Implementation of Electricity Market Reform - Energy and Climate Change Committee Contents

2  From legislation to implementation

8. The Energy Act 2013 received Royal Assent on 18 December 2013, and the first EMR delivery plan[11] was published the following day. DECC published its finalised policy positions for the timetable of EMR implementation in June 2014, maintaining that "the first CfDs are expected to be allocated during 2014" and "the first Capacity Market capacity auction will be run in December 2014".[12] Many of the key missing details on the CfD and Capacity Market were provided in June and July 2014.[13] The secondary legislation, needed to implement the package, passed into law during the summer of 2014.[14]

9. National Grid took on responsibility as the main delivery body for EMR on 1 August 2014. Its role includes:

·  Carrying out analyses to inform Ministers' decisions, including the level of support for CfDs and how much capacity to procure in the Capacity Market auctions.

·  Administering both CfDs and the Capacity Market, establishing whether projects meet eligibility criteria to receive CfDs and running auctions for both mechanisms.

Two Government-owned companies have key roles in managing EMR mechanisms: the Low Carbon Contracts Company (LCCC) acts as counterparty to CfDs, manages the contracts and is responsible for payments under them; the Electricity Settlements Company is responsible for payment flows under the Capacity Market.[15]

Setting a framework for Contracts-for-Difference

10. The Contracts-for-Difference are long-term contracts between Government and a low-carbon generator that give a guaranteed tariff or price for electricity over a defined period of time. Their purpose is to reduce price volatility by providing a top-up payment between a market-based reference price and a pre-defined "strike price".[16] EDF Energy explained that "we expect Contracts-for-Difference to support investment in low carbon generation projects and to reduce risk for investors and reduce costs for customers by removing exposure to energy price risk".[17]

11. In September 2014, DECC published the final framework for the first CfD allocation round, which opened for applications in October 2014.[18] In this round, technologies were grouped into three "pots":

·  Established technologies (Pot 1), which includes onshore wind (>5MW), Solar Photovoltaic (PV) (>5MW), Energy from Waste with CHP, Hydro (>5MW and <50MW), Landfill Gas, and Sewage Gas;

·  Less established technologies (Pot 2), comprising offshore wind, wave, tidal stream, Advanced Conversion Technologies, Anaerobic Digestion, Dedicated biomass with CHP, and Geothermal; and

·  Biomass conversion (Pot 3).[19]

Payments made to generators will be recovered from electricity suppliers, who are expected to pass on the costs to consumers. CfD expenditure is to be governed by the Levy Control Framework (LCF). The LCF places limits on the aggregate amount levied from consumers by energy suppliers to implement Government policy, so that DECC can achieve its fuel poverty, energy and climate change goals in a way that is consistent with economic recovery and minimises the impact on consumers. In its current form the LCF will support electricity policies to 2020-21. The level of the cap on spending under the LCF in 2011-12 was £2 billion, and will rise to £7.6bn in 2020—21 (in 2011-12 prices).[20] We note that the NAO report suggests there is a 20% headroom on top of the LCF cap,[21] subject to subsequent clawback.

Preparing for the first Capacity Market auction

12. The aim of a capacity mechanism is to ensure a reliable electricity supply to consumers and reduce the likelihood of future power outages. RWE explained that the Capacity Market:

    has been designed to deliver an economic and efficient outcome based on a competitive market-based approach. It has the potential to significantly enhance GB security of supply at the lowest cost for customers.[22]

In June 2013, DECC issued detailed Capacity Market design proposals, confirming that an auction would be held four years ahead of the proposed delivery year where capacity may be needed (the so-called "T-4" auction), followed by a second auction one year ahead (so-called "T-1").[23] The first delivery year is 2018-19. The "T-4" auction took place in December 2014 and the "T-1" auction is planned for 2017. This framework will apply for different delivery years, with a second "T-4" auction planned for December 2015, for delivery in 2019-20.[24]

13. The amount of capacity auctioned is based on an annual security of supply analysis carried out by National Grid.[25] In October 2014, the Rt Hon Edward Davey MP, Secretary of State for Energy and Climate Change, confirmed that the final target capacity for the 2014 four-year-ahead auction would be 48.6 GW.[26] A further 2.5 GW of capacity is expected to be contracted in the year-ahead auction in 2017.[27] Following a pre-qualification stage that saw 62 GW of capacity qualify,[28] the first Capacity Market auction successfully took place in December 2014.

