Energy and Climate Change Committee - Draft Energy Bill: Pre-legislitive ScrutinyWritten evidence submitted by Engineering the Future

This response has been developed by:

The Institution of Engineering and Technology.

The response is supported by:

The Institution of Chemical Engineers.

The Institution of Civil Engineers.

The Institution of Mechanical Engineers.

The Royal Academy of Engineering.

Pre-Legislative Scrutiny of the Draft Energy Bill

Initial Evidence from Engineering the Future, developed by The Institution of Engineering and Technology and supported by The Institution of Chemical Engineers, The Institution of Civil Engineers, The Institution of Mechanical Engineers and The Royal Academy of Engineering.

1. Engineering the Future is pleased to provide this initial response to the draft Energy Bill. In the brief time available we have focussed the response around a number of key questions which we hope the Committee will find helpful in framing its evidence sessions. We will be following up this initial response with more considered written evidence, including more on potential solutions.

Systems Issues

2. The Bill does not seem to address the energy system as a whole, despite the Government’s policy intention to substantially electrify heat and transport in the longer term. In the case of electricity it is worth re-iterating that supply and demand have to be in balance on an instantaneous basis, and the integration of the various low carbon options into a workable system will become a significant technical challenge as their contribution increases. The draft Bill is a framework with gaps where strategies are still being worked on, but these strategies seem fundamental to the overall success of EMR.

3. Other policy documents discuss large-scale electrification of heat and transport which, the CCC predicts, will double the load on the electricity grid. It is not obvious how these assumptions have been incorporated into this policy, whether such an ambitious combination of targets will be deliverable within the framework of other Government policies.

4. Particular questions that suggest themselves are:

(a)How does the Government intend to ensure that the energy system as a whole is developed in an integrated way to meet its policy goals at a reasonable cost?

(b)Gas is seen in the Draft Bill primarily as a backup/flexibility contributor in a world dominated by inflexible nuclear and variable renewables. But an urgent issue is getting enough gas fired plant built quickly to replace coal, oil and possible AGR closures, yet there is nothing to create confidence for gas investment in the short term. Given the range of scenarios of plant closures, new nuclear delays, and demand recovery, how will Government ensure sufficient gas fired plant gets built to plug short term gaps while also ensuring that the EPS is subsequently tightened to prevent overly large scale gas build later?

(c)The underlying assumption of large scale electrification of heat and transport needs to be challenged as the engineering profession is not yet confident that this will be effective. How will the Government handle the resulting uncertainty whilst still ensuring sufficient investment in generation capacity?

(d)We note further work over the summer will look at further incentives coming out of DECC’s work on demand management. How will this be integrated into the rest of the measures? Is the role and support for interconnection, energy storage and—especially—demand-side measures clear enough? Will there be sufficient provision for the encouragement of smart grid and electricity storage and other demand shifting measures to reduce peaks in demand? If not, is there a danger that some potentially beneficial measures may be locked out of the future system?

(e)Demand reduction is key and is to be delivered by the Green Deal and smart metering. However, these are untested. Again, how will the Government handle the resulting uncertainty, including uncertainty over timing of eventual demand reduction?

(f)There are huge uncertainties as to how the future energy system will develop. How has the Government addressed this in its risk analysis of EMR?

(g)People are key part of the energy system. What does Government propose to do to engage consumers positively in the debates around the underlying reasons for increasing energy prices and the affordability of future energy supplies?

The 2008 CO2 reduction targets

5. Although the draft Bill makes clear the Government’s intention to remain committed to the 2008 Act, the reality on the ground, with nuclear being at best delayed, means we will need substantial new build of gas fired power generation by the mid-2020s, with commitments by investors commencing in the near future.

(a)Given that the proposed emission performance standard will be grandfathered until 2045, how will this be managed in the context of seeking a power sector largely decarbonised by the 2030s?

The extent to which we still have a market, and its complexity

6. More and more of the market is moving out of the competitive sphere into something more rigidly controlled by Government, leaving a relatively small competitive segment behind (essentially gas fired plant) and even that will be impacted by the capacity mechanism. Hence major investment in generation will be largely determined by Government via CfDs (for low carbon generation) and the Capacity Mechanism for gas fired plant. The document recognises that the desired long-term outcomes cannot be assured by the present market arrangements but, by attempting to manage the outcomes within a market framework, incurs high levels of complexity and poor transparency.

(a)Plant closures are proceeding apace and as well as coal and oil may include AGR nuclear, as technical issues in their life extension remain unresolved at present. Demand may or may not recover depending on UK economic performance. What arrangements is the Government putting in place in the short term to evaluate realistic downside scenarios for capacity margin, and the emergency procurement of capacity if necessary?

(b)We have not found much consideration of the role of demand management and of storage in the system. What level of analysis has the Government undertaken in this area and how has it been recognised in the EMR measures?

(c)There seem significant downside risks in EMR owing to its complexity. Has the Government considered alternatives such as a carbon tax, or reverting to an overtly state controlled sector (albeit with private sector providers)? If so why were these rejected in favour of the present draft Bill?

Contracts for Difference

7. For over 20 years renewables have benefited from support from the Non Fossil Fuel Obligation and then the Renewables Obligation. Nuclear also received support from the NFFO. Hence Contracts for Difference (CfDs) is the third mechanism to be introduced since privatisation to provide support to generation which is unable to compete in the competitive market.

(a)The intent of the CfD is to reduce electricity price risk thereby improving the prospects for financing as well as reducing the associated costs of finance. However, there are many other project risks, eg cost overruns, technology failure, construction delays, etc. How will the Government ensure that project developers do not include a price premium in the CfD to cover such risks?

