Memorandum submitted by Drax
Government's policy objectives on security of supply, the decarbonisation
of electricity generation and affordability to end consumers should
be the focus of the reform package.
believes that these objectives are best achieved by maintaining
adequate generation capacity margins, promoting adequate investment
in low carbon generation technologies, addressing the relative
competitive positions of the various market participants and promoting
greater wholesale market liquidity.
believes that specific measures raised by the Electricity Market
Reform (EMR) consultation have the ability to achieve these objectives,
such as a capacity mechanism and a Contract for Difference (CFD)
Feed-in Tariff (FIT).
appropriate capacity mechanism would:
there are adequate returns for making capacity available to the
market, thereby avoiding early closure of existing plant; and
medium-term signals for investment in existing and new flexible
plant, which ensures the most efficient investment prevails, lowering
the cost to end consumers.
there are a number of considerations that must be addressed when
designing a capacity mechanism in order to avoid unintended consequences,
such as the premature closure of existing flexible plant to the
detriment of security of supply.
advocates a capacity mechanism that rewards the provision of flexibility
services, particularly in the light of the anticipated high penetration
of intermittent and inflexible generation capacity over the next
shortcoming of DECC's preferred approach is that it focuses purely
on extreme peak demand, neglecting the importance of flexibility
in securing supply.
supports the CFD FIT approach to renewables support as it provides
investors in such technologies with greater revenue certainty
by agreeing a contracted strike price, whilst avoiding windfall
profits for generators and ensuring excess revenue due to high
market prices is returned to end consumers.
believes that the carbon price support mechanism is unnecessary
as it is an economically inefficient tool that supports specific
technologies whilst simultaneously distorting the wholesale market;
in particular, there is a concern over the conflict that would
exist between the proposed GB specific Carbon Price Support and
the existing EU Emissions Trading Scheme (EU ETS).
1. Drax is predominantly an independent power
generation business responsible for meeting some 7% of the UK's
electricity demand. The Company also owns Haven Power, a small
electricity supplier serving the needs of business customers.
2. As the owner and operator of Drax Power Station
in North Yorkshire, the largest, cleanest and most efficient coal-fired
power station in the UK, Drax is committed to reducing the carbon
footprint of UK power generation. To this end, in summer 2010
the largest biomass co-firing facility in the world was commissioned
at the power station, providing the capability to produce 12.5%
of the station's output from renewable and sustainable biomass
- equivalent to the output of around 600 wind turbines. In addition,
the largest steam turbine modernisation programme is underway
at the power station and is now just over two-thirds complete.
Together these two initiatives will reduce emissions of carbon
dioxide by over three and a half million tonnes a year, which
is a reduction of 17.5% compared to 2006 levels.
3. Drax is pleased to have the opportunity to
participate in the Committee's inquiry on EMR. As a provider of
flexible generation to the System Operator and an investor in
renewable electricity generation from biomass, Drax believes it
is well placed to comment on the key issues of a capacity mechanism,
Feed-in Tariffs for renewable technologies and a carbon price
support mechanism. Drax is still assessing the benefits and risks
of the EMR proposals, however, it is encouraged by the holistic
approach taken by DECC.
A CALL FOR
Question 1: What should the main objective of
the Electricity Market Reform project be?
4. The EMR project should focus on reform of
the GB electricity wholesale market arrangements in order to ensure
that the correct framework is in place to deliver the Government's
key policy objectives, namely security of supply, the decarbonisation
of electricity generation and affordability to end consumers.
This can be best achieved by:
adequate generation capacity margins to ensure security of supply;
there is an adequate level of investment in low carbon generation
by providing investors with a greater level of certainty over
their investment returns;
the competitive imbalance between vertically integrated and independent
generation and supply companies; and
greater liquidity, competition and tenure of contracts within
the wholesale electricity market.
