Electricity Market Reform

Transcription

1 npower Roundtable on the Electricity Market Reform Capacity Mechanism and Contracts for Difference UK Business speaks: A call for certainty 22 April 2013

2 This report summarises and outlines key concerns and expectations of some of the UK s largest businesses, as discussed at npower s recent roundtable on the Capacity Mechanism and Contracts for Difference (CfD), which took place on 22 April As such, it has been discussed with DECC and BIS for consideration as part of their ongoing EMR design discussions.

3 Contents 1.0 Introduction Executive summary Roundtable discussion 1. Capacity Mechanism 2. Contracts for Difference 3. Electricity Market Reform Conclusion and recommendations Next steps Appendices i. About the Electricity Market Reform ii. Roundtable presentations Electricity Market Reform 1

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6 1.0 Introduction npower is committed to giving businesses a voice on UK energy market legislation and has been at the forefront of engaging business on the Electricity Market Reform (EMR) since it was first proposed in Giving businesses a voice in the Electricity Market Reform The purpose of EMR is to reform the UK electricity market to attract the investment needed to replace the ageing energy infrastructure and meet future increases in electricity demand. To ensure that businesses have a voice in this process, npower has worked on its customers behalf to ensure their views are heard within Government and have contributed at each design stage of legislation. To date npower has: Held customer roundtables in February 2011 and October 2011 Conducted its own consultation to ensure time-poor businesses had their say during the process Presented its findings to DECC. RWE, npower s parent company, is in the unique position of sitting on all of DECC s Expert Groups for EMR, including the groups responsible for the design of Capacity Mechanism and Contracts for Difference. This provides the opportunity for npower to offer expert knowledge on EMR to customers, as well as the inside track on latest government thinking. This latest roundtable event debated the current EMR proposals under design discussion the Capacity Mechanism and Contracts for Difference (CfD). More background on these policy areas can be found in Appendix i. The roundtable followed recent npower-hosted customer events where other key pieces of legislation affecting business consumers were discussed and debated. Topics included Feed in Tariffs, the Carbon Reduction Commitment, and the Energy Intensive Industries compensation package. Following each event, a report was produced, submitted to and discussed with Government to ensure businesses had their voices heard in each consultation. Capacity Mechanism & Contracts for Difference roundtable The Capacity Mechanism and Contracts for Difference (CfD) roundtable took place on 22 April 2013 and was hosted by Wayne Mitchell, Industrial and Commercial Sales and Marketing Director at npower. Presenters were: Fergal McNamara, Head of Capacity Market Design at the Department for Energy and Climate Change (DECC), who provided an overview of the Capacity Mechanism Paul Dawson, Head of Market Design and Regulatory Affairs at RWE Supply & Trading (RWEST), who provided an overview of how the Capacity Mechanism will affect UK businesses Arjan Geveke, Assistant Director of Energy Policy at the Department for Business, Innovation & Skills (BIS), who provided an overview of electricity intensive user exemptions for CfD Mary Teuton, EMR Project Manager at RWE npower, who provided an overview of the Contracts for Difference Supplier Obligation Further details on all presentations can be found in Appendix ii. 4 npower Roundtable

7 Introduction 1.0 The roundtable was attended by 20 delegates, of which 14 were major energy users, energy consultants and key industry stakeholders: Government representatives Arjan Geveke Assistant Director of Energy Policy, Department for Business Innovation & Skills (BIS) Fergal McNamara Head of Capacity Market Design, Department for Energy and Climate Change (DECC) npower Wayne Mitchell Industrial and Commercial Sales and Marketing Director, npower Paul Dawson Head of Market Design and Regulatory Affairs, RWE Supply & Trading (RWEST) Mary Teuton EMR Project Manager, RWE npower Ian Preston Head of Direct and Technical Sales, npower Major Energy Users Senior Energy Manager Major Energy User in the Building Materials Industry Rob Williams Head of Energy Supply, BT Senior Energy Manager Retail Sector Senior Energy Manager Retail Sector Angus Berry Energy Manager, Thames Water Senior Energy Manager Major Industrial Company Simon Russell Manager UK Electricity Supplies, Tata Steel Senior Energy Manager Major Fashion Retailer Senior Energy Manager Major Car Manufacturer Peter Beveridge Energy Efficiency Manager, Scottish Water Energy consultants Bruce Toper Head of Energy Procurement, EnergyExcel Andrew Horstead Head of Commodities Research, Utilyx Industry Stakeholders Policy Advisor Leading Business Representative Karthik Suresh Operations Director, the Energy Services Partnership Electricity Market Reform 5

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9 2.0 Executive Summary Electricity Market Reform 7

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11 2.0 Executive summary It was clear from the roundtable that businesses are worried about the Capacity Mechanism and view the scheme as complex and unwieldy. Views on the Capacity Mechanism Businesses are calling for more clarity on how the scheme will work and how this will impact on business particularly those making long-term investment decisions. The key concerns raised in the roundtable were: Cost uncertainty and impact on budget forecasting Businesses are unclear about how the Capacity Mechanism will affect energy prices, how they can respond to the costs associated with it and how this uncertainty will affect crucial planning cycles. Lack of confidence in the aims of Capacity Mechanism and scheme longevity the effectiveness the Capacity Mechanism was hotly debated and key questions were asked about whether the scheme will be successful in generating new capacity, whether the incentives will be effective enough, how it will work alongside other energy market mechanisms and how success will be measured. Lack of understanding of how the scheme will work in general, businesses find the scheme complex to understand and need fundamental questions about how the scheme will work answered by Government. Views on Contracts for Difference (CfD) The clear message from businesses on the CfD is that they need certainty over its costs, preferring a fixed CfD cost to a variable one. Businesses also want assurances that the CfD market will be transparent. The key concerns raised in the roundtable were: Cost uncertainty Businesses at the roundtable had many questions and concerns related to the cost implications of CfD, which largely focused on the need for fixed costs, the administrative burden it would create, and a call for exemptions for energy intensive industries. Investment uncertainty Some businesses with potential to invest in new generation are uncertain as to whether to progress, without clarification of the value of CfD. There is also concern about the impact of CfD on UK competiveness in the global market and the impact this will have on parent company investment in the UK. Market transparency Businesses are calling for assurances that the CfD market will be transparent. Views on the Electricity Market Reform Ongoing uncertainty around the EMR is undermining current business investment and putting off future investment. The key concerns raised in the roundtable focussed on: UK competitiveness There is real concern about the impact of EMR on the competitiveness of UK businesses with EU counterparts and within the global marketplace. Political uncertainty Businesses are asking what is being done to secure the longevity of EMR. What is to stop future governments from changing the legislation again? Electricity Market Reform 9

