Three years – and a lot of hard work – later, it now looks like the reform is likely to be fully implemented by the end of 2014. But what has changed in the meantime and what will the implications be for UK energy market participants?
EMR – A brief recap
The government’s energy policy seeks to meet the energy ‘trilemma’ of ensuring a secure energy supply, meeting statutory decarbonization targets and keeping the cost of energy affordable for consumers. At the same time, the EMR also seeks to design an investable opportunity in lowcarbon generation that provides some certainty around expected revenues (while still complying with EU State Aid guidelines and preserving free market dynamics).
The twists, turns...
While the government still publicly maintains that all three ‘trilemma’ factors are equally important, security of supply remains chief among them with a focus on affordability.
In September 2013, opposition leader Ed Miliband pledged to freeze energy prices until 2017 if his party wins the general election in 2015. Three months later, the coalition government pledged to cut energy bills by GBP50 a year, via a series of measures, including a slash in green taxes for gas and electricity firms.
The announcement by the Competition and Markets Authority of a review of the Big Six utilities on claims of anti-competitive pricing has moved the energy market near the top of the political agenda.
Against this backdrop, it is hardly surprising that some recent EMR tweaks appear to be affordability-driven. Here is a summary of what has changed:
- Carbon Price Floor (CPF): When first announced, the Department for Energy and Climate Change (DECC) had set a minimum price for carbon emissions from electricity generation by ‘topping-up’ the price of CO2 per ton with prices rising over time. However, in the most recent budget speech, the UK Chancellor announced a cap on the price that would stand for the rest of the decade, noting that the future trajectory would be reviewed later in the decade. This has three broad implications: first, it highlights the potential policy risk that investors face in the UK; secondly, it creates new budgetary challenges for developers looking to secure Contract for Differences (CfDs) for future projects; and thirdly, post-CfDs it exposes low-carbon generation to market prices now reflecting even greater uncertainty on carbon pricing.
- Contract for Differences (CfDs): Due to higher-than-anticipated interest in the CfD program, the government announced in January that – rather than use a firstcome- first-serve allocation method – it would instead offer two allocation rounds per year for all low-carbon technologies. The government has also grouped technologies into either ‘established’ or ‘less established’ categories, with a view to allocating CfDs to the ‘established’ group via a competitive sealed-bid auction. And while the government intends to set the amount of budget available depending on the allocation and the technology group, there is no indication yet whether budget will be ring-fenced for any ‘less established’ technology.
- Capacity Market: When first announced, many in the industry considered the non-performance penalties proposed on generators holding capacity contracts to be, in the words of one industry participant, “draconian and ruling out our participation”. The proposal’s 10-year cap of capacity contracts was also seen to be a deterrent to unlocking investment. In response, the DECC has recently made a number of changes, including: offering 15-year agreements for new capacity; confirming existing capacity access to rolling one-year agreements (three years if refurbishment is required); capping penalties at 200 percent of monthly and 100 percent of annual income; and capping the capacity auction at GBP75 per kilowatt hour.
These announcements are welcome developments and should help unlock the necessary investment to tackle the UK’s looming capacity shortage. The first capacity auction will take place in December 2014, subject to State Aid clearance being received, and two transitional auctions for demand side capacity will occur in 2015 and 2016. This will help grow the demand-side industry and ensure effective competition between traditional power plants and new forms of capacity.
... and bumps
Eagle-eyed readers will have noted the reference to State Aid above. Due to their nature, the UK must notify the European Commission (EC) about the capacity market and CfD elements of the EMR for State Aid clearance.
Late last year, the government formally notified the EC regarding the Hinkley Point C New Nuclear Investment Contract (an early form of the CfD) and pre-notified the EC on other renewable Investment Contracts and EMR policy aspects with full notification expected soon. The Hinkley Point C notification has been referred for full public consultation, with the EC questioning the level of support and implied rate of return for the developer. Given that the UK’s actions are being widely viewed as precedent-setting for other European jurisdictions, this move was not entirely surprising.
The UK Government remains hopeful of a positive resolution to the State Aid notification, albeit on a longer timeline than was originally anticipated. However, many would suggest that an in-depth investigation on Hinkley Point C would be well worth the effort if this helps expedite the State Aid process for the other Investment Contracts and the EMR overall.
We believe that the UK’s EMR program, which is arguably the biggest change in the electricity markets since deregulation over a decade ago, is firmly on track for ‘go live’ later this year despite the twists, turns and occasional bumps on the road to implementation.