Investment & Performance Board (IPB) Date of IPB meeting: 23 October 2012 Title of paper: To be presented by: Cleared by: (name Adviser & Director) Classification: Developing a new junior electricity supply licence Stephen Tate Matthew Pencharz and Fiona Fletcher-Smith Public 1. Executive Summary 1.1 The proposal is that the GLA apply for a new type of electricity supply licence which the GLA has been developing in collaboration with the regulator, Ofgem and the Department of Energy and Climate Change (DECC) and London boroughs. The purpose is to enable existing and new decentralised energy providers in London to sell their electricity at proper market prices rather than being excluded from the electricity market because of its costs risks and complexities. 1.2 Implementing the licence lite system will strongly support investment in decentralised energy in London, as a result generate jobs, support the attainment of the Mayor s carbon targets and offer the GLA a business opportunity to make an income over and above covering its costs. 1.3 The GLA would be the first party to apply for a licence lite and during the course of the application there will be some remaining regulatory and market issues to resolve and test out in the market. The application would therefore be made on the basis that once the terms of the new licence and the cost of the market services needed are known through tendering exercises (rather than estimated) a Mayoral Decision is obtained before any commitments are accepted. 1.4 The work involved in the application is (i) resolving some remaining regulatory issues with Ofgem (ii) inviting and evaluating tenders from the market for the provision of specialist market services (iii) the preparation of a detailed business model and business case. 1.5 For reasons explained in paragraph 4.1 below, the GLA is in the best position to apply for the licence and has a strong interest in doing so. 1.6 The licence application would be high profile within the industry, because it would enable small electricity suppliers and generators to enter the electricity market, almost entirely dominated by six large companies. The Minister for Climate Change at DECC is watching progress and the importance of implementing licence lite is specifically mentioned in the 2011 Energy White Paper and in the Mayor s Climate Change and Mitigation Strategy.
1.7 The cost of the remaining market system work to be done and the licence application fee is estimated at 20,000 included in the Environment 2012/13 budget. The cost is relatively small because of work done during earlier phases of implementation (see paragraph 4.2 below). The costs of the required business modelling and project support from consultants Arup will be met from existing EU ELENA grant funding within a budget of 49,890. 2. Recommendations 2.1 The Board approves, in principle, the GLA applying for a licence lite licence and the work which would lead to the licence being granted, namely (i) resolving some remaining regulatory issues with Ofgem (ii) inviting and evaluating tenders for the provision of specialist electricity market services and (iii) the preparation of a detailed business model and business case. 2.2 To enable the work to be delivered, the Board approves in principle the award of contracts for specialist market and legal advisory services for a sum not exceeding 19,550 and the payment of the licence application fee of 450, as referred to in the draft DD 897, noting that support for the development of the business model and business case and project support in taking the licence application forward will be provided by consultants Arup within a budget of 49,890 under existing grant funding provided under the EU ELENA programme. 2.3 That approval be subject to the requirement that on or before the completion of the licence application process when the terms of the grant of the licence and detailed business case are known, a Mayoral Decision is obtained before any commitment is accepted. 3. Introduction and Background 3.1 Dating back to 2001, the electricity market mechanisms have contained costs risks and complexities that make very high barriers to entry for small electricity generators and suppliers. Licence lite is important in supporting the Mayor s decentralised energy programme, but in addition the implementation of licence lite will help access to the market more generally, for the benefit of electricity consumers. 3.2 The strategic aims of the project are as follows 1. Remove barriers to using the new licence lite system. This can only be done through making a licence application. 2. Following the licence being granted, that the GLA provide a service to the London boroughs and other public sector owners of decentralised energy generating plant in London by selling the electricity they produce at proper market rates. 3. Through the higher revenue streams then obtained from electricity sales, to enable more new and existing decentralised energy projects in London to be more financially viable and in the longer term the GLA to earn a financial return in addition to recovering its costs.
