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Government must underwrite new "contracts for difference" if clean energy policy is to work, MPs warn

Government proposals to offer producers of low carbon power a fixed price for energy supplied to the National Grid risk becoming "botched" as a result of the Treasury's refusal to underwrite the contracts, an influential committee of MPs has claimed.26 Jul 2012

In a report presenting its conclusions on the draft Energy Bill (307-page / 1.9MB PDF), the Climate Change Committee said investors had originally been led to believe that new Contracts for Difference (CfDs), to be introduced by the Bill, would be guaranteed by the state. However, the model now being proposed will spread the liability across various energy companies instead.

Having the Government, with its AAA credit rating, underwrite the cost of these contracts would reduce the investment risk on projects with high up-front capital costs, such as nuclear reactors and new wind farms, the CCC said. It would also have the knock-on effect of reducing consumer bills, it added.

The Department of Energy and Climate Change (DECC) told the Committee in evidence sessions that it had "never been the intention" that the Government would act as a counterparty to the contracts, according to the report.

"While no one would have expected the Government to be paying these contracts, witnesses had understood that the Government would underwrite them," the CCC said in its report. "We find it impossible to believe that this "unfortunate drafting" [in DECC's original consultation paper] does not represent a policy shift. We suspect that this is the hand of HM Treasury at work, but its outright refusal to cooperate with our inquiry means we have not been able to explore the dynamic between HM Treasury's balance sheet concerns and its deficit reduction priorities and DECC's policy objectives."

The Government has claimed that the draft Energy Bill will bring about the widest reforms of the electricity market since privatisation. It proposes a new system of financial incentives designed to ensure that low-carbon forms of electricity generation can compete fairly in the marketplace, backed with a capacity market aimed to ensure that consumers continue to benefit from reliable electricity supplies at an affordable cost. Around one fifth of the UK's existing power generating capacity is due to come off-line over the next decade due to aging power plants and more stringent environmental standards, while an increasing amount of the country's power will be generated from intermittent sources such as wind.

The new system of feed-in tariffs with contracts for difference (FiT CfDs) will offer producers of low carbon power a fixed price for energy supplied to the National Grid. They will be set up between energy providers and the National Grid, acting as an independent 'system operator', with payments made by 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 "clawing back" money from generators if the market price is higher than the strike price.

"Electricity market reform is essential, but the new contracts proposed by the Government will not work for the benefit of consumers in their present form," CCC chair Tim Yeo said. "The Government has a lot of work to do over the summer to make sure that the Bill is fit for purpose in the autumn and is not subject to any further delays."

The CCC also warned that, according to the evidence it had heard, the plans contained in the draft Bill would reinforce the dominance of the 'Big Six' energy companies and so go against the Government's stated intention of reducing the barriers to entry into the electricity market for smaller renewables companies. Last month the Government published a call for evidence asking what could be done to make it easier for these companies to obtain power purchase agreements (PPAs) on competitive terms. It plans to incorporate responses into a future draft of the Bill.

Independent generators currently account for around 30% of power production in the UK; however independent suppliers only deal with 1% of the domestic retail market. While generators were concerned that the proposed FiT CfDs would "further constrain" their ability to secure long-term PPAs, allowing them to offset some of the risks of the project onto a counterparty, suppliers were concerned about the need to provide letters of credit or cash as collateral against CfD payments.

"Community-owned energy projects and small independent generators are in danger under the current plans of being squeezed out," Yeo said. "The Government must rethink its plans urgently so that the investment that is needed to replace the UK's aging power stations, cut carbon emissions and maintain energy security can be delivered."

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