Memorandum submitted by International
(I) ABOUT INTERNATIONAL
IPR welcomes the opportunity to contribute to the
Energy and Climate Change Committee's call for evidence on the
Electricity Market Reform (EMR). HMT and DECC published formal
Consultations on EMR in December 2010 so our response to the questions
posed in this Inquiry may change following detailed analysis of
the Government's proposals.
International Power Plc (IPR) is a global independent
power generation company with interests in over 34,000 MW of generation
capacity in 21 countries. This includes approximately 5000 MW
of plant in the UK market where, in partnership with Mitsui &
Co., it owns and operates the coal fired station at Rugeley, Deeside
Power CCGT, Saltend Cogeneration Plant in Hull, First Hydro Pumped
Storage Stations at Dinorwig and Ffestiniog in North Wales, and
Indian Queens peaking plant in Cornwall; the company also has
a share in Derwent Cogeneration plant. These assets represent
a 7% market share, making IPR one of the country's largest independent
IPR is one of the world's top 10 owners and operators
of wind farms with an installed capacity of 1340 MW, much of which
is in Europe. The company is keen to develop its renewable portfolio
further and is involved in a range of projects in the UK as part
of this strategy.
reform must focus on delivering a viable electricity system in
2030, and on maintaining the system during the intervening period;
it is also vital that a competitive framework is retained.
UK's electricity mix should evolve in concert with that in other
European countries to maintain economic competitiveness.
the creation of a carbon price floor - bearing in mind there are
specific market reform proposals to subsidise all low carbon generation,
the priority must be a mechanism that delivers the least extra
cost to the sector and the consumer.
the adoption of Emission Performance Standards - in light of existing
and new emission reduction regulation, Emission Performance Standards
are an unnecessary regulation.
low carbon support mechanisms - If the objective is to deliver
a mix of low carbon technologies, each with its own cost structure
and benefits, it will be necessary to offer different tariffs
for different technologies.
significant reduction in risk for all new low carbon generation
may well deliver the carbon savings being sought by Government,
but at a higher cost to the consumer than might otherwise be the
case, and to the possible detriment of the rest of the electricity
capacity payments - such a mechanism will be required to provide
sufficient plant availability and flexibility at all times to
ensure security of supplies, particularly in a sector that has
a very high penetration of intermittent renewable, and large inflexible
(III) ON THE
Q1: What should the main objective of the Electricity
Market Reform project be?
1. The main objectives of the Electricity Market
Reform process must be to maintain security of supply and help
the UK meets its climate change obligations, both at a cost the
country can afford.
2. The UK has led the way on electricity and
gas liberalisation in Europe over the last 20 years. The main
driver for this transformation was a desire for greater efficiency
across the industry and cheaper bills for consumers - it is fair
to say that the market has delivered on these objectives and it
is important that a competitive framework is maintained in the
3. With time, a number of other objectives beyond
competiveness have also become more important - the need to address
climate change, maintaining security of supply, and the renewal
of an ageing infrastructure. In the current austere times, the
need for investment, and maintaining and creating new jobs is
also high on the agenda.
4. Today, there is a view that Government interventions
in the market are needed, primarily to ensure decarbonisation
of the electricity mix. IPR believes there should be emphasis
on the market as a whole, and on establishing all
the attributes needed for a viable industry and competitive framework.
Armed with this knowledge it is possible to determine the market
structure that can best deliver these attributes, and at the same
time ensure the "health" of the industry in the interim
period to 2030 and beyond.
Q2: Do capacity mechanisms offer a realistic way
of achieving energy security, low-carbon investment and fair prices?
5. Yes - a capacity mechanism is essential to
facilitate the integration of around 30GW of wind generation needed
to meet the 2020 renewables target and this conclusion is based
on the following observations:
new, subsidised low carbon generation capacity is commissioned,
wholesale prices are likely to be more volatile in the short term
and depressed in the longer term. Price spikes have traditionally
occurred at times of high demand but as wind penetration increases,
the relevance of a demand peak to the market will be diluted,
with prices being driven more typically by the prevailing amount
of wind generation. It will therefore also be increasingly more
difficult to predict pricing patterns and anticipate capacity
noted by the Climate Change Committee in their Fourth Carbon Budget
Report "decarbonisation will also increase the level and
the variability of demand, through the electrification of heat
and transport. In particular, demand for electricity from the
heat sector could add significantly to the need for flexibility
by increasing the variability, seasonality, and peakiness of electricity
risk profile surrounding the profitability of fossil generators
will change significantly. Fossil generators will potentially
have to recover their costs and a sufficient return over a much
shorter period of running.