Meeting the timetable

14. Many contributors acknowledged DECC's efforts in meeting the "challenging"[29] timetable of EMR implementation and minimising delays,[30] describing this as "a significant achievement"[31] that should be "congratulated".[32] Mark Ripley, Director of Regulation at National Grid, acknowledged that "the last 12 months have been very busy", adding that it had been "quite a big push to get the secondary legislation through" but that "industry, DECC and ourselves, worked very well together".[33] The Rt Hon Matthew Hancock, Minister of State for Energy, told us:

    Over the last year, the implementation of EMR has involved two absolutely mission-critical moments, both of which have been successful. […] The first is that, in the summer, we successfully gained State Aid approval for the structures and the processes, and that was very important for implementing it. The second was the execution of the capacity market auction over Christmas and in the run-up to Christmas.[34]

15. However, concerns were raised that the successful pace of implementation may have been at the detriment of its quality.[35] While E.ON argued that DECC had "struck the right balance between ensuring the various rules and regulations work sufficiently and avoiding delays to implementation",[36] the Renewable Energy Association (REA) warned that there was "a danger of valid policy concerns being overlooked in the rush to meet the relevant deadlines and the bigger picture being missed".[37] The REA added that the numerous decisions rolled-out through secondary legislation may not have been subject to sufficient scrutiny.[38] Leonie Greene, from the Solar Trade Association, called it "a tale of two halves",[39] with very little being done for years and a sudden rush in the months leading to the first auctions. The Independent Renewable Energy Generators Group (IREGG) explained that:

    The timeline for the policy development of CfD auctioning has been rushed. This put significant pressure on DECC, whose consultation documents were increasingly showing signs of strain as they included multiple mistakes; on industry, who had to dedicate substantial resources to assessing hastily drafted proposals and replying to DECC consultations at extremely short notice; and on investors, whose confidence has been shaken by a mechanism developed in this manner and confirmed only weeks before the first auction is due to take place.[40]

The Minister rejected these criticisms as unfair, explaining that:

    Of course, it has been implemented at pace. There has been an awful lot of work, and I want to pay tribute to the work of the officials in DECC. This has been one of the best teams that I have worked with in Government. It has moved fast and the electricity market is a complicated market, but I don't think it has been rushed, no.[41]

16. We commend DECC for maintaining the ambitious timetable of EMR implementation and ensuring that the necessary framework was put in place in the lead up to the first Capacity Market auction and CfD allocation round.

Industry preparedness

17. The speed at which final legislation and policy positions were laid out has meant that industries wishing to participate in the Capacity Market auction or apply for a CfD have had to rapidly assimilate intricate documents and complicated eligibility criteria. Dr Nina Skorupska, from the REA, described the CfD policy as "highly complex",[42] and many stakeholders similarly commented on the intricacy of EMR.[43] Engagement with DECC and relevant EMR bodies has therefore been crucial in helping the industry gear up towards the first round of auctions. The Renewable Energy Association explained that DECC had been "very open in offering to meet with stakeholders"[44] and others similarly felt that they had been adequately engaged throughout the process.[45] However, Leonie Greene warned that the process had at times felt "quite erratic"[46] and Sara Vaughan, Director of Strategy and Regulation at E.ON, added that some in the industry considered they had "not had as much time to be consulted on as [they] might have liked".[47]

18. Within such a new and complex policy landscape, DECC, National Grid and the Low Carbon Contracts Company (LCCC) have a crucial role in communicating with industry stakeholders and potential participants. We heard that the roles of National Grid and the LCCC were well defined,[48] and several stakeholders commented positively on their interactions with both of these bodies.[49] We heard that they had made worthwhile efforts to establish and run a series of workshops, which had been "very useful in this transition".[50] However, the REA warned that the number of different bodies involved in EMR "may lead to some confusion among generators" and that these bodies should beware of "mixed messages being communicated to stakeholders".[51] Mark Ripley, Director of Regulation at National Grid, explained that:

    We spent a lot of time engaging with people in the industry to ensure that they understood what they needed to do, and understood the various bits of paper and the various commitments they needed to make.[52]

Neil McDermott, Chief Executive Officer of the LCCC, said that they had been "leading the implementation of the industry readiness to take part in the allocation rounds for CfDs",[53] adding that the LCCC was doing its best to "ensure that generators, large and small, are aware of the process, understand the contract, and can take part".[54]

Difficulties for small players

19. SMEs and independent generators, who may have more limited resources than their larger counterparts, have faced difficulties in adapting and fully engaging with the complex EMR process.[55] RenewableUK said that their "sense is that smaller players and supporting sectors, such as finance, have not had time to fully come to terms with the CfD framework".[56] The Solar Trade Association explained that:

    The eligibility requirements for the [CfD] scheme require considerable upfront expenditure, with no guarantee of return, therefore benefitting larger companies better able to spread and absorb risks over a portfolio of several possible development sites. The sheer complexity of CfDs will also favour large companies with the resources to pursue complex bidding strategies over many years.[57]

