Energy and Climate Change Committee - Draft Energy Bill: Pre-legislitive ScrutinyWritten evidence submitted by Drax Power Ltd.
Executive Summary
The draft Energy Bill will implement DECC’s chosen EMR mechanisms. Those mechanisms aim to minimise additional costs to end consumers of providing affordable, sustainable and secure electricity supplies, whilst providing pragmatic solutions to investor concerns surrounding the securing of project finance for low carbon investments. For this reason, Drax supports the introduction of a broad market-based capacity mechanism and the introduction of Feed-in Tariffs with Contracts for Difference (CfD FITs) to replace the Renewables Obligation (RO). However we have a number of issues we believe need to be addressed in order to ensure that the aims of the EMR package are fully delivered:
CfD FITs
“Bankability” of the CfD arrangements will require there to be a legally enforceable (ie. private law) contract between the scheme developer/generator and a central agency counter-party.
The CfD contract should ultimately be backed by Government.
If Government backing is not legally possible, then the counter-party should still be a public body with clear statutory duties and objectives together with a legally robust and enduring recourse to recover the monies required to make the CfD payments from electricity suppliers.
Arrangements to ensure that CfD FIT payments meet DECC’s Levy Control Framework budget requirements must not undermine the position of existing CfD FIT contract holders.
The credit/collateral arrangements for generators with a CfD FIT contract need to be minimised.
The payment model for the recovery of the CfD monies from suppliers should be via a fixed annual levy, set perhaps 12 months in advance.
Schemes supported under the Renewables Obligation should be granted a one-off, irreversible option to switch to a CfD FIT prior to 2017.
The length of the CfD contracts should be a minimum of 15 years for all technologies (including CCS), with serious consideration given to 20 year contracts.
The reference price for the CfDs for flexible plant like biomass should not be the annual forward price, and other more cost-effective options should be considered, including day ahead.
Like CCS, biomass plant should have the option of having the CfD strike price indexed to its fuel costs.
Capacity Market
The auctioning of capacity should begin as soon as practicable, and not when deemed to be necessary.
CfD FIT supported schemes should be ineligible for capacity payments, whereas RO supported schemes should be eligible.
There should be no differentiation between the treatment of existing and new plant.
Government needs to clarify the interactions between the capacity market and its recently announced Gas Strategy, as well as how the capacity market interacts with the wider EU Single energy market.
The value of capacity should be allowed to collapse if there is an over-supply.
The standard capacity product should be available over multiple tenures, for example, one year contracts may be appropriate for existing plant, five years for plant upgrades and ten years for new investment.
The auction should provide a standard capacity (MW) product, which would allow different types of user (such as Demand Side Response (DSR) and storage providers) to also take part.
About Drax
1. Drax is predominantly an independent power generation business responsible for meeting some 7–8% of the UK’s electricity demand. It also owns Haven Power, an electricity supplier serving the needs of business customers.
2. Drax is the owner and operator of the 4,000MW Drax Power Station in North Yorkshire, which is the largest, cleanest and most efficient coal-fired power station in the UK. It comprises six 660MW coal-fired generating units; the largest and most flexible in the country. This capability means that Drax is one of the most significant providers of flexible generation and system support services in the UK.
3. Drax is also highly active in the Balancing Mechanism (BM), providing National Grid with real-time balancing options (via BM Bids and Offers) throughout the year. In addition, the Black Start capability of the plant ensures further network resilience should the UK’s electricity supply be interrupted. It should also be noted that Drax currently has the capability of storing over two million tonnes of fuel on site. All of these factors highlight the significant, strategic role that Drax currently plays, and can continue to play, in ensuring the UK’s security of supply at least cost to consumers.
4. Drax is also committed to playing its part in reducing its carbon footprint and that 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. With the capability to produce 12.5% of the station’s output from sustainable biomass—equivalent to the output of over 700 2MW wind turbines—Drax is by some distance the largest renewable generating facility in the UK. In 2011, Drax produced around 8% of the UK’s renewable power, more than twice that of the next largest renewable facility.
5. Drax is pleased to have the opportunity to respond to the call for evidence on the draft EMR Energy Bill. As one of the most significant providers of system support services and a very significant investor in renewable electricity generation from biomass, Drax is well placed to comment.
Contract for Difference Feed in Tariffs
6. The CfD FIT contractual and institutional arrangements need to be “bankable” for low carbon investors/developers. We do not believe that the Government’s suggested “statutory contract” approach will achieve that.
7. At the very least “bankability” will require there to be a legally enforceable (ie private law) CfD FIT contract between the scheme developer and a central agency counter-party.
8. Clearly, the more secure and robust those contractual arrangements are, the lower the cost of capital, and hence costs to consumers. So, at best that contract should also ultimately be backed by Government, as originally announced by the (then) Secretary of State, and as most recently confirmed in the Regulatory Impact Assessment which was published with the draft Bill.
9. However, we recognise that it may not be legally possible for the contracts to be explicitly backed by Government (eg. if it was determined to be in contravention of EU State Aid rules). If that is the case, then the counter-party should, in our view, still be a public body with clear statutory duties and objectives together with a legally robust and enduring recourse to recover the monies required to make the CfD payments from electricity suppliers.
10. Any arrangements put in place to ensure that CfD FIT payments meet DECC’s Levy Control Framework budget requirements must not undermine the position of existing CfD FIT contract holders.
11. The credit/collateral arrangements for generators who have a CfD FIT contract, and who may have to pay money back to the central agency if the market price is higher than the strike price, need to be minimal. This would reflect a sensible and pragmatic assessment of the risk of non-payment, as well as ensuring that smaller, independent generators were not disadvantaged.
