Energy and Climate Change CommitteeWritten evidence submitted by Professor Catherine Mitchell and Bridget Woodman

Overview

This written evidence is divided into three main sections: (1) an introduction; (2) a few general points about Electricity Market Reform (EMR), and why this unfortunately means that the realistic recommendation is that the process should be halted; and (3) points on specific issues within EMR, such as the Contract for Difference mechanism (CfD); nuclear power and strike prices, capacity payments; firm decarbonisation targets; enabling powers for reducing total energy demand and so on. The Energy Policy Group provided written evidence to the ECC’s Inquiry into Electricity Market Reform in 2011. This response does not repeat the points raised in that submission.1 Our view is that the most viable energy policy is one that is based on renewable energy and energy efficiency in a “smart”, interconnected energy system which manages the electricity, heat and transport sectors efficiently together, and uses a decreasing amount of gas (possibly with CCS) as the interim balancer to the energy system. We do not see the need to support new nuclear power plants and we cannot understand why the Government is so determined to crowbar it into their energy policy.

Introduction

The Energy Policy Group submitted evidence to the ECC Inquiry on Electricity Market Reform in 2011. In that response, we said that we agreed that the current arrangements were not fit for the purpose of moving to a sustainable, secure and affordable energy system and that reform was needed. However, we also said we did not consider the proposals put forward in the EMR Consultation to be reform, in the sense that they were going to be an improvement on the current arrangements. That view has become stronger as time has gone on.

The ECC is now undertaking an Inquiry into the Pre-Legislative Scrutiny of the Draft Energy Bill. However, we would also argue that the Committee will be unable to scrutinise the Draft Energy Bill effectively because so many essential details have yet to be decided—for example, how the CfD will work; what the basis of it will be; how long the contracts will be for; how the strike and reference prices will be set; who the counterparty will be; whether it has met State Aid rules and so on. Without this information, the Committee will be unable to determine the likely impacts on companies’ investment decisions for low carbon generation.

The Draft Energy Bill remains based on the fundamental desire to find a way to support nuclear power without a public subsidy and without contravening state aid rules. The former is now totally discredited and the latter is still undecided, but may yet cause EMR to unravel. Of course, we cannot see into the future but, so far, history appears to be repeating itself from the 1970s and 1980s—the last time the Government in Britain unsuccessfully tried to build a set of nuclear power plants, ending up with just one: Sizewell B. Even if current nuclear output is all replaced with new stations, and that is most unlikely, they will provide around 3.5% of end use energy demand.2 They will do very little for our carbon emission reduction targets but have every chance of undermining the infrastructure, the supply technologies and the demand reduction policies necessary to make a real impact on the other more important 96.5%.

It should not be forgotten that the EMR reforms is only one of a raft of measures put in place over the last few years to reduce the risks faced by developers wishing to build new reactors in the UK.3 Britain appears to be going up a very time-consuming and expensive cul-de-sac, this despite the Government having been warned by stakeholders across the energy system, not least via evidence to the ECC’s last inquiry.4 Moreover, the ability of Britain and its people to benefit from the opportunities that a new energy system could bring will be seriously undermined if not lost.

Complexity of EMR, and as a result so few details agreed

What hits the reader of the Draft Energy Bill and its attendant publications, is how unnecessarily complex Electricity Market Reform has become; how it fails to meet its original objectives; how little seems to have been decided since the Consultation; and what a different path it is taking compared to the rest of Europe.

The EMR process should be halted.

While we would like to be helpful and solution-orientated, we feel it is necessary to make clear our view that the Government should halt the EMR process on the grounds that it will fail and that ultimately it will be cheaper (in terms of both money and environmental degradation) to consumers to stop now. Of course, a preferable outcome would be that the Energy Bill contents are altered to such a degree that the fundamental problems with EMR can be avoided by deleting them from the Bill. However, it seems to us that, whilst not optimal, a new analysis should be undertaken to take account of the energy situation, which is very different now than it was a couple of years ago.

