Government publishes major consultations on reform of electricity market and carbon floor price

Practical Law UK Legal Update 2-504-2796 (Approx. 17 pages)

Government publishes major consultations on reform of electricity market and carbon floor price

by PLC Environment

Background

In the coalition agreement, the government said it would pursue three policies that would decarbonise the electricity market:

Introducing a floor price for carbon.
Establishing a full system for feed-in tariffs (FITs).
Establishing an emissions performance standard (EPS) to prevent coal-fired power stations being built unless they were equipped with sufficient carbon capture and storage (CCS) equipment to meet the EPS.

The government also said it would reform energy markets to deliver security of supply and investment in low-carbon energy (see Legal update, Coalition agreement final version: environmental implications).

In the June 2010 Budget, the government indicated it would consult on proposals to reform the climate change levy (CCL) to provide more certainty and support to the carbon price in autumn 2010 (see Legal update, June 2010 Budget: environmental announcements: Carbon price). The CCL is a tax levied on energy suppliers with respect to energy (electricity, gas, solid fuel and liquefied gas) used by non-domestic consumers.

On 27 July 2010, in its first Annual Energy Statement and 2050 Pathways Analysis, the government confirmed it was undertaking a review of the electricity market and would publish a consultation in autumn 2010, (see Legal update, DECC publishes first Annual Energy Statement and 2050 Pathways Analysis).

In the Spending Review 2010 (SR 2010) in October 2010, HM Treasury confirmed it would consult on reforming the CCL and on a carbon floor price (see Legal update, Spending Review 2010: environmental implications: Climate change levy and carbon pricing).

In his autumn forecast statement, on 29 November 2010, the Chancellor, George Osborne, noted that two major consultations would be published on:

Proposals for setting a carbon floor price; and
Proposals to promote renewables.

(See Legal update, Autumn statement 2010: no new environmental announcements).

The Financial Times has described these consultations as "the biggest upheaval in the sector since the electricity industry was privatised 20 years ago" (see Carbon-price boost for green energy, ft.com, 29 November 2010).

Electricity market reform consultations

On 16 December 2010, the following consultation documents were published:

Electricity Market Reform consultation document, by the Department of Energy and Climate Change (DECC) (EMR consultation).
Carbon price floor: support and certainty for low-carbon investment, by HM Treasury and HM Revenue & Customs (HMRC), which includes a consultation on reform of the CCL (Carbon price floor consultation).

The EMR consultation closes on 10 March 2011. The Carbon price floor consultation closes on 11 February 2011. The reason for the shorter (eight week) consultation by HM Treasury is so that the necessary legislation can be included in the Finance Bill 2011.

Territorial extent

The EMR consultation potentially covers the whole of the UK. Although energy policy is generally a reserved matter, certain powers have been devolved to Scotland and the generation of electricity in Northern Ireland is fully devolved.

The government has not yet determined the potential impact of the EMR consultation proposals on devolved energy policy and will be working with the devolved administrations to establish how the proposed reforms might apply across the UK.

The need to reform the electricity market

The government considers that:

"A new policy framework is essential to help us change the way we use energy, deliver the investment required to build a low carbon power system that provides security of supply at a price affordable for consumers".

(EMR consultation, page 14.)

The EMR consultation sets out a number of reasons why reform of the electricity market is needed:

