UK: Energy White Paper

Last Updated: 15 August 2011
Article by Humphrey Douglas and Donna Bartley

On 12 July 2011 the Government published its White Paper "Planning our electric future: a White Paper for secure, affordable and low-carbon energy" (the White Paper) as the formal Government response to the Electricity Market Reform consultation in December 2010. This article sets out some of the White Paper's key proposals.

The general message that is delivered in the White Paper is that since the 1980s, the existing electricity market worked well. However, due to the unprecedented challenges faced by the market, wide-ranging reforms are required. The main objective of the reforms proposed in the White Paper is, therefore, to "build an electricity system fit for the future" by ensuring future security of electricity supply, decarbonising the supply and minimising the cost to consumers. This is to be achieved by encouraging cost-effective investment, at the pace required to meet the challenges that the market faces.

The Government's strategy is to set up an institutional framework for the administration of long-term contracts for low-carbon energy and capacity. It also proposes to continue the "grandfathering" approach, so that there is no retrospective change to low-carbon policy incentives and to encourage a liquid market in order to enable new entrants to the market to compete on fair terms with existing energy companies.

Contracts for low-carbon generation

In order to promote decarbonisation, the Government is proposing a new system of long-term contracts with low-carbon electricity generators in the form of Feed-in Tariffs with Contracts for Difference (FiT CfD). The aim of these is to provide predictable and stable revenue streams for investors in low-carbon energy generation. Under these agreements, a low-carbon electricity generator receives a top-up payment when it sells electricity for less than the agreed contract price, but makes a repayment to consumers when it sells electricity for more than the agreed contract price. This ensures that the generator receives the agreed tariff (but no more than that).

The White Paper confirms that these contractual arrangements will be supported by the introduction of a Carbon Floor Price (CFP) and the Emissions Performance Standard (EPS). The purpose of the CFP, which was announced in the Budget 2011, is to reduce uncertainty and provide an incentive to investment in low-carbon generation by putting "a fair price" on carbon. The purpose of the EPS, set as an annual limit equivalent to 450g CO2/kWh (carbon dioxide per kilowatt hour) at baseload, is to provide "a clear regulatory signal" on the amount of carbon new fossil-fuel power stations can emit. The Government considers that this will also reinforce the requirement that no new coal-fired power stations are built without Carbon Capture and Storage.

The Government believes that these new contractual arrangements will, amongst other things, provide a more efficient and stable framework for investors, encourage investment in proven low-carbon generation technologies, boost competition in the market and will do so at the least cost to the consumer.

The Government also proposes to assess whether there is sufficient support and incentives for making efficiency improvements in electricity usage and will consider whether there is a need for additional measures in relation to this.

In addition, the White Paper states that it will be crucial to engage with consumers on energy use issues. It considers that the introduction of the Green Deal will enable homes and businesses to improve energy efficiency with no upfront costs. This will be supported by the Government programme to introduce smart meters into every home in Britain and for businesses and public sector users to have smart or advanced energy metering in accordance with their needs. The White Paper states that this will enable consumers to better monitor and manage their energy consumption.

Contracts for security of supply

When looking at security of supply, again, the message in the White Paper is that the UK has benefited from a system that has worked. However, the challenges that the market faces mean that there could be "uncomfortably low" capacity margins by the end of the decade. Therefore, it is suggested that immediate action is required to address the issue. In addition, it is considered that the UK needs to maximise new opportunities from innovative technologies that will reduce the demand on the electricity system, store electricity and also connect the UK market to others in Europe.

The aims of these contracts are to secure diversification of supply so that the UK does not become over-reliant on one source of technology and its exposure to high and volatile fossil fuel prices is reduced; to provide operational security, ie, matching supply to demand at any one moment; and to ensure resource adequacy, securing sufficient, reliable capacity.

The White Paper sets out that the contracts for low-carbon generation will make the electricity supply more secure as they will encourage a diverse range of new generation capacity and reduce the UK's reliance on energy imports. It states that the independent regulator, Ofgem, is also currently considering reform of some of the current mechanisms of the system operator, National Grid to balance supply and demand. However, the Government's view is that these measures are likely to be insufficient. Therefore, it plans to legislate for a new contracting framework for capacity. This is referred to as a new capacity mechanism and the Government is seeking further views on the form that this should take. The White Paper sets out two options for this: "a targeted mechanism in the form of a Strategic Reserve", or "a market-wide mechanism in which all providers willing to offer reliable capacity are provided incentives to do so".

The White Paper also states that the Government recognises that reducing demand is likely to be more cost-effective than building additional capacity and that this will require "better use of existing generation through the development of a more flexible electricity network".

A new institutional framework

The White Paper sets out that it is crucial to put in place an "enduring, robust and credible intuitional framework" to ensure investor confidence. The aim is that the institutional arrangements for administering FiT CfDs (promoting decarbonisation) and capacity contracts (promoting security of supply) will provide clarity and certainty to investors.

The White Paper states that it is likely that organisation(s) at arms length from the Government will administer the contracts. It states that the Government will work with the delivery organisation(s) and will periodically evaluate their future strategy (in line with a clear planning cycle) to consider potential changes in costs, developments in technology and new challenges to the energy system. The White Paper states that the first of these evaluations will take place in 2016 and will also consider whether the new contracts structure for low carbon is achieving all benefits (especially for consumers) that the Government expects. It will also consider any amendments that may be necessary to the approach going forward.

It is expected that more details in this decision and the roles and responsibilities of Government and the delivery organisation(s) will be set out early next year. However, the White Paper states that the Government is committed to continuing to engage with stakeholders (as appropriate) in advance of these decisions.

The White Paper states that it envisages that the EPS will be administered outside of the new institutional framework and that it is likely that the environmental regulators in each part of the UK will be best placed to administer the EPS.

Improving market liquidity

The White Paper sets out that it considers that one of the main barriers to entry and growth in the electricity market and supply markets is the low level of liquidity in the electricity wholesale market. Further, it states that improvements to this are essential for promoting a competitive market and securing long-term security of supply.

The White Paper acknowledges that the current market climate is "not as conducive as it could be to the participants of new entrants, small and independent generators" and market liquidity is a key issue in dealing with this. The White Paper states that liquid markets would allow parties to manage long-term risk more efficiently, will increase confidence in traded prices (and in turn inform investor decisions) and will facilitate new entry in generation and supply.

Ofgem has set out proposals aimed at improving liquidity and meeting the needs of independent generators and suppliers. The White Paper states that to the extent that there are continued barriers to entry that are not addressed through Ofgem's actions, the Government will work with stakeholders to identify appropriate solutions.

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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