The EMR process was begun by the previous Government. Since then:

Renewable energy prices have generally fallen, particularly photovoltaics (PV),5 amidst a step-change in global investment across all renewables, taking it to $257 billion in 2011.6 These new technology costs, and their effect on energy systems has led to the reassessment of investment policies in some utilities. For example, the head of corporate R&D for RWE, talked at the Power in Europe Conference about the “...astounding solar story. Three years ago we didn’t believe in it, now we do. We are inclined to believe in further cost reductions, leading to generation costs in Germany of lower than 10 euro cent per kWh by 2020. In the longer term PV is projected to be as low as 4 cents per kWh, which beats everything except perhaps onshore wind in good locations.”7 The UK small Feed-in-Tariff (FIT ) has been spectacularly successful showing enormous interest from investors for small scale renewable energy installations around Britain. In addition, these new technologies supported by FITs have opened up the possibility of new entrants in markets, whether they are individuals or small companies. By the end of the first quarter of 2012, nearly 250,000 households and nearly 7,000 non domestic entities qualified for a FIT in the UK, together providing over 1GW of capacity, mostly PV, in little more than a year.8 We are clearly not arguing that PV is the answer to all the UK’s energy needs, but the dramatic cost reductions in the last few years show how much the game has changed for renewables since the UK reasserted its support for nuclear power in the 2008 Nuclear White Paper. The bigger and wider impacts from the PV example is the way that such a different technology initiates new ways of running, and investing in, energy systems. Given the energy policies of other countries, ie Germany and Denmark discussed below, we can expect huge changes in infrastructure technologies and the way energy systems are operated, as well as renewable energy applications and costs by the time the first nuclear power plant comes online in Britain.

The Japanese tsunami and Fukishima nuclear accident of March 2011 has had various knock-on effects including Germany’s decision to phase out nuclear power. The time delays and cost overruns for the Okiluoto and Flamanville nuclear power plants have continued and escalated9 calling into question the complexity and economic feasibility of EPRs, the nuclear power plant of choice by EDF. SSE, E.on and RWE have pulled out of British nuclear consortia. In contrast to renewable energy, the expected cost of new nuclear in Britain has escalated (or clarified) sharply, with Hinkley Point C now reportedly estimated to be around £7 billion.10 In addition, EDF appears to have delayed the possible start date for Hinkley Point C until around 2021, three to four years later than originally intended.11

Germany12 and Denmark13 have announced new energy policies, based on “smart”, flexible, interconnected, primarily renewable energy systems, which is having a knock-on effect on European energy and climate policy, as pressure builds for renewable energy to provide 30% of energy in Europe by 2030; for a legally binding energy efficiency Directive; for a 30% carbon dioxide reduction target by 2030. An integral part of both German and Danish energy policy is a whole system approach between electricity, heat and transport with greater interconnection between countries (both physically and via markets)—so that energy flows to the highest price and energy security is increased by the ability to access more geographically dispersed , wider scale, different sources of energy and total capacity—but also greater local involvement.

A rapidly changing gas market, including the expansion of the LNG market, increased exploitation of shale gas as well as new resource finds and producers of conventional gas.14

Increasing costs of nuclear power, described below.

In addition to the changed energy situation set out in the bullets above, the Government’s Impact Assessment has not been updated since the White Paper. Given that the Government has now said it will be not be the counterparty for the CfD mechanism, a fundamental aspect of EMR, another analysis should be undertaken to take account of this and the changing factors described above.

Decision-making in Britain

At a future date, an investigation by the Energy and Climate Change Select Committee into the decision-making processes of DECC and EMR would be valuable. For those of us who genuinely want to move to a sustainable, secure and affordable energy system as quickly as possible, the EMR process is one which baffles, disappoints and depresses. There is a sense of déjà vu from twenty or more years ago, the last time a programme of nuclear power plants and an auction mechanism for renewable energy was put forward by the Government in Britain. It is as if we in Britain have learnt nothing in the last 20 years, and are determined to continue to learn no lessons from the wealth of energy policy evidence now available from across the globe.