To achieve the UK's greenhouse gas (GHG) emission reduction targets under the Climate Change Act 2008 (CCA 2008) and the Kyoto Protocol. This requires the UK economy, and the electricity market in particular, to be decarbonised (see Practice note, Climate Change Act 2008 and Practice note, UNFCCC and the Kyoto Protocol).
To meet increased electricity demand triggered by the market's decarbonisation. As the economy is decarbonised, electricity will provide more of the UK's heating and transport needs. DECC expects the demand for electricity may double by 2050. Without reform, this will offset any GHG emission reductions that are being made. DECC's analysis has shown that without reform of the electricity market, carbon intensity will only fall to 60% by 2030 which will mean that the 80% GHG emission reduction target under the CCA 2008 will not be met by 2050.
To change the electricity market's bias towards using fossil fuels and encourage low-carbon technologies. The power sector has a bias towards using fossil fuels to make electricity and is responsible for 26% of the UK's GHG emissions. Therefore, its reform is key to decarbonising the UK economy. The Committee on Climate Change (CCC), the independent body advising the government on cutting GHG emissions, has proposed that the power sector should be close to zero-carbon by 2030 (see Legal update, Committee on Climate Change advises on fourth carbon budget and 2030 target). To achieve that objective, the electricity market needs to allow equal access to a wider range of technologies, including:
- low-carbon generation technologies, such as, wind and tidal technologies, nuclear power and new fossil fuel power stations that use CCS;
- energy efficiency technologies to reduce the need for electricity; and
- electricity demand management technology, so that the electricity market is more flexible. This includes building additional grid interconnectors, introducing more electricity storage or increasing demand side response (DSR) (which involves reducing electricity demand by consumers at peak times rather than increasing generation). All of these technologies will help electricity consumption match peak wind generation in particular.
To meet the UK's 2020 target of 15% renewable energy consumption under Directive 2009/28/EC on the promotion of the use of energy from renewable sources (the Renewable Energy Directive). The UK must increase the percentage of electricity generated from renewable sources from nearly 7% currently, to 30% by 2020.
A number of the UK's existing nuclear power stations will have to be decommissioned and some coal-fired power stations will fail to meet new environmental standards. A quarter of the UK's power stations will need to be replaced by 2020 in order to ensure security of supply.
To attract investment. Addressing the previous points will require a large amount of investment. Ofgem estimated that this will cost around £200 billion in generation, electricity networks and gas infrastructure. At least £110 billion would be needed in new generation and transmission assets in electricity which is over double the rate of investment of the last decade. Without reform of the electricity market, the objectives of decarbonising the UK economy, meeting the UK's renewables targets and ensuring security of supply will not be met.

The government's objectives in reforming the electricity market are:

Decarbonisation.
Ensuring security of supply.
Ensuring affordability (that is, the reforms should be at a minimum cost increase to consumers).

Proposals for reform in both consultations

DECC confirms, in the EMR consultation, that the framework for the electricity market will continue to be market based.

The proposals in the EMR consultation and the Carbon price floor consultation fall into four categories:

Carbon price support. These proposals are set out in the Carbon price floor consultation and aim to give long-term certainty about the costs of running polluting power plants and to encourage investment in low-carbon power technologies (see Carbon price floor consultation).
Low-carbon generation revenue support. These proposals aim to provide certainty on revenues (income) for low-carbon generation for developers and investors, while controlling the costs to consumers (see Low-carbon revenue support).
Emissions performance standard. These proposals will limit how much carbon the most carbon-intensive power station (a coal fired power station) can emit and reinforce current requirements that new coal-fired power stations cannot be built without demonstrating CCS technology (see Emissions performance standard).
Capacity payments. As part of the EMR consultation, the government has proposed a targeted capacity mechanism to ensure security of electricity supply. The government considers that this is an important reform as low-carbon generation is often intermittent and inflexible as to when power is supplied, for example, wind power. Increasing low-carbon generation is, therefore, likely to increase the risks to security of supply. This mechanism would reward the provision of capacity, as opposed to only rewarding the provision of electricity generation (see Capacity payments).

The government will use four principles to assess the effectiveness of the different proposals for reform:

Cost effectiveness to consumers and taxpayers.
Durability and flexibility.
Practicality.
Coherence.

Low-carbon revenue support

Chapter three of the EMR consultation considers three alternative policy options for providing revenue support to low-carbon generation, that is, renewable energy, nuclear power and fossil fuel energy with CCS:

Low-carbon obligation. This is essentially an extension of the existing Renewables Obligation (RO) to include nuclear and CCS. It would require suppliers to source a certain percentage of their generation from low-carbon generation. For more information about how the RO works, see Practice note, Renewables Obligation.
Regulated Asset Base (RAB). This option would extend the current approach used to finance transmission and distribution networks to low-carbon generation. It would allow a low-carbon generator to make a regulated return on their investment in line with their average cost of capital through a regulator setting a limit on the returns that can be made.
FITs. The EMR consultation sets out proposals for introducing a low-carbon revenue support mechanism based on FITs. For more information about how the current UK FITs scheme works, see Practice note, FITs: feed-in tariffs.

DECC rejected the low-carbon obligation and the RAB policy options for the reasons set out on pages 64-66 of the EMR consultation. Small-scale FITs installations are not affected by the FITs reforms proposed by the EMR consultation, as these are aimed at large-scale low-carbon generation. The EMR consultation does not say what will amount to small-scale installations. As the EMR consultation does not mention any changes to the current FITs scheme (which applies to installations up to 5 megawatts (MW)), it may be that it will not be changed by the proposed reforms.

