diluting
wholesale price risk to encourage new entrants and new investors
into the market. The proof of their success will be if they do
indeed result in new entrants or new investors committing to new
low carbon projects.
4. We believe that more work needs to be done
to understand the synergies and conflicts between the proposed
measures in the EMR package, to avoid over-design and policy redundancy
and to ensure that the EMR delivers its objective of the transition
to secure, low carbon electricity system at least cost to the
consumer. For example, further consideration is needed with regard
to the interplay between a carbon floor price and a Feed-in-Tariff
with a two-way CfD.
Question 1: What should the main objective of
the Electricity Market Reform project be?
5. We believe that the primary objective of the
Electricity Market Reform project should be to assess the ability
of the existing market arrangements, and what possible interventions
might be necessary, to deliver a secure, low carbon, affordable
electricity mix for the 2020s and beyond and, in particular, delivering
the decarbonised electricity system by 2030 at the lowest achievable
cost. A key outcome of the Electricity Market Reform project should
be an attractive, stable and predictable investment
environment for all stakeholders in the electricity
market (including generators, suppliers and customers) and should
deliver value for money for customers and maintain the competitive
nature of the electricity market.
Questions 2 and 3: Do capacity mechanisms offer
a realistic way of achieving energy security, low-carbon investment
and fair prices? What is the most appropriate kind of capacity
mechanisms for the UK?
6. We do not believe that the case for a new
capacity mechanism has been adequately made. National Grid operate
a well managed reserve market that is understood by market participants.
This market is capable of managing the increased reserve requirements
to meet the renewables targets and is open to both generation
and demand. There is an issue with the pricing of reserve back
into the energy market that needs to be resolved as part of a
cash out review. The suggestion of introducing a "strategic
reserve" market needs to be carefully considered as it has
implications for the energy market and is likely to dampen price
7. In the current electricity market, capacity
signals are provided through clear and transparent electricity
prices in the balancing mechanism together with a role for the
system operator that ensures there is sufficient back up or reserve
generation. In the future, demand side participation in the market
will be facilitated through the investment in smart metering and
appropriate new tariff structures.
8. We believe that the current arrangements could
be refined and extended to ensure security of supply even with
increasing connection of variable renewable generation and that
an explicit capacity mechanism is not required at this time. In
their Future Balancing Services Requirements document, National
Grid, for its Gone Green scenario, has indicated the level of
positive reserve requirement per year to 2025/26 as a result of
the increasing penetration of wind generation but also the increase
in large unit size of nuclear. National Grid go on to say that
this increased reserve can be met either by increasing the amount
of STOR or from the balancing mechanism. The choice of which one
to use would come down to cost.
We believe that this will be best achieved by an extension to
the Short Term Operating Reserve (STOR) arrangements which meet
the requirements laid out by DECC in the EMR consultation, in
is administered by a central body, National Grid;
is volume based; and
is a targeted mechanism.
Question 4: Should the system of Feed-in Tariffs
be focused on particular technologies or maintain a wider technology-based
9. In order to deliver decarbonisation of the
electricity system at the lowest cost to the consumer, we believe
that all low carbon generation technologies should be able to
compete on a level playing field.
10. The current renewable support mechanism,
the Renewables Obligation is well understood and through its robustness
has proved to deliver investment - giving strong incentives to
efficient projects. In this context, we continue to believe that
a Low Carbon Obligation that is fully compatible with the existing
Renewables Obligation could - with minimum interruption to the
market and investor confidence - provide support to all forms
of low carbon electricity generation, including nuclear, CCS and
11. However, we recognise that the Government's
favoured option for low carbon generation support is in the form
of a low carbon "Contract for Difference". We believe
this proposal may have some merits, and we are currently evaluating
the proposal as part of our response to the Electricity Market
Reform consultation. The CfD approach may enable investment in
low carbon generation provided that there are adequate returns
and sufficient long term guarantees associated with the key contract
Question 5: Will it be feasible to deliver EMR
in one go, or will regulations and implementation be spread over
12. Given the scale of the market reform envisaged
in the Electricity Market Reform project we believe that it is
essential that the interaction between all of the important elements
is considered together. This should ensure that there is a consistent
approach towards the various market interventions and a stable
environment created for investment.
13. We note that the implementation of the key
elements of the proposals required consideration of the associated
timescales. For example, the detailed systems required to deliver
the proposed low carbon support mechanism have significant lead
times. Consequently we believe that as part of the implementation
process a detailed plan and clear overarching guidance is required
to ensure that market participants can understand the impact.
14. We would be concerned if elements of the
EMR were implemented in a piecemeal basis and unilaterally without
a clear overarching strategy for implementation. Equally, the
implementation must have due regard for the European context.
