Energy and Climate Change CommitteeWritten evidence submitted by Good Energy
Introduction: Good Energy
1. Good Energy is the UK’s only dedicated 100% renewable electricity supplier. We supply 30,000 electricity customers of which 6,000 are dual fuel customers. We are also the FIT licensee for 35,000 generators.
2. We own and operate a 9MW wind farm in Cornwall, and have embarked on a five-year plan to develop a further 40MW of renewable energy generation, all of which will be connected to the local network as opposed to the transmission system.
3. Good Energy was founded in 1999, and is one of the oldest “new” entrants into the domestic electricity market. Our ambition is to empower people to make a difference to climate change by choosing a renewable energy supply, generating their own power, and growing renewables in the UK. Good Energy has grown year-on-year since it was founded, in terms of customer numbers, turnover and profit and employees, with customer numbers growing by 15% last year despite the economic downturn. We have consistently delivered stable prices and have not increased our prices for over three years.
4. We continue to be an innovator in the energy market. We developed the UK’s first FIT and RHI scheme and we were instrumental in setting up the Green Energy Supply Certification Scheme under Ofgem’s guidelines. Last year we came top of the Which? Customer Satisfaction survey of energy suppliers, for the second time.
Executive Summary
5. Good Energy wishes to bring to the attention of the Committee the following concerns:
The Energy Bill (and wider EMR) proposals miss the opportunity to create a more open, transparent and liquid energy market, that is more accessible, flexible and dynamic and therefore more capable of responding to the challenge of decarbonising the power sector.
The FIT CFD is too prescriptive in its outcomes relating to Power Purchase Agreements and will skew the market in favour of larger existing players.
The FIT CFD will act as a new barrier to market entrants, potentially harming efforts to improve liquidity in the wholesale power market and undermining competition in the retail market. If the Government is to continue with the FIT with CFD it should scrap its plans to use a day ahead reference price, and move to a longer term reference price instead.
The Energy Bill is primarily focussed on the needs of nuclear and offshore wind, potentially to the detriment of other forms of low carbon generation.
The current proposed arrangements will increase the influence of the “Big Six” and reduce competition and choice for consumers.
Specific Comments
Renewables and current electricity market arrangements
6. The current electricity market arrangements were designed around fossil-fuel based generation which could be called on or off line as required and based on contractual arrangements between generators and suppliers. The main financial risk that generators faced was that they controlled their fuel cost in alignment to their Power Purchase Agreement (PPA) with the supplier. If the cost of generation rose too high, then the risk of being uncalled by the supplier in their merit order increased. Large generation businesses mitigated this risk by becoming a vertically integrated business with both generation and supply businesses. The risk of non-delivery (and subsequent imbalance cost) remained low as plant was able to deliver precise capacity on demand.
7. The characteristics of power generated from renewable resources are fundamentally at odds with this model. First, the cost of fuel is removed, and the costs are principally concerned with return on capital. Second, an intermittent generator such as a wind farm, cannot produce electricity on demand in the same way as a traditional generator, so there is an increased imbalance risk. As a result, a market which requires precise delivery on demand is unsuited to the current arrangements.
8. In response to this, independent renewable generators have reacted by developing PPA arrangements with suppliers that allow them to deliver their output in an unconstrained manner in return for a discount on the price paid in relation to the market. This impact has to date being cushioned by the Renewable Obligation, where the price paid for Renewable Obligation certificates (ROCs) is the same irrespective of when the energy is generated.
9. Vertically integrated suppliers will be able to manage this change through direct control of their own generation assets and through their ability to hedge any imbalance through the size and breadth of their power trading portfolios. Arguably, the resources required to manage this imbalance mean that under the current arrangements, the market will be even more prone to vertical integration than previously as they seek to control this risk. However in reality it is widely recognised that the size and scale of investment required in the market is beyond that which the traditional “Big Six” suppliers are capable of providing.
10. Under the EMR proposal, the contract for difference removes the RO cushion, and any independent generators’ income is completely exposed to the discount on the market price. This contradicts the principle in the FIT with CFD of fixing the CFD between the strike price and the market price, which assumes a generator can achieve market price.