Three different types of FITs mechanism are considered:

Premium FIT. A generator will receive a static payment per unit of electricity generated, in addition to the revenues that it receives from selling its electricity in the wholesale market. This is close to the existing FITs and RO schemes, as they provide fixed revenues to renewables generators in addition to the revenues that they receive from electricity sales.
Fixed FIT. A generator receives a static payment per unit of electricity (that is not connected to the wholesale electricity price), instead of the revenues that it would receive from selling its electricity on the wholesale market.
FIT with a contract for difference (CfD). A generator has a long-term contract with the government (or an entity acting on its behalf), which is set at a fixed level. The generator sells electricity in the wholesale market. Then, either a top-up payment is made to the generator, or he has to make a repayment depending upon the difference between the average market wholesale price and the agreed tariff. The generator has to make a repayment to consumers if the electricity prices are higher than the agreed tariff. These variable payments/repayments would ensure that the generator receives the agreed tariff, but no more than that.
The CfD FIT allows the government more flexibility to amend the carbon price support mechanism as the CfD FIT changes in response to the average wholesale electricity price. If the government increased the carbon price or decreased it, the overall return made by low-carbon generators would not be affected. This is DECC's preferred option.

Emissions performance standard

Chapter three of the EMR consultation considers DECC's proposal for an emissions performance standard (EPS) to place an annual limit on the amount of carbon dioxide (CO2) that could be released into the atmosphere from a new source of electricity generation.

The aim of the proposal is to prevent new coal-fired power stations being built without CCS measures. This means that although coal can continue to contribute to the security of the UK's electricity supply, it must do so in a way that is consistent with the UK's decarbonisation objectives. It would not apply to existing power stations as this would increase the risk to security of supply already present due to the closure of coal-fired power stations required by Directive 2001/80/EC on the limitation of emissions of certain pollutants into the air from large combustion plants (LCPD) and Directive 2010/75/EU on industrial emissions (integrated pollution prevention and control) (IED) (see Practice note, Air pollution: overview: Implementation of LCP Directive in the UK and Practice note, PPC: Pollution Prevention and Control regime).

The EPS proposal is intended to build on the government's current policy that developers of coal-fired power stations applying for consent under section 36 of the Electricity Act 1989 must:

Include technically-feasible plans to capture the CO2 from at least 300 MW net of the power station's capacity from the outset if the power station is within the scope of the LCPD (that is, those with a generating capacity of over 50 MW).
Show that CO2 will be captured from their full capacity from the outset, if the power stations are within the scope of the LCPD, but with a generating capacity of less than 300 MW net.

For more information on the requirements regarding CCS, see Practice note, Carbon capture and storage: regulatory regimes: Government under pressure to make CCS compulsory.

The government is currently consulting on a requirement that CCS must be demonstrated successfully on at least 300 MW of new fossil fuel electricity generating capacity (see Practice note, Government consults on revised draft National Policy Statements for energy infrastructure: How have the draft NPSs changed?).

The EMR consultation considers two options on the level of the EPS:

An EPS set at a level equivalent to 600 grammes of carbon dioxide per kilowatt hour (gCO2/kWh) consistent with demonstrating post-combustion CCS on a new supercritical coal-fired power station.
An EPS set at a level equivalent to 450gCO2/kWh with specific exemptions for plant in the UK's CCS decarbonisation programme, or benefiting from EU funding for commercial scale CCS projects.

The first level has the advantage of being consistent with the CCS demonstration programme and the draft National Policy Statements (NPSs).

The second level is tighter and sends a stronger signal on the need for decarbonisation, but would mean the UK and EU CCS demonstration projects would need to be exempted. Otherwise, this tighter limit would increase the costs of these demonstration projects, which would raise concerns over the affordability of the demonstration projects and, therefore, the EPS.

The government proposes to grandfather existing coal-fired power stations. This means that the level of the EPS in place when a power station is consented remains the level which is relevant for the economic life of that power station (which would be a period linked to the time over which investors would expect to receive a return on their capital). However, to avoid incentivising power station owners from extending the lifetime of existing plants, instead of building new plants, the EPS would apply at its existing level when the life of an existing plant is significantly extended or upgraded. Installing selective catalytic reduction equipment needed to meet new IED standards or retrofitting CCS to a proportion of the existing station's capacity, would not count as upgrading so that the EPS applied.