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13 3.0 Roundtable Discussions Electricity Market Reform 11

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15 Roundtable discussion 3.0 One of the main areas of interest to attendees was the basis for payment and it was indicated that DECC was closely considering triad peaks as a charging methodology 3.1 Views on the Capacity Mechanism DECC Overview What is the Capacity Mechanism? Fergal McNamara from DECC discussed how the Capacity Mechanism a market-wide mechanism designed to give electricity generators financial incentives to provide adequate, reliable capacity has been created to address the security of the supply challenges facing the UK. He set out how closure of existing generation plant, coupled with tightened capacity margins, have led to a need for government intervention to incentivise the generation capacity that the UK needs over the coming decade. Fergal presented the high-level design of the Capacity Mechanism, from the Reliability Standard that will be established by Government to set the net amount of capacity which is needed to ensure security of supply, through to the auction, trading, delivery and payment stages of the market. One of the main areas of interest to attendees was the basis for payment and Fergal indicated that DECC was closely considering triad peaks as a charging methodology, which would then be recouped by suppliers. More detail on the Capacity Mechanism design can be found in Appendix ii. What are the key milestones for the legislation? Fergal explained that the design of the Capacity Mechanism is going through the House of Commons as part of the Energy Bill, before going on to the House of Lords, and is expected to achieve Royal Assent in December He also detailed how DECC has been working with industry stakeholders to try to finalise a design for a capacity market with the aim of running the first auction in 2014 for capacity delivery in Fergal also noted that the draft Delivery Plan of how the Capacity Mechanism will work will be published in July 2013, with a final version published in December of this year. Electricity Market Reform 13

16 3.0 Roundtable discussion There are concerns that the timescales are too tight to implement the Capacity Mechanism, especially with many details still yet to be decided and the consultation response not due until Spring 2014 The Supplier View Implications of the Capacity Mechanism for business Paul Dawson, Head of Market Design & Regulatory Affairs for RWE Supply & Trading (RWEST), which is part of the RWE group, went on to discuss how the Capacity Mechanism will impact the UK energy market and major energy users. He discussed how RWE has several key concerns about the impact of the mechanism, including: i. Cost to consumer - The Capacity Mechanism will come at a price, and these costs will be passed on to energy users. Its design is yet to be finalised but RWE is concerned that this additional cost will further add to the burden on UK businesses, with the cost to end-users being disproportionately high, relative to the energy security risk. The proposed Capacity Mechanism design also risks encouraging the building of new plant instead of using existing plant, given that DECC is minded to award longer term contracts to new plant, which is, again, a more expensive way to secure capacity ii. Investor confidence - There is an argument that says that having a Capacity Market actually reduces the perceived need for one. This is because a Capacity Mechanism would increase the cost and lower demand for energy at times of energy scarcity, reducing the need for the Capacity Mechanism to come into play. This could create uncertainty among investors. Additionally, while the Capacity Mechanism is aimed at supporting investor confidence, any new scheme that is introduced undermines previous ones on which investment decisions had already been made. This can create a general lack of confidence going forward. It also defers potential investment while policy decision-making is ongoing. iii. Design evolution during implementation phase - There are concerns that the timescales are too tight to successfully implement the Capacity Mechanism, especially with many details still yet to be decided and the consultation response not due until Spring As a result, if there are issues in the design, there may not be time to address them within the current timeframes. iv. European approval and integration - The Capacity Market requires State Aid approval from the EU, but the EU is concerned about individual state interventions in energy markets in case they lead to the dilution of the single internal energy market they have been working on for 10 years. The EU is therefore considering what role individual state interventions can play and how they will fit into their overarching vision. 14 npower Roundtable

17 Roundtable discussion 3.0 Paul did, however, stress that the Capacity Mechanism also offers opportunities for businesses: i. Demand side response within the Capacity Mechanism - Businesses can generate additional revenue by participating in the demand side response part of Capacity Mechanism (where consumers can bid to reduce their demand at periods of system stress). ii. Indirect demand side response - Based on the current thinking regarding the Capacity Mechanism Supplier Obligation, there may also be opportunities to reduce costs via load management (through the avoidance of costs such as triads or equivalent Capacity Mechanism costs). However, it was noted that while some of these benefits are attractive for business, RWE considers that businesses would have had access to similar benefits in the existing UK energy market. The Business View Summary It was clear from the roundtable that businesses are worried about the Capacity Mechanism and view the scheme as complex and unwieldy. The topic was hotly debated at the roundtable, with key industry stakeholders, major energy users and consultants all expressing real concerns about the scheme, questioning how it works, the lack of cost certainty associated with it, and confusion about how it sits alongside other legislation with similar aims. The key concerns raised in the roundtable were: Cost uncertainty and impact on budget forecasting Lack of confidence in the aims of Capacity Mechanism and scheme longevity Lack of understanding of how the scheme works Detailed views Cost uncertainty and impact on budget forecasting It was understood from Fergal s presentation that the impact on costs would be two-fold - initially the Capacity Mechanism is expected to reduce wholesale costs. However, it would also incur an additional charge on customer bills to pay for the scheme itself as a non-commodity charge. Businesses are unclear about how the Capacity Mechanism will affect energy prices and how they can respond to costs associated with it. The clear and passionate message from businesses at the roundtable is that any costs associated with the Capacity Mechanism need to be communicated as early as possible by Government so they can be factored into energy and business planning cycles. This point was reiterated by most at the roundtable, as the necessity for known costs is paramount in helping to build robust business cases for investment in energy efficiency - a crucial element of meeting the UK s climate change targets. It was also highlighted how this is particularly important in regulated industries such as the water sector. Electricity Market Reform 15

