The show must go on

The Energy Bill has set the stage for EMR, but with most of the detailed design work yet to come, it's still very much the start of the show. Mark Bartholomew explains

Electricity Market Reform (EMR) is the most fundamental set of changes to the power market in Great Britain since privatisation. Its aim? To improve energy security and decarbonise generation while keeping the cost of electricity at affordable levels.

The formal legislative process for implementing EMR commenced on 29 November when the Energy Bill was introduced in Parliament. While the Bill covers a broad range of issues, it is the core elements of EMR that are at its heart, namely: a feed-in tariff with contracts for difference (FIT CfDs); a capacity mechanism; an emissions performance standard; and a carbon floor price (this latter element was first introduced in the 2011 budget and subsequent Finance Act).

The Energy Bill is based on the draft published in May for pre-legislative scrutiny and reflects a number of criticisms made during that process. It does not contain any real surprises, just a few more details and refinements. However, in relation to EMR, the Energy Bill is essentially a set of enabling provisions and as such much of the detailed design work has yet to be completed. But what’s the story so far?

Contracts for Difference: one of the most talked-about features of EMR is the new FIT CfD, designed to underpin investment in low-carbon generation (nuclear and renewable) and which will replace the current Renewables Obligation. Last May’s draft Bill envisaged an instrument created through statute to which the parties would be the low-carbon generator on the one hand and all suppliers, acting collectively, on the other.

Concerns were voiced by investors that CfDs in this form would be unbankable, largely owing to nervousness as to how an instrument of this nature could be enforced. The House of Commons Committee on Energy and Climate Change recommended that a conventional contract form should be used with a single creditworthy counterparty. This recommendation has been reflected in the Energy Bill, which now provides for the creation of a government-owned ­company to act as a single counterparty to a conventional bilateral contract (suggested heads of terms for the new contract were published alongside the Bill).

While this key design feature has been resolved, there is still much detail to be worked out including, most importantly, the setting of strike prices for each technology type – something that will be the subject of consultation next summer.

Funding for the new FIT CfDs will come from consumers. Alongside the Energy Bill the government confirmed that the Treasury’s cap under the Levy Control Framework will be raised to permit an increase in the “green levy” charged to consumers, from £3 billion to £7.6 billion.

However, the government has recognised the difficulties here for energy-intensive industries. Higher energy costs could make them uncompetitive globally and potentially jeopardise the domestic economic recovery. Accordingly, it plans to exempt energy-intensive industries from the costs of FIT CfDs, although this will require state aid clearance. The design of the exemption and the mechanics for its delivery is to be developed by the Department for Business Innovation and Skills in conjunction with the Department of Energy and Climate Change (Decc).

Capacity market: roughly one-fifth of current electricity generating capacity is scheduled to close by the end of the decade, and Decc has expressed concerns that there could be generation shortages and a risk of blackouts with increased intermittency (wind, solar) and inflexibility (nuclear) in our generation mix. In particular, and as highlighted in the Gas Generation Strategy published by Decc last week (5 December), further gas-fired generation is likely to be needed to balance the network and keep the lights on.

The EMR proposals included a capacity market to provide some insurance against this risk, and the Energy Bill contains the necessary powers for its introduction. Capacity auctions could be held as early as 2014 for delivery in the winter of 2018/19, if needed, to ensure the lights stay on. While the high level design of the capacity market has been developed, there is much detailed work still to be completed.

Emissions performance standard: as set out in the EMR proposals, the Energy Bill includes a duty on the operator of new fossil fuel plant not to exceed a specified carbon dioxide emissions limit. This will effectively mean no new coal-fired plant can be built after the Bill has been enacted unless equipped with carbon capture and storage technology.

Decarbonisation target: a proposal to include a target of zero carbon in generation for 2030 reportedly split the coalition in the run-up to publication of the Bill. The renewables industry prized a target because this would set a clear policy objective in favour of green energy. The Treasury, though, feared it would result in unacceptable increases in consumer energy costs.

The Treasury apparently won the argument, because the Energy Bill does not include a carbon target for 2030. Instead, Decc says a decarbonisation target range for 2030 might be set in secondary legislation, although a decision on this will not be taken until after the Climate Change Committee has provided advice in 2016 on the fifth Carbon Budget.

Wholesale market reform: a lack of liquidity has been a consistent feature of the British wholesale electricity market for some time, although there has recently been limited improvement in traded volumes. Given that the proposed new FIT CfDs will provide only top up payments to low-carbon generators, it is still necessary for the developers of new generation to find buyers for their power and, for funding purposes, long-term contracts are generally required. The government has recognised that further market intervention may be necessary to address this issue and has included powers in the Energy Bill to modify electricity generation licences and retail supply licences for these purposes.

So, other aspects of the Energy Bill aside, on EMR alone there is still rather a lot to do in terms of detailed design work. Plus there are continuing consultations in a number of areas related to the main reforms – such as incentive measures for demand reduction – which might result in additions to the Bill. If EMR is to be implemented by 2014 as planned, there is little time to lose in preparing the enabling legislation.

Mark Bartholomew is a partner in the energy team at SGH Martineau

This article first appeared in Utility Week’s print edition of 14th December 2012.

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