Proposals to reform the UK energy sector took a significant step forward in December when the Energy Bill was granted Royal Assent. One of the foundations of the new Energy Act is the Government’s Electricity Market Reform (EMR) programme designed to incentivise investment in the UK’s electricity infrastructure. Mark Ripley, National Grid’s Project Director for EMR, explains why we all have a stake in a successful outcome.
On the surface, the subject of reforms to the electricity market makes for pretty dry subject matter. But do persevere with me, because the reality is that EMR matters to every household and every business in the UK.
Why? Because when you boil down what we’re talking about here, it affects two critical things:
• Making sure that the country has enough generation capacity to maintain future security of supply, in other words keeping the lights on, and
• Encouraging more low-carbon generation, so that the UK can meet its 2020 and 2050 environmental and emissions commitments.
These are pretty fundamental issues for our country and they also need to be achieved in an affordable way, maximising benefits for us all and minimising the cost to taxpayers.
The Government estimates that £110 billion of new investment is needed to replace current generating capacity and upgrade the grid by 2020 to meet the rising demand for electricity. Simply put, EMR is designed to ensure we get this investment.
The reforms in context
It’s worth posing the question: why is reform necessary in the first place? The answer lies in our current energy mix, which relies heavily on oil, coal and gas plus emerging renewable generation.
If we continue with the status quo, we probably won’t see the investment needed for the UK to achieve its 2020 target of meeting 15% of energy demand from renewable sources – or the 2050 goal of cutting emissions by 80% from 1990 levels. It follows therefore, that decarbonising electricity offers us the largest potential reward in terms of a low-carbon future.
Doing this successfully requires the right incentives to develop renewable and low carbon technologies, many of which are still immature in terms of their development. We have to change the economics, otherwise the business case to develop this generation is not strong enough.
So, where do we stand today? The Energy Act is now law and the Government has published its first Delivery Plan. This sets out important decisions such as the price that will be paid to generators for each type of generation over the next five years – so-called ‘strike prices’ – and also the security of supply standard that generators will be expected to meet.
However, the real detail will come in the secondary legislation package expected in the spring and which will go before Parliament in the summer. It will be later this year, therefore, before we start to see the true fruits of the reforms.
The key measures within EMR
There are two new mechanisms that are central to the EMR process.
The first is the introduction of Contracts for Difference (CfDs), which are designed to encourage low-carbon generation by giving eligible generators the certainty of a long-term contract and a set ‘strike price’.
The CfDs reduce the risk of investment by topping up renewable generators’ revenue if the wholesale price is below the ‘strike price’. If the wholesale price is higher, then the generator must pay back the difference. The first CfDs are expected to be signed by the end of this year.
The second key development is the introduction of the Capacity Market. This will give generators and their investors the certainty they need to put in place reliable capacity, backed by a predictable revenue stream and committing them to ensure generation is available when electricity supply is squeezed. This approach will help protect consumers against possible supply shortages. The first capacity auction is due to take place in December 2014 to provide capacity for 2018/19.
There are two other aspects to the reform package that are briefly worth explaining. The first is the Carbon Price Floor, which is a tax on fossil fuels used to generate electricity. The second is an Emissions Performance Standard, which will place an annual limit on the CO2 emissions from fossil-fuel power stations.
National Grid’s role
What part does National Grid play in these changes? The first thing to say is that we do not formulate policy; that is the role of Government. But we have long experience in the challenges of managing the UK’s energy infrastructure. For the past two years, we have been advising Government on the potential outcomes of policy decisions and how these might play out in the future, as well as working very hard to engage with the wider industry on all the issues related to EMR.
We have been designated as the delivery body for EMR. Among our responsibilities will be assessing generators’ eligibility for capacity payments, running the auction process and awarding contracts.
In terms of CfDs, National Grid will again check the eligibility of applications and run an allocation process. We will also instruct the Government-owned CfD Counterparty Body to sign contracts with the successful generators. These contracts are important from a legal standpoint, but also in helping generators attract the necessary investment.
One other important aspect of our responsibilities is to continue to provide to the Government detailed economic analysis and modeling, so that we have the best possible forward view of the impact of EMR in the long term.
The importance of dialogue
The changes in the energy sector through EMR are wide-ranging and it’s vital that all stakeholders are properly consulted and engaged in the process. This is something that National Grid is strongly committed to. For example, we’ve taken part in all the Government-sponsored expert groups in the past two years and we’ve just kicked off a series of implementation workshops on the Capacity Market, which will involve a broad cross-section of the industry.
The overall message is that EMR is important for all of us. It’s the vehicle by which we will ensure that the UK has a secure supply of electricity for many years to come – and it is a vital component in delivering a greener future for our country.
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