Energy and Climate Change Committee - Draft Energy Bill: Pre-legislitive ScrutinyWritten evidence submitted by EEF

Executive Summary

EEF backs electricity market reform. Support for low carbon technologies needs to be made both more attractive to investors and more affordable for consumers.

Manufacturers urgently need a more affordable approach to decarbonisation. UK industrial electricity prices have been consistently above the EU/G7 average since 2006. The cost of policy is a major differentiating factor—its impact on prices is already significant, set to rise and difficult to pass on to consumers in international markets.

Yet despite some good features, government proposals remain disproportionately focused on the needs of investors to the detriment of consumers. This is reflected in the provisions and omissions of the draft Bill. To address this issue, EEF believes the draft Bill needs strengthening in three key areas.

First, stronger statutory safeguards are needed to control the costs of Contracts for Difference, Investment Instruments and the Capacity Market. In addition, the Bill must avoid giving the government too great a latitude to intervene in the market unless there are compelling reasons to do so.

Second, an explicit commitment to move to technology-neutral auctions, underpinned by primary legislation, is needed. Competition between low carbon technologies is the key to keeping costs down. The Bill must refer explicitly to the government’s stated plans to restore competition in the market after the initial phase of administered pricing.

Third, the Bill must provide greater assurance that the competitiveness of energy-intensive manufacturers operating in international markets will not be compromised by the reforms. Explicit provisions empowering the government to reduce the exposure of these companies to EMR-related costs are needed.

About EEF

1. EEF is the representative voice of manufacturing, engineering and technology-based businesses with a membership of 2,500 companies representing 6,000 industrial sites.

2. A large part of our policy work focuses on the issues that make a difference to the productivity and competitiveness of UK manufacturing, including investment, innovation, skills and tax issues.

3. This memorandum is a submission to the Energy and Climate Change Committee’s inquiry into the draft Energy Bill published on 22 May 2012.

Electricity Market Reform Urgently Needed

4. Given the UK’s stretching commitment to cut carbon dioxide emissions, the British electricity market is in urgent need of reform. We need to find a better way to support low carbon power generation, one that is more attractive to investors and more affordable for consumers.

5. The package of reforms being developed by the government has the potential to help achieve both of these objectives—it could encourage more investment in low carbon technologies and cut the cost of decarbonising the UK’s electricity supply.

6. Most notably, the proposed long-term contracts for low carbon power generation, the centrepiece of the reforms, are designed to provide certainty over returns for investors. The theory being that de-risking this activity will help both attract more investment and cut the cost of decarbonising electricity by lowering the cost of capital for power generation projects. In practice, this will depend on setting the rate of support for low carbon technologies at the right levels.

Affordibility is Key for Manufacturers

7. Manufacturing urgently needs a more affordable approach to decarbonisation. UK industrial electricity prices have been consistently above the EU/G7 average since 2006, with the competitiveness gap widest for the most energy-intensive industries.1

8. The cost of policy is a major differentiating factor—its impact on prices is already significant, set to rise and, for companies competing in international markets, more difficult to pass on to customers than global factors like commodity prices.2 The energy intensive industry package being developed for the most affected industries is welcome, but will only offset part of the cost for a handful of companies.

9. Electricity Market Reform (EMR) must deliver on its promise to industrial consumers and reduce the level of green subsidies they have to support through their electricity bills. This will primarily be achieved by encouraging the most cost-effective mix of low carbon generation, but also by ensuring that the energy-intensive industries competing in international markets are not overly burdened by policy costs.

10. Despite many good features, EEF is concerned that EMR proposals focus disproportionately on the needs of investors at the expense of consumers. This shortcoming is reflected in the draft Bill.

11. Specifically, the Bill needs strengthening in three key areas—more robust cost controls, a clearer timetable for moving to a technology-neutral approach and greater assurance that the competiveness of the UK manufacturing base will not be compromised.

More Robust Cost Controls are Needed

12. EMR represents a significant shift away from a liberalised market towards a more centrally-planned approach. Under the arrangements being developed, the government will be making key decisions on pricing, volume and technology for an increasing share of the market.

13. The consequences of getting these decisions wrong will be significant for the consumers who will be financially liable for any mistakes. Therefore, robust cost control must be deeply embedded into the design of the new arrangements.

14. The cost of the new arrangements will largely be driven by the Contracts-for-Difference (CfDs), the Investment Instruments (IIs) designed to ensure against a hiatus in investment in the run up to the implementation of EMR and the Capacity Market (CM).

15. On this basis, we strongly oppose the ability granted to the Secretary of State by the draft Bill under clauses 5 and 6 to delegate the power to set CfD strike prices and the market reference price to whomsoever he or she decides, without any conditions. This unbounded power risks subverting the institutional framework being developed to underpin the new arrangements—ie the most important decisions could be made outside this governance framework.

16. We welcome the power that the Bill gives the Secretary of State to cap the overall cost of the CfD programme in clause 8(1). However, some elements of the CfD provisions risk unnecessarily driving up costs and other elements of EMR need stronger statutory safeguards built in. EEF has identified four key issues that we believe need to be addressed.