20. Neil McDermott, Chief Executive of the LCCC, and Mark Ripley, Director of Regulation at National Grid, explained that they had put particular emphasis on running workshops on both CfDs[58] and the Capacity Market,[59] respectively, and engaged with trade associations "to ensure that generators, large and small, are aware of the process, understand the contract, and can take part".[60] Neil McDermott reassured us that he was "particularly interested in the small end of the generators and suppliers," and that one-on-one meetings had been "offered […] to all generators".[61] He added:

    You mentioned the Solar Trade Association. We have worked with them. We have worked with Energy UK, RenewableUK and the Renewable Energy Association to be able to try to maximise the reach that we tried to achieve.[62]

Some organisations claimed that the framework was still geared towards people who really understood the market very well rather than people who wanted to enter the market.[63] However, Mark Ripley considered that "some familiarity with the electricity sector is in fact necessary if you are going to choose to be generating".[64]

21. In addition to being potentially disadvantaged by the complexity of the process, SMEs also face financial barriers in attempting to secure CfDs. In particular, the frequency of CfD allocation rounds-currently once a year-means that, after having invested large sums of money to meet prequalification criteria, unsuccessful applicants have to remain afloat for an entire year before being able to bid in the next auction for a chance to secure revenues for their projects.[65] Lark Energy, a UK-based developer of large-scale solar projects, explained that:

    As a minimum, we strongly believe that there should be more than one auction a year to enable SMEs to participate properly in the auction market. The alternative is to allow the CfD market to be totally dominated by large companies and utilities.[66]

The REA questioned "the feasibility of meeting Ministers' stated aims for moving 'from the Big 6 to the Big 60,000', as the reality is likely to be the opposite".[67]

22. The Minister explained that the desire to open the market to new entrants and small businesses had to be balanced with "a reasonable certainty that the businesses on the other side are going to be able to deliver on their piece",[68] explaining that other routes were available for small generators:

    Of course, there will be very small suppliers who say they would love to be part of the capacity market or the CfDs, but they do not have the money to get going and they do not have a track record, and that presents us with a challenge. The answer is that this is only one part of the suite of solutions. The other part of the suite of solutions includes the feed-in tariffs and other measures to be able to encourage small generation.[69]

Reviewing the first year of EMR

23. Following the first Capacity Market auction and first allocation of CfDs, DECC expects to conduct a comprehensive review of the first round of EMR delivery, ahead of the rounds opening later in 2015. The second "T-4" auction will take place in December 2015, and the volume to be procured will be published before the prequalification window opens.[70] A second CfD allocation round is intended to open in October 2015,[71] with the budgets to be confirmed later this year.[72] The Minister explained that DECC "will go through this [review] process over this summer to make any decisions on whether there needs to be changes"[73] and "do things in time to make changes".[74] He added that he "fully expect[s] this to be an annual process".[75] While the review has been welcomed by industry, Dr Skorupska told us that:

    We believed we needed more auctions, more frequency in the year, and the argument we got back was that they needed to do an in-depth review first before they know how to run the next one. That is very good—big tick. However, it is not very good for businesses that have to wait and see if they have the chance to have a go again.[76]

24. We welcome the efforts by DECC, National Grid and the Low Carbon Contracts Company to help prepare industry in the run-up to the first Capacity Market and CfD auctions. However, the complexity of the policies and the speed at which participants have had to assimilate information have made it a challenging environment for smaller companies. A robust review of the auctions is clearly needed and lessons learned must be acted upon ahead of the next round of EMR delivery. We are worried that the timing of the review means that it risks taking place too close to the opening of the second CfD allocation round and Capacity Market auction. This may mean that industry concerns-particularly the concerns of small companies-are not addressed.

25. We recommend that DECC ensure its review of the first round of CfD allocation and first Capacity Market auction is concluded by the end of August 2015. The review should detail lessons learned from each step of the CfD allocation and Capacity Market auction outlined by DECC, and assess the extent to which the 2014 rounds contribute to the objectives of EMR. In conducting the review, DECC should particularly look at how engagement with small players can be improved. The review should also include an assessment of the pros and cons of running more frequent CfD auctions.

11   Department of Energy and Climate Change, Electricity Market Reform Delivery Plan (December 2013) Back

12   Department of Energy and Climate Change, Implementing Electricity Market Reform (EMR) (June 2014), p 27 Back

13   Department of Energy and Climate Change, Implementing Electricity Market Reform (EMR) (June 2014), Department of Energy and Climate Change, Final Capacity Market Design Presentation (July 2014) Back

14   The Contracts for Difference (Allocation) Regulations 2014 (SI 2014/2011) Back

15   Department of Energy and Climate Change, Implementing Electricity Market Reform (EMR) (June 2014), p 22 Back

16   Tempus Energy Ltd (IEM 015) para 11 Back

17   EDF Energy (IEM 021) para 8 Back

18   Department of Energy and Climate Change, Contracts for Difference: Final Allocation Framework for the October 2014 Allocation Round (September 2014) Back