Once introduced, the government proposes to review the EPS as part of the wider decarbonisation reviews required under section 5 of the Energy Act 2010.

Although the proposed EPS is technology neutral (that is, it does not specifically target coal-fired power stations), the levels currently proposed for the EPS would only affect coal-fired power stations. Over time as the EPS level is reviewed and tightened, it would affect gas-fired power stations as well. As and when this happens, existing gas-fired power stations would be grandfathered under the EPS.

In order to address any security of supply issues that may arise, the government proposes that the EPS will have exceptions that apply in short-term or longer-term energy supply emergencies. This would allow CCS equipment to be turned off or the plant to run at a higher output (or load factor) than the constraints imposed by the EPS, in very tightly defined circumstances.

The government recognises that the EPS needs to support burning, or co-firing with, biomass, as a renewable technology. It is considering options such as zero-rating emissions relating to biomass or differentiating them in some other way.

Capacity payments

Chapter 4 of the EMR consultation sets out DECC's proposals for capacity payments.

As part of the EMR consultation, the government proposes a targeted capacity mechanism to ensure security of electricity supply. The government considers that this is an important reform as low-carbon generation is often intermittent and inflexible as to when power is supplied, for example, wind power. Increasing low-carbon generation is, therefore, likely to increase the risks to security of supply. This mechanism would reward the provision of capacity, as opposed to only rewarding the provision of electricity generation. These proposals will encourage security of supply through the construction of flexible reserve plants or demand reduction measures (known as negawatts).

The government proposes introducing a mechanism that would place responsibility for maintaining a set capacity margin (of 10%) on a central body, as follows:

That body would assess the level of spare generation capacity provided through the energy generation market.
If there was a shortfall between the level of capacity provided by the energy generation market and a centrally determined margin, the body would run tenders for additional capacity.
The mechanism would be designed to reward DSR (that is, reducing consumption of electricity when demand is high), as well as additional generation. This would encourage energy efficiency measures and other smart technologies.

The government notes that Ofgem and the National Grid's work to improve the balancing system and to increase the liquidity in the wholesale market is also a vital part of ensuring security of supply (see Legal update, Ofgem publishes open letter on liquidity in GB power market).

Carbon price floor/CCL consultation

The Carbon price floor consultation indicates that notwithstanding the introduction of the EU Emission Trading Scheme (EU ETS) in 2005, the carbon price has not been stable, certain or high enough to encourage sufficient investment in low-carbon electricity generation in the UK.

Price volatility has been reduced by amendments to the EU ETS made by Directive 2009/29/EC amending Directive 2003/87/EC so as to improve and extend the greenhouse gas emission allowance trading scheme of the Community (for example, the introduction of an EU-wide allocation of allowances). However, they have not eliminated uncertainty over long-term carbon price trends. (For more information about the amendments made to the EU ETS, see Practice note, EU ETS Amending Directive 2009.)

The Carbon price floor consultation recognises that carbon price certainty is particularly important given the long life of low-carbon generation investments. Also, the lead times between a decision to invest and the plant actually generating electricity are relatively long. Typically these are around eight years for nuclear power, 2-3 years for offshore wind and 4-5 years for CCS. So it is important to influence decisions that will be taken over the next few years by acting now to give an indication of how the government will support the carbon price in the future.

It is proposed to introduce a carbon price support mechanism from 1 April 2013.

This will involve making changes to the way that the CCL and fuel duty are levied so that the levy/duty (as applicable) is paid on all fossil fuels used to generate electricity in the UK.

Currently, fossil fuels used to generate electricity are generally exempt from the CCL. For more information about how the CCL currently operates, see Practice note, Climate change levy and climate change agreements. Oils are not subject to CCL, but a fuel duty is payable at the point that the oil leaves the refinery. Electricity generators can reclaim the duty charged on oils in full. It is proposed to reduce the amount of fuel duty that electricity generators can reclaim.

