Electricity Market Reform - Energy and Climate Change Contents

Supplementary memorandum submitted by Climate Change Capital

1.  The committee noted your comments about the importance of getting the detail of the FiT/CfD right and would like your views on what form that detail should take. In particular:
(a)  Do you prefer a premium FiT or CfD? Does this differ between technologies?

Of the two options we prefer the CfD, as long as outstanding issues such as auctioning are resolved in the right way. A premium FIT is not materially different from the RO and we see little point in creating uncertainty and an investment hiatus via EMR if the end result is the retention of a system almost identical to the RO. This would do little to improve certainty for investors.

(b)  Given your comments about the importance of simplicity is the government right to exclude a fixed FiT from further consideration?

Fixed FITs should be an option under consideration because they could help deliver the Government's objectives, ie providing certainty to investors in low carbon technologies, equally or more effectively than a well-designed CfD. But, there are also downsides of going with Fixed FITs, such as the fact that you could end up splitting the electricity market into two.

(c)  How should the strike price for the CfD be set? The government has expressed a preference for auctions. Is this the right approach?

Tendering or auctions will increase barriers to entry, result in under-bidding/gaming, and create significant uncertainty. Auctions do not tend to work for immature technologies with unpredictable costs (eg offshore wind and CCS) and/or projects with too few bidders (eg nuclear). The introduction of auctions, while desirable under certain conditions in economic theory, would be of serious concern for financiers and project developers if implemented in practice. We are strongly against the introduction of auctions for setting the strike price.

2.  We have heard from some respondents to our inquiry that switching from the RO to a FIT would remove the obligation on suppliers to buy renewable electricity, thereby increasing offtake risk. Would this make investment in renewables a more risky proposition than it is under the current system?

Yes, this could have the stated undesirable affect.

3.  You suggested that an EPS might give concern to those who have already invested in fossil-fuel power stations. However, could a tough EPS also provide a clear sales volume opportunity for low-carbon generation, which might help encourage investment in to the UK's low-carbon power sector?

An EPS applied to new build only (as is proposed), should not have that affect on investment. An EPS can provide additional certainty to low carbon investors that the UK is committed to a low carbon pathway and this is valuable.

4.  You mentioned a number of other risks that investors consider when making investment decisions (such as construction and technology risk). How much weight would be given to these kinds of risk compared with the revenue risk that the EMR is trying to address?

The primary difference between low carbon infrastructure and traditional forms of infrastructure are the unique risks associated with the underlying asset and its cash flows. Low carbon infrastructure is generally much more dependent on income generated through subsidies, regulations, obligations and incentives that are created by public policy, whereas conventional infrastructure is generally significantly less so.

In addition to these risks, the fact that some of these technologies are FOAK (eg CCS) or are relatively new and operate in difficult environments (eg offshore wind), are significant additional risks. All things being equal, measures to reduce policy risk, technology risk, and construction risk will improve the revenue certainty of low carbon assets and lower the average cost of capital.

We believe that the actors best placed to manage risk should bear it, and for technology and construction risks, this will be project developers, manufacturers, EPC contractors, financiers and insurers. In contrast, government is best placed to manage policy risk. So while government can support R&D and testing to help reduce technology and construction risks for sectors as a whole, we do not believe that government is best placed to take on construction or technology risks directly. Doing so directly or via public financial institutions (eg UK GIB) can create significant moral hazards and crowd out the private sector.

March 2011

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Prepared 16 May 2011