Energy and Climate Change Committee - Draft Energy Bill: Pre-legislitive ScrutinyWritten evidence submitted by Dr David Toke
Summary
It is wrong that nuclear power should be given access to similar funding streams as renewable energy, and it would be ridiculous for nuclear power to be given financial concessions that are greater than those given to renewable energy.
Given the unlikelihood that new nuclear build will be competitive with widely available large-scale renewables, proposed subsidies for nuclear power should be transferred to support renewable energy and energy efficiency.
Subsidies must be transparent.
The Contracts for Differences system is inefficient, opaque, and restricts competition compared to a German-style fixed feed-in tariff.
A fixed FIT would allow equal opportunities for the independent generators compared to the main electricity suppliers.
Incentive systems proposed for renewable energy seem as much designed to limit renewable energy as to incentivise it.
Auction systems designed to award renewable energy contracts after 2017 are innappropriate, and unworkable in the case of onshore wind
Little serious consideration seems to be given to the implementation of the EU Renewables Directive which requires a focus on volume deployment rather than caps and auctions.
1. Relative financial concessions to nuclear power and renewable energy My own analysis, in addition to the analysis performed by Michael Atherton, implies that EPR reactors would require a strike price of over £160 per MWh. This would be necessary to create the due diligence conditions to allow new nuclear build investment by a company such as EDF to go ahead and satisfy the sort of terms demanded by credit rating agencies. This is significantly higher than the funds currently being paid to offshore windfarms. It is approximately double what is likely to be paid to onshore wind power schemes.
2. This assessment deviates from those made previously by Government and the Committee on Climate Change, However these did not take into account either the full extent of cost overruns in the two EPR power stations being built. Neither does it take into account (a) the fact that the capital for these power stations will have to be raised from company equity as banks will not lend and (b) the considerable levels of uncertainty about construction costs and times for nuclear power station meaning that their investments will be assessed at much higher internal rates of return compared to renewable energy schemes.
3. It seems unlikely that the Government could be seen to allow a higher level of support from electricity consumers (per MWh) to be paid to nuclear generators than offshore windfarm operators since there is a bigger majority of public support for funding offshore wind power compared to nuclear power. There is certainly considerable offshore wind power capacity available, with The Crown Estate having issued around 48 GWe options representing over 35% of UK electricity consumption—and this figure does not include considerable quantities of other renewables.
4. Consequently the only way that the strike price for nuclear power is to be held down to levels that look more politically acceptable will be achieved through the Government underwriting nuclear construction costs. This may be presented as some sort of normal, technical option but would in fact represent a massive state subsidy to nuclear power that is not available for renewable energy.—The blank cheque option. Whatever the exact configuration of such a move it would have a high opportunity cost in that renewable energy projects could, if offered similar support, be able to set up in greater numbers at lower costs and at greater deployment speed compared to the nuclear power stations. Such a move would represent a very clear breach with Coalition Agreement commitments not to give subsidies, at least ones that are not available to other power plant including renewable energy.
5. The “blank cheque for nuclear” option would also fall foul of EU rules on state finance. Renewable energy support schemes are subject to strict protocols which would be clearly breached by underwriting construction costs. I note that the Conservatives stated, in their policy document on energy issued just prior to the 2010 General Election that: we agree with the nuclear industry that taxpayer and consumer subsidies should not and will not be provided—in particular there must be no public underwriting of construction cost overruns (Conservative Party 2010: 18). I note Ed Davey s insistence that there will be no blank cheque for nuclear. If that is the case then the prospect of a new nuclear programme is at an end. The Government should recognize the uncompetitiveness of new nuclear power and move on to shift resources originally earmarked for nuclear power to be offered to renewable energy and energy efficiency. We need now to discuss how renewable energy and energy efficiency schemes should be better organized.
6. Ed Davey has suggested the use of transitional contracts to help secure investment in low carbon generation prior to 2017. Any project-specific transitional contracts should be issued must be done in a transparent manner so that the contract prices are known in advance.
7. Nuclear power uses a non-renewable resource (uranium) and so should not be should be offered subsidies similar to renewable energy. It is even more unacceptable that nuclear power should be given access to greater support than is available to widely available renewable energy schemes such as wind power. Given that nuclear would require such support, it is apparent that a policy of trying to promote new nuclear build is misguided, and than policy should be re-shaped to see renewable energy and energy efficiency as the policy objectives that need Governmental support.