18 3.0 Roundtable discussion Angus Berry Energy Manager for Thames Water Senior Energy Manager Major Industrial Company Rob Williams Head of Energy Supply for BT Bruce Toper Head of Energy Procurement for EnergyExcel We work on a five year business plan cycle so having a five year window to plan for any changes is really essential to us. Will we know what the charges for the Capacity Mechanism will be in advance so we can forecast these costs or invest in ways to reduce our capacity at peak times? Quite often all these costs come too late and we re left making guesses in our business plans. There may be a reconciliation mechanism proposed for the Capacity Mechanism but some sort of cost certainty would help us with our business planning. The pace at which we re moving forward on cost certainty is what frustrates us the most. I think it s important that we have visibility of what the costs will be as early as possible so we ve got it in our planning cycle. Businesses also expressed real concern about how the additional pass-through charges associated with the Capacity Mechanism will impact on the different elements of their bill. As the wholesale price element is proportionally reduced, so is the businesses ability to manage price risk through flexible purchasing arrangements. How will these costs affect the split between the wholesale price and all the other charges? Wholesale prices are getting proportionally smaller and smaller as time goes on because of all these additional charges. 16 npower Roundtable

19 Roundtable discussion 3.0 Is there any evidence or analysis showing that the proposed Capacity Mechanism will achieve its aims of ensuring a reliable UK energy supply? Peter Beveridge Energy Efficiency Manager for Scottish Water Senior Energy Manager Major Fashion Retailer Lack of confidence in the aims of Capacity Mechanism and scheme longevity A major topic for discussion was how robust the Capacity Mechanism will be and whether it will actually be effective in achieving its aim of providing adequate, reliable capacity at times of peak demand. Businesses are keen to know if there is any evidence or analysis showing that the proposed Capacity Mechanism will achieve its aims of ensuring a reliable UK energy supply. The broad concerns surrounding the aims of the scheme fall into four main areas: i. Will it successfully generate new capacity? Businesses at the roundtable were unconvinced that the proposed Capacity Mechanism design will be successful in creating new generation sources. Many sought reassurances from Government on how the mechanism will actually create new generation, and real and lasting energy security for the UK. Is there any analysis to prove that the Capacity Mechanism will be successful in attracting generators to provide capacity to the UK? What are we going to get out of the Capacity Mechanism in terms of energy security? Will it be a service that is largely similar to what we have now? In terms of political pressure then, if you re telling me that we are going to pay more for electricity, have more likelihood of brown-outs and we re not going to get any protection from the penalty scheme, that puts a case for us to start trying to apply political pressure to scrap the whole scheme. I think if you apply that to industry-wide service sectors, generation, manufacturing, I don t see this scheme lasting. I think this will be another CRC where we will get two years into it and it will be binned by a new minister. Electricity Market Reform 17

20 3.0 Roundtable discussion ii. Are the incentives effective enough? There was also debate around whether there will be sufficient incentives and penalties within the capacity market to ensure it is effective and generators stick to their obligations to help balance the grid. Senior Energy Manager Major Fashion Retailer Senior Energy Manager Major Industrial Company Senior Energy Manager Retail Sector Simon Russell UK Electricity Supplies Manager for Tata Steel My concern is that the capacity market won t be of any worth to us as end users. For example, if I lose 50% of my revenue stream at peak selling because the power capacity has failed and the relevant generator is fined, and you give me my remuneration based on expected demand, that s not going to be equivalent to my loss of selling. So I don t see that there s an incentive there to guarantee that capacity on the power grid. So are we going to face higher payments for electricity, have a higher likelihood of brown-outs and also not have any protection from the penalty scheme? iii. Will it work alongside other energy market mechanisms? Businesses at the roundtable were confused about how the Capacity Mechanism and triads would work together. Businesses that have the ability to turn down consumption during peak triad periods can make significant financial savings in transmission charges. Presumably we can assume that the Capacity Mechanism will have a higher cost than triad charges - otherwise there s not much point in doing it because triads provide a cost effective mechanism already. So, why go through all the trouble of creating another mechanism to stop your peak demand? I can see the benefit in switching things off in peak triad periods and making savings through energy efficiency. However, I don t think we re going to see the same sort of benefit from a capacity-style market just focussing on the same periods as triads. Our sites already have massive incentives to avoid the peak periods now with balancing cost, distribution and transmission tariffs. But we would be receptive of any optional schemes to gain additional benefits. Businesses were also concerned that raising investment to support participation in the Capacity Mechanism as a small-scale generator will be difficult, as company boards no longer have confidence in the longevity of energy initiatives. STOR was cited as an example of where energy managers succeeded in raising investment. However, as the Capacity Mechanism is being introduced before the benefits of STOR have been fully realised, it will be a very difficult for businesses to sell to their boards to secure the necessary funds to support. 18 npower Roundtable

21 Roundtable discussion 3.0 iv. How will success be measured? In addition, due to the long timeframes between auctions and delivery dates it will be some time before it is clear if the schemes are successful or not. Businesses are also concerned that by the time the results are known, many auctions will already have taken place, making it difficult to build in effective scheme improvements. Senior Energy Manager Major Industrial Company Simon Russell UK Electricity Supplies Manager for Tata Steel Because capacity is provided with a delivery date that s four years in advance, it s going to be the fifth or the sixth Capacity Mechanism auction before you can tell if the process is right. So, how do you know in the second year of auctions, before any capacity has been delivered, if the system works? You won t know what the problems with the system are because delivery of the first power still won t have happened. Is there a risk that we end up in some kind of feedback loop with the Capacity Mechanism? As time goes on, could we keep reassessing our future energy capacity and keep finding an insufficient supply, so we would need to keep going for more and more capacity. Eventually this becomes the way we build all power stations in the UK and we end up chasing our tail. Electricity Market Reform 19

22 3.0 Roundtable discussion Lack of understanding of how the scheme will work It was clear that businesses have fundamental questions about how the scheme will work, with much of the debate focusing on key questions about the design of the mechanism and its impact on major energy users. Senior Energy Manager Retail Sector Bruce Toper Head of Energy Procurement Response by for EnergyExcel Fergal McNamara Head of Capacity Market Design for DECC Simon Russell UK Electricity Supplies Manager for Tata Steel For example, businesses are unsure whether participants in the capacity market are judged on a site-by-site or whole organisation basis. I m not clear on the criteria planned to be used to determine the charges on end users. Is it going to be based on peak demand and will it be like triads or will there be some other way of determining this peak demand? Will suppliers bid on volume on a plant-by-plant basis or as whole organisations? Would smaller generators be able to bid on volume or would the market be restricted to large suppliers? It would be helpful if there was more to be done for small users on a portfolio basis rather than by a plant-by-plant basis. That might be possible in subsequent years, but in the early years we are very focused on investment so it will be done on an organisation basis. Businesses are also asking for exemptions from the cost of Capacity Mechanism for intensive users. Exemptions have not currently been planned into the Capacity Mechanism design. This seems illogical as big energy intensive users are baseload users, yet the reason for the Capacity Mechanism is for intermittency cover and major energy users are not contributing to intermittent peaks in demand. So, there is a strong argument for energy intensive exemptions in the Capacity Mechanism. 20 npower Roundtable