For example, the package of measures needs to be compatible with
the third Package, while the unilateral imposition of the proposed
carbon floor mechanism needs to be considered in the context of
the future development of the EU ETS to ensure it does not unduly
impact on UK competitiveness.
Question 6: Will market reform increase political
risk for investors or create uncertainty?
15. Any intervention in the market creates uncertainty
for investors. The publication of the Electricity Market Reform
consultation on the 16th December is the first step
in defining the scope and scale of the proposed reform that can
be expected. The development of the legislative framework and
the detailed implementation rules (which government envisages
will be in place by 2013/14) will inevitably create a period of
time when the investment climate is uncertain. The more rapidly
we can move to detailed proposals the greater the certainty of
the new regime for all stakeholders. In this context, we welcome
the government's intentions to present final decisions on the
market reform package in its Spring White Paper. It is crucial
that there is no slippage in this timetable and that primary legislation
is enacted as soon as possible in 2011. The publication of a detailed
implementation road map and plan is essential at this stage.
Question 7: 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?
16. We believe that some elements of the Government
proposals in the Electricity Market Reform consultation could
- subject to detailed design - have the capacity to facilitate
the low carbon transformation of the GB electricity market. However,
at this stage we have concerns that certain aspects of the government's
package will prove difficult to implement and could lead to some
perverse incentives. We are not, therefore, convinced that the
proposals are the most effective in terms of the likelihood of
delivering the decarbonisation objective, or in terms of minimising
the impact on consumers.
17. We are currently evaluating the details of
each market intervention and considering the potential implications
for GB stakeholders of the proposed package as a whole. We believe
that cost-efficiency needs to be at the centre of any market reform.
In order to achieve this it is important to:
over-designing the market (ie policy package should be the minimum
set of interventions required to achieve the overall objectives);
a coherent package of measures that not only work together to
complement each other, but avoid unnecessary duplication and policy
the efficiency of the market to bear to minimise the cost to the
18. In this regard, we have some specific concerns
about the coherence and aggregate impact of the proposed interventions
in the EMR package:
proposal for an Emissions Performance Standard (EPS) is unlikely
to provide any additional certainty for investors in low carbon
generation. The proposed EPS aims to prevent new coal-fired generation
being built without installation of carbon capture and storage,
but it is not clear that this provides any additional benefits
beyond current Government policy on new coal-fired power generation.
The consultation itself notes that the proposed EPS has limited
interaction with the other mechanisms. It is difficult to see
how the EPS will provide any additional certainty or incentive
in delivering the investment needed to achieve climate change
The ECC Select Committee is already aware from our
evidence to its recent inquiry on EPSs that we believe that a
moratorium on unabated new coal (with through a requirement for
CCS demonstration or an EPS) will have the impact of stopping
the development of CCS in the UK. A more considered policy with
Government, for example, underwriting some of the risk if CCS
were not feasible technically or economically, would be more likely
to encourage the UK to develop CCS expertise.
agree with the Government's conclusion that a carbon price floor
is unlikely by itself to provide sufficient incentive for investment
in low carbon generation. However, more work is required to understand
the relationship between the proposed carbon price floor and Government's
preferred option of a two-way Contract for Difference (CfD), in
particular to establish the role that a carbon price floor plays
- if any - in incentivising investment in low carbon generation
when set alongside a FiT.
The EU has set emissions reductions targets through
the EU ETS and this should remain the central mechanism for determining
carbon prices. Introduction of additional measures in the UK should
not be seen to undermine the EU ETS. We are concerned that the
rate of the proposed tax on the carbon content of fossil fuels
supplied to generation could be decoupled from the EU carbon allowance
(EUA) price resulting in an undue impact on UK competitiveness
if, for example, the Commission strengthens the EU ETS or the
EU moves to a 30% emissions reduction target. There needs to be
a dynamic element with the EUA price.
A carbon floor price should only be introduced on
the timescales where it could have an impact on investment decisions.
Any benefits of certainty in the price of carbon are likely to
be over the period from 2020-2030 (particularly until future carbon
targets are agreed at EU level) and there are likely to be very
limited benefits for investment decisions if introduced earlier
than 2018. In particular, there is a danger that if it is introduced
at a rate that results in higher electricity prices in the short-term
it risks, resulting in windfalls for existing low carbon generators
and being seen simply as a further revenue raising measure for
the Government which unduly impacts on UK competitiveness.
a CfD may dilute market risk for nuclear and renewable plant,
a two-way CfD will increase risk for fossil plant with carbon
capture and storage (CCS) and is likely to deter investment in
CCS further. Under a two-way CfD, plant with CCS will be unable
to recover the costs of their input fuels when coal and gas prices
rise significantly in the future.
do not believe that the case for a capacity mechanism has been
adequately made. In the current electricity market, capacity signals
are provided through clear and transparent electricity prices
in the balancing mechanism together with a role for the system
operator that ensures there is sufficient back up or reserve generation.