Specifically, CCL and fuel duty will be amended as follows:

The exemptions/relief for generation will be removed and CCL carbon price support rates will be introduced (in addition to the existing main CCL rates for gas, coal, liquid petroleum gas (LPG) and electricity which will be retained).
The CCL carbon price support rates will tax fossil fuels used to generate electricity at rates that take account of their average carbon content.
Electricity used to generate further electricity (for example, as an input into a combined heat and power (CHP) plant), will remain exempt from the CCL.
The CCL that the final consumer of electricity pays will not change.
The treatment of imported electricity under the CCL will not change.
CCL carbon price support rates will be charged on fossil fuels that are used to generate electricity which is exported from the UK. Oils used in the same way would be subject to a higher rate of duty than at present because the duty would no longer be able to be reclaimed on that electricity.
Fossil fuels used by CHP stations currently receive various exemptions or partial reliefs from the CCL to acknowledge their generating efficiency. The extent of the exemption/relief depends on the CHP Quality Assurance (CHPQA) programme rating of a CHP station. Similarly, fuel duty on oil used by a CHP plant to produce electricity can be reclaimed by the generator. Reductions in this relief would be made in proportion to the performance of the CHP plant against the CHPQA quality threshold. The government does not propose to provide exemptions or relief for fossil fuel used by CHP plant, so their CHPQA rating will not make any difference to the carbon price support rates of CCL charged on fossil fuels burnt by a CHP station.
Partial relief would be given from carbon price support rates charged on fossil fuels burnt at CCS enabled power stations. This proposal is subject to state aid approval being granted by the European Commission. The legislation for such a partial relief will only be put forward once the CCS technology has been proven and is available commercially.

Supplies of fossil fuel to auto-generators (that is, a person who produces electricity principally for its own consumption) will remain liable to CCL rates and fuel duty but it is proposed that:

The carbon price support rates will apply.
They will not be able to reclaim the CCL or fuel duty in respect of fossil fuel that they use to produce electricity that is subsequently supplied to the electricity transmission and distribution networks.

Apart from affecting power stations, CHP stations and auto-generators, these changes will also affect anyone supplying gas, solid fuels (such as coal or coke) or LPG to generators as they will need to register with HMRC for CCL and account for the levy. In practice, most fuel suppliers will already be registered as they are likely to supply fuels for a range of purposes, not just for generation. (Suppliers of oils are already required to be registered with HMRC for fuel duty.)

A final decision on the carbon price support mechanism will be taken in the Budget 2011 (see Next steps below).

The mechanism for setting CCL carbon price support rates and fuel duty rebates

The Carbon price floor consultation considers establishing the appropriate level of support for the carbon price will involve looking at a number of factors, including:

The expected market price of carbon in the future.
The impact on investment in new low-carbon generation under different assumptions about generation costs and fossil fuel processes.
The impact on decisions about how to operate existing generation and decisions to close existing plant.
The implications of potentially higher electricity prices on businesses and consumers.

In setting the CCL carbon price support rates, the Carbon price floor consultation notes that it is difficult for the tax system to provide long-term certainty, as rates for environmental taxes, such as the CCL are usually set a year in advance.

Three options for setting rates are considered:

A rate escalator. This would set rates to achieve a specific carbon price trajectory over the life of a Parliament consistent with the overall target for a carbon price in 2020.
Annually adjusted CCL rates and fuel duty rebates. This would be able to take account of short-term trends in the carbon market and economy to target the government's carbon price trajectory more closely from year to year.
Rates set annually based on a carbon market index. This would be averaged over a specific annual or biannual period to reflect future carbon prices.

The government's preferred option is to introduce carbon price support rates at a different level to the main CCL rates and increase them incrementally from 2013 until the tax-inclusive carbon price is consistent with the government's target price trajectory.

The amount of fuel duty that would be reclaimed would be reduced to a level that was equal to the CCL carbon price support rates.

The government would review the CCL carbon price support rates and fuel duty rebates to ensure that they delivered the desired carbon price over the long term.

Setting the carbon price targets

The Carbon price floor consultation recognises that developers need to be confident that the level of the carbon price support mechanism will rise over time to target a combined carbon price (from the EU ETS and the carbon price support mechanism). The impact of supporting the carbon price depends not just on the level of support, but on the amount of certainty it provides to investors. The consultation looks at targets for 2020 and 2030.

Owing to the range of factors that affect investment decisions, it is difficult to determine the appropriate level of carbon price to target. The government modelled three carbon price scenarios of £20, £30 and £40 tonnes of carbon dioxide (t/CO2) in 2020 rising to £70t/CO2 in 2030 (all in real 2009 prices) against a baseline to give examples of how they might work in practice.