23 Roundtable discussion 3.0 At present, npower estimates the impact of the CfD to be between 5 and 10 per MWh - so it is a very significant cost. 3.2 Views on Contracts for Difference (CfD) BIS Overview Arjan Geveke, Assistant Director of Energy Policy at the Department for Business, Innovation & Skills (BIS), provided an overview of energy intensive exemptions for CfD. He detailed how Government intends to exempt electricity intensive industries from additional costs arising from new long-term contracts for difference designed to bring on investment in low carbon power plant, such as nuclear power stations and wind farms. He went on to discuss how the scope of the exemption is currently being considered by DECC and BIS, who will run a consultation in 2013 once the proposed exemption has been further developed. The exemption will require State Aid clearance from the European Commission. More detail on CfD can be found in Appendix i & ii. The Supplier View Implications of Contracts for Difference (CfD) for business Mary Teuton, EMR Project Manager at RWE npower, discussed how the CfD will impact the UK energy market and major energy users. As the final CfD Supplier Obligation is not yet finalised, it is unclear as to how electricity suppliers intend to manage CfD. However, Mary explained how npower is committed to approaching the CfD in a very open and transparent manner. It intends to pass the costs of the CfD through to all customers equally (save for any exempted industries) and industrial and commercial customers will be able to see CfD costs as a separate line item on their bills. At present, npower estimates the impact of the CfD to be between 5 and 10/ MWh so it is a very significant cost. Once strike prices are known in July it will be possible to calculate a more accurate figure. npower also discussed how it is pushing strongly for a fixed rate CfD set by DECC, with any under / over recovery factored into the next period s rate. The key reasons for this approach are that it: Reduces costs to the consumer as it negates the need for suppliers to build in any risk premium Reduces monthly volatility of bills Provides transparency and visibility of price and volume information with early / timely publication of information, supporting budget forecasting for end users Will be the easiest to implement (and hence lowest cost) Provides a level playing field across competitors (removing any confusion when comparing suppliers). Electricity Market Reform 21

24 3.0 Roundtable discussion To ensure cost certainty - which is fundamentally important for businesses - there should be a fixed cost for CfD, not a variable one. The Business View Summary While businesses are largely supportive of the Government s broader aims to move to a low carbon future, it was again apparent during the discussions on CfD just how concerned and confused they are about ongoing policy developments. Fundamentally, businesses are unsure of the aims of the scheme and how they translate into what they are doing in their own business. The key concerns raised in the roundtable were: Cost uncertainty Investment uncertainty Market transparency Detailed Views Cost uncertainty: Businesses at the roundtable had many questions and concerns related to the cost implications of CfD, which largely focused on the following four areas: - Fixed costs are needed - Administrative costs - Exemptions needed - Impact on Power Purchase Agreements (PPAs) i. Fixed costs are needed The sentiment from the businesses attending the roundtable was clear and unanimous. To ensure cost certainty which is fundamentally important for businesses there should be a fixed cost for CfD, not a variable one. There was a feeling that Feed in Tariffs a variable rate had caused issues in 2012 in terms of interpreting the number, forecasting the budget required and the practicality of asking for additional funds from their boards to cover FiT payments, which had run into millions for some customers. Customers are therefore keen to avoid repeating this situation with CfD. Senior Energy Manager Major Car Manufacturer Senior Energy Manager Retail Sector Senior Energy Manager Major Industrial Company The complexity of the variable rate just gives us more work to do. We have lots of variable costs already, so adding to them would just make my job more difficult and most of us are looked at to provide price certainty as the main function of our roles. Businesses don t like taking risks so price certainty is key. 22 npower Roundtable

25 Roundtable discussion 3.0 ii. Administrative costs There are also real concerns that there will be heavy administration costs on business, particularly through the process of reconciling costs for CfD. Simon Russell UK Electricity Supplies Manager for Tata Steel Senior Energy Manager Major Car Manufacturer I m not sure I like this word reconciliation being used. I d much rather it was like distribution network charges so that if they under recover it goes into next year s charges and there is no reconciliation. I think reconciling costs would be difficult for cash flow forecasting and whatever mechanism you use would be very difficult to administer. iii. Exemptions needed There was also strong feeling that Government should endeavour to keep the costs down for electricity intensive industries as much as possible. The CfD exemptions were discussed and businesses attending the roundtable were concerned about which businesses will qualify for exemptions and the uncertainty over when there would be EU State Aid approval for these exemptions. In particular, there were calls for exemptions for vulnerable industries to protect UK competititveness. Senior Energy Manager Major Energy User in the Building Materials Industry While there may be potential CfD exemptions for energy intensive industries, they are subject to State Aid approval. Until this is finalised, we are still in the land of total uncertainty and unable to make any predictive planning in terms of our energy strategy. And it s how long uncertainty carries on for that is the real issue for us. Electricity Market Reform 23

26 3.0 Roundtable discussion iv. Impact on Power Purchase Agreements (PPAs) Businesses were also concerned that CfD could impact on their ability to secure Power Purchase Agreements (PPAs). Senior Energy Manager Retail Sector Angus Berry Energy Manager for Thames Water Angus Berry Energy Manager for Thames Water Senior Energy Manager Major Car Manufacturer The water industry is a long energy user so PPAs form part of our risk strategy. We need to know if our ability to get PPAs will be affected. How will this impact the ability of organisations to get PPAs? Investment uncertainty Some businesses with potential to invest in new generation are uncertain about whether or not to proceed, without clarification regarding the value of CfD. This is compounded by further questions regarding the longevity of the Renewables Obligation (RO) scheme and how this will be affected by CfD. There is big uncertainty if you try to do embedded renewable investment as a multi-site business, not knowing what the value of CfDs are. I can t make the business case because we don t really know what CfDs are worth. I d like to have more embedded renewable but I don t know if I should take Renewables Obligation certificates or go for CfDs? This is compounded by uncertainty if CfD s will be available for embedded generation, this all makes the investment case uncertain. Equally, organisations have to attract investment in the UK from their parent companies, often competing with sister companies or operations spread across the globe. There is concern that rising energy costs contribute to their UK business being less attractive in comparison with other countries that have fewer environmental levies included within their energy bill. We re looking to secure manufacturing operations within the UK rather than other countries in Europe. We need to plan three to five years ahead for this so any uncertainty over energy costs doesn t help our case for securing business here. 24 npower Roundtable