17. First, the power that the Bill gives the government in relation to CfDs under clause 8(2) risks driving up cost. The provision, which empowers the Secretary of State to set binding technology, capacity and location targets for the CfD programme, seems unwarranted and counter-productive. Not only does this power increase the risk of costly mistakes being made, the prospect of it being exercised could increase the perception of political risk amongst would-be investors.

18. Unless these provisions are essential for the move to competitive auctions for CfDs, which seems unlikely as clause 5 allows for “competitive” setting of strike prices, they are unjustified.

19. Second, the Bill needs provisions to control the costs of IIs. Potential investors targeted by IIs will, by definition, be reluctant to invest in the current climate creating a risk that consumers will pay over the odds for them. As a minimum, the power under clause 8(1) to cap the cost of CfDs should be widened to include IIs.

20. Third, the Bill needs stronger safeguards to control the potential cost of the CM. As drafted, it gives the Secretary of State an unconditional power to trigger the CM. Given that many industry stakeholders still question the need for a CM and its costs will be borne by consumers, the exercise of this power must be circumscribed by explicit and stringent conditions for its use. For example, that there is (1) a manifest threat to security of supply unless the CM is triggered and (2) doing so will demonstrably be in the financial best interests of consumers.

21. Fourth, the documentation accompanying the draft Bill say that a “Panel of Technical Experts” will be set up to scrutinise the advice that the system operator provides to the governments in its capacity as EMR delivery agent (eg on strike prices and the market reference price). Yet there is no mention of this body in the draft Bill.

22. We believe setting this panel up should be a statutory duty because it is an essential element of the institutional arrangements designed to control the costs of EMR. In addition, it is vital that the panel includes expertise on industrial electricity markets and consumers which can be markedly different from their domestic counterparts.

An Explicit Commitment to a Technology Neutral Approach is Vital

23. EEF has long been sceptical of the 2020 renewable energy target, concerned that it arbitrarily commits the UK to a decarbonisation strategy that could prove unnecessarily expensive to achieve. We believe that, as far as possible, the market should be left to develop the most cost-effective mix of low carbon technologies.

24. EMR is an opportunity to lay the foundations for a technology-neutral approach post-2020. As such, EEF welcomes the government’s commitment to evolve support for low carbon power under EMR through four phases: administered prices, technology-specific auctions, technology-neutral auctions and carbon pricing only.

25. However, we are concerned that there is no reference to this evolution of the arrangements in the draft Bill, let alone a clear indication of the timetable it will follow.

26. In our view, it is essential that the Bill includes an explicit reference to the stages of EMR and provisions to provide assurance that they are being progressed as quickly as possible—eg the “Strategy and Policy Statement” must set out a timetable for each stage.

27. The government should work towards a target of introducing technology neutral-auctions in 2020. By then, several years’ operational experience of CfDs, completion of the government’s offshore wind cost reduction programme and nuclear new build should have significantly improved understanding of the relative costs of different low carbon technologies.

28. A stretching and explicit target for technology-neutral auctions will be essential to driving cost reduction and competition in low carbon technologies. Failure to set a target creates the risk that the UK persists for a long time with uneconomic technologies at the expense of the consumer despite.

29. Moving through the stages of EMR to progressively more competitive arrangements will be reliant on full and timely disclosure of the costs of different low carbon technologies by recipients of CfDs and IIs. Within phases, this information will help inform the setting of strike-prices and the running of auctions.

30. The provisions in 4(3) (for CfDs) and 14(6) must enable the full disclosure of cost-related information to the government, the system operator and the expert panel. We raise this issue because the requirements in these provisions are much vaguer than the explicit information sharing provisions relating to the CM in 25(2). The CM information sharing model should be adopted for CfDs and IIs.

Stronger Safeguards are Needed for Energy Intensive Industries

31. From a manufacturing perspective, energy-intensive industries operating in international markets are most at risk from policy-driven electricity price rises. The government has acknowledged the threat with its commitment to develop a compensation package to offset the costs of its policies for these industries.

32. However, the package fails to address one of the most significant drivers of competitive disadvantage for UK-based companies—the cost of policies to support low carbon electricity. In contrast, in many other EU countries, such as Germany and Sweden, energy-intensive industries are only exposed to a fraction of the cost of measures to support renewable energy.

33. The new market arrangements being developed in Britain must allow for the government to reduce the exposure to EMR-related costs of manufacturing industries whose international competiveness are at risk. For example, by allowing for different rates and amounts to be levied on different types of consumers to fund CfDs. This would be coherent with the government’s export-led growth agenda. The draft Bill’s provisions for the transitional arrangements, that appear to allow this for Renewable Obligation costs (32AC(3) and 32AC(4)), should be replicated for CfDs

34. The decision to exercise the option would ultimately be dependent on robust economic analysis of the costs and benefits—eg the effect on those consumers who might pick up a higher share of the costs.

June 2012