11. This is further aggravated by the current absence of liquidity in the market. Even Ofgem’s liquidity proposal will still leave a majority of trades opaque to the market as they will be between the generation and supply arm of vertically integrated companies.
Impact on distributed and independently owned generation
12. A key objective of the EMR programme and the Energy Bill is to bring forward new investment in the UK energy market. It is now almost universally accepted that the traditional “Big Six” energy suppliers are simply not capable of providing the investment needed, and that new forms of investment will have to be found instead.
13. EMR is a rare opportunity for the Government to improve liquidity. Improving market liquidity is key to this in order to aid accurate price discovery, improve transparency, and so reduce the risks and therefore the cost of investment. In June 2012, the International Energy Agency warned that EMR will only be success if it is matched with decisive action to improve market liquidity.
14. Distributed generation (also described as decentralised generation), ie locally based generation typically connected to the Distribution Network (which for the purposes of EMR would need to be larger than 5MW in capacity), has a significant role to play in this respect. In encouraging greater direct involvement in the production of electricity at a range of scales by independent organisations, it not only acts as a new source of investment, but also ensures that electricity is produced at a range of sizes to help improve wholesale market liquidity.
15. Based on Good Energy’s experience, a more decentralised approach will lead to the greater geographical dispersion of generation, and the more diverse deployment of different renewable technologies, each with their own power production characteristics. This will aid the management of intermittent generation at a national level by creating a natural “hedge” against weather risk and so reduce the need for carbon-based back up plant and interconnection, and help engage consumers with their energy demand to aid demand side reduction.
16. The UK is already starting to see the benefits of more distributed generation through the current sub-5MW FIT scheme, which has acted as a catalyst for new independent investment in the market, created new sources of power for small suppliers to purchase and led to the deployment of renewable technologies that help suppliers manage the intermittency of wind (large scale solar in particular). For example, based on Good Energy’s experience, solar generators are often producing power when output is low from wind or hydro generators, and vice versa.
17. However the FIT with CFD which is designed for larger generation built and operated by the traditional market industry makes new entry into the market particularly difficult above the 5MW level. Under the Government’s plans, liquidity will be provided for by the mandatory auctioning of just 25% of power produced by the ‘Big Six’ suppliers.
18. At best, this is overly complex, a completely artificial method of improving market liquidity which may or may not work. A traditional, straightforward FIT, however, with the required budgetary safeguards in place, is likely to be a far more effective method of creating a genuinely liquid market through a more level playing field, because it is one where the chief policy mechanism does not fundamentally favour the market incumbents over new entrants.
19. In addition to the points outlined above, distributed generators above the 5MW fixed FIT threshold face additional hurdles, which make the FIT with CFD even less suited to support their development.
20. The first hurdle is that these generators are generally independent of supply businesses and have to find a buyer for their energy in the skewed, illiquid market. Many of these generators are non-industry professionals, and the FIT with CFD is significantly more complex than the current RO arrangements. Many of these generators are single site generators, who do not have a portfolio of generation, and in order to finance their build, will show security of income by signing a fixed price PPA, rather than a market-tracking, variable PPA, thus increasing further the risk of the inability to achieve their strike price.
21. In addition, their small clip sizes, and lack of access to weather forecasting software means that the discount to market price increases as the supplier takes on the forecasting risk, and administration cost of a smaller output.
22. All of these factors mean that independent, distributed generators typically incur a discount on the price paid to them for any power produced. This discount will not be reflected in the standard day-ahead power price which is planned for the Intermittent FIT with CFD, because it is market wide rather than specific.
23. At the same time, the EMR Operational Framework has confirmed that the Intermittent FIT with CFD will mean that generators are likely to require variable, rather than fixed price PPAs, in the future. This will be necessary to ensure that the revenue the generator receives from the PPA matches the day-ahead reference price used for the CFD as closely as possible, to ensure that any CFD ‘top-up’ payment is accurate.
24. However for the supplier, managing a PPA that is linked to a volatile day ahead price will incur additional costs that will be passed back to the generator in the form of an increased discount. The nature of these costs is likely to be fixed, and so smaller, distributed generation is more likely to be impacted on by them, proportionally speaking.