27 Roundtable discussion 3.0 Market transparency Businesses are calling for assurances that the CfD market will be transparent. There are real concerns about how the costs of CfD will be reconciled, with those at the roundtable worried there is a risk of the Treasury or energy suppliers holding money collected from the CfD scheme, and that any surplus will be lost rather than being reconciled. Senior Energy Manager Retail Sector Karthik Suresh Operations Director for the Energy Services Partnership CfD costs need to be transparent, so if the fixed price is too high or too low then there would be a reconciliation process and sufficient time to allow for this. If HM Treasury is responsible for managing CfD payments, is there a risk that consumers will not receive reconciliation payments? Electricity Market Reform 25

28 3.0 Roundtable discussion There is grave concern among businesses that the ongoing development of EMR is negatively impacting on the competitiveness of UK businesses in the EU and global marketplace. 3.3 Views on the Electricity Market Reform Summary As part of the discussion on Capacity Mechanisms and CfD, businesses also used the roundtable as a forum for airing their views on the broader Electricity Market Reform (EMR). The key concerns raised in the roundtable focussed on: UK competitiveness Political uncertainty Detailed Views i. UK Competitiveness There is grave concern among businesses that the ongoing development of EMR is negatively impacting on the competitiveness of UK businesses in the EU and global marketplace. This is due to two main reasons: - cost uncertainty is making the UK a risky place to invest - the UK is becoming an increasingly expensive place for energy intensive industries to do business. i. Cost certainty Businesses discussed the importance of understanding costs early enough to factor into forecasting and planning. The uncertainty of future energy costs in the UK makes it difficult for businesses to plan ahead, and makes other jurisdictions where there is cost certainty seem more attractive for long term investment in business operations. Senior Energy Manager Major Car Manufacturer We re looking to secure manufacturing operations within the UK rather than other countries in Europe. But, we need to plan three to five years ahead for this so any uncertainty over energy costs doesn t help our case for securing business here. Wider discussion on this point focused on how cost certainty is particularly important in regulated industries that are subject to increased energy efficiency legalisation. This is because known costs help all organisations build robust business cases for investment in energy efficiency - a crucial element of meeting the UK s climate change targets. 26 npower Roundtable

29 Roundtable discussion 3.0 ii. UK becoming too expensive for energy intensive industries The businesses represented at the roundtable are also experiencing growing concern that the cumulative effect of the cost of energy legislation is making the UK more expensive to do business, which could push energy intensive activities overseas. Senior Energy Manager Major Industrial Company What will the cost of these reforms be to UK businesses and how does that compare to our German competitors? German businesses already have a huge advantage over us. What s the distortion going to be? At the moment we don t know. It s less important to know what the costs of CfD and the Capacity Mechanism will be. It s the relative cost against our EU competition that matters. There was a collective call from businesses for the Government to provide far more certainty on how the proposed EMR schemes will work and what the cost impact will be. Energy managers around the table were unanimous in their conviction that certainty is key for them to efficiently plan their businesses energy use and budget. ii. Political Uncertainty Businesses are feeling jaded about the longevity of the proposed EMR schemes. Many feel that as other schemes have been proposed, launched, then ultimately watered down and/or changed, that there is much political uncertainty of what future governments may do. Senior Energy Manager Major Fashion Retailer In terms of political pressure, then if you re telling me that we are going to pay more for electricity, have more likelihood of brown-outs and we re not going to get any protection from the penalty scheme, that puts a case for us to start trying to apply political pressure to scrap the whole scheme. I think if you apply that to industry-wide service sectors, generation, manufacturing, I don t see this scheme lasting. I think this will be another CRC where we will get two years into it and it will be binned by a new minister. Electricity Market Reform 27

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31 4.0 Conclusions and Recommendations Electricity Market Reform 29

32 4.0 Conclusion and recommendations The overarching message from business is that EMR has left them feeling confused about the intricacies of how each part will work, and concerned about the impact on UK competitiveness. Overview npower fully supports the objectives of the EMR proposals, and recognises the need for the UK to have modern, efficient energy infrastructure with a diverse mix of technologies to ensure our economy can grow and compete globally. However, it is clear following the recent npower roundtable that the overarching message from business is that EMR has left them feeling confused about the intricacies of how each part will work, and concerned about the impact on UK competitiveness. Businesses are calling for: COST CERTAINTY - More information from Government on how each part of the EMR will impact on business in terms of financial and administrative cost. PROTECTION OF UK COMPETITIVENESS - Reassurances from Government that it is doing all it can to protect the competitiveness of the UK in the international marketplace. MARKET TRANSPARENCY - Greater transparency from Government on how EMR schemes will operate, with further details on how costs will be set and markets will be regulated. LONGEVITY - A system that will have longevity so that businesses are not affected by governments working within relatively shortterm parliamentary cycles. npower s recommendations Taking on the views expressed by its customers, npower recommends the following actions: Greater clarity on the detailed design of the EMR proposals is required urgently. While we welcomed the publication of the Energy Bill and Policy Updates in November 2012, many of the detailed Policy decisions have not yet been taken. Government may have met their legislative timetable, but final policy decisions on the key elements of the EMR the CfD and the Capacity Mechanism are still outstanding and are not expected until mid to late npower Roundtable

