Canada: UK Energy Market Reform Gathers Momentum: Energy Bill 2012 And Shale Gas Developments

1. Introduction

We reported in a previous issue on the UK's draft Energy Bill (please refer to the Energy@Gowlings Newsletter dated 7 September 2012).

The Energy Bill has now been published and was introduced to Parliament on 29 November 2012 by Edward Davey, Secretary of State for Energy and Climate Change. This note summarises the key provisions of the Bill and a recent announcement concerning shale gas exploration in the UK.

The stated purpose of the reforms to be made by the Bill is to deliver secure, affordable and low-carbon energy by supporting investment in new generating capacity and upgrading transmission networks. This could translate into cheaper energy for consumers (the Department of Energy and Climate Change indicated that "the average household bill will be 7%...lower in 2020 than it would be without low-carbon energy policies being pursued") but many commentators, including consumer groups, disagree. The Energy Bill Revolution (an alliance between several charities, businesses and politicians) states: "The Treasury has generously agreed to stick the entire cost of de-carbonising UK power on to consumer bills. At the same time, they are pocketing all the money they are raising in carbon taxes".

2. Energy Bill 2012 - Key Provisions

(a) Contracts for Difference (CfDs)

The UK Government currently supports larger renewable energy projects through the Renewable Obligation system, with smaller projects benefiting from feed-in tariffs.

The Bill will introduce a new form of support in the shape of contracts for differences (CfDs). These will apply to low-carbon generation projects (new nuclear and Carbon Capture and Storage (CCS) as well as renewables) and will have broadly the same effect as a feed-in tariff.

Under a CfD, there will be a "strike price" with the generator entitled to be paid, in respect of the energy it delivers, the difference between the strike price and the electricity market price assuming that the strike price is above market price. If the market price is above the strike price, the generator would be obliged to pay an amount equal to the difference between the strike price and the market price.

Low-carbon projects are typically capital intensive and CfDs aim to encourage investment by stabilising revenues, thereby providing more certainty for companies investing in these projects.

A Government-owned company will be the counterparty in the CfDs – this follows a recommendation made by the House of Commons Energy and Climate Change Committee following its review of the draft Bill.

CfDs will be available in respect of renewables, new nuclear and CCS technology and a strike price will be set at the level necessary to support each particular technology. In July 2013, Government will consult on strike prices for renewables and it expects, by the end of 2013, to be able to announce the strike prices for each technology for each of the five commissioning years from 2014/15 until 2018/19.

A 74-page heads of terms document has been published and it is expected that the CfDs will be standardised across all technologies.

(b) Capacity market

Low-carbon energy is typically available on an intermittent and/or inflexible basis and, as such, back-up power is required. The Bill will introduce a capacity market aimed at providing security of electricity supply. It is envisaged that capacity auctions will be held in 2014 for successful bidders to deliver capacity in the winter of 2018/2019, as required.

(c) Emissions Performance Standard (EPS)

The Bill provides for the establishment of an EPS which will limit carbon emissions from new fossil fuel power stations with a capacity of 50MW or more, consented to after 2014. The EPS limit will be reviewed every three years but a "grandfathering" system will be in place until 2045 whereby plants which operate within the current limits will remain unaffected any change.

The annual EPS limit will initially be set at 450g CO2/kWh. New coal-fired plants will need to be fitted with CCS technology if they are to operate within these limits. Government has stated that the limit has been set so that it does not discourage investment in new gas generation and the grandfathering system outlined above aims to provide long-term certainty to investors, including gas investors.

(d) Transitional arrangements

Investors in renewable energy have the option until 2017 to choose between support under the existing Renewable Obligation system and the new CfDs. For new renewable energy projects, after 2017, only CfDs will be available.

(e) Appointment of the System Operator

National Grid plc will be responsible for delivering the Electricity Market Reforms (in particular to administer the CfDs and the Capacity Market). Government will have powers to manage any conflicts of interest arising from this appointment.

(f) Nuclear Regulation

The Bill will establish a new statutory body, the Office for Nuclear Regulation, which will regulate the safety of the next generation of nuclear power plants.

(g) Strategy and Policy Statement (SPS)

The Bill sets out a power for the Secretary of State to publish an SPS, subject to requirements for consultation and parliamentary approval. The intention behind the SPS is to ensure that Government and Ofgem (the regulatory body governing the gas and electricity markets) are aligned on a strategic level, thus improving regulatory certainty. The SPS will be reviewed at least every five years.

(h) Market liquidity

Government will have additional powers to promote greater competition and liquidity in the wholesale market.

(i) Timing and scope

The Energy Bill is expected to obtain Royal Assent by the end of this year, with the reforms effective from 2014. All provisions of the Energy Bill extend to England and Wales and the majority also extend to Scotland, whilst only some to Northern Ireland.

3. Shale Gas Exploration

(a) Decision to allow fracking

Exploratory hydraulic fracturing ("fracking") was suspended in the UK in May 2011 after two seismic tremors were detected near the country's only fracking operations in Lancashire in the north west of England.

On 13 December 2012, the Secretary of State for Energy and Climate Change announced that exploration for shale gas in the UK can resume, subject to new controls being introduced to mitigate the risks of seismic activity. These controls are now a prerequisite for further exploration.

As part of the new controls, operators will need to submit a fracking plan to the Department of Energy and Climate Change, showing how they intend to address seismic risks. They will also need to monitor seismic activity before, during and after fracking. Exploration operations will be subject to a "traffic light" regime so that they can be suspended promptly if unusual levels of seismic activity are observed.

The Secretary of State highlighted that this is a developing area of knowledge, so the controls outlined above will be continuously reviewed to ensure that they are proportionate to the risks.

It is worth noting that ahead of potential large-scale production of shale gas, the Government has commissioned a study into the possible impacts of shale gas extraction on greenhouse gas emissions.

It is expected that, in practice, it will be some months before new exploration operations proceed and some years before the UK has significant shale gas production even if exploration is successful.

A new Office for Unconventional Gas and Oil will be set up, led by the Department of Energy and Climate Change, in order to provide a single point of contact for investors and streamline the regulatory process.

(b) Gas strategy context

The decision concerning shale gas, outlined above, comes within the context of what some commentators call the Government's new "dash for gas". In its new gas strategy (published on 5 December 2012 alongside the Autumn Statement outlining the UK's fiscal strategy), the Government concludes that up to 26GW of new gas capacity could be required by 2030, a strategy which the Secretary of State for Energy and Climate Change says is necessary to "keep the lights on" and "consistent with...significant decarbonisation of the power sector".

The Government plans to consult on an appropriate fiscal regime for shale gas exploration. HM Treasury is currently engaging with companies and the outcome of this consultation will be announced as part of the 2013 Budget, on 20 March 2013.

4. Conclusion

It is widely acknowledged that there has been inadequate investment in new generation capacity in the UK in recent years. The Energy Bill is the Government's response. Long-term CfDs should provide a stable investment environment for low-carbon generation, with the proposed capacity market underpinning investment in gas-fired plant but further details are needed (concerning CfD strike prices and capacity market auctions, for example) before investors will be in a position to judge how attractive these reforms will be in practice.

It is clear from statements made by Government that, although most new generation capacity is expected to take the form of low-carbon generation, there will remain a significant place for gas, in particular in the short to medium term, until the transition to low-carbon energy has been made. The Government's decision to allow the resumption of fracking can be seen as both an acknowledgement of the fact that gas has an important part to play within the energy mix and also as a wish to see as much gas as possible sourced from within the UK rather than from expensive and, in some cases, politically unstable jurisdictions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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