Energy and Climate Change Committee - Draft Energy Bill: Pre-legislitive ScrutinyWritten evidence submitted by Statkraft
Statkraft is a committed investor in the UK electricity sector and a significant new entrant in the wholesale market. Our strategic ambitions for expanding our investments and market activities in the UK are built on the following requirements:
A stable, transparent policy regime and low levels of political risk exposure.
An investment framework for renewables (offshore and onshore wind in particular) that delivers manageable risks and a balanced risk-reward picture.
Effectively functioning wholesale markets which enable us to manage our commercial risks.
We fully and actively support the UK Government in its objectives of cost effective growth in renewables, decarbonisation and security of supply. However, Statkraft is not yet convinced that the current proposals will deliver the Government’s stated objective of vastly increasing investment in low carbon energy generation at least cost to the consumer.
There is an urgent need for improved transitional arrangements for renewables support when introducing EMR—the logical solution is to prolong the RO to 2020 in parallel with introducing the CfD:
The RO is successful, well understood and bankable, has attracted Statkraft and other major utilities to invest in renewables in the UK and has supported significant growth in renewables generation.
Nuclear and CCS projects may clearly benefit from an introduction of the CfD as there have not been any significant support mechanisms available for these technologies. In addition, levels for the CfDs for nuclear and CCS will be negotiated on a project by project basis. For renewables the advantages of the shift to a CfD are less apparent. We see significant challenges related to the introduction of CfD for renewables investors in particular.
Challenges related to the introduction of CfD for renewables may be solved, but improved transitional arrangements are urgently needed to avoid an investment hiatus. The logical solution is to prolong the RO to 2020 alongside introduction of the CfD.
There are significant challenges related to allocation, strike price setting, and counter party risk that need to be solved before introducing a CfD:
Although the conditions for competitive price discovery for renewables support may be met in the long term, this is not the case for offshore wind in the short or medium term. We do not believe that auction or auction-like mechanisms for setting the strike price levels for offshore wind should be introduced before the mid 2020s.
The process and timing for allocation of CfD contracts to renewable projects is a serious risk factor that could destroy investor confidence if not properly addressed. It is our belief, especially for large complex projects like offshore wind, that there is a need for allocation of contracts well ahead of Final Investment Decision (FID) as currently proposed. Instead, allocation of CfDs should be made at consent stage. This will partially reduce risk, but investors still need visibility on contract allocation at an earlier stage. A transparent system for allocation with clear and stable criteria is therefore needed.
To avoid “stop and go” and a lack of predictability on contract availability we believe a longer term (multi-year) approach for CfD contract allocation in relation to the Levy cost control framework is necessary. Allocation should not be heavily influenced by annual wholesale price fluctuations for example.
The legal status and the counterparty risk are serious challenges with making the CfD model acceptable for investors. A model that eliminates any significant counterparty risk is a prerequisite for introduction of the CfD.
Given the large and diverse project portfolio of offshore wind resulting from the different Crown Estate rounds there should be more than only one strike price level for offshore wind. We believe that round specific levels would be much more appropriate. For the round three offshore wind projects—which have significantly different characteristics—there should be a provision for project specific strike price setting in line with the approach for nuclear and CCS.
For intermittent renewables, there will be an additional cost compared to baseload generators in balancing the position in the within-day market and through the cash-out mechanism. This additional cost must be taken into account when setting the strike prices. For times when a plant is constrained off or prices are negative, we believe the payment must be based on availability instead.
A well functioning wholesale market is essential. The introduction of a capacity market may have significant negative market impacts:
Despite recent measures by incumbents, liquidity and transparency issues remain in the UK wholesale markets, which we hope Ofgem and DECC are going to address through appropriate measures.
We are sceptical of the need for and the desirability of a capacity mechanism due to its potentially negative impact on the power market and total overall costs
Statkraft is a successful entrant into the UK electricity sector and a committed investor
1. Statkraft is Europe’s leader in renewable energy and is a major player on the European energy exchanges. The company is wholly-owned by the Norwegian state and has 3,300 staff in more than 20 countries.