It will be very difficult for flexible plant to fully capture
the unpredictable price "spikes" and earn a sufficient
return to cover fixed and variable costs.
the current energy-only market has delivered significant investment
over the last 20 years, it was not designed with these increasing
levels of subsidies and intermittency in mind. There will be a
fundamental shift in the relationship between capacity and energy
across the energy system, with a very significant tranche of capacity
operating at very low load factors.
6. IPR's view, supported by a number of industry
commentators, is that a capacity-based mechanism will be required
to provide sufficient plant availability and flexibility at all
times to ensure security of supplies. This capacity mechanism
is distinct from a low carbon support mechanisms or carbon floor
price, both of which provide incentives to address the Government's
low carbon investment agenda.
7. DECC favours a targeted capacity mechanism
- IPR does not believe this is appropriate. The Brattle Group
undertook an extensive study of worldwide capacity market designs
and noted that:
.administratively, limiting payments to new
. constitutes an out-of-market mechanism
additional capacity maintained through such payments will create
or prolong the "missing money" problem for all resources
that are not receiving the special payment
. the need to
extend such payments to existing generation will quickly grow
as the suppression of energy market prices forces existing resources
into retirement unless they too receive the additional payment.
In essence a targeted payment will create a "slippery
slope" as referred to by DECC in the EMR consultation; the
central body has to procure ever more generating capacity. Whilst
in the short term a targeted mechanism has its attractions, in
the long term costs are likely to be higher due to the market
distortions a targeted mechanism will create.
Q3: What is the most appropriate kind of capacity
mechanisms for the UK?
8. IPR believes a capacity mechanism should have
the following basic characteristics:
avoid picking winners, it should be universal; the RO/FITs, support
for CCS, and the carbon floor price, if implemented, will each
provide a "targeted" subsidy;
should avoid exacerbating the current level of vertical integration.
This criterion rules out a supplier based capacity obligation
as under this mechanism, suppliers would self-contract first and
only go to market to meet their residual capacity need;
should provide a forward price for the value of capacity and reward
availability at the "net demand" peak (ie demand net
of wind generation);
should allow for genuine demand side participation;
should provide an appropriate and common penalty mechanism for
non-availability. This would encourage the required flexibility
and reliability; and
costs of the capacity mechanism should be paid for by end consumers
since they are the beneficiaries of incentivising security-of-supply.
9. To meet the above criteria, a long-term centrally
administered capacity mechanism is most appropriate. Such capacity
mechanisms have been in operation elsewhere - IPR believes two
could be suitable: the Pennsylvania, New Jersey and Maryland (PJM)
market in North East USA and the capacity mechanism within the
All Ireland Market (AIM). Both could form the design basis for
a GB capacity mechanism. Of the two, the AIM mechanism is the
simpler and can more readily be adopted alongside the existing
Q4: Should the system of Feed-in Tariffs be focused
on particular technologies or maintain a wider technology-based
10. Government proposals in the DECC Consultation
are for a mechanism that subsidises all low carbon generation:
renewables, nuclear and in time, fossil with Carbon Capture and
Storage. If the objective is to deliver low carbon generation
at least cost to the consumer a single FIT is the most appropriate.
If there is a desire to deliver a mix of low carbon technologies,
each with its own cost structure and benefits, it will be necessary
to offer different tariffs for different technologies.
11. However there are some potential unintended
consequences in providing subsides for all low carbon generation.
The complete removal of risk from new low carbon generation may
well deliver the carbon savings being sought by Government, but
at a higher cost to the consumer than might otherwise be the case,
and to the detriment of the rest of the electricity sector - eg
by reducing the wholesale power price - perhaps leading to early
closure of valuable UK generation.
12. Item (4) above stresses the importance of
ensuring that all attributes associated with a viable electricity
system are incentivised - this does not necessarily require the
same mechanism across all technologies, rather a package of economic
instruments that best suit the range of attributes needed, whether
it is low carbon, stand-by generation, flexible plant, or fast-response
facilities. Feed-in Tariffs have a role to play but so do other
mechanisms including capacity payments.
13. As indicated earlier the Government has indeed
proposed a package of measures in its recent Consultation documents
on the creation of a Carbon Price Floor and Reform of the Electricity
Market. The only concern at this stage is the question of whether
more than one economic instrument is needed to support the low
carbon sector as is being proposed by Government.
Q5: Will it be feasible to deliver EMR in one
go, or will regulations and implementation be spread over time?
14. The Emission Performance Standard (EPS) is
independent of the other pillars of the EMR and could be implemented
at any point in the future. If an EPS is adopted then it should
only apply to new coal plant.