19   Department of Energy and Climate Change, Budget Notice for CFD Allocation Round 1 (October 2014) Back

20   Department of Energy and Climate Change, Annex D: Levy Control Framework Update: Extending the framework to 2020/21 (July 2013), p 2 Back

21   National Audit Office, The Levy Control Framework (November 2013), p 9 Back

22   RWE (IEM 010) Back

23   Department of Energy and Climate Change, Electricity Market Reform: Capacity Market - Detailed Design Proposals (June 2013), p 7 Back

24   Department of Energy and Climate Change, Electricity Market Reform Annual Update 2014 (November 2014), p 20 Back

25   Department of Energy and Climate Change, Implementing Electricity Market Reform (EMR) (June 2014), p 91 Back

26   Department of Energy and Climate Change, 'Update to the target capacity for the Capacity Market auction,' accessed 5 February 2015 Back

27   Department of Energy and Climate Change, 'First Capacity Market auction begins today,' accessed 6 February 2015 Back

28   National Grid, 'Results of Capacity Market prequalification announced,' accessed 5 February 2015 Back

29   Scottish Renewables (IEM 016) para 2.1, VPI Immingham (IEM028) para 8, Vattenfall (IEM 032), Q173 [Mark Ripley and Neil McDermott] Back

30   Scottish Renewables (IEM 016) para 2.1, E.ON (IEM 017) para 2, InterGen (IEM 018) para 7.1, EnergyUK (IEM 020) para 1.3, EDF Energy (IEM 021) para 6, Renewable Energy Association (IEM 024), Institution of Civil Engineers (IEM 034), ScottishPower (IEM 038) para 5, RenewableUK (IEM 040) para 1, Q1 [Leonie Greene and Paul Spence], Q108 [Chris Elder] Back

31   Statkraft (IEM 045) para 2.1 Back

32   Q108 [Sara Vaughan] Back

33   Q173 [Mark Ripley] Back

34   Q242 (Matthew Hancock) Back

35   Q1 (Leonie Greene) Back

36   E.ON (IEM 017) para 2 Back

37   Renewable Energy Association (IEM 024) Back

38   Q1 (Dr Nina Skorupska) Back

39   Q1 (Leonie Greene) Back

40   IREGG (IEM 036) Back

41   Q243 [Rt Hon Matthew Hancock] Back

42   Q28 [Dr Nina Skorupska] Back

43   Solar Trade Association (IEM 008), E.ON (IEM 017) para 1, Statkraft (IEM 045), Q8 [Paul Spence], Q84 [Andrew Buglass] Back

44   Renewable Energy Association (IEM 024) Back

45   Q1 [Paul Spence and Danielle Lane], Q67 [Andrew Buglass] Back

46   Q3 [Leonie Greene] Back

47   Q108 [Sara Vaughan] Back

48   Solar Trade Association (IEM 008), Renewable Energy Association (IEM 024), RenewableUK (IEM 040) para 14 Back

49   Vattenfall (IEM032), Q4 [Danielle Lane], Q5 [Paul Spence], Q109 [Rupert Steele] Back

50   RenewableUK (IEM 040) para 5 Back

51   Renewable Energy Association (IEM 024) Back

52   Q179 [Mark Ripley] Back

53   Q188 [Neil McDermott] Back

54   Q189 [Neil McDermott] Back

55   Renewable Energy Association (IEM 024), Qq1,3,25 [Dr Nina Skorpuska], Qq3,25,33,34 [Leonie Greene] Back

56   RenewableUK (IEM 040) para 4 Back

57   Solar Trade Association (IEM 008) Back

58   Q197 [Neil McDermott] Back

59   Q208 [Mark Ripley] Back

60   Q189 [Neil McDermott] Back

61   Q188 [Neil McDermott] Back

62   Q188 [Neil McDermott] Back

63   Q11 [Dr Nina Skorupska] Back

64   Q208 [Mark Ripley] Back

65   Lark Energy (IEM 011), Renewable Energy Association (IEM 024), Q25 [Leonie Greene] Back

66   Lark Energy (IEM 011) Back

67   Renewable Energy Association (IEM 024) Back

68   Q263 [Rt Hon Matthew Hancock] Back

69   Q268 [Rt Hon Matthew Hancock] Back

70   Department of Energy and Climate Change, Electricity Market Reform Annual Update 2014 (November 2014), p 20 Back

71   Department of Energy and Climate Change, Electricity Market Reform Annual Update 2014 (November 2014), p 16 Back

72   Department of Energy and Climate Change, Electricity Market Reform Annual Update 2014 (November 2014), p 10 Back

73   Q250 [Rt Hon Matthew Hancock] Back

74   Q294 [Rt Hon Matthew Hancock] Back

75   Q294 [Rt Hon Matthew Hancock] Back

76   Q33 [Dr Nina Skorupska] Back

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Prepared 4 March 2015