12. The payment model for the recovery of the CfD monies from suppliers should be designed so as to minimise costs to customers and not to disadvantage smaller and/or independent suppliers. In our view a fixed annual levy, set perhaps 12 months in advance, would best achieve those aims. We recognise that this might lead to some over or under recovery between periods which will need to be managed by National Grid. However, without certainty over the CfD charges, suppliers will price in risks to customers and this will raise overall prices unnecessarily. On balance we believe that the costs of managing the under/over recovery will be less than the costs of suppliers managing the cost uncertainty. Having a charge fixed for 12 months would also smooth the impact of potentially variable and unpredictable CfD payments on customers’ bills.
13. Schemes supported under the RO should be granted a one-off, irreversible option to switch to a CfD FIT prior to 2017. Given that CfD FITs are recognised by Government as a cheaper alternative to the RO, customers would end up paying less for any scheme that exercised the option. Provided that any such switch could only occur at the start of an RO compliance period, and that at least 12 months’ notice was required, this would also have no detrimental effect on the on-going operation of the RO.
14. The length of the CfD contracts should reflect investment timescales and should therefore be a minimum of 15 years for all technologies (including CCS), with serious consideration given to 20 year contracts. This would likely reduce the cost of capital associated with such investments ultimately benefiting consumers.
15. On the CfD reference price, DECC has stated that for intermittent technologies (ie. wind) its preferred option is the day-ahead price; and for baseload plant (eg. Nuclear) it is the annual forward price. However, DECC has not specified what its preference is for plant which is neither baseload, nor intermittent. Such plant potentially includes biomass plant which is likely to be technically and practically capable of flexible, dispatchable operation. That is one of its key advantages over other low carbon technologies, in that it can support and complement the operation of wind and nuclear. The reference price for the CfDs for such flexible plant should not be the annual forward price An annual reference price would introduce costly collateral requirements, reduce the capability of generators to “capture” the price index to secure their overall revenue stream, and raise liquidity concerns. As a result, other more cost-effective alternatives should be considered, including day ahead.
16. Biomass plant should also be given the option of having the CfD strike price (or at least a proportion of it) indexed to its fuel costs, as is proposed for the other main low carbon technology which has a significant fuel in put cost, CCS plant. This would lead to a lower CfD strike price than would otherwise be the case.
Capacity Market
17. If designed correctly, the proposed market-based capacity mechanism will maintain security of supply by delivering continued capacity adequacy, whilst simultaneously encouraging new investment in reliable electricity generation. The use of an auction to enable efficient price discovery will also encourage investment in the most cost effective technologies.
18. We welcome the Government’s recognition that the capacity auction should be possible as early as 2014. However, we believe there is merit in starting the process as soon as it is available rather than only doing so when Ofgem/Grid advise that it is necessary. Our approach would ensure:
the chosen mechanism works as a concept;
the associated IT systems and settlement processes have been adequately tested; and
the mechanism is available to determine the value of capacity in line with investment timescales and demand requirements.
19. The interaction between the capacity mechanism and the CfD FiT arrangements should ensure that generators are not remunerated twice for the provision of capacity (ie via both arrangements). CfD FIT supported schemes should therefore be ineligible for capacity payments, whereas RO supported schemes should be eligible.
20. We can see no economic justification for the proposed differential treatment for existing/new plant in the capacity market. Such an approach will simply increase overall costs to customers by limiting competition for the procurement of capacity.
21. Government needs to be clear about how the interactions between the design of the Capacity Market and its recently announced Gas Strategy will be taken forward. In particular, the latter seems to be looking to address similar issues to the capacity market, but just for gas plant.
22. It will be important to ensure that the capacity market model does not distort the efficient operation of the GB wholesale power market. The Government also need to clarify how the GB capacity market interacts with the wider and developing EU Single energy market.
23. As the mechanism is to be market based, the value of capacity should be allowed to collapse if there is an over-supply. This ensures that consumers do not overpay for a commodity that is in abundant supply. In the event of an under-supply, investors will be incentivised to build the most efficient generation technologies in order to stay ahead of the competition in future auctions.
24. This should provide the most cost effective solution for end consumers over the long-term and reduce the risk of future political intervention. A lower risk of future political intervention may also bring additional advantages, such as a lower cost of capital for new generation investment.
25. When determining the procurement lead time for capacity, it is important to be mindful of the investment timescales surrounding the planning and construction of new plant. The average development lifecycle for new plant is in the region of seven years. The chosen capacity mechanism must provide investment signals that reflect the time required to develop new plant.
26. It will also be crucial to ensure that the correct products are available for different types of investor. The auction should provide a standard capacity (MW) product, which would allow other types of user (such as Demand Side Response (DSR) and storage providers) to take part. The standard product should also be available over multiple tenures, for example, one year may be appropriate for existing plant, five years for plant upgrades and ten years for new investment.
Institutional and Transitional Arrangements
27. Given that the System Operator will take on the role of the central delivery body, careful consideration should be given to the potential conflicts of interest between the System Operator’s existing and new obligations.
28. Not enough information is available yet to identify what these conflicts may be, but particular attention should be given to the potential for perverse outcomes or unintended consequences due to any indirect relationship between the new mechanisms and the existing SO duties and Price Control incentives.
A key challenge will be to minimise the consequential effects of introducing the new CfD and capacity arrangements on existing commercial contracts. In particular, consideration must be given to the potential for adverse effects on smaller independent suppliers, where the majority of customers are on fixed price contracts. Transitional arrangements are required to allow suppliers sufficient time to implement an appropriate mechanism for cost recovery.
June 2012