15. The remaining parts of the EMR can be implemented
separately although the regulations need to be delivered at the
same time or at the very least developed in parallel to ensure
they work together and minimize costs to consumers. For example,
setting the level of any FIT will need to take account of the
level of the carbon floor price and the carbon floor price will
need to take into account the prevailing wholesale price and the
income being earned from a capacity payment mechanism.
16. With ROCs/FITs providing the necessary subsidy
for renewables, a carbon floor price is clearly targeted at nuclear
generation and potentially CCS. On the expectation that the first
nuclear power station is realistically not generating until around
2020, a carbon floor price is not needed until then. If brought
in before this date, the floor price will merely create windfall
profits for existing low carbon generation. However, its introduction
could be signaled far in advance in order to provide the appropriate
investment signals, and some stability, for all types of generation.
There is nonetheless the question of whether, in light of the
proposals to subsidise nuclear through a FIT mechanism, a carbon
price floor is needed at all.
17. By the start of 2016, 12GW of plant opted-out
of the Large Combustion Plant Directive (LCPD) will have shut
as well as Wylfa and Oldbury nuclear stations. The remaining coal
plant will be subject to reduced operating hours unless they fit
Selective Catalytic Reduction to reduce NOx emissions to comply
with the Industrial Emissions Directive.
Also, over the next decade or so some of the AGR nuclear power
stations may close. Introducing a capacity mechanism would aid
investment decisions at this point when capacity shortfalls are
expected to become apparent. Again the introduction and design
of the capacity payment should be well signaled to aid investment
18. Replacing ROCs with FITs could happen at
any time but needs to be signaled well in advance to allow renewable
developers to know at project financing stage which mechanism
will be providing the renewable subsidy. The linkages between
a new scheme and the RO also need to be clearly defined in order
that grandfathering for existing projects is made effective.
Q6: Will market reform increase political risk
for investors or create certainty?
19. Regulatory risk is arguably one of the most
important considerations for market participants, not only for
new investment decisions but also for existing assets where financial
decisions were taken in the prevailing regulatory regime. Existing
and new investments must be considered when assessing risks associated
with potential new market arrangements.
20. Government interventions such as those being
proposed in the EMR are likely to transform the market and as
such create considerable uncertainty for all stakeholders. This
will remain the case until the Government delivers its new market
21. The way in which the new arrangements will
be implemented and, in particular, the potential for further interventions
will also increase uncertainty. Government must decide, with all
the market participants, what is needed for the market over the
long-term, and then implement the changes in a timely and predictable
Q7: 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?
22. International Power agrees that a package
of measures is needed to meet the goals on climate change and
security of supply - the difficulty will be to ensure the measures
being proposed deliver at least cost to the consumer. This is
best achieved if:
in measures, such as the creation of a carbon price floor and
CfD/FiTs mechanisms to reduce risk for low carbon technologies,
consequences, such as "windfall" profits for existing
low carbon generation that would occur from a broad based "carbon
tax" on fossil fuels, is avoided;
regulation such as Emission Performance Standards is avoided;
solutions continue to be promoted in order to deliver efficiencies,
maintain equilibrium with other European markets, and deliver
improved levels of competition.
23. IPR believes the
EMR should also address liquidity - healthy levels of liquidity
are highly desirable in the market, and will in any case be needed
to ensure a robust reference price for the CfD FITs mechanism
being proposed to incentivise new low carbon generation. Since
each of the six Vertically Integrated (VI) companies have a broadly
balanced generation and supply position, there is currently little
imperative to trade in the market, resulting in low liquidity.
24. IPR would like
to see a significant improvement in longer term market liquidity,
particularly for less standard products such as peak and off-peak,
as these markets are particularly "thin". Improved price
formation and market access are, for instance, important to independent
generators looking to "hedge" output forward at a fair
price, and on timescales that are more consistent with availability
Q8: What synergies and conflicts will there
be between proposed mechanisms and policies already in place?
25. The current ROC mechanism has a headroom
calculation to ensure that the target is always ahead of the build
rate. If new renewables receive their support via a FIT and existing
renewables continue with ROCs, the headroom mechanism will need
to be modified so that it can work alongside the FITs mechanism.
26. It is worth noting
that the creation of a carbon price floor as described in the
recent Treasury Consultation will deliver "windfall profits"
for all existing low carbon generation such as nuclear
and renewables due to higher than anticipated wholesale prices.
