Electricity Market Reform

In late 2010 the Government proposed a new structure for electricity markets in the UK, described as the most radical reforms for 20 years.  After consultation, detailed ideas were set out in a 2011 White Paper, Planning our electric future –
a White Paper for secure, affordable and low-carbon electricity.

What we want from our electricity supply industry

We need four things from our energy (and electricity) systems: 

  • secure and reliable supplies;

  • economically effective supplies;

  • environmentally acceptable supplies;

  • politically and socially acceptable supplies.

There are two challenges which underlie and complicate energy policy.  First, it is rare to find any single policy that delivers on all of these requirements at the same time.  Secondly, over time the relative importance of these four requirements can change.

Electricity Market Reform

The reforms to the market outlined in the 2011 White Paper  aim to create more long-term confidence that investment in new power stations, especially low-carbon sources like nuclear power and renewables, will lead to acceptable levels of profit for investors prepared to commit the necessary huge sums for long periods of time.

The main measures are: 

  • a way of guaranteeing companies investing in low carbon electricity sources a predictable price for their power output (‘feed-in tariffs with contract for difference’);

  • a guaranteed minimum financial penalty for companies releasing greenhouse gases, mainly carbon dioxide, into the atmosphere, with the likely effect on climate change (‘carbon price floor’);

  • a maximum amount of carbon dioxide that could be released from a new power station per unit of electricity produced (‘emissions performance standard);

  • rewards for companies which have capacity available at times of high demand even if that capacity is not called on to generate and so makes money from selling the output (‘capacity mechanism’);

  • measures to make it easier for companies to enter the electricity supply field, so making it more competitive (‘market liquidity measures’).

More details are given below.

Feed-in tariffs with contract for difference (FiT CfDs)

The White Paper suggests replacing the current scheme of subsidy for renewables – the Renewables Obligation (RO) – with long-term contracts in the form of FiT CfDs.  FiT CfDs will offer 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 FiT CfDs will be ‘two-way’ – if market prices are lower than the ‘reference’ or ‘strike’ price then low-carbon generators will get an extra payment, but if the market prices become higher the low-carbon generators will have to pay some back.  In effect this offers investors the comfort of a more or less fixed price, but at the cost of preventing them from making large profits when market prices rise significantly above that fixed price.

The carbon price floor

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

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

Emissions Performance Standard (EPS)

The Emissions Performance Standard is to be set at an annual limit equivalent to 450g of carbon dioxide per kWh generated for new power stations.  This will provide a clear signal of the amount of carbon that new fossil-fuel power stations will be allowed to emit.  The EPS is targeted at coal-fired power stations (CCGT in general already meets this standard) to reinforce the existing requirement that no new coal-fired power stations can be built without carbon capture and storage (CCS) technology.

A capacity mechanism for generators

In order to ensure security of supply the government will introduce a new capacity mechanism for generators – essentially a financial reward for back-up power plants.  Two possible options have been suggested – a targeted mechanism focused on capacity which is used in certain extreme circumstances only, or a market-wide mechanism where all providers are given incentives to offer reliable capacity.

A new institutional framework

To support these new measures the White Paper proposes 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) will need to be accountable, independent, credit worthy, technically expert, commercially and financially skilled and value for money.  The new framework would be designed to increase investor confidence in the operation of the market by ensuring that necessary resources are available and reducing any perceived interference of the government in how the market is operating from day to day (or year to year), while making clear that the government will continue to be responsible for setting policy.

Market liquidity

The White Paper identifies a number of barriers to companies wanting to get involved in 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 there being enough competing companies for the market to work efficiently.  Ofgem (the regulator) and the government will work closely together to increase market liquidity.

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