ELECTRICITY MARKET REFORM (EMR) & THE ENERGY BILL INENCO OVERVIEW

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1 ELECTRICITY MARKET REFORM (EMR) & THE ENERGY BILL INENCO OVERVIEW February 2014

2 ELECTRICITY MARKET REFORM (EMR) & THE ENERGY BILL The Energy Bill is the government s flagship energy policy. There have been talks of this happening for nearly a decade, but it s only over the last few years that the urgency and need for change has occurred. Why Is It Happening? The context of the Energy Bill is essentially a response to four key issues being faced by the UK Energy sector at present: Carbon Reduction Targets The government is committed to a 20% reduction in carbon emissions by the year 2020 benchmarked against 1990 levels. What is the lowest cost way of doing this? A Generation Gap The UK is losing approximately 25% of its generation capacity over the next 10 years. How does the UK stop this happening? Increasing Demand The UK population is growing, and a tentative economic recovery is underway, therefore demand is forecast to increase. How do we meet the increase in demand? Security of Supply The UK needs a stable baseload of power generation in order to prevent rolling black outs. The rise of solar and wind generation capacity provides low carbon generation but this technology is intermittent; the UK needs guaranteed generation. How do we achieve this? What Is It? The Energy Bill is a broad policy with Electricity Market Reform, being the key policy within this. There are four main strands to this: Low Carbon Generation This is the key part of the legislation; it will focus on reducing the cost of renewable subsidies. This is to see the introduction of the Contracts for Difference (CfD) replacing the existing Renewables Obligation (RO) scheme (the Feed In Tariff Scheme will remain in place for smaller projects). Capacity Market This is aimed at keeping the lights on. With a fleet of ageing power plants, the cost of running some of these less efficient plants is no longer economical. The capacity market will try to address this through payments to generators available at peak capacity and during triad periods in the winter. Carbon Floor Price Whilst this has been in effect since April 2013, this is part of the government s work towards achieving the reduction in carbon emissions. The carbon floor price is aimed at supporting carbon prices and will rise year on year until 2030.

3 Emissions Performance Standard This is another strand of the government s aim to reduce the amount carbon dioxide emitted by the UK. Its aim is to clean up the UK s power generation facilities so that they are less pollutant than they have been previously. In essence, the government s aim is to move us away from coal-fired generation and toward renewable, nuclear and gas-fired generation. Low Carbon Generation At present, the UK offers subsidies in the form of the Renewables Obligation Certificates (ROCs) and Feed In Tariff (FITs) payments to generators who produce renewable electricity. The government believes that there are several flaws within the current system, and is keen to reign in the costs associated with them. Currently, generators with a capacity above 5MW cannot choose FITs. Business customers ultimately pay for this through RO and FIT charges as part of the pass through costs. Under the new scheme to come into force from 2017 (although from 2014 onwards generators will have the choice to pick from the RO or the CfD scheme), projects over 5MW will be obliged to take the new Contracts for Difference. These contracts will offer a guaranteed price (known as the strike price) in /MWh for the power that is generated from renewable projects. The government tops up the difference between the strike price and the reference price, not from the price at which the generator sells the power, necessarily. Projects under 5MW will still be eligible for the FIT scheme, with payments made as they are at present through this scheme. The government believes that the scheme will ultimately reduce the cost to the tax payer and the energy buyer. As the wholesale price of power rises, the level of subsidy falls. The strike price also differs for technologies and decreases over time as, in theory, the cost of the technologies should fall over time. The final important difference between the RO and the CfD mechanism is the length of time that support is offered for. Under current arrangements, the generator gets the subsidies for a 20 year

4 period, with this subsidy linked to the Consumer Price Index (CPI). Under the CfD scheme, generators will receive 15 years of support linked to the Retail Price Index (RPI). Initially, customers are unlikely to see any change in the rate of pass-throughs charged on their bills. However, over time, with the caps on the budget that have been set, this will prevent further rises above that of CPI, but in the short to medium term, pass through costs are likely to increase. That is because the energy suppliers are charged for the payments to generators with the initial budget having been set at 7.6 billion, and therefore they pass through the costs of the payments to the end user. Capacity Market The capacity market mechanism proposed by the government aims to ensure that during the coming years, with supply margins falling in the power market, the lights stay on. With the economics of power generation seeing some forms of generation (namely older gas plants) becoming less economical and being mothballed, the aim of the capacity market is to ensure that they are available to generate power at peak times. The problem is likely to be exacerbated further, as we move through the decade and an even greater volume of wind and solar power is brought to the grid; the intermittent nature of this generation runs the risk of not generating when peak demand is reached, particularly solar during peak winter demand. Stopping the generation gap is to be done through payments to generators, the exact amount of which will not be known until the first auction happens in In theory, these payments will be attractive enough to prevent plants being mothballed, and keeping them online. Admittedly, particulars on how this will work are vague at present; this is due to the need for secondary legislation early in 2014 to implement this. As details become clearer, Inenco will issue further notes advising of the likely impacts. Our initial thoughts are that as this policy takes effect, the costs will ultimately be passed back to the consumer, possibly through a new pass-through charge. It is estimated that the initial costs of this will add around 2/MWh to pass-through costs from 2018 onwards. Carbon Floor Price This is being legislated for within the bill, however the carbon floor price was introduced from April this year. Its aim is to underpin the price of emissions by forming a top up to the cost of emissions, as traded through the EU Emissions Trading Scheme (EU ETS). The goal here, is to push the cost of emissions up in the hope of driving down the amount of carbon emitted by the UK as a whole. As such, each April, the carbon floor price is set two years in advance, and by 2030 this will be equivalent to 70/tonne.

5 Emissions Performance Standard This is primarily aimed at large-scale power plants and is legislation which prevents any power plants being built that emit over a certain amount of carbon dioxide per MW of electricity produced. This is unlikely to have any direct effect on bills. What it will mean, as we move through this decade, is that there will be less coal-fired power plants on the grid. This is likely to force the wholesale cost of power higher, as coal is the cheapest form of commodity-based generation the UK has. Ultimately, some of this risk can be mitigated by a risk management strategy, which Inenco can help with. What Will It Cost? Whilst there remain considerable uncertainties at present over the EMR framework, it is generally agreed that, initially at least, customers will have to pay. Although, the Department for Energy and Climate Change (DECC) counter this, by stating that from 2021 onwards, it will be saving customers money in real terms. The breakdown of how costs are expected to rise is as follows: Levy Control Framework the mechanism into which both RO and FIT currently pay into, which will include CfDs, is expected to increase to 16-17/MWh by Carbon Floor Price expected to add to the wholesale costs of power at an increasing rate, starting at 4/MWh this year, rising to 9/MWh by 2017/18. Capacity Market expected costs are around 2/MWh from 2018 onwards.

6 How Can Inenco Help? Inenco s qualified experts can help you prepare for and understand this initiative. We offer a Complete Energy Solution that is tailored to meet your company s requirements. Inenco can help you keep your energy bills down with effective energy procurement, targeted energy reduction and generation and a risk management strategy tailored to suit your business objectives. Contact your account manager, or Call Us on: to discuss your plans for EMR. Alternatively, please Us:

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