EMR: 'Unremitting' cost increases?

During a conference at The Energy Event, at the Birmingham NEC, Andrew Buckley, director-general of the MEUC, asked whether the biggest challenge facing energy buyers in the UK was volatile gas prices or the fact that “the Government wanting to be the greenest of the green” could mean “a future in store for us of unremitting price increases?”

In response, Robin Welsby, commodity manager energy Europe, global chemical company Celanese AG, said “Energy may vary in price up or down but to a certain extent we as buyers can make decisions as to how to limit that risk. The government’s [carbon reduction] strategy is an express train which, I think, we will have difficulty stopping.”

UK energy users, therefore, face significant issues both from a cost point of view and how they actually contract in future. They need, said Welsby, to take a view on where they are now and how it is going to look in three, five, 10 years time and try to understand what the low carbon world is going to look like going forward.

Risk offload

“Most of these issues revolve around the fact that over the last few years we as customers have progressively accepted more of the risk and liabilities, with the suppliers tending to offload as much of this as they can in our general direction,” he said.

Energy buyers, noted Welsby, operate in a very complex marketplace, comprising not just customers and suppliers but many other players at various levels of the supply chain.

Carbon reduction strategy is an express train which, I think, we will have difficulty stopping

“It is probably not so much a supply chain as a bit of chain mail,” he commented. “There are so many interactions that you need to look at who are the players, their influence, as well as where they come from and where they will be going.”

The Celanese manager’s comments followed a presentation from the Department of Energy and Climate Change (DECC) on the Electricity Market Reform (EMR), which alongside interventions, such as the renewables roadmap, is intended to help the UK meet the security of supply and decarbonisation targets.

Following the publication of a White Paper on the reforms earlier this year, the Government is preparing to issue details of how EMR will operate towards the year-end. Legislation is due in May 2012 to pave the way for implementation of the EMR in 2014, delegates heard at the conference, which was sponsored by Total Gas & Power.

Explaining the background, Richard Sargeant, head of energy futures at the DECC, likened the UK’s energy supply outlook as a “ski slope”, with capacity on the system set to drop sharply as the current increase in gas generation is eclipsed by the retiring nuclear and coal stations. By 2020, he said, about a quarter of UK power plants will close the biggest retirement quantity in Europe.

“To keep the lights on and meet our carbon targets, we need to [incentivise] investment to come forward at twice the rate of the previous decade. We also need to do all that cost effectively and keep power affordable, both for domestic consumers and for business.”

Sergeant said that while the renewables sector had the current Renewables Obligation (RO), it was unlikely that there would be investment in areas such as nuclear and carbon capture and storage (CCS). The plan, therefore, is to change incentive arrangements and transition away from the RO in 2017.

Within the EMR, the main instrument for achieving this goal is Contracts for Difference (CfD). This mechanism is designed to stabilise revenues for low-carbon generators, providing a top-up mechanism that counters fluctuations in fossil fuel prices, by paying out the difference between the strike price and the electricity price.

According to Sergeant, CfD will be more cost effective than the RO, as it covers all forms of low-carbon generation for the same cost, or less, than supporting just renewables.

It is vital that plants don’t get a great big slug of money from CfD and then also get topped up from the Capacity Mechanism

“The aim is to deliver the minimum level of reward necessary for projects to be financed and power facilties to get built,” he said. “And, if the price spikes above the strike price, generators would then pay money back and that would mean a rebate on bills for households.

The DECC, however, has yet to choose where to take the reference electricity price from. There are, said Sergeant, several options, including using an exchange or a collection of brokerages to give an average price. The strike price, he added, is likely to be different, at least initially, for different technologies.

Price discovery

“The government wants to move to a competitive price discovery: it is really important that we try to discover the lowest possible price that people are willing to build new forms of generation for. So initially this will be administrative, leading to technology-neutral auctions in the 2020s,” the DECC official commented.

The other key instrument within the EMR is the Capacity Mechanism, which is intended to ensure investment for power plants, which might not be used very much.

“If we have a lot of wind turbines and a windless week in winter, we need to ensure that there is enough back-up generation to make the lights stay on, and these capacity payments are like a retainer payment to ensure that backup plants have enough certainty about their revenue streams to get built,” Sergeant explained.

There is, however, concern about how the CfD and Capacity Mechanism interact, conceded Sergeant, who stressed: “It is vital that we don’t pay twice for the electricity, that plants don’t get a great big slug of money from CfD and then also get topped up from the Capacity Mechanism for that same electricity.”

Likewise, the body that runs the CfD and the Capacity Mechanism has yet to be established. We will be saying more about that in the New Year, said Sergeant, noting that this could either be a public body or a private body like National Grid.

“We are also very focused on smooth transition,” he concluded. “One of the trickiest aspects of electricity market reform is that, as well as the complexity of the reforms themselves, we have an enormous amount of investment taking place at the moment through the RO and outside it. We don’t want to disrupt that. We want to do everything possible to prevent a hiatus from a policy perspective.”