27. There is also
the potential for windfall profits for existing
and new low carbon generation if gas prices and
therefore wholesale prices rise (since gas generation tends to
sets the marginal price) beyond that assumed when the carbon price
floor was set. The level at which the carbon price floor is set
then, should also take into account the prevailing wholesale price
for electricity ie the carbon price floor should be linked to
the wholesale price such that the former declines to the market
price for carbon as wholesale prices rise.
28. The support being
proposed for all low carbon generation, and the creation of a
carbon price floor will undermine confidence in the EU Emissions
Trading Scheme, the Government's declared principle instrument
for emissions reduction.
Q9: Will a carbon floor price be feasible in the
context of EMR and at what level should it be set?
29. The Governments original reason for the creation
of a carbon price floor was to reduce the risk of a low carbon
price (and therefore a low pass-through to the wholesale price)
for nuclear and other low carbon generation. In the event, the
Government now proposes to establish a mechanism in the Contract-for-Difference
or a premium Feed-in Tariff to subsidise the economics of nuclear
and other low carbon generation; in light of this, the economics
of low carbon generation is assured and we believe it is no longer
necessary to create a carbon floor price.
30. Also, the creation of a carbon price floor
will undermine the EU Emissions Trading Scheme in the UK, the
Government's declared principle instrument for emissions reduction.
Further, a carbon price floor is unlikely to be adopted elsewhere
in Europe putting UK industry at a competitive disadvantage.
31. However if the Government chooses to go ahead
with the creation of such a mechanism:
should only apply when new low carbon plant begin operating, thus
minimising the potential for windfall profits to existing nuclear
and renewable generation;
carbon price floor should be set at a level that provides "certainty"
and not subsidy, and minimises the chances of "windfall"
profits. This could be achieved by delaying its introduction to
align with the expected commissioning of the first new nuclear
power station; and
carbon price floor needs to be linked to the wholesale price,
again to avoid "windfall" profits to new low carbon
generation as discussed in item 27 above.
32. Bearing in mind there are specific market
reform proposals to subsidise all low carbon generation, the priority
must be a mechanism that delivers the least extra cost to the
sector and the consumer. The priority must be a mechanism
that delivers the least extra cost to sector and the consumer.
Q10: 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?
33. IPR owns and operates Dinorwig and Ffestiniog
pumped storage power stations in Snowdonia, representing 2088
MW of capacity in the GB market.
34. There are no specific proposals on storage
in DECC's consultation, nor any detailed assessment of the economic
value that it can provide for a low carbon plant mix. Notwithstanding
this, the natural synergies with intermittent generation tend
to support the view that there is some long-term potential for
economic development of new storage schemes, perhaps with more
significant energy backing than the existing schemes which were
primarily built for rapid response services rather than wind-related
35. There are however conflicting pressures on
storage emerging from the EMR process:
viability of storage is driven by the value in price arbitrage
in peak to off-peak, taking account of the inherent cycle efficiency
of the storage technology. If the EMR is successful in delivering
new low carbon investment, the traditional pattern of prices in
these periods is likely to change significantly, with less certainty
over the timing and extent of peak and off-peak periods and more
day-to-day volatility. Whilst storage can benefit from price volatility,
the uncertainties over the nature and price impact of market interventions
may undermine some of these benefits;
low load factor pumped storage plant faces large capacity-based
costs (eg business rates, Transmission Use of System charges)
and needs to earn revenues via an energy-only market (alternatively
contracts for reserve can be tendered via the system operator.)
The potential introduction of a capacity market has the potential
to improve the economics of storage, and bring forward new development
introduction of a carbon floor price is a negative factor. It
is likely to directly reduce the energy margin available to storage
36. These schemes typically entail high capital
costs, long lead times, and significant construction risks. It
is therefore important the future pricing environment is well
understood in order to establish whether any additional development
is needed from an economic standpoint - for example, as implied
in the question, any requirement for storage can be reduced through
increased interconnection, particularly with Europe. The EMR will
be helpful in providing more certainty on the future shape of
the market and therefore whether there is an economic case for
more storage. International Power intends to undertake more work
on this issue.
10 For example, the recent study by Poyry showed that,
under 33 GW of wind in 2020, load factors for "new CCGTs"
will fall to 55% (from around 75% at present) and for "Old
CCGTs", load factors will fall below 5% (from 25%). "Super-peaking"
plants may be used a few hours one year and not at all the next,
depending on wind speeds during peak demand periods. Back
A Comparison of PJM's RPM with Alternative Energy and Capacity
Market Designs, The Brattle Group, September 2009 pp 40 - 41 Back
Some of the older CCGT stations may also be required to invest
in additional NOx control technology Back