The government's modelling found that, compared with DECC's current published projections for the carbon price based on the EU ETS, a carbon support mechanism would:

Increase investment in a new low-carbon capacity by up to 11 gigawatts (GW) by 2030. The low-carbon share of UK electricity generation would reach more than 65% by 2030 where the carbon price support mechanism is introduced as compared to 50% under the baseline. Nuclear power appears likely to gain more from the carbon price support mechanism than renewables (see chart 5.C on page 32 of the carbon price floor/CCL consultation).
Significantly reduce emissions from UK electricity generation from 207gCo2/kWh in 2030 in the baseline, to 126gCo2/kWh, 124gCo2/kWh and 105gCo2/kWh in scenarios 1-3 respectively. This compares to emissions of 486gCo2/kWh in 2010.
Increase wholesale electricity prices over the medium-term although prices would start to decline in the mid 2020s relative to those of the baseline scenario.
Cause small increases in non-domestic electricity bills, although in the mid 2020s they would begin to decrease compared to a "do nothing" policy.
Affect profit margins for some energy-intensive businesses.
Increase household electricity bills in the short, and medium-term, although they would decrease in the mid-2020s.

Implementation issues for the EMR consultation

The EMR consultation indicates the more detailed aspects of the market design will be developed and then legislation, codes and licences will be drafted with a view to the reforms taking effect around 2013/14. The issues regarding implementation fall into three groups:

Instrument design: How the various policy instruments will function and are to be structured.
Institutional capability and framework: Identifying the skills needed to introduce the mechanisms and which institutions are best placed to administer the market.
Ensuring a smooth transition: How to manage the policy changes so as to minimise disruption to market participants.

Instrument design

A key design issues for any FITs scheme is setting the support at the correct level. Support must be sufficient to incentivise investment in low-carbon generation projects but not so high that generators make high returns at the expense of consumers. The EMR consultation says that the level of support can either be set by the government (as is currently the case with the RO and the current FITs scheme) or by an auction/tender which reveals bidder's underlying costs to government. The EMR consultation says that the government is attracted to the greater use of auctioning to set the levels of support under a FIT scheme but recognises that there are a number of issues to be considered such as whether there will be sufficient bidders, or whether a single auction would apply to all renewable technologies or there would need to be separate auctions for different technologies.

Institutional capability and framework

Two reviews that are already underway will help inform which bodies should be responsible for the various functions under the new schemes:

The Delivery Landscape review that resulted from the Annual Energy Statement. Under this review the government is considering how to streamline the existing delivery channels for energy and climate policy.
The Ofgem Review launched in July 2010 which is looking into the role of the regulator (see Legal update, Ofgem publishes an assessment of wholesale electricity market liquidity).

Ensuring a smooth transition

DECC considers that the following will help to ensure a smooth transition to the reformed electricity market:

Publishing its conclusions on the EMR in a white paper in spring 2011.
Ensuring the timetable for reform enables investors to bring forward their proposals for renewables, coal CCS and nuclear projects.
Ensuring the smooth transition of responsibilities between different bodies if such responsibilities are reallocated.

Changes to the RO

The EMR consultation proposals will necessitate changes to the RO during the transition to the new market framework.

The EMR consultation indicates the following principles will underpin the transition process:

Grandfathering: The EMR consultation gives comfort to existing RO generators and states "the government recognises the importance of honouring commitments given to provide generators with a particular level of support as part of maintaining investor confidence".
Accelerating the RO banding review: The RO banding review, which DECC recently announced would be brought forward to 2011 will give earlier notice of support levels for projects that will obtain accreditation between 1 April 2013 and 31 March 2017 (see Legal update, DECC announces early banding review in 2011 for Renewables Obligation).
Keeping the RO open to new projects until 31 March 2017: This will avoid disruption to projects being planned now. Depending on the responses to the consultation, DECC may offer a choice of support under the RO or the new low-carbon support mechanism between 2013/14 (when it is introduced) and 2017.
After 31 March 2017, only existing projects accredited under the RO would receive support for the full 20 years that support is offered (subject to end dates set in the RO). The EMR consultation refers to this as "vintaging the RO".
Working with the devolved administrations. The government has not yet determined the potential impact of the EMR consultation proposals on devolved energy policy and will be working with the devolved administrations to establish how the proposed reforms might apply across the UK.
Fuelled renewables: DECC will consider implications for technologies not currently grandfathered in England and Wales (that is co-firing of biomass, bioliquids, energy crops and CHP). A consultation is taking place in Scotland during autumn 2010 regarding grandfathering for biomass and waste technologies. A different approach to these technologies may be taken in different parts of the UK.