Generation projects
2. Statkraft is currently involved in four on-shore wind farms in the UK (200 MW) and, together with Statoil, is investing around £1 billion in constructing the Sheringham Shoal offshore wind park (317 MW) off the North Norfolk coast. Sheringham Shoal is already generating power and will be completed later this year. It will provide power to more than 200,000 UK homes when fully operational. The project employs 500 workers in the field and provides significant indirect employment.
3. Statkraft is also a partner in the Forewind consortium which has the licence to develop offshore wind projects at Dogger Bank off the East coast of Yorkshire. Forewind has a target of 9 GW installed capacity in the zone, which could require up to £30 billion of investment. The project could provide more than 10% of the UK’s electricity needs, create thousands of jobs, and reduce CO2 emissions by 13.7 million tonnes per annum.
Trading
4. The company is active in trading and origination in the power market. Our entry strategy for trading in the UK was to offer long term PPAs to independent developers of renewable electricity generation in the UK, facilitating their participation in the market. Statkraft is a leading provider of PPAs for other independent generators as well. Almost all entrants in the UK have had to become vertically integrated such that 85% of the players are now in this position. Statkraft will be the only pure energy retailer and we will concentrate entirely on larger industrial and commercial customers. By doing this we will benefit from being able to mitigate the problems of low liquidity in the power market and achieve better value for the ROCs and LECs from the PPAs than we get from selling them to the Big Six.
5. Our existing and planned investments in the UK electricity sector and our market activities are substantial. These will make a significant contribution towards the UK objectives of cost effective decarbonisation, penetration of renewable energy, inward investment, and security of supply. Given the significant pressures on the balance sheets of the incumbent Big Six, entry by non-vertically integrated investors into the generation sector is essential for attaining the Government’s objectives.
The RO regime has provided a sound basis for investment. Better transitional arrangements are urgently needed when moving to a new regime
The Renewables Obligation
6. The Renewables Obligation (RO) has delivered significant investments in renewable energy. The share of renewable electricity has increased from 4.1% in 2005 to 9.5% in 2011 (normalised according to Renewables Directive) with growth picking up in the later years. Installed renewables capacity grew by 32% from 2010 to 2011. UK is now is the leading market for offshore wind, with a capacity growth of 37% from 2010 to 2011.
7. The RO is well understood and bankable. The process of RO banding is based on objective factors such as developments in technology costs and is well-established. The drivers for the ROC prices are well-understood. The UK Government’s proven commitment to the principle of grandfathering means that the risk of asset stranding is low.
8. The fact that under the RO, market participants remain fully exposed to wholesale market price signals preserves overall market functioning. There is a risk for investors related to the wholesale power price development, but Statkraft, like other major utilities in the UK, is well positioned to manage this risk provided that UK wholesale markets are transparent and liquid and allow for effective competition. Indeed, our wholesale market entry strategy for the UK is based on taking on the commercial risks of other new entrants through the provision of PPAs.
Transition from the RO to CFDs
9. A key element of Electricity Market Reform is a change from renewables support in the form of the RO to a new CfD mechanism covering both renewables and other forms of low carbon generation. There are a number of unclear and unresolved issues around the CfD and wider EMR proposals. These need to be solved before investors will trust the new scheme and be willing, and able, to make investments under it.
10. The EMR proposals represent a comprehensive and complex package of reforms. The timeline for introduction of the EMR is very tight indeed given the number of complex issues that need to be resolved. The policy and legislative process already lags behind the original schedule. This fact, combined with the long lead times and significant up front cost for offshore wind projects ahead of FID means there is an urgent need for improved transitional arrangements. A legislative option for the premium FiT as alternative to the CfD should also be kept open if the challenges with the CfD mechanism cannot be duly resolved.
11. It is important that remaining issues are resolved in way that is workable, stable and do not need to be redefined and changed frequently. If not, this would expose investors to political risk and the policy development to significant lobbying. Compared to new entrants and smaller market participants, large incumbents will always have an advantage in lobbying Government and managing political risks.
12. The investment instruments and FID enabling process suggested in the Draft Bill to ensure a smooth transition from the RO remain opaque and not able to underpin the necessary investor confidence. The simple and logical solution to avoid a further hiatus in investments and enable the 2020 renewables target to be met is to prolong the RO towards 2020 alongside the introduction of the CfD.