8. Contracts for Difference. The contract for differences’ (CfD) method of organizing feed-in tariffs for nuclear power and renewable energy is a retrograde step. The CfD proposal is widely held to be an inferior and certainly less cost-effective methods of financing renewable energy compared to the tried and tested fixed feed-in tariff mode of operation.
9. The CfD system has serious repercussions for independent renewable generators. They will have to contract in advance on the wholesale electricity market to sell their electricity. This is disadvantageous in two ways. First because there will be a discount on sales of electricity sold this way on a scheme by scheme basis when it would be much more efficient for the system as a whole for sales of electricity from renewables to be organized by the System Operator. This observation has already been made by David Newbery who estimated that this would result in substantial wastages of subsidies, much of which could be earned by the major electricity companies for no added value to the system. In addition independent generators of less than around 100 MW cannot trade on the wholesale market directly. They simply will not usually have the financial credentials to do so. They will be forced to contract with major electricity suppliers, who, on past evidence of such deals, are likely to absorb around 20% of the income stream. This will make things very difficult for independent generators.
10. The CfD system makes it effectively impossible to make an exact determination of the level of subsidies for different fuels. This is because trade in wholesale electricity is done on a commercially confidential basis and so it will not be possible to calculate exactly how much subsidy has been given to reach the reference strike price for a particular fuel. This will only be alleviated if the National Grid (or whoever pays the subsidy to generators) reveals the payments made. Annex B of the legislative proposals is replete with complex proposals for dealing with complexity of the CfD mechanism. This complexity is a problem in itself which can only but allow the large electricity companies opportunities to game the market to their advantage.
11. The Renewables Obligation also had cost inefficiencies built into its system since it involves greater risk of variation in future returns to developers compared to a fixed feed-in tariff system. However, it gave much greater opportunities for competition than the CfD system offers. This is because the generators themselves receive the incentives, the Renewable Obligation Certificates, which they can sell on an open market. The CfD requires any independent developer to be beholden to the contractual terms of an electricity supplier for the whole of their income stream.
12. The solution to these problems is to have a “fixed feed-in tariff” system on the German model. We already have one in operation to support the small renewables programme. It would be a relatively simple matter to use a broadly similar structure to this instrument and have a fixed feed-in tariff for large scale renewables. The system is administered by OFGEM. Under the current system suppliers are obliged to pay proscribed tariffs to renewable generators. Under a scheme suitable for larger scale projects suppliers would be obliged to issue contracts of a model type offering pre-determined guaranteed prices over 20 years. The money thus paid out by suppliers to renewable operators would then be reclaimed from OFGEM. OFGEM would reclaim this money via a levellised levy on all electricity consumers. This would be much more transparent, more cost effective and also offer more opportunities to independent renewable energy generators compared to a CfD.
13. A German-style fixed feed-in tariff system (what we could call as real feed-in tariff scheme) has the advantage of supporting renewable energy schemes independently of the Big Six electricity companies who dominate the market. The CfD proposals, by making independent renewable companies beholden to them, would reduce competition in the electricity system just at a time when the Big Six are under attack for the consequences of the existing oligopolous market.
14. Security of Supply The Government s own projections of availability of generation capacity now suggest that in 2025, there would still be just about enough capacity to cover current peak electricity demand even without any contribution from variable renewable energy supplies (DECC 2011). This is the position even if no other generating plant were built, and taking into account projected plant closures. Yet there are plenty of plans for more gas fired power stations to be built, so it does seem that there is no danger of the lights going out. Indeed the Government, in its EMR, is proposing further measures to promote the building of gas fired power stations through the capacity mechanism. The role for renewables here is to expand their operation so that they increasingly reduce the need to use this gas generation capacity. We need innovative means to integrate fluctuating renewables in the grid. There has been much talk of the growth of electric cars but there is very little work being done on utilizing their ability to store and discharge energy to suit the need to balance variable renewable energy sources. Neither is there sufficient thought within the proposals on measures that are needed to support a range of demand response techniques, or, indeed, on conventional energy efficiency measures.
15. Targets, Caps and Auctions “Annex B” of the legislative proposals outlines various options for caps, volume control by prices and auctions. These devices imply that a central purpose of the legislation is to limit renewable energy development, and, once again, have the effect of introducing uncertainty into investment decisions, rather than achieve the sort of volume needed to come anywhere near meeting the UK s EU Renewables target. If the current trajectory of renewable deployment continues until 2020 there will be no more than around 7% of UK energy supplied by renewables compared to the EU target of 20% by 2020. The Government is determined to introduce auctions for contracts, despite their notoriously poor record in achieving deployment.