(b)How will the proposals to increase market liquidity and hence price discovery for CfD reference prices be implemented, noting not only the present issues caused by inter-company trading but potentially future issues when the competitive part of the market has shrunk further?

(c)Whilst EMR is intended eventually to evolve into a technology-neutral platform, it is clearly envisaged that CfDs will be used to support renewable technologies for the short and medium term, and priced differently by technology. Does the Government intend to specify how many MW of each technology it envisages to be built as part of each five year strategy, so that investors and their supply chains can plan accordingly? The target amounts themselves need to take account of power systems impact as well as affordability, deliverability and other constraints. Some confidence and transparency is needed in this area to allow markets to evolve amongst project investors and supply chains, including novel supply chains for balancing services. How is this to be achieved?

(d)How is Government proposing to establish the CfD counterparty?

(e)Is the Government considering extending the mechanism to facilitate rapid investment decisions to developers of gas fired plant—or some other mechanism, as some of this is needed urgently?

(f)We note that Government intends to negotiate directly with nuclear project developers for CfDs. How will the Government benchmark costs to ensure value for money?

(g)We note that Government intends to use a single strike price which is indexed to inflation. The risks with this approach is that many of the project’s costs will have a very different form of indexation involving multiple indices including those exposed to exchange rate movements. As a consequence the CfD could deviate substantially from project costs, particularly for very long term contracts which may be required for nuclear and plant with CCS. Has consideration been given to an alternative arrangement whereby the CfD covers one component of the project’s costs such as part of the project’s loan facility?

(h)We note that CfDs take no account of the fact that generation has different worth to the system at different times of the day and of the year. (For example it is more valuable on an early evening in winter than a summer afternoon.) How are incentives to be developed which reflect this time value, eg to ensure maintenance schedules are scheduled optimally or to assign less value to solar PV output which typically makes most contribution when demand is low.

Capacity Market

8. The introduction of specific incentives for low carbon electricity generation plant means that investment conditions for conventional thermal power plant have become less certain, and such conventional plant will be needed in the future, both in the shorter term to ensure supply security, and in the medium and longer term as backup to variable renewables. For such plant to be able to fulfil this backup role it will need sufficient flexibility and control to allow effective management of variable output renewables, inflexible nuclear and a mix of controllable demand and potentially large swings in demand arising from new classes of load such as electric vehicle charging.

9. The extent of backup needed is currently very unclear, and to a degree the industry will be learning as it goes along. Hence within the context of the other parts of EMR, we would be supportive of a capacity mechanism.

(a)The capacity mechanism appears designed to encourage retention of old plant where possible, demand reduction measures and potentially building cheap open cycle gas turbines. These would all potentially be capable of paying back within the 5 years allowed. However pumped storage and other electricity storage technologies, which are vital components of a low carbon energy system, are longer term investments. How does the Government intend to incentivise this type of investment?

(b)How will the Government trigger the capacity auction? We believe this will need an element of judgement and realism, not just hard evidence, because it will be necessary to second guess whether and at what time investors will commit. Transparency will be important owing to the impact on investors, but will be difficult to achieve in these circumstances.

(c)How will the Government ensure that appropriate flexibility and control is available from generation operating in the capacity mechanism?

Emissions performance standard

10. We appreciate the need to balance reducing emissions from thermal power plant in the short term with needing to encourage new thermal power plant to come forward to ensure sufficient generation is built over the next few years to replace old plant that closes down. Within the context of EMR this seems a broadly reasonable approach, however some issues arise, as below:

(a)There would appear to be a loophole that would allow plant offering a Carbon Capture and Storage (CCS) demonstrator component for part of its output to not be covered by the EPS, which would potentially allow a plant with only partial CCS and high emissions to continue to operate for an extended period. This would not be consistent with decarbonisation of electricity by the 2030s. What is the Government’s vision for moving beyond the CCS Commercialisation Programme to address this?

(b)How does the Government intend to incentivise combined heat and power within the context of the EPS?

Carbon Floor Price

11. The EU ETS has failed to deliver a robust and stable carbon price of sufficient magnitude to support investment in low carbon generation. The Carbon Floor Price (CFP) attempts to address this failing. However, this will increase electricity prices to British consumers and risks adversely impacting British industry.

(a)Would it have been better to have concentrated efforts on fixing the EU ETS rather than going it alone?

(b)With the CFP in place what assurances can the Government give that it will not lose sight of the importance of addressing the EU ETS failings for Phase 4 which commences in 2021?

(c)The clarity on carbon floor price is helpful, but has the Government tested this against latest estimates of new nuclear construction costs to see if sufficient incentive exists?

Energy Strategy and Policy Statement

12. We welcome the concept of clear strategic direction from Government, but it is important that strategies are not changed without good reason. In particular the suggestion that a change of Government could be the occasion for an early policy review does not give the required level of confidence. Supply chains need to invest over many years, and the development of engineering and craft skills can take decades.

(a)What will be put in place to guard against major and sudden changes in strategy without very good reason?

(b)Will the strategy contain specific policy goals about the amount of each generation source to be developed?

(c)What is the Government’s plan to join up heat, transport, demand reduction and energy efficiency strategies most of which involve other Government Departments as well as DECC?

(d)The Statement will define clear outcomes that Ofgem will have an important role to deliver. However, Ofgem’s remit is limited to electricity and gas. Who will be responsible for the other components of energy policy such as heating and transport? How will they be integrated?

(e)How does Government plan to deal with the scale, sophistication and open-ended nature of the programme management challenge?

June 2012

Prepared 21st July 2012