Electricity Market Reform

In December 2013 the Energy Bill received Royal Assent, becoming the Energy Act 2013. This was a significant milestone which laid the way for Electricity Market Reform (EMR) to provide the UK with secure, affordable, diverse and low-carbon electricity. EMR gives the certainty investors require to consider investments, making the UK one of the best places in the world to invest in new nuclear.

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 made through the Energy Act address these challenges.  The reforms deliver long-term confidence that investment in new capacity, especially low-carbon sources like nuclear power and renewables, will deliver a fair price for the consumer and a fair return for the investor.

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 Energy Act brought in long-term contracts in the form of Feed in Tariffs with Contract for Difference (CfD). This mechanism offers 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 CfD is ‘two-way’ – if market prices are lower than the ‘reference’ or ‘strike’ price then low-carbon generators will receive a top-up payment. If the market price increases (above the strike price) then the low-carbon generators will have to refund the consumer. 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

As of 1 April 2013 the Carbon Price Floor (CPF) came into effect. Launched at £16 per tonne of carbon dioxide, with the price expected to increase annually to 2020. In the March 2014 budget, amendments were made, with the decision to cap the CFP at £18 per tonne from 2016 to 2020; this was to help limit the competitive disadvantage faced by business and reduce energy bills for the consumer.

CPF imposes 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 Energy Act established an EPS to limit carbon dioxide emissions from new fossil fuel power stations. The EPS has been set an annual limit of 450g of Carbon Dioxide per KWh for a new power station operating at baseload. This provides 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

The Capacity Market will ensure the future security of our electricity supply by ensuring that sufficient reliable capacity is in place to meet demand – essentially a financial reward for back-up power plants. The Capacity Market works by offering all capacity providers (new and existing power stations, electricity storage and capacity provided by voluntary demand reductions) a steady, predictable revenue stream on which they can base their future investments. In return for this revenue (capacity payments) they must deliver energy when needed to keep the lights on, or face penalties.

A new institutional framework

The Government has established two bodies to administer and run the mechanisms discussed above. The CFD Counterparty Company will manage long-term Contracts for Difference. The Electricity Settlements Company will facilitate payments under the Capacity Market agreements.

The CFD body is headed up by Dr Martin Read CBE and came into existence on 1 August 2014.The Electricity Settlements Company is headed up by Jim Keohane. Both bodies will work collaboratively to reflect the fact that the companies will share a number of features and services, and should minimise their cost to industry.

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