Energy and Climate Change Committee - Draft Energy Bill: Pre-legislitive ScrutinyWritten evidence submitted by Carbon Capture and Storage Association
Introduction
The Carbon Capture and Storage Association welcome the opportunity to respond to the Energy and Climate Change Committee call for evidence for pre-legislative scrutiny into the draft Energy Bill. As requested in the call this submission details the CCSA’s initial response to the Electricity Market Reform (EMR) package contained in the draft Energy Bill. The CCSA will provide further comments in due course as thinking on the draft bill develops.
The CCSA brings together a wide range of specialist companies across the spectrum of Carbon Capture & Storage (CCS) technology, as well as a variety of support services to the energy sector. The Association exists to represent the interests of its members in promoting the business of CCS and to assist policy developments in the UK and the EU towards a long term regulatory framework for CCS, as a means of abating carbon dioxide emissions.
Summary
The CCSA welcomes the Electricity Market Reform package and is supportive of a number of developments including the Feed in Tariff Contract for Differences (FiT CfDs).
Designed appropriately, the FiT CfD will be the primary tool to drive the deployment of CCS in the UK power sector.
The EMR must send strong, clear signals to CCS project developers, investors and the CCS supply chain that the EMR will support CCS. Failure to do so risks the future prospects of a UK CCS industry.
The CCSA believes that there are questions on the viability of the proposed FiT CfD contracts for CCS projects.
The CCSA also believes that the investment signal from the EMR for CCS projects developers is extremely weak providing virtually no detail on how CCS projects might be supported. The CCSA may be able to submit more thoughts on this matter to the Committee in due course as the principles of EMR develop.
The CCSA has outlined a number of issues and recommendations that need to be reflected in the design of CfD contracts for CCS projects.
Overarching comments
1. The CCSA welcomes the Electricity Market Reform and is supportive of a number of developments including the Feed in Tariff Contract for Differences (FiT CfDs). Designed appropriately, the FiT CfD can be an effective mechanism to support the deployment of mature, low-carbon technologies. Of the four EMR instruments it is the FiT CfD that will be the primary tool to drive the deployment of CCS.
2. Multiple CCS project developers are currently applying for support as part of the DECC CCS Commercialisation Programme launched on 3rd April 2012. However, given the funding constraints of the programme it is clear that the majority of projects will not receive the support necessary to be developed. It is therefore critical that the EMR sends strong, clear signals to CCS project developers, investors and the CCS supply chain on the EMR support that will be made available to CCS. This is necessary to ensure that the projects not selected under the Commercialisation Programme are kept alive and taken forward for development at a later stage but within a commercial timeframe.
3. The CCSA believes that the draft Energy Bill and its supporting documents raise questions on the viability of the proposed FiT CfD contracts for CCS projects. Failure to develop viable FiT CfD contracts for CCS would have the consequence of stalling the development of CCS in the UK. This issue is considered in more detail below.
4. The CCSA also believes that the investment signal from the EMR for CCS projects developers is extremely weak providing virtually no detail on how CCS projects that are not supported by the Commercialisation Programme might be able to receive support. The CCSA may be able to submit more thoughts on this matter to the Committee in due course.
5. To deliver the EMR objectives of a secure, low-carbon and affordable electricity system requires the deployment of fossil fuel plants fitted with CCS alongside renewables and nuclear energy. To achieve this FiT CfDs have to be viable for each of the low carbon technologies. The CCSA’s view is that much of the EMR documentation is based on the paradigm that low-carbon technologies have high capital costs and low operational costs. This view risks the development of instruments that are not able to deploy the full range of technologies necessary to meet EMR objectives.
FiT CfD design
6. CCS projects have a number of specific characteristics that need to be reflected in the design of CfD contracts.
7. The cost of a CCS project comprises a high capital cost combined with a high operating cost. The cost profile of CCS projects needs to be carefully considered in the construction of the CfD as the contract has to support both the capital cost and operating cost of the project. The capital costs of a CCS project is high due to the additional costs of constructing the capture, transport and storage assets while the operating costs are also significant as the operation of the CCS chain requires additional energy inputs, for example to operate the capture unit, as well as other operational costs, for example monitoring of the storage site and costs associated with the required financial security provisions. This cost profile contrasts with some other sources of low-carbon generation that face high capital costs but low operating costs.