25. We believe that if a FIT with CFD is to be introduced, it should use a longer term reference price (ie at least a year, ideally three years) to address this problem.
26. By removing the RO, which is a form of premium FIT, the proposals increase the basis risk to distributed generators, which did not form part of the impact assessment by Government as it admits that no consideration was given to sub 50MW sites in selecting FIT with CFD over a premium FIT.
27. Good Energy’s experience to date has shown that the terms of reference of the EMR programme are set so that instead of being focussed on reducing existing barriers to a more decentralised market so that it can deliver the wider public policy benefits described, the programme is simply focussed on ensuring that it does impact further on those generators. There is a fundamental lack of ambition in the terms of reference of the EMR programme in this respect.
Impact on smaller suppliers
28. Smaller suppliers are the natural PPA counterparties of decentralised generators. In order to set their consumer tariffs for a reasonable period of time, they need to be confident about the price they are paying for their PPA contracts and therefore favour fixed price PPAs. Any PPAs that track the market price increases the risk that the supplier’s costs will not be truly reflected in their consumer tariffs. This could result in more frequent tariff changes; just at a time when Ofgem’s Retail Market Review is restricting variable domestic tariffs in favour of fixed price contracts.
29. Compared to larger suppliers, small suppliers have a more limited ability to manage any wholesale price fluctuations. This is not only because they do not own the plant in question, but also because they lack the same ability to hedge through energy trading portfolios, due to low levels of liquidity and associated credit problems.
30. To date, the Government has not published any Impact Assessment on the decision to move away from the Government being the FIT with CFD counterparty to one backed by energy suppliers. However, Good Energy is concerned that this adds another risk to non-vertically integrated suppliers as they will not have a view of the cost of being a counterparty nor any way of mitigating these costs, which will vary based on volume of FIT with CFD contracts in any half hour and the price (the gap between strike price and market price) attached to each unit of generation.
31. The only logical solution is to factor in a risk premium to consumer bills, which means that independent energy suppliers will be faced with higher risk premiums than larger vertically integrated businesses who will have the protection of having a net position, based on the cost to their supply business less the income to their generation businesses. Larger players will also be less vulnerable to unpredictable changes in cash flow, due to their better access to credit.
32. The decision to make suppliers the counterparty increases the risk of operating as an independent supplier and will therefore deter new market entry, thus entrenching the dominance of the “Big 6” energy suppliers in the market. This will restrict rather than encourage competition which is not in energy consumers’ best interests.
Conclusions
33. The proposal in the Energy Bill for a new FIT with CFD mechanism is based on evidence that only considers large generation sites such as nuclear and offshore wind. The Government has not considered the suitability of the mechanism for smaller, distributed and independently owned generation.
34. The Government appears to have recognised this in its belated call for evidence on the issue, but the onus of this is for the industry to prove that FIT with CFD will be a problem for independent and decentralised generation, rather than seeking the best and most efficient support mechanism for them. This reflects a lack of ambition in the terms of reference of the EMR programme, to encourage greater independent involvement in the market, improve liquidity and recognise the benefits of more distributed generation to a reformed market place with a significant proportion of intermittent generation.
35. The Energy Bill could be used to support distributed generation in combination with demand-side response, energy efficiency and most importantly consumer engagement with their energy use. However, the Bill chooses to focus on delivering a mechanism for new nuclear that avoids state aid rules and other options must “make do or die”
36. The FIT with CFD mechanism is overly complex, which creates risk to the market, not just in that it will be difficult to administer effectively, but could create unintended consequences such as deterring generation at time of high prices caused by tight margin between generation and supply.
37. If the Government is to continue with its plans for a FIT with CFD, then it should use a longer term reference price for intermittent generation, as a day ahead price will disproportionately impact on independent and distributed forms of generation. This is due to their reliance on PPAs as a route to market.
38. The Government does not appear to have undertaken an Impact Assessment on the decision to switch the FIT with CFD counterparty from themselves to suppliers. In particular, there has been no consideration on the impact of independent suppliers and market competition in general. We strongly urge this Impact Assessment is produced and published before this decision is enacted in law.
June 2012