13. Nuclear and CCS projects may benefit from an introduction of the CfD as there have not been any significant support mechanisms available for these technologies. In addition, levels for the CfDs for nuclear and CCS will be negotiated on a project by project basis. For renewables the advantages of the shift to a CfD is less apparent. Support for technologies such as nuclear is more challenging than for renewables from a State Aid perspective, and it is possible that this could delay or block the introduction of a CfD.
Risk of an investment hiatus
14. Under the current timetable, an offshore project would have to reach final investment decision (FID) in 2014 at the latest to have a chance of being accredited under the RO. Given the supply chain, network connection and technical challenges these projects face, it is unlikely that this deadline would be met on many existing projects. Therefore, in the near future, all FIDs would have to be taken on the basis that the project is likely to fall under the CfD regime. However, it is not yet possible to assess whether CfDs will provide an acceptable risk adjusted rate of return and understand the overall risk exposure. It will be difficult to start allocating significant pre-FID capital before CfD levels are transparent. Many companies will be unable to reach a positive FID on major projects, unless the RO is extended towards 2020.
15. The current proposal of prolonging the RO to 2017 only, endangers the project pipeline of significant offshore and onshore wind power investments which are absolutely essential for the UK to be able to meet its 2020 renewables and decarbonisation targets and also for the UK to maintain the momentum it is building up as a key centre for renewable technology deployment and development in Europe.
16. We see significant challenges related to the introduction of CfD for renewables investors in particular. They may be solvable, but improved transitional arrangements are urgently needed. The logical solution is to prolong the RO towards 2020 alongside introduction of the CfD.
The allocation of CfD contracts is a serious risk factor that could destroy investor confidence if not properly addressed
Allocation risks
17. Under the CfD regime renewables and nuclear power would be covered by one subsidy regime, with the political and cost risks associated with nuclear power directly influencing the prospects for renewable investors. The CfD contracts will also be subject to Treasury’s control framework for DECC levy-funded spending. This approach raises both political risks with respect to (a) the volume of CfD-contracts available for that year; and (b) the volume of contracts available to renewables projects as opposed to nuclear and CCS.
Timing of CfD allocation
18. Offshore wind projects typically have long lead times; project evaluation and the consenting process prior to FID will take three–five years and may cost significantly more than £100 million for a large zone. Further time and cost needs to be spent post consent prior to a FID. It is therefore not acceptable to investors to have such uncertainty related to whether a project will actually be offered a CfD contract when reaching the stage of final investment decision. It is our belief that large complex projects like offshore wind there is a need for allocation of contracts well ahead of FID. Instead allocation of CfDs should be made at consent stage. This will partially reduce risk, but investors still need visibility on contract allocation at an even earlier stage. A transparent system for allocation with clear and stable criteria is therefore needed.
Levy control framework
19. The uncertainties surrounding the levy control framework means that long-term business planning becomes challenging for investors. A “stop and go” pattern of project development related to annual levy control framework decisions would not only result in higher risk and associated cost for investors but also hinder the development and expansion of supply chains and hence raise cost levels in the sector in the medium term.
20. To avoid “stop and go” and a lack of predictability on contract availability we believe a longer term (multi-year) approach for CfD contract allocation in relation to the Levy cost control framework is necessary. Allocation should not be heavily influenced by annual wholesale price fluctuations for example.
21. The legal status and the counterparty risk are additional, serious challenges with making the CfD model acceptable for investors. A model that eliminates any significant counterparty risk is a prerequisite for introduction of the CfD.
Strike price setting should be transparent and not based on auctions at this stage—strike price levels for offshore wind should be round or zone-specific
Strike price levels for offshore wind
22. Although the conditions for a competitive price discovery for renewables support may be met in the long term, this is not the case for offshore wind in the short or medium term. There should be no provision for introducing auction or auction-like mechanisms for setting the strike price levels for offshore wind before well into the 2020s.
23. Corresponding to the banding principles for the RO, we understand the intention with the CfD is to set technology-specific strike prices. This approach should encourage investment in projects from a range of available technologies, whilst at the same time avoiding unnecessarily high levels of support. This principle is sensible.