Learning from Evidence for Renewable Energy Deployment

The evidence of technological change to do with renewable energy is that domestic markets need to be developed with support mechanisms which reduce risk (thereby bringing in investors, increasing deployment and its attendant learning effects) and stimulating the enabling environment around those technologies (for example, market rules, infrastructure change, domestic manufacturing, skills, laws, attitudes etc). This is not contentious, and is the underlying argument in the original Electricity Market Reform approach. However, while there is an explicit recognition within EMR of the need to support new technologies in competitive markets to allow them to develop and eventually compete, the Government is choosing a group of instruments, and particular the CfD mechanism, which as it stands will favour an established technology (nuclear power) over newer, less developed ones (renewable energy technologies). Reducing risk requires regulation but does not have to be more expensive—indeed evidence from the most successful countries which deploy renewable energy such as Germany and Denmark is that their renewable electricity is cheaper per kWh, for the comparative technologies.15 Evidence shows that mechanisms put in place to support renewable energy which do not reduce risk and knowingly incorporate competition will be less successful in terms of deployment and will be more expensive per kWh for the same technologies, compared to risk-reducing, non-competitive mechanism. This is evidenced across the world from over 100 countries or State policies.16

The UK has deliberately chosen to go down the more risky, more expensive route for renewable energy which will also be undermining to its nascent domestic manufacturing base.

Not all Technologies are Complementary

The essence of UK Government policies is that all low carbon technologies are complementary to each other and to the goal of reducing carbon and enabling the transformation from one energy system to another. It is not that Government or EDF argue that nuclear power is the central technology for the transformation of the energy system. However, they do argue that it is important that nuclear power takes its place along with other technologies as a key component of that move. For this argument to be correct, nuclear power has to complement the other aspects of the transition to a sustainable, secure and affordable energy system. However, this is clearly not the case, with operational conflicts; institutional support conflicts and so on.17 If one technology is not complementary to another, then supporting it will undermine the other. Moreover, if the non-complementary technology (ie nuclear power) is the one which provides a limited amount of energy and is constraining the set of technologies which are able to provide far more energy (ie renewables) in the UK, then it is positively worse to support the non-complementary one.18 As far as we know, no opportunity cost valuation has been undertaken of the current EMR technological pathway from this perspective.

Government Logic—Treatment of Nuclear Power

Under EMR, nuclear power faces different rules than renewable energy. Nuclear power developers still have to deal with construction risk but otherwise price, volume, market and off-take risk are all removed and handed to Government, and ultimately the British public. As is described below, the cost of nuclear power is extremely uncertain and will have to be underwritten by the British public, thereby in all likelihood tying them to expensive contracts and nuclear waste costs for decades to come. It has even been agreed that the additional costs of running the electricity system caused by connecting each new nuclear power plant (about £160 million/year/per plant) will be socialised19—ie spread across all bills—unlike all renewable energy power plants which have to pay their additional system costs themselves. As said above, nuclear power currently provides around 3.5% of end-use energy and, with the best will in the world, is unlikely to produce much more than that.

In this way, nuclear power, a mature technology which has certain serious dis-benefits (such as its waste) and which is not complementary to most renewable electricity technologies is being treated preferentially to the latter, a set of technologies whose prices are tumbling, which have a far greater UK resource and which makes up the lion’s (and growing) share of global energy technology investment (roughly half of electricity capacity for example20).

We have watched the progress of policy towards nuclear power with interest since the PIU Energy Review of 2002,21 which argued that nuclear power should be put on hold for five years so that other options, including renewable energy technologies, could develop and be assessed. Since then there were calls to overturn that policy, based on the argument (now shown not to be the case) that the energy situation assessed by the PIU and the EWP team of 2003 had changed. Slowly but surely over the last decade, Government Reviews and White Papers have all changed positions and policies to meet the requirements that were said to be needed if new nuclear power were to be built. Concrete measures which delivered renewable energy and energy efficiency have taken a backseat throughout this decade to a determined effort to shape policy to support nuclear power, despite the limited amount of power that can be provided by nuclear power. Moreover, this is despite a strong pro-market logic in most other aspects of British policy; the changes to the global energy system described above; and the increasing costs of nuclear power described below. Yet, even with all these policy changes called for by most of the large energy companies (for example E.on), and culminating in EMR, only EDF and Centrica remains interested in investing in nuclear power.

We would argue that any rational analysis would question why energy policy in Britain has followed this path over the last decade, and why it has shown such preferential treatment to nuclear compared to renewable energy and energy demand reduction.