33 Conclusion and recommendations 4.0 We have particular concerns regarding the impact of the current proposed Capacity Mechanism design on it's affordability and impact on investor confidence. Cost and affordability to consumer is of paramount importance: Both the proposed CfD payment model and Capacity Mechanism will add costs to consumer. A fixed rate CfD Supplier Obligation will reduce the overall cost to the consumer We have particular concerns regarding the impact of the current proposed Capacity Mechanism design on its affordability and impact on investor confidence, specifically the discriminatory nature of it (different contract length for old and new plant, and exclusion of RO plant) - The proposed design of the capacity mechanism discriminates between new and old plant, resulting in huge inefficiencies that will cost the consumer between 2bn and 5bn over the proposed 10 year contract term (potentially rises to 7bn if the system is unnecessarily reliant on open cycle plant). 1 - The Capacity Mechanism should not undermine the value of recent investments in new plant made in response to efficient market signals if the government is to sustain investor confidence in the UK market going forward. We welcome the move to a single counterparty body for CfD payments, but now need to make progress on detailing the CfD final contract terms to give investors the clarity they need. For example: - Sub-optimal policy design may "lock-in" unnecessary risk - In particular, we are very concerned that DECC are considering contract lengths of 15 years for Renewables, rather than 20 years (as is the case under the RO), which threatens to: introduce perverse incentives, through inconsistency with turbine design life increase short term costs to the consumer unnecessarily expose generators to wholesale price volatility reduce Strike Price by up to 50% - dramatically increasing short term costs to consumers. Time limiting the powers of the Secretary of State to implement the EMR package could help to reduce scope for recurring change and reduce regulatory risk and uncertainty for investors. - We are concerned by the delivery timelines and the risk of the timescales for implementation being too short for policy to be implemented effectively 1 - Assuming 60GW peak demand, locking in 10-15% margin through 10 year contracts. Electricity Market Reform 31

34 32 npower Roundtable

35 5.0 Next Steps Electricity Market Reform 33

36 34 npower Roundtable

37 Next Steps 5.0 The views of businesses reported here will be considered as part of the Government s ongoing Electricity Market Reform. Should you have anything you would like to add to this discussion or any questions, please contact Wayne Mitchell, npower s Industrial and Commercial Markets Sales & Marketing Director, by ing [email protected] npower will continue to work closely with businesses and Government on energy legislation developments and will endeavour to keep our customers and interested parties informed. Electricity Market Reform 35

38 36 npower Roundtable

39 6.0 Appendices Electricity Market Reform 39 37

40 38 npower Roundtable

41 Appendices 6.0 Appendix i - About the Electricity Market Reform Overview Electricity Market Reform (EMR) is the UK Government s initiative to make sure the UK remains a leading destination for investment in low-carbon electricity. The main elements of EMR are: CONTRACTS FOR DIFFERENCE these guarantee a price for generators to enable investment, the strike price will be associated with generation type. CAPACITY MECHANISM a market-wide mechanism designed to ensure adequate, reliable power generation capacity is in place to meet peak demand. EMISSION PERFORMANCE STANDARD (EPS) - Clearly defined set of emission levels to prevent investment in carbon intensive power stations (i.e. coal without Carbon Capture and Storage). CARBON PRICE FLOOR (CPF) The CPF came into effect on 1 April It is designed to provide an incentive to invest in low-carbon power generation by providing greater support and certainty to the carbon price in the UK s electricity generation sector. DECC is intending for the EMR to be operational by mid-2014, when CfDs will be available and the first capacity auction will be held. EMR Timeline MAY 2013 JULY 2013 OCTOBER 2013 DECEMBER 2013 MID TO LATE 2014 Policy update on the capacity mechanism Consultation on exemptions for EEIs Publication of the draft strike price, which will help determine CfD costs Consultations on the capacity mechanism and CfD Final strike prices published following consultation in December 2013 Implementation of EMR Electricity Market Reform 39

42 6.0 Appendices Capacity Mechanism What is it? What is the Capacity Mechanism? What is the impact on business? It is a market-wide mechanism designed to help secure the UK s energy supply by giving capacity providers financial incentives to provide adequate, reliable capacity - making sure the lights stay on at times of peak demand. DECC confirmed the introduction of a capacity mechanism with the first auction in 2014, delivery DECC estimates this will add an average of 14 per annum to domestic bills, no per MWh cost available so difficult to estimate business impact at present. How will it work? Capacity to procure Auction Trading Delivery Payment Forecast of Total amount Capacity Providers of Costs of peak demand of capacity providers may capacity capacity shared made, and contracted for trade between commit to between translated into from providers auction and be available suppliers, a capacity willing to delivery when needed probably in requirement provide it or face proportion through penalties to their market a central in the delivery share auction. year Includes DSR, storage etc as well as generation Implementation Bodies have clear roles and responsibilities Capacity Market can evolve as necessary Source: DECC, February npower Roundtable

43 Appendices 6.0 Contracts for Difference (CfD) What is it? CfD guarantees a price for generators to enable investment, the strike price will be associated with generation type. How will it work? CfDs will be available for renewables, new nuclear and carbon capture and storage From 2014 to 2017, developers will have the option to choose between CfDs and the Renewables Obligation (RO) with the RO closing to new projects from April 2017 Technology specific strike prices will be available from National Grid s Delivery Plan that is published every 5 years with an annual update (the first delivery plan will be published in December 2013) Initially, strike prices will be administratively set with the intention to move to technology specific auctions later this decade and technology neutral auctions in the mid 2020s A single CfD counterparty body payment model with private law contracts to low carbon generators will be implemented Will it have a fixed or variable cost? DECC is minded to introduce a variable rate supplier obligation based on actual monies owed in a defined period based on market share, leading to potentially highly volatile monthly costs. An alternative option is a fixed rate levy which is a fixed p/kwh based on a central forecast with a reconciliation, which would provide more budget certainty. Electricity Market Reform 41

44 6.0 Appendices Appendix ii - Presentations Capacity Market Outline Design Work in Progress Fergal McNamara, Head of Capacity Market Design EMR Roundtable 22 April We face increasing i security of supply challenges l The market faces new, long-term challenges Closure: around a fifth of existing capacity closing in the next decade Market failures: e.g. reliability is public good, SO actions in scarcity situations not fully priced in Intermittency ncy and inflexibility: large proportion rtion of new capacity acity will be intermittent t or less flexible Insufficient incentives ntives to invest in reliable capacity: harder for reliable / despatchable capacity acity to capture revenues, leading to under- investment and there is consensus that margins will tighten, potentially to uncomfortable levels 2 42 npower Roundtable

