UK Energy Bill unleashes the winds of change

Posted: 10/05/2013

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The Energy Bill, currently passing through Parliament, has ambitious but necessary goals; to secure the UK’s energy supply for the next few decades. The Bill aims at encouraging £110 billion of private investment into the electricity sector to help produce cleaner energy. The development and use of renewable energy forms a key part of this under the Electricity Market Reform (EMR).

Two of the most important proposals are:

• the replacement of the Renewables Obligation (the RO) and the Renewables Obligation Certificates (ROCs) by Feed in Tariff with Contracts for Difference (CfD); and
• the development of a capacity market.

The RO and CfDs

The RO was introduced as a scheme predominately designed to support large-scale renewable energy generation, that is projects over 5MW. The system works as follows:

• generators are allocated ROCs in relation to the amount of electricity generated and dependent upon source;
• these ROCs are tradable on the open market as between generators, brokers and energy suppliers;
• by the end of the year, suppliers are required to have a certain number of ROCs relative to the amount of electricity they have supplied to consumers; and
• any supplier failing to meet these targets will incur fines.

The problem with the RO has been the sharp fluctuations in the price that ROCs have traded at. In July 2008, ROCs were trading at a high of just over £53, compared to a low of around £38 in January 2006. The latest trading price is hovering around the £43 mark. Price instability has led to a degree of uncertainty in the renewable energy market and is believed to have acted as a disincentive to increased levels of investment, particularly in less established technologies such as tidal power. The new CfD programme aims to resolve this problem.

The Energy Bill envisages that from 31 March 2017, the RO scheme will close to new entrants and all large-scale renewable energy projects will be part of CfD. However, new schemes starting between the 31 March 2014 and 31 March 2017 will have a choice between the RO and CfD.

CfDs work by setting a strike price for each MWh of electricity produced. Should the price of the electricity fall below the strike price, the generator will receive a ‘top-up’ to the strike price. However, should the price of each MWh of electricity rise above the strike price, the generator will owe money back to the system administrator. As a result, generators do not take the risk of price volatility; although they also give up any potential windfall benefits resulting from higher electricity prices.

The contracts are to be made between the National Grid and the green energy generator. They are to be underwritten by a government-owned bond.

To date, the strike price has not been set, although current plans are for there to be a range of technology specific strike prices. The long term aim is that of a market based technology neutral price, allowing low-carbon technologies to compete against each other.

Running alongside the RO scheme, and often seen as a ‘sister’ scheme is the Feed-in-Tariff (FiT). This provides payment to small-scale renewable energy generators for the electricity they produce. The scheme is predominately aimed at those producing less than 50kW of electricity. FiT’s are here to stay, although the amount that can be ‘earned’ under them is set to consistently reduce.

Capacity market

This aim of this scheme is to secure a reliable energy supply. It works as follows:

• predications of peak future demand are made four years in advance;
• the system administrator analyses whether there is likely to be a shortfall in capacity to meet that demand;
• if so, auctions of ‘capacity contracts’ are held, allocating the supply of the excess demand in the relevant ‘delivery year’ to the successful bidder;
• non-generators can also bid to reduce demand for electricity by a specified amount;
• the winner commits to provide a certain amount of electricity or to reduce demand for electricity by a certain amount, whichever is applicable, in return for a steady stream of capacity payments;
• if these contracts are not adhered to, the winner will face financial penalties; and
• the costs of the ‘capacity contracts’ will be passed to suppliers and, ultimately, consumers.

Other notable features are that penalty payments will be capped in order to provide certainty for investors and that the ‘capacity contracts’ will be tradable between the auction and the ‘delivery year’.

The first of these auctions has been pencilled in for late 2014, for winter 2018/19 delivery.

Interaction

Current plans are that, whilst the strike price under CfD is set by the system administrator, CfDs and the capacity market are to be run as alternatives; generators will not be able to operate under both. This is obviously to prevent double compensation. However, the Government envisages that once the CfD strike price is set via the market, generators may be able to benefit from both schemes.

Alongside these EMR measures, demand side measures will also operate with the intention, quite simply, of reducing demand and ensuring consumers are more sensitive to price rises in the energy market.

The Energy Bill has been carried over to the 2013-14 session of Parliament and will continue its progress through the houses. It was referenced in the recent Queen's Speech and briefing notes to the speech indicate that the Energy Bill will include a power to set a target range for the decarbonisation of the power sector.

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