The Goal for British Energy Policy

Britain has a legal obligation to cut carbon dioxide emissions by 80% by 2050 and to provide 15% of energy consumption from renewable energy by 2020. This will lead to a very different energy system in 2050 and it will require changes:

in Government (and its institutions) decision-making and way of acting (ie move away from markets as providers to a strategic framework based on transparent, legitimate, open-decision making to a more discursive, inclusive communication between Government and stakeholders);

in energy business practice—and this needs rules and incentives to make it happen. This reflects directly back to policy makers and their need to create an “enabling environment” to allow business to deliver policy outcomes;

in customer and community practice. Consumers need to be engaged in delivering policy outcomes, rather than the passive recipients of them.

Government needs to keep its eye on the ultimate goal—not just decarbonisation, but a sustainable, secure and affordable system. EMR is focussing on one very small part of that energy system change—nuclear power which currently provides 3.5% of end-use energy— while ignoring or undermining the other aspects which are essential to delivering the sustainable, secure and affordable energy system.

Comments of Specifics of the Draft Energy Bill

The EMR process and the Draft Energy Bill is now very complex. This complexity has led to difficulties in policy design, and the detailed working of the Draft Energy Bill is still very unclear.

Contracts for Differences (CfD)

There are so many questions about how (for example who the counterparty is) and whether the CfDs will work (for example, if compliance is possible and whether it will gain EU State Aid approval) and what the potential differing impacts on different technologies might be, that it is difficult to know where to start. As it stands, the CfDs seem to be an unworkable mechanism which should be scrapped.

Nuclear Power and the Strike Price

The cost22 of nuclear power has come under considerable scrutiny because of the EMR process—which is to be welcomed. The original cost put forward by EDF for Hinkley Point C was $4727/KW23 whilst the latest one given is$4260/kW,24 already far higher than the price put forward by DECC in the 2008 Nuclear Review.25 There have been recent reports saying that figure has gone up to £7 billion.26 EDF has not confirmed or denied that but was reported as saying that it would cost two to three times the basic price of electricity, although less than offshore wind.27 In theory, it is in the interest of the nuclear companies to have the price of nuclear electricity bid up. If the cost of nuclear energy is at the level put forward originally by EDF then it does not need a subsidy. On the other hand, as set out in the latest NAO report, nuclear power has a history of over-optimistic cost claims before contracts are signed, and that the actual costs come in far more expensively. The Government’s plan to overcome this likelihood is wholly inadequate. It seems to us highly likely that the nuclear generators will be paid an extremely inflated price. Given the discussion of complementarity above, we cannot see that this is a wise use of public funds.

CfD and Renewables

There are significant worries about how CfDs will affect renewable energy deployment, although until details are published we cannot be clear in what ways. This includes issues around Power Purchase Agreements and discounting of the reference price; how the proposed reference price for intermittent generation will be calculated; who is eligible for a CfD; what the strike price and contract length will be; how the allocation rounds and penalties will work; who the counterparty is and numerous more technical issues such as what type of inflation indexation should be used. Individually and collectively decisions on these issues are going to be incredibly important for the development of renewable energy in the UK.

As stated earlier, there is a great deal of evidence about how to implement successful renewable energy projects. This is to reduce risk, keep them simple and make them inclusive to all potential investors. The CfD for renewable energy is the opposite of this. There will be no obligation to buy RE. As pointed out above, RE takes second place to nuclear power in EMR time and again despite RE having a far greater resource than nuclear power and being able to be deployed far quicker. Notwithstanding Ofgem’s liquidity review, all nuclear generation has a guaranteed buyer for that period but it is still unclear how the renewable energy is to be bought. If there is to be a purchaser of last resort to ensure that all renewable electricity is bought (for example, by the system operator), then much of the EMR process for renewables is unnecessary. A mechanism whereby the system operator gives renewable energy and the combined heat and power output priority would be welcomed and far easier to implement.

Auctions

As if CfDs are not risky enough, the Draft Bill sets out its framework to the late 2020s/beyond (page 6 of the Policy Overview), whereby after a few years some technologies are expected to be able to move to competitive, technology auctions, although again not nuclear power. This is reminiscent of the Non-Fossil Fuel obligation from 1990–98 (please see the numerous papers Mitchell wrote about that particular mechanism at that time28)—an unsuccessful mechanism for a variety of reasons, which also destroyed the British wind manufacturing base because the level of competition was so great that cheaper overseas turbines were used. I predict if an auction is put in place in Britain for wave energy, it will destroy our nascent wave industry.