45 Appendices 6.0 Capacity Market high-level h l design Capacity acity to procure Enduring Reliability Standard established by Government SO forecasts peak demand and translates into a capacity city requirement Auction Trading Delivery Payment Total amount of capacity contracted for from providers willing to provide it through a central auction Limited physical trading (novation) of obligations Capacity providers may hedge Providers rs of capacity commit to be available when neededd or face penalties es in the delivery year Costs s of capacity city shared between een suppliers, in proportion rtion to their share of system their peak Includes position in Capacity demand d private DSR, storage Market does markets etc as well as not replace generation the energy ergy market Implementation Bodies have clear roles and responsibilities Capacity Market can evolve as necessary 3 The material in this presentation n is work in progress and is not a statement of Government ent policy or policy intent Deciding the volume of capacity to procure Minded d to run the first auction in 2014, for delivery of capacity in the winter of 2018/19 Ministers will set enduring ng reliability standard and a method for establishing shing a demandd curve Ministers will decide volume of capacity to procure, on basis of advice, using reliability standard and demand curve Quantity procured auctions ahead year (for DSR) required through 4 years and 1 ahead Successful sful bidders can participate in National Grid administered STOR tenders Process s intended to be as mechanistic c as possible, while enabling costs to be controlled The material in this presentation n is work in progress and is not a statement of Government ent policy or policy intent 4 Electricity Market Reform 43

46 6.0 Appendices Auction The material in this presentation n is work in progress and is not a statement of Government ent policy or policy intent 5 Trading Auction type: Pay-as-clear descending clock auction with downward sloping demand curve (to enable trade-offf between cost and volume) Eligibility: Eligible: Generation (inc CHP), Demand Side Response, Storage Ineligible: CfD plant while CfD administratively set, RO plant, interconnected capacity Pre-Qualification: ation: All participants pants have to pre-qualify Plant de-rating factors set by SO Existing plant wishing to be price makers need to produce supporting evidence Offers in auction: Price, Capacity, Term ( /MW, MW, Term) Different ferent contract lengths available e.g. 1 year for existing, 10 years for new, 3 years for refurbished Obligations can be physically traded (novation) from the year ahead of a delivery year SO s consent to each trade required; trading parties eligibility and pre-qualification status assessed Plant able to take on additional ditional obligations ons include: Plant unsuccessful in auction New plant commissioned oned early Capacity acity pre-qualified ed but didn t participate i t in auction Registry platform for capacity obligations Plant with existing capacity able to take on additional city obligations, opted out plant or retiring plant will not be ditional obligations All plant able to hedge their positions financially in private markets The material in this presentation n is work in progress and is not a statement of Government ent policy or policy intent 6 44 npower Roundtable

47 Appendices 6.0 Definition i i of product / penalties & overdelivery very payments Stress event defined as the issue/rescinding of demand d control instructions by SO to DNOs Delivery defined as lower of metered output or FPN plus SO s instructions ions VoLL-cash out based penalty rate for providers failing to deliver as per their obligation; on; overdelivery paid at the same rate Ex-post assessment of obligation and delivery Penalty liability is capped on portfolio-wide olio-w basis Light touch physical checking regime Penalties/overdelivery es/overdelivery payments only where stress event e preceded by Capacity Market Warning ng at least four hours in advance Changes in delivery in periods of stress ss s between warning and elapse of four hour period rewarded/penalised enalised The material in this presentation n is work in progress and is not a statement of Government ent policy or policy intent 7 Payment Model and Settlement Requirement on industry participants to meet financial commitments ments All l licensed generators and suppliers [and aggregators] gregators] required to accede Capacity acity Instruments s issued to successful ssful bidders d Settlement agent has right of Cost Recovery ery (including administration fees) es) Costs recovered from suppliers according to proportion of system peak demand Surplus/shortfall distributed/collected from suppliers (following year) Billing Period monthly Collateral required from suppliers Work on flow-through of penalties to affected fect ed customers The material in this presentation n is work in progress and is not a statement of Government ent policy or policy intent Electricity Market Reform 45

48 46 npower Roundtable Appendices 6.0 RWE npower 10/06/2013 PAGE 9 IMPLICATIONS OF THE CAPACITY MECHANISM FOR BUSINESS Paul Dawson Head of Market Design & Regulatory Affairs, RWEST RWE npower 10/06/2013 PAGE 10 Headline impacts > Wholesale energy prices fall (by some 5-10/MWh 1 ). > Higher capacity margins result in fewer periods of relative scarcity. > Retail prices rise on average to recover additional costs. > Infrequent tight years will be lower than otherwise, but most years will be higher. > Costs recovered on peak demand as per triad methodology. > Volatility in wholesale energy prices falls (prompt to year 3). > Volatile capacity payments (year 4+). > Negative impact on excluded RO plant. Wholesale price comparison (DECC UEP) per MWh Counterfactual wholesale price Basecase All-in price (includes capacity payments) Basecase wholesale price Source: Independent analysis commissioned by RWE, Nov

49 Appendices 6.0 Indirect impacts and interactions with other regulations & policies Electricity Balancing Significant Code Review Carbon Price Floor Low Carbon Support Wholesale market liquidity EBSCR aims to improve market signals to: > Sharpen trading signals > Encourage increased forward trading > Incentivise balancing ahead of gate closure. Success may obviate need for a capacity mechanism. CPF currently only set 2 years in advance, so massive uncertainty as to how it will affect plant costs, load factors, power prices and therefore the level of stranded costs that operators will be looking to the capacity mechanism for recovery. RO and CfD will incentivise exogenous capacity additions that will affect the capacity market. Auction for residual capacity, is inherently more unstable. Reduced volatility. Increased perceived risk of market intervention. RWE npower 10/06/2013 PAGE 11 Many aspects of the design remain to be pinned down, which results in uncertain prices and outcomes at this point Known Known Descending clock cleared auction. 10-year contracts for new. Unknown Capacity prices. Capacity breakdown (new vs. existing, fuel types etc). Secondary market liquidity. Incidence of demand control. Unknown Value of Lost Load (VOLL). Cost of new entry (CONE). Penalty caps. Governance of rule changes. Future market reform. EU capacity market rules. RWE npower 10/06/2013 PAGE 12 Electricity Market Reform 47

