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Clarity over contracts for difference among changes in forthcoming Energy Bill

The central counterparty that will form the backbone of a new system of financial incentives designed to promote investment in renewable energy generation will take the form of a Government-owned company, the Energy Secretary has said.23 Nov 2012

Announcing further details of a package of energy policy measures, Ed Davey said that the new body will be given levy-raising powers, enabling it to raise funds from suppliers to meet its costs. The counterparty will underwrite new contracts for difference (CfDs) between the National Grid and producers of low carbon power, guaranteeing them a fixed price for energy supplied to the national grid.

The Government will also introduce a capacity market, with the power to hold capacity auctions from 2014, to guarantee reliable energy supplies and will consider whether to set a decarbonisation target range for 2030. It has agreed to make £7.6 billion available for investment up to 2020, to be funded by an increase on energy bills.

Addressing press speculation about energy policy disagreements within the Coalition Government, Davey described the proposals as "true to the Coalition Agreement". The changes will be introduced as part of a new draft of the Energy Bill, which Davey said would be published next week.

"This is a durable agreement across the Coalition against which companies can invest and support jobs and our economic recovery," he said. "The decisions we've reached ... mean we can introduce the Energy Bill next week and have essential electricity market reforms up and running by 2014 as planned. They will allow us to meet our legally binding carbon reduction and renewable energy obligations and will bring on the investment required to keep the lights on and bills affordable for consumers."

The Government has claimed that its electricity market reform (EMR) programme will bring about the widest reforms of the electricity market since privatisation. It is being introduced to provide certainty to investors against a backdrop of one fifth of the UK's existing power generating capacity due to come off-line over the next decade. According to Government estimates, £110 billion investment is needed in new infrastructure to replace aging power plants and deal with more stringent environmental standards and to guarantee sufficient generation to meet demand.

An early draft (307-page / 1.9MB PDF) of the Energy Bill, made available for 'pre-legislative scrutiny' in May, has been criticised by the industry for leaving much of the detail of the EMR programme to be covered by later secondary legislation.

CfDs are long term contracts that provide stable revenues for investors in low carbon energy projects, including nuclear as well as renewable energy sources. Payments made under the CfD will be calculated with reference to a technology-dependent 'strike price' and a market reference price. The payments are intended to replace existing subsidies and incentives such as the Renewables Obligation, and will also protect consumers by enabling the system operator to 'claw back' if the market price is higher than the strike price.

The new capacity market will enable the National Grid to purchase the total volume of generation capacity it requires through a central auction including all providers willing to offer capacity, and will offer incentives for energy companies to invest in new capacity or keep existing capacity operational. Davey said that the Energy Bill would allow for auctions to take place from 2014 for delivery of capacity in the winter of 2018-19 if needed.

Energy law expert Simon Hobday of Pinsent Masons, the law firm behind Out-Law.com, said that although the announcements were a "welcome step forward" it would be "premature" to greet them as the "landmark agreement" claimed by the Government.

"The big players familiar with the UK market will be relieved that progress is being made and that a sense of direction has been at least partially restored - clarity over the counterparty to CfDs is a key development," he said. "However the potential overseas funders required to back projects - particularly large insurance, pension and asset management from areas like North America and Asia Pacific - will still have questions and there are still some unsettling elements."

For example, questions remained about the Government's impending Gas Generation Strategy, he said. Although the document, which will be published alongside the Chancellor's Autumn Statement on 5 December, will form a "key component" of the UK's future energy supplies, its publication appeared to be "separated from the main reform package", Hobday said.

"This perhaps reflects a dominance of Treasury thinking rather than DECC's on the role of gas," he said.

The Government also intends to introduce a power under the Energy Bill which will allow it to set a decarbonisation range for 2030 in secondary legislation. It will take a decision on whether to do so in 2016, following further evidence from the Committee on Climate Change. The Government will provide guidance on an "indicative range of decarbonisation scenarios" for 2030 to the National Grid as an interim measure.

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