3.3 The expected outcomes from a successful licence application are as follows 1. The more certain and accelerated delivery of the Mayor s target contained in his Climate Change and Energy Strategy of 25 per cent of London s energy being locally sourced by 2025. 2. The increased uptake of more investment in decentralised energy systems to London, bringing forward in excess of an estimated 300 million of additional investment by 2020. This would have created by that date an estimated 1,650 short term construction jobs and 160 permanent jobs in operating the energy centres and networks; and thereafter larger amounts of investment and numbers of jobs as the potential for decentralised energy in London is realised. 3. An increase in the opportunities available to the London boroughs to follow their own ambitions to deliver within their borough competitively priced electricity which they generate themselves. 4. Issues for consideration 4.1 Why the GLA should make the licence application. The GLA is in the best position to make such a licence application and has a strong interest in doing so 1. Although there is strong interest in licence lite amongst smaller electricity generators in the private and public sectors, none of them has accepted the challenge of completing the implementation processes. That is because of the complexity involved and apparent unwillingness to spend time and money on a new venture that will benefit their competitors as much as themselves. Once the first application has been successfully made, licence lite applications could be made on a relatively standardised basis, using the same basic documentation and implementation procedures. 2. The large electricity suppliers have very substantial resources and expertise to make the first licence application, but they have shown no interest (indeed it may fairly be said they have a negative interest) in seeing licence lite implemented, despite Ofgem publishing its licence lite proposals as long ago as 2009. 3.The GLA has the market knowledge and expertise to complete the implementation process for the benefit of the boroughs and other members of the GLA group. Individually the boroughs do not have that resource, nor are other GLA group members in a position to lead the process. 4. By collecting the electricity generating capacity of the boroughs under one licence, the GLA can deliver economies of scale for the benefit of the boroughs and itself. 5. For the earlier stages of the project, the GLA formed a Supervisory Board of six London boroughs, namely LB s Haringey, Islington,
Hackney, Camden, Waltham Forest and Croydon who have shown considerable interest in the licence lite project. The GLA will continue the project on a similar basis, but will form a wider group of all London boroughs owning or planning electricity generating capacity, the output of which is best sold under licence lite. 6.There is in effect a market failure which the GLA is best able to resolve as a strategic body. 7. The Mayor s Climate Change and Mitigation Strategy refers to licence lite being used by small electricity suppliers / generators to diversify the electricity supply market within London through making access by new entrants easier. 4.2 The cost of applying for the licence lite licence and how it will be resourced. 1. Substantial preparatory work has already been done, financed in part by DECC and partly by the GLA. The result is that the cost of the application itself is relatively small, namely an estimated total 20,000 for market and specialist legal advice and the licence application fee itself. 2. The consultants (Arup) to be appointed through the ELENA programme will provide support in the preparation of the business model and business case and also project support to take the licence application forward, at a cost of 49,890. The GLA staffing commitment should be no more than that required during the earlier stages of the implementation process, which was approximately 30 per cent of one staff member. 3. No tenders nor the terms of a licence will be accepted until a Mayoral Decision has been obtained. 4.3 Continuing financial obligations 1 Once the licence is granted and the GLA starts to purchase electricity from the boroughs and other public sector decentralised energy operators and re-sell it to buyers, long term resource will be required to carry out the necessary actions under the licence. These activities are related to the buying and selling of the electricity and administering the market interface agreements that manage the market mechanisms for the licence lite licensee. 2 The GLA has already made a preliminary evaluation of the resources required during the earlier phase of this project. Most such activities will be outsourced and their costs incorporated within Arup s business modelling. The GLA s role would mainly be limited to monitoring contract performance by its chosen subcontractors. That is estimated as involving the full time of one staff member trained in financial administration [ Grade ]. There would be internal matters within the GLA regarding the management and governance structures within which the staff member would be placed. There will also be some initial set up
costs which using Arup s estimates and taking into account the work which will have already been done during the course of the licence application, would amount to approximately 25,000. 3. The costs of the GLA s role under the licence would be recovered from the boroughs and others who sell their electricity to the GLA for re-sale. They would reimburse the GLA before the proceeds of the re-sale are passed back to them. Depending upon how the business modelling turns out when actual (rather than estimated) costs are known, there would be potential in the longer term for the GLA to earn a financial return, above the recovery of its costs, which would be available to support continued investment in decentralised energy in London. 4.4 Assumptions made. 1. Preliminary modelling was done by Arup for the LDA to demonstrate prospective increases in the rate of return in decentralised electricity generation under a licence lite regime, relative to current market opportunities. Assuming a minimum of approx 15 MegaWatts of generation capacity, there is an estimated increase in rate of return of up to 25 per cent. Larger amounts of generation capacity may offer a greater increase in returns. 2. The increases in return are based on assumptions on operating costs obtained from best available market information. If the estimates made are substantially incorrect, the financial outcome would not be as predicted. If that leads to excess cost, the cause will be addressed with Ofgem or by means of modifying the business model, depending upon the cause of the excess cost. 3. There is an assumption that there will be sufficient generating capacity immediately available from the London boroughs and other public sector owned decentralised electricity generation in London to enable GLA to buy and re-sell electricity on the required scale. An effective minimum is estimated at approximately 15 MegaWatts of generating capacity. Given the capacity already owned by the boroughs and other sources, in principle the available capacity should substantially exceed that amount. 5. Risks arising / mitigation 5.1 Risks arising in making the application 1. The financial risks on account of making the licence application are limited to the loss of value in the expenditure on consultancy fees and the licence application fee (totalling 20,000), if the application does not lead to the grant of a licence. The ELENA grant funding expended of 49,890 would also be at risk for the same reason. 2. Loss of value for money spent in such circumstances in however a small risk. In the event that there are barriers which prevent grant of the licence or its grant on terms acceptable to the GLA, the next step would be for Ofgem / DECC and the GLA to address how they are removed and then continue with the licence application.