24. However, we note that for offshore wind—by far the largest technology by expected growth to 2020—there is however only a single banding factor in the RO. Given the large and diverse project portfolio of offshore wind resulting from the different Crown Estate rounds, round-specific levels would be much more appropriate. Having only one strike price for offshore wind level may mean superprofit for the projects with the lowest cost of energy, and differentiated levels will deliver more for the same money spent.
25. It is proposed that nuclear and CCS projects can expect a specific strike price level per project. We see no reason why there should not be a provision for individual setting of strike prices for round 3 offshore wind projects given their scale and uniqueness.
National Grid’s role
26. National Grid will have a key role in administering the CfD and capacity mechanism, including setting strike prices. In this respect there needs to be strong ring-fencing of the National grid body that will act as delivery agent for EMR, and there needs to be complete transparency into the decision-making process taking place at National Grid.
Reference price for renewables
27. Setting a reference price for renewables with intermittent generation is very different from doing so for baseload technologies. Whereas a baseload generator can expect to achieve the average market price, an intermittent renewables generator will tend to generate when prices are low. This is partly mitigated by using hourly day-ahead prices as reference price, as put forward in the draft Bill. This does however not mitigate the additional cost of balancing the position in the within-day-market and the cost of handling unbalances through the cashout-mechanism. This additional cost should be taken into account when setting strike prices for intermittent renewables.
28. For times when a plant is constrained or there are negative prices, we believe the payment must be based on availability instead.
To incentivise investment by non-vertically integrated companies and market innovation effective wholesale markets are key
Market liquidity
29. To meet the Government’s objectives of security of supply, decarbonisation and affordability, the electricity sector will have to attract significant investment and facilitate commercial and technological innovation.
30. Given the significant calls on the balance sheets of the incumbent Big Six, entry by non-vertically integrated investors into the generation sector is essential for attaining the Government’s objectives. To facilitate such investment, the wholesale market has to generate price signals along the curve which are transparent, cost reflective and resistant to gaming.
CfDs and liquidity
31. The implementation of CfDs relies on highly liquid wholesale markets to generate robust reference prices. However, true liquidity in the UK wholesale market continues to be too low to support effective market functioning in both retail and wholesale. High levels of vertical integration have resulted in a situation where incumbents mostly trade at the margins.
32. The CfD should underpin liquidity in the Day Ahead Market as there is an incentive to holders of CfD to sell into this market to hedge their position. At the other hand the CfD could reduce liquidity of trading along the power market curve. To manage our current PPA exposure (based on the RO) we have to trade power several seasons ahead to fix prices, as well as the month and week ahead to hedge volumes and prices and the day ahead and on the within day market to balance final generation as the weather changes. With the CfD there is not a corresponding need to trade along the power market curve
33. Despite various recent measures by incumbents, liquidity and transparency issues remain in the UK wholesale markets, which we hope Ofgem and DECC are going to address through appropriate measures.
A capacity mechanism will impact on the wholesale market and blur signals to generation investments and demand response
34. Maintaining security of supply is clearly essential. However, we do not believe it is clear that the proposed capacity market is a necessary measure. Statkraft’s view is that there should be a high threshold for introducing such a measure due to its potential negative market impacts.
35. A capacity mechanism will blunt price signals by depressing average wholesale price levels and flattening them at peak. The mechanism is likely to impose significant overall costs on consumers as wholesale price reductions are likely to be more than outweighed by capacity payments, with a highly negative NPV for the scheme overall.
36. The impacts on security of supply are unlikely to be highly valued by customers. Any security of supply benefits of a capacity mechanism are likely to be back-loaded (ie they will occur from the mid- 2020s onwards) and constitute improvements on already high levels of security of supply. In addition, increasing interconnection, improved storage technologies and better demand responsiveness are all technological innovations which are likely to occur in this time-frame and which are likely to remove any need for, and benefits of, a capacity mechanism. Wide-spread implementation of smart metering technology is one example. It is not clear what demand will respond to if wholesale prices are going to be both depressed and flattened at peak as a result of the capacity mechanism. It is also less likely that there will be effective price signals for investment into interconnector capacity under a capacity mechanism, even if this could be a more cost effective and flexible way of obtaining security of supply benefits than the mechanism itself.
37. If a capacity mechanism is introduced, cross EU harmonisation should be sought, and the mechanism should be open for participation through cross border interconnectors.
June 2012