Government must ensure energy framework is fit for purpose

When MPs get back to Westminster, one of the pieces of legislation that will be facing them is the Energy Bill. The centrepiece of the Bill is implementation of the government's contracts for difference (CfDs) based ­proposals for Electricity Market Reform (EMR).

The Energy and Climate Change Committee has already raised some trenchant criticism, centring on whether the proposed approach to implementation is overly complex. The government will therefore have to use this term wisely if it is to successfully deliver its intentions.

What are the concerns for investors and bill-payers?

Those looking to invest in low-carbon generation through CfDs will be looking for stability and certainty about the terms on offer. In particular, for reassurance that if they make the necessary investments and deliver low-carbon generation, they will get their money back from assets whose economic lives cover decades. Many industry figures – and the committee – were critical of the plans in the draft Bill for the CfDs counterparty to be a body owned by the industry, because it was not clear if contracts could be legally enforced. Ministers have already suggested that we may see a change of plan here when the Bill is published, with government backing for the CfDs counterparty to reduce the perceived financial risk.

Another decision that will need to be taken – either in the Bill, alongside it, or after it – is how to choose between the different forms of generation that will be seeking CfDs. Will the government make an explicit or implicit choice about how much generation it requires from each technology, and then secure CfDs to deliver this? Alternatively, will it see how much willingness there is among different forms of generation to take contracts at a given strike price? The government has floated the idea of moving to some form of auction. That may or may not be feasible given the significant costs incurred in preparatory work for nuclear or offshore wind, say, but the government will have to find some credible process for demonstrating that it is bearing down on costs and protecting the interests of the bill-payer.

Can the government please everyone?

To solve these problems, the government has to recognise that it ­cannot have its cake and eat it. While private investors are willing to take on market risks, they are understandably not willing to take on political risks that are much harder to assess and manage. To achieve its overarching policy goal of decarbonising the power system, the government will have to provide insurance against the political risk inherent in key technologies – most obviously, nuclear power. And if it remains committed to setting and meeting ambitious targets for renewable generation – which is not entirely clear in light of the recent reshuffle – then it will have to design a mechanism that explicitly procures renewables.

In this respect, Ofgem has been more clear-sighted than the government. Its 2010 Project Discovery document recognised implicitly that government control over the choice of generation technologies is largely incompatible with the existing market arrangements, and proposed (among other options) shifting away from the market through the introduction of a “single buyer” system. Ofgem received few thanks for this intervention, and arguably it may have undermined the generation market by putting radical non-market ideas on the table. In retrospect, however, it may have been right to raise the issue. In the absence of a proper debate there is a risk of ending up with the worst of both worlds: a new regime that provides neither the certainty of central planning nor the efficiency of the market.

So the government has a lot on its hands this autumn and beyond. Of course, some form of legislation to implement EMR will be passed. The challenge will be to ensure that this new framework is fit for purpose in terms of achieving decarbonisation and associated goals while remaining sustainable and affordable.

Boaz Moselle, senior managing director,FTI Consulting

This article first appeared in Utility Week’s print edition of 28th September 2012.

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