UK: Eversheds' Clean Energy And Sustainability Briefing: Electricity Market Reform – The Highlights

Last Updated: 14 July 2011
Article by Michelle T. Davies and Jason Lovell

1.  SUMMARY

On 12 July the Department of Energy and Climate Change (DECC), released its eagerly anticipated Electricity Market Reform White Paper (the White Paper). The contents of the White Paper bring some further clarity to the measures described in DECC's prior consultation document of 16 December 2010. 

The White Paper sets out the Government's commitment to transform the UK's electricity system to "ensure that our future electricity supply is secure, low-carbon and affordable."

Chris Huhne, Secretary of State at DECC, has described the measures, as the "most significant reform of our electricity market for 30 years."

The White Paper was accompanied by the Renewables Roadmap which outlines a plan to enable the UK to achieve the UK's renewable energy target over the next decade (the goal being to ensure that 15% of our energy demand is met from renewable sources by 2020).

The main areas of reform set out in the White Paper are as follows:

1.1  Feed-in Tariffs with Contract for Difference (FiT CfDs)

As widely expected, the White Paper contemplates a replacement of the existing Renewables Obligation (RO) with long-term contracts in the form of FiT CfDs. FiT CfDs will constitute the price support for all low carbon generation, including nuclear, with the expectation that they will provide clear and stable revenue streams attractive to investors.

The Premium Feed-in Tariff and Fixed Feed-in Tariff now appear to have been discounted by the Government as alternative options.

The FiT CfDs will be "two-way" – providing for payments to be made to a generator when the market price for electricity (the reference price) is below the strike price set out in the contract but also providing for the generator to pay back an amount equal to the difference when the reference price is above the strike price.

The Government has accepted that a single FiT CfD will not necessarily suit all types of generation and has outlined alternative approaches using the FiT CfD for intermittent generators (for example, wind) and baseload generators (for example, nuclear).

Following resistance in the consultation to the setting of strike prices by means of auctions the Government has not committed to auctions at the outset but has declared an intention to move towards technology specific auctions or tenders towards the end of the decade.

The White Paper broadly reflects the position previously set out in the Government's consultation document with regard to the transition from the current RO regime to FiT CfDs. Existing accredited generation will continue to be supported under the RO - with the grandfathering of RO support for all technologies at the rate applicable on 31 March 2017. The RO will remain open until 31 March 2017 for new projects. This is intended to avoid disruption to developers who are currently making plans under the RO regime. The Government proposes that it will offer a choice of either the RO regime or FiT CfDs for new renewable electricity capacity accrediting after the introduction of the new FiT CfDs but before 1 April 2017.

1.2  The Carbon Price Floor

The White Paper contemplates the introduction of a carbon price floor for the emission of carbon (as already trailed by the Budget 2011) with a floor price that will come into effect from 1 April 2013. The Carbon Price Floor as announced, will begin at around £15.70/tCO² in 2013 rising in a straight line to £30.00/tCO² in 2020 and then rising to £70.00/tCO² in 2030.

The proposed carbon price floor imposes a cost on the emission of greenhouse gases to give greater long term certainty to the additional cost of running polluting plants. The rationale is to encourage investment in the deployment of low carbon generation and to act as a disincentive for electricity generators to the use of relatively more polluting coal, gas and oil fired stations.  

1.3  Emissions Performance Standard (EPS)

The Emissions Performance Standard is to be set at an annual limit equivalent to 450g CO²/kWh with the stated intention that it will provide a clear regulatory signal on the amount of carbon that new fossil-fuel power stations can emit. The Government had previously suggested two possible options of an annual limit equivalent to 600gCO/KWh and 450gCO/KWh (in each case for plant operating at baseload).

The EPS is targeted at coal powered power stations and reinforces the existing requirement that no new coal powered power stations may be built without carbon capture and storage (CCS) technology.  The EPS will not operate retrospectively.

1.4  A Capacity Mechanism for Generators

In order to ensure security of supply the Government will legislate for a new capacity mechanism for generators – which will essentially be a price support for back-up power plants. This is one of the less developed areas in the White Paper and it is acknowledged that further consultation will be required – based on two possible options, a targeted mechanism (focused on capacity which is used in certain extreme circumstances only) or a market-wide mechanism (where all providers are provided incentives for the offering of reliable capacity).

1.5  A New Institutional Framework

The White Paper contemplates a new institution (or institutions) operating at arms length from the Government to administer, amongst other elements, FiT CfDs and the capacity based mechanism. Such new institution(s) in order to fulfil the demanding role will need to satisfy the stated requirements of accountability, independence, credit worthiness, technical expertise, commercial and financial skill and value for money. The rationale behind the new framework appears to be to increase investor confidence in the operation of the market by ensuring the necessary resource is available and reducing any perceived interference of the Government in commercial delivery, whilst making clear that the Government will continue to be responsible for setting policy.

1.6  Market Liquidity

The White Paper identifies a number of barriers to entry into the electricity market in the UK and focuses on the low level of liquidity in the electricity wholesale market. The need for liquidity is of particular importance in the context of the FiT CfDs which depend, to a large extent, on the liquidity of the market to work efficiently.

It is explained that Ofgem and the Government will work closely together to increase market liquidity and the Government appears to be largely aligning itself with Ofgem's pre-existing proposals in this area.

2.  NEXT STEPS

Further consultation is now expected in relation to the proposals for the Capacity Mechanism with the results expected by the end of 2011 which will be a pre-cursor to the decision as to the identity of the new institution responsible for its administration.

Even in areas where there is a relatively large amount of information, such as the FiT CfDs, detail remains to be filled out, such as the method by which the strike price will be set and the timing of entry into FiT CfDs for new projects – detail such as this will be significant to an overall evaluation of the merits of the Electricity Market Reform.

The Government intends to legislate for the key elements of this package by Spring 2013, with the intention that the first low carbon projects can be supported in 2014.

Please note that the proposed reforms all remain subject to the will (and timetable) of Parliament. We recommend that you take legal advice before taking any action based on the White Paper or the highlights we have described herein.

For further information, please contact:

Michelle Thomas
Partner, Head of clean energy and sustainability
Tel: 0845 498 7553
michellethomas@eversheds.com

Jason Lovell
Partner
Tel: 0845 497 4554
jasonlovell@eversheds.com

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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