3. If the barriers discovered during the course of the application cause the GLA to re-apply later for a licence rather than continue with the existing application, the lost investment would amount only to the licence application fee of 450. 5.2 Continuing risks 1. There are risks in buying and supplying electricity under the licence when granted. These risks are either managed under the market interface agreements referred to above or are judged capable of effective management or transfer to third parties. 2. These risks do not arise until after the licence is granted. That stage will be preceded by and conditional upon a Mayoral Decision to accept the grant of the licence. 5.3 Risks to the licence lite project 1.The actual operating costs could be so much in excess of the estimated cost as to make the operation of the licence uneconomic (see 4.4.2 Assumptions above). The risk is however capable of management as explained in that paragraph. 2 There are risks to the project if the GLA licence application does not proceed. In the absence of an alternative body willing and able to make an application in the GLA s place, the continuation of interest and support from the interested London boroughs, DECC, Ofgem and a range of stakeholders in licence lite would be put at risk and the full potential for decentralised energy in London not realised. 6. Financial comments of the Executive Director Resources 6.1 Approval is being sought to commission specialist market consultancy and legal Services, in order to make an application to Ofgem for a licence lite licence. The estimated cost of these contracts is up to 19,550 with an additional payment of 450 in respect of a licence application fee. 6.2 Provision for the cost of 20,000 has been made within the existing 2012/13 Environment Programme budget. All requisite budget adjustments will be made. 6.3 As this decision relates to contracts, officers have to ensure that the requirements of the Authority s Contracts and Funding Code are adhered to. 6.4 Officers are also advised to ensure that the requirements relating to consultancy services within the Authority s Financial Regulations and Expenses & Benefits Framework are adhered to. 6.5 Any changes to this proposal must be subject to further approval via the Authority s decision-making process.
6.6 The Environment Programme Delivery Team within the Development and Environment Directorate will be responsible for managing this project. 7. Legal Comments 7.1 The above sections of this report indicate that: 7.1.1 the decisions requested of the Director relate to expenditure for the commissioning of services which fall within the Authority s duty to take action on climate change and its statutory powers to do things facilitative of and conducive of the promotion of economic development and wealth creation and the improvement of the environment in Greater London; and 7.1.2 in formulating the proposals in respect of which a decision is sought officers have complied with the Authority s related statutory duties to: (a) pay due regard to the principle that there should be equality of opportunity for all people; (b) consider how the proposals will promote the improvement of health of persons, health inequalities betweens persons and to contribute towards the achievement of sustainable development in the United Kingdom; and (c) consult with appropriate bodies 7.2 Section 3.6 of the Authority s Contracts and Funding Code ( Code ) requires that contracts with values of those proposed be awarded following the seeking of competitive tenders. However, section 5 of the Code also provides that an exemption from this requirement may be justified where there are a limited number of suitable suppliers. Officers have confirmed that this is the case here. Therefore, the Director may approve the proposed award of contracts and exemptions if satisfied with the content of this report. 7.3 Officers must ensure that appropriate documentation is put in place and executed by the Authority, Cornwall Energy and Nabarro before the commencement of the services. 8. Next steps 8.1 The next steps following consideration/in-principle approval by IPB are summarised below: Activity The appointment of specialist electricity market advisors, lawyers and consultants Arup and working with them on (i) resolving some remaining regulatory issues with Ofgem (ii) inviting and evaluating tenders for the provision of specialist market services (iii) the Timeline Nov 2012 March 2013
preparation of a detailed business model and business case and (iv) provision of project support to the GLA A Mayoral Decision to accept the grant of a licence lite licence, subject to the development of the business case being positive. April 2013 Appendices: None.