The EMR consultation also notes that industry needs as much clarity as possible on how the obligation level under the RO would be calculated beyond 2015/16 (which is when the fixed targets set out on the Renewables Obligation Order 2009 (SI 2009/785) end).

Three options are set out in Annex A to the EMR consultation:

Continue the existing system of using calculations A (fixed targets applied to DECC's projections of the expected licensed supply level) and B (estimating the amount of Renewables Obligation Certificates (ROCs) likely to be issued in the obligation period and then adding 10% headroom). This would involve extending the fixed targets beyond 2015/16.
Using calculation B only from 2017/18.
Moving to a fixed ROC system which would involve fixing the price of a ROC and requiring Ofgem to buy ROCs funded through a levy on energy suppliers. This option is problematic because it has an impact on current Power Purchase Agreements and on suppliers who would have to pay a levy more frequently than annually.

Packages of reforms

In order to ensure that all the reforms are coherent, the government has considered four different packages of policy options (see chapter 5 of the EMR consultation). In analysing the effect of these different packages the government has assumed that the carbon price of the combination of the carbon price support (CPS) and the EU ETS reaches £30/tCO2 by 2020.

Package 1: CPS, Emission Performance Standard (EPS) and a targeted capacity measurement.
Package 2: Premium FITs, CPS, EPS and a targeted capacity measurement.
Package 3: FITs with CfD, CPS, EPS and a targeted capacity measurement.
Package 4: Fixed FITs, CPS, EPS and a targeted capacity measurement.

The EMR consultation says that the government's modelling shows that:

Decarbonisation: All four packages can deliver the 2030 decarbonisation level of 100g/CO2/kWh if the incentives are set at the right levels. Packages 3 and 4 result in a higher take-up of CCS than package 2.
Security of supply: The inclusion of the targeted capacity mechanism means all the packages would result in a capacity margin of at least 10% being maintained in the period to 2030.
Affordability: The impact of these reforms on household energy bills to 2020 are broadly in line with the government's existing plans which were set out in the Annual Energy Statement. DECC considers consumer bills would be lower under Package 3 than continuing with the current policies, although no targets or trajectories for household energy bills have been set out to 2030. The government accepts that there is a small impact on consumer bills in the near-term with longer-term bills expected to fall by 4% by 2030. The government notes that the actual impact on bills cannot be accurately forecast until the rate of decarbonisation is set.
The impact on business bills to 2020 is also broadly in line with the government's existing plans in the Annual Energy Statement. The government estimates that the impact of Package 3 on the average business bill to 2020 will be a 2% increase and then (subject to decarbonisation trajectories being set) bills for 2025-2030 that are 5% lower than they would be if current policies were continued. The EMR consultation notes that the impact on different sizes and kinds of businesses will vary from the average that DECC has modelled.
Coherence: The EPS has a very limited interaction with the other policy options (that is, CPS, FITs (of any kind) and the targeted capacity measurement). Packages 1 and 2 are considered to be coherent. Package three is considered to be the most coherent of the four packages as CPS and FITs with CfD are complementary. Package 4 is not considered to be coherent.
DECC's preferred reform package is Package 3 as it is the most cost-effective way of supporting low-carbon generation. It does not think that Package 1 will be able to deliver the scale of low-carbon generation at the pace demanded by the UK's decarbonisation (including renewables targets) without the price of carbon being set very high (£50t/CO2 by 2020). However, DECC recognises that Package 3 contains outstanding design issues which, if they cannot be resolved, will mean an alternative package of reform will be needed. It is considered that Package 2 is the next best alternative.

Next steps

The EMR consultation closes on 10 March 2011. The EMR consultation indicates the government will publish a white paper in late spring 2011, which will:

Include a response to the EMR consultation.
Set out detailed legislative and administrative proposals to introduce the reforms.

Ofgem is currently undertaking a review of the liquidity of the electricity wholesale market (see Legal update, Ofgem publishes an assessment of wholesale electricity market liquidity), which will consider whether further changes are needed to protect consumers and increase transparency. The conclusions of Ofgem's review will be published alongside the white paper.

The Carbon price floor consultation closes on 11 February 2011. The reason for the shorter (eight week) consultation is so that HM Treasury can prepare the necessary provisions to be included in the Finance Bill 2011. The carbon price floor consultation indicates that primary legislation to introduce a CPS mechanism will be included in the Finance Bill 2011. This will be followed by secondary legislation at a later date. Draft legislation on the government's proposal will be available for comment in January 2011.