There are few successful auctions around the world.29 One of the more successful ones is in support of renewable energy in Texas. The Transmission System Operator executes an auction for a certain amount of capacity of particular renewable energy technologies, with minimum payments and contract lengths. There are similarities to the Feed-in-Tariff except the effect has been supportive of incumbents, as is to be expected. Denmark has recently had a one-off auction for off-shore wind. In that case, a block of offshore area was set aside for offshore wind energy where planning permission would be given; connection to the offshore plant and its cost were agreed; and the sale of the generation was guaranteed. The only cost that was being bid for was effectively the capital costs, all other risks were being covered. Penalties were part of the contract. Even in this very different situation from that contemplated by EMR, only Dong the Danish State Company bid—with a higher price to make up for the risk of penalties—and the process is currently under review.30

Again, the details of the EMR auction are still unknown. However, why Britain is returning to a type of mechanism which was so unsuccessful before in Britain is unclear. It is hard to reach any other conclusion than that DECC wants to maintain some sort of competitive aspect to its mechanism to support renewable energy, despite the clear evidence, as said above, that reduced risk is the way to increase investment and deployment for renewable energy and often at less cost (technology for technology).31

At the time of the inception of the NFFO in 1990, Britain, Germany and the Netherlands were putting in place new mechanisms in support of RE, and to that degree Britain could be forgiven for such a flawed mechanism given the relative lack of alternative mechanisms to learn from Denmark and California). However, there is now ample evidence. If Britain is serious about wanting to support RE, then it has to put in place a mechanism which reduces risk for investment. The CfD/auction mechanism put forward in EMR is extremely risky and a throw-back to a past era which reflects badly on DECC’s intentions for RE, and its capability of analysis.

While the pressure within EMR on renewable energy is explicitly to move towards a more competitive system, the government seems to be constructing the CfD format in a way which will only expose the nuclear industry to changes through negotiation with the developers.

Firm Decarbonisation Targets

The Draft Bill lacks firm decarbonisation targets. These should be included to fit the Committee on Climate Change’s recommendations.

Enabling Powers to Reduce Total Energy Demand

Managing the demand side of the energy system to reduce total energy demand (through utilising energy in as an efficient manner as possible; demand side responses and by reducing energy use when possible) should be the most important focus of our energy policy. We strongly believe that there should be a parallel policy instrument to ensure total energy demand reduction, in the same way that there are UK policy instruments to increase renewable energy deployment and to reduce carbon emissions. It seems to us that a parallel mechanism to the supply FIT should be developed for energy efficiency. The Draft Energy Bill lacks this ability to implement these actions and it should be incorporated.

Infrastructure, Including Interconnection and Storage

Infrastructure (whether generation, heat networks, storage, interconnectors, data collection and dispersal etc) holds the key to the most cost-effective and energy efficient energy future. The Draft Bill lacks a clear strategy for this and should be incorporated.

Flexibility and Resilience Mechanism

An interconnected European energy system should fundamentally reduce the capacity requirements for individual countries. However, as variable power increases new security challenges will be faced. We support a flexibility or resilience mechanism rather than a capacity mechanism per se, which should be open to demand side response, storage, interconnectors as well as generation capacity. To this degree we are reasonably supportive of the capacity mechanism idea, and that the system operator is the executive. Generally, system operators in Europe are state owned and there are clear incentive problems for National Grid. Nevertheless, overall, we are theoretically supportive of a system operator beginning to undertake this type of role, and see it as a step in the right direction.

Conclusion

This brings us back to the way that decisions are made for UK energy policy. For renewable energy, in the face of incontrovertible international evidence about what works in enabling technical change, the UK continues to plough its own lonely furrow of emphasising short term competition over long term delivery, in spite of our experience to date from the NFFO and the RO that this approach is flawed. The EMR as it stands will continue to inhibit the deployment of a diverse set of renewable technologies, while at the same time creating a protected environment for nuclear power.

The threat to the UK meeting its renewable energy obligations for 15% of its energy from renewable sources by 2020 is only one part of the picture. The bigger question is about why the Government continues to support a technology—nuclear power—to the degree that it does given the appalling record of cost escalations and delays and the significant technological, system and energy policy developments which are going on within the global energy system.

What the UK needs is a process by which stakeholders (including Government) keep up with these changes at the global level in a legitimate and transparent manner.

June 2012