Question 2: Do capacity mechanisms offer a realistic
way of achieving energy security, low-carbon investment and fair
5. It should be recognised that significant investment
is needed to meet future peak demand and flexibility requirements,
despite relatively low forecast demand growth over the medium-term.
The closure of 20GW of flexible plant and 7GW of nuclear plant
is scheduled by 2020, with the connection of 25GW of intermittent
wind capacity expected over the same period.
6. When designed correctly, capacity mechanisms
do offer a realistic way of achieving greater energy security.
This is best achieved by:
(a) ensuring there are adequate returns for making
capacity available to the market, thereby avoiding early closure
of existing plant; and
(b) providing medium-term signals for investment
in existing and new flexible plant, which ensures the most efficient
investment prevails, lowering the cost to end consumers.
Neither of the above is provided by the current energy-only
7. In addition, reduced availability of existing
flexible plant is also expected over the next decade, due to environmental
legislation and more onerous operating regimes. However, it should
be noted that the need for flexible plant has not diminished because:
demand increases by up to 50% on a winter morning between the
hours of 5.00 am and 9.00am; and
2020, the most extreme hour-to-hour change in demand net of wind
output could be as much as 17GW,
which is a significant increase from the maximum variation of
5GW in 2009.
8. In order for capacity mechanisms to be successful,
they must address the risk of flexible plant closing prematurely.
Early closure could be caused by:
reduction in wholesale market liquidity as the volume of capacity
that is subsidised increases in a market that already suffers
from low liquidity:
increases the risk of the market not valuing flexibility in the
load factors for thermal plant as they fulfil a "flexibility"
role, rather than the traditional baseload generation role; and
hour-to-hour variation in output due to the incentivised growth
of intermittent (ie wind) and inflexible (ie nuclear) generation.
9. A well designed capacity mechanism would ensure
that the value of both capacity and energy is transparent to all
investors in the market, promoting a competitive and efficient
wholesale electricity market.
Question 3: What is the most appropriate kind
of capacity mechanism for the UK?
10. In order to deliver efficient investment
in flexible capacity, thereby creating the least cost to the end
consumer, the capacity mechanism must provide signals to the market
that allow both new and existing plant to compete. DECC's preferred
approach to a capacity mechanism, as set out in DECC's EMR consultation
document, does not provide existing plant with the appropriate
signals to deliver security of supply services. The proposal could
force existing flexible thermal capacity to close prematurely,
when such plant could be the most efficient investment option
to provide peak demand and flexibility services.
11. DECC's preferred solution appears to only
focus on a peak demand scenario, neglecting to address the looming
issue of flexibility in low demand periods. Given the Government's
policy to incentivise investment in a large volume of intermittent
(ie wind) and inflexible baseload (ie nuclear) generation capacity
over the next decade, it is essential that the capacity mechanism
addresses both capacity demand extremes and flexibility requirements.
The technical characteristics of certain plant (eg the ability
to quickly increase or decrease output) makes them more suitable
for providing flexibility services than others; it will be crucial
to maintain a sufficient level of flexible plant to respond to
sudden changes in demand or intermittent plant output.
12. The preferred approach outlined in the EMR
consultation document requires a central body to determine the
difference between a capacity demand forecast and a capacity availability
forecast, in order to determine the volume of capacity for which
the mechanism will contract. These figures are notoriously difficult
to forecast, which, in turn, makes forecasting the difference
between the two particularly difficult. The longer the term of
the contracts in the proposed capacity mechanism, the less likely
it is to be accurate.
13. In addition, the options suggested in the
EMR consultation are the two extreme solutions, ie a targeted
approach that is limited to a small volume of Open Cycle Gas Turbine
(OCGT) plant and an all inclusive (ie all plant) approach based
upon a fixed capacity payment value. Whilst the consultation document
critiques the difference in cost between the two approaches, it
fails to recognise that there is the potential for models that
fit between the two extremes that could deliver greater security
of supply at an acceptable cost to the consumer, ie an approach
that is open to all flexible generation plant, but takes an auctioning
approach in order to contract with the most cost effective provider.