16. The Energy Bill proposals talk of adopting a Danish system of auctions which has been deployed to set prices for offshore windfarms. Given this, it is worth spending some time on critiquing the use of this instrument. In fact this (Danish) system has so far yielded only 400 MW of capacity in nine years. The latest version of this mechanism, which is recommended for use by the Government, does not seem to be performing well in producing volume deployment, and the cost reductions are illusory. Impressions that the Danish system has reduced prices are misplaced and notions that this auction system can usefully be utilized for onshore windfarms represent a misunderstanding of the relevant institutions—perhaps a classic case of how a rule bound economist approach fails to take into account relevant institutions.
17. The Danish system s yield of relatively low prices can be ascribed to the low water depth compared to Round 2 UK windfarms. For instance Greater Gabbard, a typical example of the UK projects, has a water depth of 20–32 metres while the last Danish offshore windfarm, Rødsand II, has a water depth of only six–12 metres. Even so this project ran into trouble when the original developer s who had won the contract withdrew, and they had to be replaced. As a result the system was changed so that failure to complete the project bears a penalty. This has been followed by the setting of a higher price for the next project, Arnholt, which has an agreed has a price of 10p/KWh. This is still, at 15–19 metres, at a rather lower depth than the UK s Round 2 (and also Round 3) windfarms. It should also be remembered that this site was specially selected by the Danish Energy Agency, and thus there is likely to be a much higher knowledge of a range of factors (including grid connection and guaranteed planning consent) , at the time of making a tender, than in typically British projects.
18. Taking into account the fact that the fixed-feed-in tariff used by Denmark produces cost savings of lower interest rate charges on project debts compared to the Renewables Obligation (where currently prices of around £135per MWh/13.5p/KWh are payable), there is no case for arguing that this Danish procedure results in a measurable cost saving. Establishing such a procedure in the UK would undercut the Round 3 preparations and will likely lead to extensive delays as new projects are formulated and investigated.
19. However, it would be much worse if this (auction) procedure was re-established in the UK for the onshore wind sector. This could mean a return to the sort of NFFO system sued in the 1990s where, because of a combination of over-optimistic tenders for contracts and the failure of projects to achieve planning consent, only about 30% of projects given contracts are likely to be implemented. Notions that better results would be obtained by employing a penalty fine system for non-compliance are misplaced. The penalty would be simply added to project costs, nullifying potential savings, but in addition it would in reality be very difficult to enforce penalty fines since it would be foolish, if not impossible in practice, to hold the developers responsible for failure to gain planning consent. In practice several factors are unknown to the developer, planning outcome being perhaps the biggest, but also grid connection costs, and even windspeeds, which, being usually very site-specific in inland UK, will not be known with as much precision in advance compared to offshore windfarm cases. In short, the Government s proposals for auctions for onshore wind contracts are unworkable.
20. In fact the auction system is scheduled to be applied to onshore wind before other renewable energy technologies, despite it being even less applicable than these other technologies. Onshore wind is scheduled to be the first to be subject to this auction procedure because it is said to be a more mature technology. The technology may be mature, but the land use and grid-connection planning environment in which it has to cope contain many uncertainties that will lead to the non-implementation of a large proportion of projects that nominally win contracts under an auction system.
21. There is no tremendous problem with running fixed feed-in tariff system that needs to be fixed , let alone by an auction technique that is likely to restrict deployment rather than enhance it. Very low prices have been obtained in Germany for wind power for many years. What is not often appreciated in the UK is that windspeeds in Germany are much lower than in the UK, so the feed-in tariff rates given to wind power in Germany really are very low compared to the Renewables Obligation in the UK, where the average capacity factors of projects is much higher compared to Germany. In Germany the rates are set by law following studies done by analysts and negotiations between Government and trade associations. A similar pattern in the UK would reap benefits and a system could emerge that has the advantages of low cost and high deployment rates. This is especially necessary given the economic failure of the nuclear power alternative.
June 2012
References
Conservative Party (2010) Rebuilding Security—Conservative Energy Policy in an Uncertain World, London: Conservative Party,
http://www.conservatives.com/News/News_stories/2010/03/Conservatives_propose_radical_overhaul_of_Britains_energy_policy.aspx
Department of Energy and Climate Change (2011) Statutory Security of Supply Report, http://www.decc.gov.uk/en/content/cms/meeting_energy/en_security/sec_supply_rep/sec_supply_rep.aspx