In the future, demand side participation in the market will be
facilitated through the investment in smart metering and appropriate
new tariff structures.
We believe that the current arrangements are suitably
robust enough to ensure security of supply even with increasing
connection of variable renewable generation and that an explicit
capacity mechanism is not required at this time. The review of
electricity cash out prices previously announced by Ofgem is an
important element in ensuring that the current arrangements can
develop to respond to increasing variable generation.
In addition, we note that National Grid have already indicated
the extent to which the current reserve market can accommodate
the additional requirements identified as a result of increased
connection of wind generation.
Question 8: What synergies and conflicts will
there be between proposed mechanisms and policies already in place?
19. There is the potential for significant interaction
between the Electricity Market Reform proposals and the EU Emissions
Trading Scheme and the EU Products Directive. The EU ETS sets
a price of carbon through the cap on allowances that are either
auctioned or issued to companies. Ideally the UK should not need
to set additional limits on carbon prices through the proposed
floor price mechanism as this could potentially lead to competitive
impacts for the UK compared with other EU Member States. Future
certainty in emissions reductions through the EU ETS would reduce
the need for a carbon floor price set only in the UK.
20. The Energy Products Directive sets minimum
levels of tax for energy used across different sectors and it
has been suggested that this should be reformed to take account
of the carbon content of the energy product. Carbon floor price
proposals need to take into account any potential for reform of
the Energy Products Directive.
21. There is a potential for conflict between
the impact of policies that result in costs on electricity compared
with other fuels, for example, gas where for some consumers there
are only limited costs associated with the carbon emissions from
the use of those fuels. Further analysis is needed to assess the
impacts of the EMR proposals on fuel switching in the context
of the broader energy market particularly if greater electricity
use is seen as part of the strategy for delivering emissions reductions
in sectors such as transport and heating.
Question 9: Will a carbon floor price be feasible
in the context of the EMR and at what level should it be set?
22. Providing the proposed mechanism (ie through
reform of the climate change levy) meets requirements of European
legislation (in particular the Energy Products Directive) and
future changes to this legislation then it will be feasible to
introduce a carbon floor price. However, a carbon floor price
is both insufficient on its own and provides diminishing support
over time as the electricity system is decarbonised and the role
of fossil plant in setting price declines (particularly for investments
from 2020 with more than a 30 year payback in the context of an
EMR aspiration to drive the carbon intensity of electricity generation
down to at least 100g/kWh by 2030).
23. Furthermore, in the context of the EMR package,
it is unclear what additional role a carbon floor price will play
- if any - in incentivising investment in low carbon generation
when set alongside the Government's preferred option of a two-way
Contract for Difference (CfD).
24. Looking at the carbon price support mechanism
on its own, it is not clear that the current proposals will set
a carbon price floor or will simply act as an additional tax on
electricity. There is a danger that if the level of the tax rate
is set too far in advance and carbon prices under the EU ETS subsequently
rise significantly (for example, if the EU moves to a 30% emissions
reduction target), consumers will be paying far higher prices
than necessary. It is crucial that there is a dynamic element
with the EU carbon allowance (EUA) price to minimise any undue
impact on UK competitiveness.
25. On the other hand if the level of the tax
is set without sufficient lead time to allow the level of tax
to be taken into account in forward prices, generators will need
to factor in the additional risks from uncertainty in tax levels
in their pricing structure. The rate of any carbon tax on input
fuels would need to be set no less than two years in advance.
26. Any assessment of the level at which a floor
price is set must take into account the overall impact of all
proposed support mechanisms and the timescales over which new
investment in low carbon generation is likely to be delivered.
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?
27. The issue of electricity storage and interconnection
is related to the temporal and geographical electricity price
differentials that emerge as a consequence of the proposals under
the Electricity Market Reform package. The extent to which price
signals are impacted by the proposals through, for example, the
capacity payments mechanism is an important consideration. Companies
will not invest in demand management or storage if they think
price signals will be undermined by government and regulators,
or the operation of reserve capacity by National Grid. Given the
scale of the intervention it may be difficult for the market to
deliver increased storage or interconnection without understanding
the interaction of all elements of policy.
5 National Grid Future Balancing Services Requirements:
Reserve, http://www.nationalgrid.com/NR/rdonlyres/55610D9A-C53A-4E28-88C6-29AE5DF72EF2/42697/Future_Balancing_Services_Requirements_Reserve1.pdf Back
Open letter consultation: Potential Significant Code Reviews (SCRs),
Ofgem, 12 August 2010 Back
National Grid Future Balancing Services Requirements: Reserve,