14. In Drax's view, the capacity mechanism should
be a centrally administered scheme, where a central body takes
a decision on the total volume of capacity required (ie the forecast
total capacity requirement; similar to DECC's proposed solution).
To meet the forecast total capacity requirement, the scheme would
be open to all
plant (new and existing) and should be based upon two to five
year contracting periods. This would allow the mechanism to focus
on a range of plant types, providing a solution to both peak demand
and flexibility requirements.
15. It would also reduce the risk of over or
under contracting by making the forecasting of future requirements
more straightforward (ie calculating the total requirement only).
This would mean that rather than there being a focus on investment
in a new generation of OCGT plant, market participants should
continue to take decisions on the most appropriate investment
option, such as whether to invest in new plant or to upgrade and
decarbonise existing plant.
16. Drax believes it is potentially inefficient
to build a capacity mechanism around an assumption of the type
of plant required. For example, the traditional "last resort"
peaking plant in the UK has been OCGT, which run for around 30
minutes on a few occasions per year; however, this was against
a background of coal and gas fired generation, whereas the future
generation mix will be dominated by wind and gas. This raises
a number of questions including:
OCGT (gas or oil) plants appropriate to provide this service given
their low efficiency and high level of carbon emissions?
the high volume peaking capacity (currently supplied by large
oil fired plant) still be required? and
GB, in fact, need a greater volume of total capacity?
17. A capacity mechanism that is available to
all types of plant capable of providing reliable flexibility services,
and is based upon clear investment signals set by a central body,
would allow the market to provide the most efficient and flexible
solution to issues encountered by both extreme demand periods
and changes in intermittent generation output in low demand periods,
at the lowest cost to the end consumer. Government policy objectives
will ensure that such plant is incentivised to decarbonise, in
order to continue to be competitive and remain on the system.
Question 4: Should the system of Feed-in Tariffs
be focused on particular technologies or maintain a wider technology-based
18. Drax believes that FITs should be available
types of renewable generation technologies. Drax believes that
all support models, whether for renewable and/or low carbon generation
technologies, should be designed in a way that promotes wholesale
market liquidity. It is essential that all generation technologies
continue to participate in the wholesale electricity market in
order to ensure that all plant continues to respond to fundamental
market signals and to avoid perverse actions from generators that
are immune to the consequences of their actions.
19. It is essential that the chosen subsidy model
provides renewable generators with the support they require when
prices are low, but avoids providing windfall profits to both
new and existing plant when prices are high. The design of the
CFD FIT approach (the preferred option in DECC's EMR consultation)
provides both of these benefits by recouping windfall profit from
generators and passing the benefit straight back to consumers
via their bills.
20. Furthermore, Drax supports the movement away
from the current support mechanism (the Renewables Obligation
(RO)) to a mechanism that provides greater revenue certainty and
ensures that the full value of the subsidy reaches the investor,
removing a significant investment barrier currently faced by independent
generators and new entrants.
Question 5: Will it be feasible to deliver EMR
in one go, or will regulations and implementation be spread over
21. Whilst it is tempting to take a "big
bang" approach to reform, there are a number of issues that
must be taken into account, such as the complexity of the current
arrangements, the nature of industry contracts, commitments already
made to investors (such as grandfathering or guaranteeing a level
of support under the RO) and the fact that differing types of
plant may require support at differing points in time (eg new
nuclear capacity will not be delivered until around 2020 at the
earliest, therefore only requires certainty of support before
that time, not support itself).