8. Market risk creates uncertainty on the CCS plant’s future load factor as a result of the increasing capacity of intermittent and inflexible generation sources expected on the system. Therefore the CCSA does not believe that the baseload metered output contract model currently described in the Energy Bill is viable for CCS projects. The metered output model means that while the plant would notionally be on a baseload CfD the actual plant load factor might be substantially lower if the plant is unable or not required to despatch (ie the CCS chain is available to operate but is unable to do so as a result of conditions in the electricity market). Fossil fuel plants, including CCS, face a significant market risk in the future as significant volumes of intermittent, inflexible and low marginal cost capacity is added to the system generating uncertainty on the plant’s future load factor and revenues. This is a critical issue on which the CCSA would welcome further dialogue.
9. The CCSA believes that the appropriate market model for the first CCS plants should be as baseload plant as this enables the plant to be operated in the most economically efficient manner. However, fossil fuel plant with CCS is ultimately likely to be required to operate with a degree of flexibility to provide the valuable system support services which this technology can deliver and further thought should be given to how this can be properly incentivised.
10. CCS projects have a long-operating life (multiple decades). The long operating life of CCS projects has implications for the length of the CfD contracts. The CCSA believes that the current proposal for a 10 year CfD contract for the first projects is completely inappropriate and too short for CCS projects. As a general principle the CCSA believes that the length of CfD contracts for CCS projects should match the operating timescales—ie be for an extended period of time, perhaps 20—25 years. Longer contract terms are likely to be preferable as they more closely reflect the operational life of the asset and, as the revenues are spread over a longer period, should result in a lower cost for consumers than a shorter contracting period. However, in practice individual projects may require greater flexibility on the length of the CfD contract. The CCSA believes that, initially at least, the length of the FiT CfD contract should be determined separately for each project on the basis of negotiations between the Government and individual projects. It seems inconsistent that unabated gas plant will be guaranteed freedom to operate as such for 30 years whilst abated gas or coal plant would only be guaranteed a commercial lifespan of 10 years.
11. CCS plants are exposed to the international prices of fossil fuels which are highly uncertain over the operating life of the asset. The CCSA emphasises the importance of providing the project developer with the option to index a part of the CfD strike price to the costs of the plant’s fossil fuel inputs. Failure to incorporate fuel price indexation would expose UK CCS plants to global fossil fuel commodity prices and risks rendering CfDs an unbankable support mechanism. The CCSA is not aware of any fuel supply contracts which would fix the fuel price for a period of time equivalent to the likely length of the CfD contract. To attempt to hedge such a risk in the commercial market is likely to be very expensive and the indexation of the strike price to fossil fuel price could ultimately benefit electricity consumers through a lower strike price.
12. The CCSA welcomes the Government’s position that it is minded to include the option of fossil fuel price indexation for the first CCS projects under the commercialisation programme, however it is essential that the option to index strike prices to fossil fuel prices is extended to subsequent projects.
13. Determining the appropriate reference price is of central importance to the viability of the CfD model. The CCSA believes that the year-ahead baseload price is not an appropriate reference price. There is not adequate liquidity in the current market or confidence in this as a reference price. There is concern about current market liquidity and whether proposed reforms will be sufficient to increase liquidity to the extent required. For these reasons the CCSA advocates a shorter reference price and requests further discussion with the Government on the appropriate reference price for CCS projects and the proposals to improve market liquidity before taking a final position on this matter.
14. There are inherent uncertainties and key additional risks, associated with the first CCS projects. These include:
(a)
(b)
The CCSA welcomes the Government’s recognition of these challenges and the proposal that these should be reflected in the CfD terms which should be negotiated on a project by project basis. However, it is by no means clear how these risks can be dealt with by the CfD alone. For example, if the base generating plant is prevented from producing electricity for a period, for perhaps an issue with the transport or storage elements of the chain, then there will be no CfD payments flowing. This is a critical issue, particularly for the financability of the early projects, on which the CCSA would welcome further dialogue.
15. The CCS chain may have different owner structures along the chain; power plant, transportation provider and storage provider. The transportation and storage providers will be required to make significant investments and incur operating costs and liabilities over a long period of time. Providers of the infrastructure will need strong commercial arrangements in place to meet the requirements of investors and banks. Under the terms of the CCS Directive the storage providers will have responsibilities for the storage sites which extend for multiple decades after the injection of carbon dioxide has ceased. The CCSA would like to highlight that the storage providers responsibilities and liabilities will extend for decades after the CfD, power sales and injection of carbon dioxide has ceased. Infrastructure providers would also be exposed to the future carbon price. The CCSA may be able to submit more thoughts on these matters to the Committee in due course. The CCSA understands that work is commencing on the Financial Security and Financial Mechanism requirements of the CCS Directive and the successful resolution of this issue will be crucial if potential CCS project developers are to fully understand the risk/reward balance of developing UK CCS projects.
June 2012