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Electricity Market Reform and conventional power

Despite providing around 75% of the UK's electricity in 2010, the environmental impact of fossil fuel power generation means its popularity is in decline. This is indicated by the Government's approach in its White Paper on Energy Market Reform (EMR) (142-page / 1.8MB PDF), which intends to create a guaranteed price for power generated from low-carbon sources as well as other reforms.

However, the EMR recognises the need for huge investment in gas and coal plants. There is also recognition of the role gas plants are still likely to play in power generation in the UK, particularly in balancing intermittent generation from wind farms.

This guide considers how the provisions of the EMR may encourage or discourage investment coal and gas plant.

What is the EMR?

The EMR is the Government's proposed framework for encouraging investment in electricity generation which is cleaner and more secure, diverse and sustainable. The Government hopes that legislation reflecting the contents of its White Paper will be approved in 2013, although much of the detail of the reforms is not expected to be in force until 2014.

The Emissions Performance Standard

As part of the strategy to decarbonise electricity generation, an emissions performance standard (EPS) will be set at an annual limit of 450g CO2/kWh for all new fossil fuel plant over 50MW. Setting the EPS at this level is intended to prevent the construction of high emission coal power plants but still allow gas plants, albeit that these may need to operate at a reduced capacity. The EPS level will not be retrospective and protection from future tightening of the standard will be available for a limited period – although this is not expected to be the full working life of the plant. This means that plants which, when approved, meet the EPS may at a later date be required to meet a lower EPS.

The EPS will also apply to plants which undergo significant life extensions or upgrades, unless those upgrades are to comply with EU law or facilitate the use of biomass. The Government recognises that further work is required to more clearly define what is meant by a 'significant life extension or upgrade'.

The White Paper specifically refers to allowing the Secretary of State for Energy and Climate Change to make limited exceptions to the EPS in order to maintain energy security - for  example, allowing a coal plant to switch off its carbon capture and storage (CCS) technology to allow it to provide additional electricity.

The Carbon Price Floor

As announced in the 2011 Budget, a Carbon Price Floor (CPF) will be introduced in 2013. The CPF will aim for a minimum price of £30/tonne by 2020, rising to £70/tonne in 2030. The difference between the future market carbon price under the EU Emissions Trading Scheme (ETS) and the UK CPF is known as the carbon price support rate.

To give effect to the CPF, from 1 April 2013 supplies of fossil fuel used in most forms of electricity generation will be liable to a charge levied either by way of the Climate Change Levy or by way of fuel duty. It will be calculated by reference to the carbon price support rate and the average carbon content of the fuel. Fossil fuel generation is exempt from the Climate Change Levy until April 2013. Plant specific relief will be provided for plants using CCS technology in proportion to the amount of carbon stored.

There is, however, a question over the long-term certainty of the CPF as it will be included in the annual Finance Bill. This means that, at every annual vote, the legislation may be subject to political pressure to either increase or decrease the price floor.

Feed-in Tariff

Under the Feed-in Tariff with Contract for Difference (FiT CfD) proposals an electricity generator is assured of a long-term fixed price, known as the 'strike price', for its electricity. If the market price falls price falls below this strike price then the generator will receive a top-up payment, but if the market price exceeds the strike price then it will pay back the excess. It is not yet clear how this strike price will be set, but the Government's preference is to move away from administrative discovery (price setting by the Government or a central body) towards competitive price setting (by auction or tender). It seems that initially strike prices will be centrally determined.

Under the Government's calculations this would bring about a 0.4% reduction in the cost of capital for a coal plant with CCS and a 0.1% reduction for a gas plant with CCS. However, current plans are for the FiT CfD only to apply to 'intermittent' and 'baseload' generation – for example, wind power or nuclear. This would seem to leave out non-peaking or mid-merit gas plant with CCS or unabated gas plants, although specific forms of generation are not confirmed.

A FiT CfD for a third, 'flexible' class of plant is identified but considered not to be required until the 2020s because of the "continued role played by conventional gas fired power plants" until then. It is not clear whether at that time any such FiT CfD would also extend to gas fired plant in addition to renewable plants, such as biomass operating on a flexible rather than baseload basis.

Capacity Mechanism

An increase in electricity generation from renewable sources – particularly wind – and nuclear will lead to an increased proportion of intermittent (wind) and less flexible (nuclear) generation capacity. The Government proposes to introduce a Capacity Mechanism to seek to ensure there is sufficient reliable and diverse capacity to meet demand.

The Government has identified two different approaches to the introduction of a Capacity Mechanism:

  • a strategic reserve approach, which involves removing specific plant from the electricity market to be utilised only in certain circumstances; and
  • a capacity market approach, which allows all generators to offer additional capacity.

A further consultation on these proposals was initiated with the White Paper.

Conclusion

The EMR is clearly targeted at encouraging the large capital investment required in the development of electricity generation from large scale renewable technology, nuclear power plants and coal and gas plants with CCS. However if, as acknowledged in the White Paper, there is a requirement to build new gas plants to quickly address supply issues, has the Government done enough to encourage investment in those plants?

In the UK the main electricity generation and supply businesses are already heavily involved in nuclear power and offshore wind, and it must be questioned whether they have the financial resources available to build new gas plants as well as everything else. If they can't afford it then where will the money come from to build them? Will the utilities borrow the necessary finance or could we see project financing moving into the UK energy market in a more significant way than has been seen for many years?

Such is the scale of market intervention proposed that the reforms are likely to cause price uncertainty, at least in the short to medium term. This is likely to leave many potential investors sitting on their hands for a few years until it is clear how such a wholesale reform - and, effectively, the re-regulation of the market - will play out.

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