50 48 npower Roundtable Appendices 6.0 RWE npower 10/06/2013 PAGE 13 RWE has several key concerns about the impacts > Cost of distortions to cure market power disproportionate to risk. > Design risks adverse selection of new plant ahead of cheaper existing plant. > Design risks long-term lock in of unnecessary capacity. > IED plant. > Co-fired biomass. > Penalty risks and ability to mitigate through the secondary market. 1 Cost to consumer > Legitimate expectations of recently commissioned plant. > Credibility of an intervention to reduce the perceived risk of intervention. > Circular counterfactuals. > Treatment of RO plant. > Future changes to (and existence of) capacity market. > Governance of capacity agreements. 2 Investor confidence RWE npower 10/06/2013 PAGE 14 Design and delivery risks > Limited consultation on details. > Absence of rigorous end-to-end testing of design prior to commencement of delivery work. > Risk of unforeseen outcomes and unintended consequences. > Risk of delay and delivery. Design evolution during 1 implementation phase > State aid approval required. > Commission is still developing approach to capacity mechanisms. > Policy must also be consistent with rules on Public Service Obligations under third-package. > Key issues will surround treatment of interconnections and necessity of support. European approval 2 and integration

51 Electricity Market Reform Appendices RWE npower 10/06/2013 PAGE 15 Opportunities for business > Interim scheme. > Enduring scheme. Demand side response 1 within the CM > Triad avoidance. > Embedded benefits. Indirect demand side 2 response BUT, WHAT WOULD OPPORTUNITIES HAVE LOOKED LIKE IN AN ENERGY-ONLY MARKET WITH MORE FREQUENT SCARCITY? RWE npower 10/06/2013 PAGE 16 Conclusions > Fundamental shift in level and profile of wholesale and retail pricing. > Significant uncertainty on final design, outcomes and prices. > Both internal and external risks to delivery. > Significant potential for undesirable outcomes for consumers and investors.

52 50 npower Roundtable Appendices 6.0 RWE npower 10/06/2013 PAGE 17 OVERVIEW OF CONTRACTS FOR DIFFERENCE Mary Teuton EMR Project Manager, RWE npower RWE npower 10/06/2013 PAGE 18 Suppliers will be responsible for funding Contracts for Difference Costs via a Supplier Obligation > Low carbon generators will receive a Contract for Difference Feed in Tariff (CfD) which provides them with a fixed price for their electricity output Monies received from selling generation output onto the wholesale market Top up payment to the agreed CfD strike price (the difference between the pre-defined reference price and strike price) > If the reference price rises above the strike price, then generators will have to pay back the difference > Suppliers will have to fund the difference between the reference price and the strike price via a Supplier Obligation (details on next page) > Funds will be raised from suppliers via a compulsory levy enforced as a relevant requirement > A government owned counterparty body will sit between the generator and the supplier, managing the flows of money > CfD costs will form part of the government s Levy Control Framework1 which is set at 7.6bn2 in 2020 > Energy Intensive Industries will be exempt from CfD payments (subject to State Aid clearance and consultation) CfD Payment Model Illustrative CfD Costs Electricity Price /MWh Market Revenue /MWh FiT CfD payment /MWh Monthly Electricity Price Time Strike Price Generator pays back Generator topped-up to strike price p d-up Generator toppe to strike price

53 6.0 Appendices Two Supplier Obligation options are on the table: a fixed and a variable with DECC currently minded towards the variable rate Area Description Risks and Issues Cost implication Variable Fixed >!Based! on actual monies (based on actual generation) owed in a defined period according to market share by consumption >!Suppliers! will have to post collateral equal to the amount due in the billing period >!Central! forecast translated into a fixed p/kwh and paid on a defined basis according to market share >!All! risk transferred to suppliers >!Every! supplier will have to produce their own forecast based on various unknowns (volume and price risk) likely to be large difference in forecasts and hence large differences as how priced into tariffs >!Monthly! payment expected to be highly volatile as dependent on weather >!Posting! of collateral creates an additional cost burden on suppliers >!Unclear! as to interaction with RMR and tariff simplification >!If! central forecast wrong, costs likely to go up / down in the following period and could be substantial! >!Addition of a risk premium to cover potential of getting forecast wrong will add costs to consumer bills >!Easier! to price in as costs known in advance >!Collateral! requirements unclear, but will be cost implication of posting collateral! >!Additional cost of posting collateral will not be insubstantial by 2020! >!Increasing number of price changes for customers to price in changing CfD >!Reconciliations! on a periodic basis to update forecast >!Accuracy! of previous central forecasting >!If! a surplus or deficit is built up, then risk as to what happens to money under government accounting rules (could be subsumed into Treasury) RWE npower 10/06/2013 PAGE 19 RWE are lobbying for a fixed rate Supplier Obligation, a position shared by most of industry >!! RWE intends to pass the costs of the CfD through to customers equally >!! For our I&C customers, we would expect to show CfD costs as a separate line item on bills >!! We are lobbying strongly for a fixed rate CfD Supplier Obligation with any under / over recovery factored into the next period s rate:!! Reduces costs to the consumer!! Reduces monthly volatility of bills!! Transparency and visibility of price and volume information with early / timely publication of information!! Likely to reduce cost of collateral!! Easiest to implement (and hence lowest costs)!! Provides a level playing field across competitors (and will allow comparison across suppliers) RWE npower 10/06/2013 PAGE 20 Electricity Market Reform 51

54 6.0 Appendices EXEMPTIONS FOR CONTRACTS FOR DIFFERENCE Arjan Geveke Assistant Director Energy Policy, BIS RWE npower 10/06/2013 PAGE 21 EMR Energy Intensive Industries s Exemption 52 npower Roundtable

55 Appendices 6.0 Cumulative impact of energy ergy and climate change policies Electricity ci ty Market Reform Government s s [intends] to to exempt energy y intensive ive industries i from additional di ional costs s arising from new long term contracts for difference fe designed to bring on investment in low carbon power plant, such as nuclear power stations and wind farms. The scope of the exemption is currently being considered d by DECC and BIS, who will l run a consultation in 2013 once the proposed exemption has been further r developed. The exemption will l require state aid clearance from the European Commission. Electricity Market Reform 53

56 6.0 Appendices Key issues Exemption Scope Spring consultation Redistributive e effect fect impact on non-exempt energy ergy consumer bills Supplier Obligation Administration n Timetable State aid pre-notification on of FIT + European context EU Context EU Member States have different ferent renewable support port mechanisms in place Everybody as some kind of EII exemption emption from these e support costs Some are classified sified as state aid others are not Germany: PreußenElektra ra Latest Commission approach 54 npower Roundtable

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60 npower is a registered trademark and a trading name of Npower Limited (registered in England and Wales No ) and Npower Commercial Gas Limited (registered in England and Wales No ) and associated companies. Registered Office: Windmill Hill Business Park, Whitehill Way, Swindon, SN5 6PB. npmxxxx/06.13