Hill+Knowlton Strategies

Following the Queen’s Speech, today the Government publishes its landmark piece of legislation to reform the electricity generation market in the UK. The draft Energy Bill contains the long-awaited Electricity Market Reforms, which are intended to provide the support necessary to balance future electricity generation over a mix of energy sources in order to reduce dependence on any one source and to meet carbon reduction targets. Against a challenging economic backdrop and with a fifth of existing generating capacity due to be retired from the grid in the next decade, these reforms are critical to ensuring the lights stay on while meeting our commitments to cut carbon emissions.

Overview

The key part of the Electricity Market Reform (EMR) are ‘market mechanisms’ designed to transform our generating capacity. The first of these is the introduction of Feed-in-Tariffs with Contracts for Difference (CfDs), long-term instruments designed to provide stable and predictable incentives for companies to invest in low-carbon generation. This will replace the system of Renewables Obligations (RO), which is due to end in 2017.  DECC has also committed to working with industry on Final Investment Decisions (FID) Enabling to enable some investment to begin in advance of the CfD regime coming into force. The second is an Emissions Performance Standard (EPS) that will limit carbon dioxide emissions from fossil fuel power stations by setting emissions standards for all new fossil fuel powered generation. This will prevent the construction of new coal plants which emit more than 450g/kWh.

Further support for the market mechanisms is the introduction of a Carbon Price Floor. This was announced by the Chancellor in the 2011 Budget and was introduced in the Finance Bill. This provides a clear economic signal to move away from high carbon technologies by increasing the price paid for emitting carbon dioxide. It places an initial value on the price of carbon of around £16/tCO2 (2009 prices) in 2013, which will rise to £30/tCO2 (2009 prices) by 2020. This will be complemented by a Capacity Market that will, if required, provide security of electricity supply by ensuring sufficient reliable capacity is available.

The measures are set to increase consumer bills, although the Government argues the rises will be less than if the UK carries on without reforms. The Department of Energy and Climate Change estimates the average bill will increase by GBP160 by 2030 instead of the GBP200 rise predicted if the market is left as it is. The costs of this investment will preoccupy media interest today and in the coming weeks, especially as consumer bills continue to rise and incomes tend to fall. One aspect of energy policy that will be critical to ensure that the cost increases stay within Government targets is the drive to improve the energy efficiency of the UK’s housing stock, and therefore reduce energy usage. The Green Deal is not part of the Energy Bill, but will be very important to achieving the Government’s affordability ambitions.

In addition to EMR, the Energy Bill also aims to ensure that Government and regulator Ofgem are aligned at a strategic level through a Strategy and Policy Statement (SPS). The Bill also establishes a new nuclear regulator, the Office for Nuclear Regulation, to regulate the building of new nuclear power stations. Finally, the Bill contains provisions that will enable the sale of the Government Pipeline and Storage System (GPSS). The Parliamentary Under Secretary of State for Defence Equipment, Support and Technology, at the Ministry of Defence provided a separate Written Ministerial Statement about this.

Gas

The Government have said that gas will continue to play an important role in the transition to a low-carbon economy, to provide flexibility and help maintain security of supply. A separate strategy on the role of gas will be published in autumn 2012. This is the subject of a public consultation and the deadline for submissions is 28^th June 2012. Also the Government announced earlier this year that the Emission Performance Standard for gas fired power stations in the UK that will allow them to continue to operate until 2045. Gas may well play a critical role in filling any gaps in supply created by a delayed roll out of the EMR.

Nuclear

The introduction of CfD for nuclear, together with other forms of low-carbon generation, is an important part of the Government’s plans to support the construction of new nuclear capacity. Some commentators have suggested that the EMR has been designed firstly to accommodate the nuclear consortia that are bidding to build new nuclear reactors, to the detriment of other energy sources. This is primarily because the Government have stuck to their no subsidy line for nuclear. This appears to provide very positive reading for nuclear and DECC appear very ready to engage with project developers in the short term before CfD comes into force. This will be welcomed by EDF Energy, who today suggested that they may apply to extend the life of their existing nuclear power stations.

Renewables

The CfD is seen by many commentators as favouring developers of larger renewables projects, but as an industry the EMR will be welcomed as a first step to providing the investment certainty required to build new capacity, especially the third round of offshore wind. For developers though the devil will be in the details and there remain some questions about issues like the tenure of CfDs, the details about contracting parties on CfDs, but perhaps most importantly around the proposed timeline for implementing EMR. The industry suggests these timelines look ambitious. The CfD must be in place to support investment decisions before the end of the RO, which currently expires in 2017.