22. Drax supports a transitional approach that
(a) urgent fundamental market reform occurs sooner
rather than later:
of greater certainty over renewable generation investment returns;
mechanism to ensure the network retains much needed flexible reserve
need to address the balance of competition between different types
of energy company (ie those that are vertically integrated and
those that are independent); and
to improve wholesale market liquidity;
(b) support is provided / introduced in line
with investment timescales:
support mechanisms are required now to support technologies that
can be deployed and utilised now; and
support mechanisms for low carbon plant that cannot be deployed
now should be put in place in line with delivery timescales (ie
CCS and new nuclear is expected to arrive around 2020);
(c) transitional arrangements are put in place
where contracts and commitments currently exist:
current RO must continue alongside FITs for those investments
that are operational / under construction;
transition process between schemes should be notified as soon
as practicable in order to avoid a detriment to investor confidence;
must be given to the nature of the market:
may be contracted a number of seasons ahead; and
participants may have existing contracts in place that span multiple
years, where it may not be possible to pass on new costs.
23. The implementation approach taken by DECC
must provide certainty of longevity and allow sufficient time
for the relevant industry codes to be modified.
Question 6: Will market reform increase political
risk for investors or create certainty?
24. Whilst Drax advocates stable and enduring
market arrangements, there are a number of major issues that exist
in the current market structure that must be tackled now.
25. Market reform measures must concentrate on
creating a competitive and liquid wholesale market, with a renewable
subsidy regime that provides certainty to investors and their
financiers. It is essential that the market arrangements in place
over the next decade encourage investment in low-carbon technologies,
whilst maintaining a sufficient level of efficient, flexible thermal
capacity to ensure security of supply.
26. If market intervention does not occur now,
it is highly likely that inefficient investment decisions will
be taken and regulatory uncertainty will remain. Drax believes
that change to the current market arrangements is unavoidable
if the Government is to encourage greater levels of investment
to achieve its policy objectives.
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?
Question 8: What synergies and conflicts will
there be between proposed mechanisms and policies already in place?
27. Drax believes that the Carbon Price Support
is unnecessary; it is an economically inefficient tool that supports
specific technologies whilst simultaneously distorting the wholesale
market. Drax is concerned over the conflict that would exist between
the proposed Carbon Price Support and the existing EU Emissions
Trading Scheme (EU ETS). The Carbon Price Support is a unilateral
measure taken by the Government on a European-wide market, where
there is currently a mechanism in place to support the price of
carbon allowances (ie the EU ETS cap). Drax continues to believe
that the price level of carbon allowances should continue to be
determined by the market, which in turn is driven by the EU ETS
28. As the level of interconnectivity increases
between GB and other EU Member States, it is imperative that those
investors that have sites in GB are not placed at a competitive
disadvantage to those sited in mainland Europe. If such a competitive
disadvantage were introduced, this could lead to investment being
redirected to other Member States, with GB becoming more reliant
upon imports of energy in order to meet national demand.
29. There is a further conflict between the proposed
Emissions Performance Standard (EPS) and current European directives
that have been put in place to tackle exactly the same issues.
The EPS is an unnecessary layer of legislation that will be introduced
alongside the existing Large Combustion Plant Directive (LCPD)
and Industrial Emissions Directive (IED); each of these directives
define emissions standards for electricity generation plant.
Question 9: Will a carbon floor price be feasible
in the context of EMR and at what level should it be set?
30. A carbon floor price will only be feasible
benefits new low carbon investments, ie it does not provide a
windfall to plant that is already operating;
applies when the new plant that the mechanism is attempting to
incentivise begins to generate electricity and not before;
set at a level that provides "certainty" and not subsidy;
does not dissuade the much required investment in GB.
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?
31. If the separate elements of the EMR project
are carefully designed, the final package could have the potential
a competitive and liquid market that encourages new entry and
all generators located in GB (and partaking in the wholesale market)
on the same footing as those generators located in mainland Europe;
greater consistency between European wholesale markets, thereby
encouraging market linking, interconnectivity and competition.
8 Green, R, (2010) "Are the British Electricity
Trading and Transmission Arrangements Future-proof?", Utilities