The government's response to the Carbon price floor consultation will be published in the Budget 2011. It is intended that the CPS mechanism should take effect from 1 April 2013.

The government has asked the CCC to provide further advice in spring 2011 about the longer-term potential for renewable energy.

Green Investment Bank

The Carbon price floor consultation confirms the government's intention to finalise the policy design of the Green Investment Bank (GIB) in spring 2011. For more information, see Legal update, Green Investment Bank: further details emerge.

Comment

RenewableUK, the trade and professional body for the UK wind and marine renewables industries, gave a cautious welcome to the consultations' proposals. Noting that its preference would be to retain the current successful support mechanism, the RO, RenewableUK said:

"Major investment is required in the UK's electricity sector, both to replace generating capacity that is reaching the end of its life and to meet our targets for renewables and carbon emission reductions. In the long term, the cost of doing nothing to the country and to consumers will be much greater than the cost of low carbon measures. However, we must also bear in mind that the Renewables Obligation has turned the UK into an offshore wind powerhouse, and brought forward 20,000 megawatts of applications onshore. We shouldn't be looking to solve a problem that doesn't exist, or take a leap in the dark which might undermine investment."

(See RenewableUK press release, EMR - wind industry cautions against 'leap in the dark', 16 December 2010.)

The Confederation of British Industry (CBI) said:

"These proposals could help, but the Emissions Performance Standard shouldn’t be included, since it duplicates existing policies. Instead, ministers should focus on getting the detail right on policies that could work, such as guaranteed electricity prices through 'contract for differences' and capacity payments. The Government must support all low-carbon technologies while letting the market determine which are most effective. Changes of this scale will not be cheap, so it’s vital that we build the most cost-effective mix of energy sources."

(See CBI press release, Will Electricity Market Reform work?, 16 December 2010.)

The Institution of Civil Engineers (ICE) said:

"This consultation and the proposal to set a price floor for carbon, are crucial and welcome steps towards creating more certainty for investors on the likely returns from investing in low carbon electricity generation...This momentum must now continue with a raft of other measures to help provide this much needed investor certainty – these include firming up the energy policy statements so industry has a clear idea of Government’s commitment and vision and reassurance that the new planning system will aid progress. If industry has any reason to doubt the Government’s long term commitment, we could be facing a very real energy gap within a decade."

(See ICE responds to consultation on the reform of the electricity market, Institution of Civil Engineers, 16 December 2010.)

Generally, the EMR and carbon price floor/CCL consultations set the policy landscape for the changes that will be made to the electricity market. However, clearly more detail is needed on each of the four proposals. It is anticipated further detail will be set out in the white paper that the government will publish in spring 2011. Two areas of the proposals deserve particular comment.

The FITs with CfD proposal appears to be very similar to the proposal to amend the RO to include a revenue stabilisation mechanism, which was the subject of consultation in autumn 2009 (see Legal update, Government announces next set of changes to the Renewables Obligation: Revenue stabilising mechanism). Respondents to that proposal did not support it for a variety of reasons including that it would make the RO overly complex which might have the effect of driving away investment. It would be of great concern if the introduction of the FITs with CfD failed to build on the success that the RO has achieved in attracting investment in renewables because it had traded reducing costs to consumers in exchange for simplicity.

Another area for concern in the EMR is the proposal to remove the CCL exemption for good quality CHP. This part of the proposal appears to be inconsistent with the proposed treatment of CCS plant for which a partial relief from CCL is being considered.

While CHP that uses fossil fuel undoubtedly results in CO2 emissions, it is more efficient than the separate production of heat and electricity and so should be rewarded.

CCS aims to lock up CO2 emissions so that they are never released. However, the process of pumping CO2 underground for storage itself uses up considerable energy, which makes the overall consumption of fossil fuels by CCS plant less efficient.

It is not clear why the government has chosen to prefer a technology that sequesters emissions over one that avoids some emissions.

The Carbon price floor consultation says that the carbon price support mechanism will provide an additional incentive for renewable CHP. Fossil fuel CHP will still face a significantly lower CCL liability than separate generation of heat and power as a result of its relative efficiency and the other existing CCL exemptions. The government has asked for views as to whether additional preferential treatment for CHP is needed. No doubt the CHP industry will be responding on this point.

Government publishes major consultations on reform of electricity market and carbon floor price | Practical Law