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Electricity Market Reform

Around a fifth of the total electricity generation capacity in the UK as at 2011 is set to close by the end of the decade and much of the capacity built to replace it is increasingly intermittent such as wind, or inflexible such as nuclear. Government has recognised that it needs to do something to encourage more renewable generation as well as ensuring sufficient capacity remains available to meet demand (which is set to increase over the coming decades as major sectors such as transport and heat are electrified).

The Government’s view is that we cannot rely on any single form of generation to meet these challenges and instead we should pursue a portfolio approach, leading to a diverse mix that balances the risks and uncertainties of different technology options. This has resulted in the proposals for Electricity Market Reform (EMR), the key elements of which are set out below.

Replacing the Renewables Obligation scheme with Contracts for Difference (CfD)

CfDs will be available to low-carbon projects (not just renewable schemes) and are intended to give a more certain return to developers of these projects than is available under current incentive schemes.

Generators will sell their power production as normal into the wholesale market. The CfD will then pay the generator the difference between an estimate of the market price for electricity and an estimate of the long-term price needed to bring forward investment in a given technology (the strike price). However, where the estimated market price is higher than the strike price, the generator will pay back the difference. This essentially ensures that the generator receives a stable return over a long contract term, providing certainty to investors and smoothing out long-term exposure to electricity price volatility.

Introducing a capacity mechanism

The Capacity Mechanism is intended to support security of supply by ensuring sufficient electricity generation capacity is available to meet peak demands.

Under the mechanism, where the Government determines there may be a capacity constraint four years ahead, an auction will be conducted by the system operator to secure the required additional capacity. Both generation and non-generation providers of capacity (such as demand-side response and storage) will be eligible to participate in the auction, although low-carbon plants receiving a CfD will not be permitted to participate. Providers of capacity successful in the auction will enter into capacity agreements, committing to provide electricity when needed in the delivery year/s (in return for steady capacity payments) or face financial penalties. The costs of the capacity payments will be shared between electricity suppliers in the delivery year.

Implementing a carbon price floor

This is an adjustment to the Climate Change Levy (CCL), meaning that hydrocarbons used in power generation will be subject to CCL, where they were exempt previously. The scheme is also designed to underpin the carbon price in the EU Emissions Trading System by ensuring that there is a minimum floor price for carbon. The intention is that this will discourage investment in traditional fossil-fuelled generation, with investment in low-carbon generation increasing as a result.

It will be introduced from 1 April 2013 at around £15.70/tCO2 and follows a straight line to £30/tCO2 in 2020, rising to £70/tCO2 in 2030 (real 2009 prices).

Bringing in an Emissions Performance Standard (EPS)

The EPS is a regulatory measure which will provide a backstop to limit emissions from new fossil fuel power stations, with the intention of preventing new unabated coal-fired power stations. The EPS will apply to all new fossil fuel power stations at or over 50MW and will initially be set at a level equivalent to 450g/kWh. Power stations consented under the 450g/kWh-based level will be subject to the level until 2045. This ‘grandfathering’ is intended to provide long-term certainty to investors, particularly in relation to new gas generation that is needed to ensure security of supply.

Bringing forward arrangements to achieve electricity demand reduction

The Government is considering a range of options to unlock the energy savings that are currently perceived to be embedded in the system. It has recently consulted on a number of market-wide financial incentives, including a premium payment, use of the capacity market and a new obligation relating to electricity efficiency for non-domestic customers. The consultation also sought views on the potential for more targeted, sector-specific financial incentives and broader policy approaches by sector, including a number of voluntary and information proposals.

Timetable

It is anticipated that the first CfDs will be entered into in 2014, with the ROC scheme closing to new entrants on 31 March 2017. However, the Government recognises that this timetable may not help large projects with long lead times, and so it is prepared to consider bilateral discussions with developers of such projects to provide appropriate certainty prior to CfDs becoming available.

The Government is minded to run the first Capacity Mechanism auction in 2014, for delivery of capacity in the year beginning in the winter of 2018/19, subject to a need for additional capacity in that delivery year being identified. The Carbon Price Floor becomes effective in April 2013.

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