The Department of Energy and Climate Change (DECC) has recently published a Technical Update Paper elaborating on its proposals for Energy Market Reform (EMR). The Government intends to legislate for the key elements of EMR in the second parliamentary session, with legislation reaching the statute book in spring 2013. The Technical Update will be one of several papers published by DECC in the coming months, as the EMR proposals enter a stage of more detailed policy design.
Institutional framework
DECC has selected the System Operator (SO), the National Grid, as the delivery body which will administer the Feed-in Tariff with Contracts for Difference (FiT CfD) and capacity mechanism. The Technical Update notes that these new functions are closely related to the SO’s current role, and DECC hope to draw on this existing expertise. Additionally, the SO has existing relationships with suppliers and large generators which will give the industry greater confidence in the management of these new mechanisms.
The Government’s policy approach will be implemented though a delivery plan, intended to be published in 2013. The SO will advise the Government on the creation of the delivery plan, with final responsibility for the delivery plan resting with the Government. Once the delivery plan has been published, the SO will have operational independence to administer the FiT CfD and capacity mechanism, and will report annually to the Government on its performance against the delivery plan.
The Technical Update comments that the institutional framework will be underpinned by the principles of accountability and independence. Final responsibility for public expenditure and policy outcomes under the framework will rest with the Government. Additionally, the SO will be accountable to the Government for its performance against the delivery plan. Ofgem will continue its independent regulation of the market, including the new institutional framework. In particular, Ofgem will consider any potential conflicts of interest between the SO’s current role and the implementation of the new mechanisms. The independence of the SO will ensure that the mechanisms are implemented predictably and transparently, which is intended to provide certainty to investors.
Capacity mechanism
The capacity mechanism to be introduced under EMR will be a Capacity Market. Under this mechanism, providers of capacity may bid in a market-wide auction to commit to provide a quantity of reliable capacity in a particular year. The providers of capacity will receive a regular payment for this availability, and will be subject to penalties if they are unable to meet their commitment. The volume of capacity to be contracted for will be decided by the Government. It is hoped this decision will take place several years in advance of the year capacity must be in place, to allow for the construction of necessary generation. Likewise, the Government will decide when the auction for capacity will take place.
The Technical Update notes that in response to the EMR White Paper consultation, five of the six large vertically integrated companies intimated a preference for this model of capacity mechanism. Four of the eight independent generators that responded preferred this model, with the other four favouring a Strategic Reserve model. DECC acknowledge in the Technical Update that only high level decisions for the capacity mechanism have been provided so far, and state they will work closely with the SO, Ofgem and other stakeholders during the detailed design phase.
A Capacity Market model has been selected as it will reduce the risk of volatile and uncertain prices, which may reduce investment in capacity. DECC state that the Capacity Market will provide stable and secure income for those able to provide capacity, and so will incentivise investment in this area.
A central auction system will ensure transparency, and provide a route to market for smaller participants.
The Technical Update notes that payments received by those providing capacity will be offset by reductions in electricity wholesale prices. The capacity mechanism will work to reduce the likelihood of periods of system shortage, during which the wholesale price of electricity will increase.
Enabling investment decisions for early projects
The Technical Update recognises that changes to the market under EMR may delay investment decisions for certain projects. In order to provide certainty to investors, DECC will enter into discussions with developers with a view to providing forms of comfort which will allow projects to progress while EMR is being implemented. A project must satisfy the following criteria in order to obtain comfort from DECC:
- The type of generation to which the project relates is one that is capable of benefitting from the proposed FiT CfD;
- The developer is able to demonstrate to the satisfaction of DECC that there is a real prospect that if the project is not in receipt of some form of comfort from Government before 2014, it will be cancelled, put at significant risk or delayed;
- The developer is able to demonstrate to the satisfaction of DECC that there are credible plans in place to progress the project in order to start generating electricity in or after 2016;
- The project is not eligible for the Renewables Obligation (RO) or if it is eligible for the RO then the developer must demonstrate to the satisfaction of DECC that:
- There is no realistic prospect of it being accredited as being eligible to receive Renewables Obligation Certificates (ROCs) by 31 March 2017; or
- At the time an expression of interest is made to DECC there is a real prospect of the project being delayed and that this delay is likely to prevent the project being accredited as being eligible to receive ROCs by 31 March 2017.
The Technical Update does not provide details regarding forms of comfort available to developers, and states that developers should not assume that comfort will be available even if the above criteria are satisfied.
Renewables Obligation transition
The Technical Update gives further details on the transition arrangements from the current RO to the new FiT CfD mechanism. As set out in the EMR White Paper, new generation projects may choose whether to receive support under the RO or FiT CfD. After 2017, the RO will be closed to new generation projects. The price of ROCs will be fixed after 2027. DECC note that whilst many of the required changes can be implemented through a Renewables Order, the transition to a fixed price for ROCs must be implemented through primary legislation. The fixed ROC price will be the 2027 buyout price, plus ten percent.
The purchase of ROCs during the period 2027-2037 will be carried out through a Supplier Levy model. The Technical Update states that this system will ensure a simple transition to the fixed price ROC and remove the risk of a ROC price crash. Additionally, the preservation of the ROC market means that Power Purchase Agreements and finance structures can continue to be used. Under this system, Ofgem will continue to issue ROCs. The levy on suppliers will be based on the expected costs of purchasing ROCs in the year ahead. The costs will be spread across suppliers in accordance with their market share. DECC state that the levy will be due quarterly, and acknowledge that this may result in inconvenience to smaller suppliers, who are accustomed to “buying out” their obligation annually.
The Technical Update states that the RO transition proposals are under discussion by a Steering Group, which includes representatives from the Scottish and Northern Irish administrations. The detailed regulations resulting from these discussions will be subject to a statutory consultation before they are made.
Next steps
- January 2012 - Draft decisions on Ofgem’s Liquidity Review to be published.
- Early 2012 - Update on technical details of FiT CfD and Emissions Performance Standard.
- Spring 2012 - Introduction of primary legislation and publication of an Electricity Market Reform policy document.
- Spring 2012 - Publication of Response to Renewables Obligation Banding Review consolation.
- Summer 2012 - Completion of Government’s Assessment of Electricity Demand, including details on sufficiency of support and incentives for reducing electricity demand.
- Summer 2012 - Publication of Government’s Electricity System Policy document, focussing on balancing and system flexibility.
- Spring 2013 - Primary legislation to reach the statute book.