Because of the need to meet decarbonisation targets, the capacity margin will also become less stable as the UK's energy mix will include more intermittent sources such as offshore wind. It will also include more inflexible sources, which are those, like nuclear, which cannot start quickly in order to prop up a shortfall.
While the UK seeks an 80% reduction in carbon levels by 2050 (compared to 1990 levels), its demand for electricity is expected to double in the same timeframe. Consumers, meanwhile, are intolerant of price rises despite the £200 billion investment required in generation and transmission capacity in order to meet demand and decarbonisation requirements.
The White Paper on Energy Market Reform (EMR) (142-page / 1.8MB PDF) published by the Department of Energy and Climate Change (DECC) in July 2011 proposes a number of changes that the Government estimates will save the UK economy £9 billion between 2010 and 2030 while ensuring delivery of decarbonisation and the continuity of electricity supplies.
In summary, the proposals are:
- the introduction of Feed-in Tariffs with Contracts for Difference (FiT CfD), to replace existing subsidies and incentives such as the Renewables Obligation
- the introduction of a Carbon Price Floor (CPF) to provide a clearer, long-term investment signal for low-carbon generation by putting a firm price on carbon emissions
- the introduction of an Emissions Performance Standard (EPS) – an annual limit on carbon emissions of 450g CO2/kWh to reinforce the requirement that no new coal-fired power stations are built without Carbon Capture and Storage (CCS)
- the introduction of a new capacity mechanism either through a Capacity Market or a Strategic Reserve, where generation capacity is procured by a central body and removed from the energy market and for use in certain circumstances.
What is a Feed-in Tariff with Contract for Difference (FiT CfD)?
At present, support for low-carbon generation is provided through mechanisms such as the Renewables Obligation or Feed-in Tariffs. This support is necessary because, with the current costs of production, low-carbon electricity is considerably more expensive than electricity produced from fossil fuels. This means that investors' ability to recover those costs and their return is correspondingly low, reducing the incentive to invest in the first place.
However, when the market price rises and low-carbon generators are able to charge in a way that allows them to cover their costs without support, one-way mechanisms such as the Renewables Obligation and Feed-in Tariffs have the potential to provide the generator with a windfall benefit.
FiT CfDs are intended to remove the potential for windfall benefits while retaining the level of support necessary to make low-carbon investment viable. The Feed-in Tariff element of the package "tops-up" any shortfall between the amount the generator receives per unit of electricity and a pre-defined "strike price" in the long-term Contract for Difference. Once the strike price is exceeded, the generator is required to pay the surplus back. The result is that generators neither suffer nor benefit from price volatility as illustrated below:
Source: Planning Our Electric Future: a White Paper for Secure, Affordable and Low-Carbon Electricity DECC, July 2011, reproduced under the Open Government Licence.
DECC's intention is for FiT CfDs to replace the Renewables Obligation from 31 March 2017 for new developments. Developers will have the option between 31 March 2014 and 31 March 2017 to remain with the Renewables Obligation or to adopt the new approach. For those projects which receive support under the Renewables Obligation the calculation of the support will, subject to the separate ROC rebanding exercise currently underway, remain the same.
This grandfathering of support means that the Renewables Obligation will not extend beyond 2037. Depending on how the FiT CfDs and grandfathering arrangements are implemented, change in law provisions may be triggered in existing power purchase arrangements.
Carbon Price Floor
The Carbon Price Floor was announced as part of the Budget in 2011, and so strictly speaking it is not part of the Electricity Market Reform package. However, it is so intimately related to the functioning of the market that they should be considered together. The plans, which are subject to confirmation in the 2012 Budget are for the carbon price payable by UK based entities to be subject to a base of £16 per tonne of CO2 (/tCO2) increasing to £30/tCO2 by 2020.
The price floor would mean that the levels of actual price support are predicted to be £4.94/tCO2 in 2013, £7.28/tCO2 in 2014-15 and £9.86/tCO2 in 2015-16. These are subject to confirmation in the Budget in 2012. The support under the price floor regime is to be treated as fiscal spending and so will count as Government Spending in the annual budget setting process.
The Emissions Performance Standard (EPS)
The White Paper includes proposals for a new constraint on carbon emissions from fossil fuel generation plant. The EPS would require all new generation plant to have carbon emissions lower than 450gCO2 per kilowatt hour (/KWh). Such a level would prevent coal fired generation which did not have Carbon Capture and Sequestration (CCS) capability from being built. In addition, our understanding is that it would also prevent open gas cycle gas fired plant (OCGT) from being constructed; closed cycle gas turbine plant (CCGT) would remain unaffected by the constraints. For more information on the impact on Conventional Power Plant, see Out-law guide, Electricity Market Reform and conventional power. Biomass plant is being zero rated as although it produces carbon emissions, DECC regard the technology as green and therefore not to be constrained.
The EPS is due to come in to force in mid 2013. Existing fossil fuel fired plant will be grandfathered, which means that the EPS will not apply to them. However, life extensions or significant upgrades would bring such plant within the EPS. The EPS will be subject to periodic review. The first is due in 2015 and will be combined with a Government review on the progress of CCS.
The Capacity Mechanism
The White Paper has suggested two possible approaches to a capacity mechanism and DECC has consulted on both forms of approach. The outcome of that consultation has not yet been published. The two forms consulted on were: a capacity market and an administratively managed strategic reserve.
Capacity Market
In a capacity market all providers willing to offer capacity (whether in the form of generation or non-generation technologies and approaches such as storage or demand-side response) can sell that capacity, and the total volume of capacity required is purchased. There are several forms of Capacity Market, depending on the nature of the ‘capacity’ and how it is bought and sold. In particular, there are a number of ways to purchase capacity, including through a central auction or a supplier obligation. It is not clear from the information provided to date which form any capacity market might take.
Strategic Reserve
A Strategic Reserve is where generation capacity is procured by a central body and removed from the energy market for use only when market prices rise above a certain level, indicating a scarcity of supply.
In establishing the Strategic Reserve, a determination would be made centrally about the level of reliable capacity required in future, as well as an assessment of whether the market would be likely to deliver the amount of reliable capacity required. When a shortfall in reliable capacity is anticipated, a central organisation would be responsible for competitively procuring the necessary volume and mix of Strategic Reserve to meet future demand. Criteria would be set to govern the central body's procurement. Plant under contract to provide strategic reserve is excluded from the normal market and suffers penalties if called on to generate but is not able to do so.
Under plans in the Energy Act, Ofgem will from 2012 have to assess the level of electricity supply capacity needed to meet existing and future consumer demand. It will also have to monitor risks to the security of that supply. UK energy regulator Ofgem has issued a consultation on the best way to monitor the difference between the maximum energy which can be generated and user demand. It will be charged with reporting the figure to the Government from September next year.
The consultation is open until 7 December 2011, and the Regulator intends to publish its final plans in early 2012. It will submit its first report to the Secretary of State by 1 September 2012. For more on this see Out-Law.com's previous coverage of the issue.
The costs associated with a capacity mechanism would be met by consumers through revised supplier and generator pricing arrangements, although DECC anticipates that these would be outweighed by the benefits associated with security of supply.
Implementation
The Government has published a planned timetable (1.8MB / 142-page PDF, see page 17) for implementation of the EMR package. DECC anticipates finalising its policy approach during the remainder of 2011 and early 2012 with primary legislation being published in spring 2012, receiving Royal Ascent in July 2013. Secondary legislation would follow between then and Autumn 2014. It should be noted that the Carbon Price Floor is intended to come into effect in 2013 as will the EPS, with DECC envisaging the fist FiT CfD being signed in early 2014.