Energy and Climate Change Committee - Draft Energy Bill: Pre-legislitive ScrutinyWritten evidence submitted by Oil & Gas UK

Introduction

Oil & Gas UK is the principal trade association representing the offshore oil and gas exploration and production (E&P) industry in the United Kingdom, with over 250 members ranging from the largest, well known international oil and gas companies through the independent operators and utilities with E&P subsidiaries to an extensive supply chain covering all aspects of E&P activities. We are pleased to be able to submit this evidence to the Committee about the reform of the electricity market.

We fully support the government’s desire to reduce emissions of GHGs in economically efficient ways and to encourage investment that will achieve this objective, coupled with securing the country’s energy supplies in a manner which is both affordable for consumers and keeps the economy competitive. We also understand the government’s desire to end some of the investment uncertainties which are currently evident in the electricity generating market, in particular.

It is worth noting that such uncertainties have not been evident in gas, with perhaps the exception of storage where the economics is currently difficult. Gas has seen multi-billion pound investments in new supplies and infrastructure in the period 2005–10 which stood the country in good stead during the severe weather conditions experienced during the winter of 2009–10 and the early part of the winter 2010–11. According to National Grid, of the ten days of highest demand for gas ever recorded in Great Britain, nine occurred in 2010, with three in January and six in December. In other words, the gas market has worked, so there may be lessons from it which are applicable to electricity.

It is worth remembering at the outset that government, both in the EU and UK, has three over-arching policy objectives:

(i)reducing emissions of GHGs (by 80% between 1990 and 2050);

(ii)security of energy supplies;

(iii)affordability, with which comes economic competitiveness.

Price of Carbon

The underlying difficulty is that, currently, there is a lack of confidence in the price of carbon. This is meant to be set by the market, through the EU ETS, but the price has been undermined by the consequences of recession, other EU obligations such as the renewable energy targets and the lack of signals about what will happen to the EU ETS after 2020. It ought to be the mechanism for setting the price of CO₂ through the market in the longer term, but it is not clear whether this will be the case or not. In these circumstances, it becomes difficult for companies to plan their long term investments. This requires attention at an EU level.

Multiple Regulation

The picture has also become clouded by the number of initiatives and instruments which have been introduced in recent years or are under consideration: CCL/CCAs, EU ETS, ROCs and CRC EES in the former category and the RHI, a carbon price floor starting in April 2013 and the three measures (Contracts for Difference, Capacity Mechanism and Emissions Performance Standard) proposed under the reform of the electricity market (and in this draft Energy Bill) in the latter. Ensuring cohesion across all these measures must be a priority.

Contracts for Difference

Determining the counter-party to the CfDs will be of crucial importance. A further, significant concern is that the CfDs will be set to cover the difference between “strike” prices (to be agreed) for various types of power generation and the open market price for electricity. However, an open market price will be determined under narrowing and increasingly variable, if not volatile, conditions as ever more generation, be it nuclear or renewable, is supported by CfDs and much less generation is left to be contested in a normal, competitive manner. This may well make it difficult to set a reliable open market price for electricity in future.

Capacity Mechanism

With more intermittent power generation being connected to the electricity grid, it becomes increasingly likely that a capacity mechanism will be needed to stabilise the grid and provide back-up generation. Beyond pumped storage, gas fired plant is best placed to do this, because of its low capital cost and generating flexibility. Just how payments for capacity and payments for electricity generated will interact is far from clear, however, and this will need to be resolved.

DECC has also announced that it will undertake a review of the role of gas in power generation. This is a most welcome sign that the Government has now recognised how important gas will be in future in order to keep customers reliably supplied with electricity.

Carbon Price Floor

While it may be understandable for the government to introduce a price floor for carbon, it is likely to have mixed results. Firstly, it will help undermine the EU ETS and, secondly, within the EU as a whole it will not reduce emissions, because, as far as power generation and other energy intensive industries are concerned, these are limited by the EU ETS within an overall cap set for all 27 Member States (MSs). Therefore, the Carbon Floor Price risks raising the cost of electricity in the UK while reducing the need to abate some emissions of CO₂ within the other 26 MSs.

Emissions Performance Standard—Carbon Capture and Storage

The proposed EPS is sensibly designed in the first instance to ensure that gas fired power can be built to help replace the very large amounts of existing generating plant which will have to be closed in the next 10–12 years, as well as ensure back-up for intermittent renewable generation. However, the Committee should note that a limit of 450 grams of CO₂ per kWh will allow CCGT, but not OCGT1 generation; OCGTs are the cheapest and most flexible form of gas fired power plant and best suited to short term or peak requirements.

Carbon Capture and Storage is widely seen as one of the main ways of reducing CO₂ in conventional power generation. However, CCS is yet to be proven on a commercial scale. It is encouraging to see ministers promoting CCS with gas for one of the planned demonstration projects.

Conclusions

We would encourage all parties to concentrate on simplification where ever possible. There is a material risk that the complexities of having so many measures and instruments will become unmanageable and counter productive. A price for CO₂ is becoming less and less likely to emerge through normal market mechanisms, with the risk that this in turn will encourage ever more governmental intervention and the creation of more instruments.

June 2012