Electricity Market Reform draft legislation needs strengthening

The Electricity Market Reform (EMR) process is designed to prepare the UK Electricity Market for a shift to Low Carbon generation and in the process correct certain failings in the current renewable support schemes. It is continuing the liberalisation process started in the 1980s with the privatisation of the electricity utilities.   It seeks to encourage further competition in the electricity generation sector.

The Contracts For Difference Feed in Tariff (CFD FIT) has much to recommend it compared to the Renewable Obligation Certificates (ROCs) and is welcomed by Mainstream as a positive step forward.  However, the draft legislation needs strengthening if it is to encourage new entrants into generation and to facilitate the necessary investment to meet the new generation build required.

The precise areas that need strengthening are:
1.    The lack of a visible route to market for power generated due to the absence of incentives for the current market players to offer Power Purchase Agreements (PPAs);
2.    The lack of clarity about the base or reference price in the CFD FIT;
3.    The need to reflect intrinsic cost drivers in the strike price – for example, in offshore wind distance from shore, water depth and ground conditions – given that designated sites were selected by the initial Government-designed process.

The green power option market (GPAM) addresses the first two for the following reasons:
a.    Power is auctioned and so a base price is set for every time period for the coming six months and being repeated gives certainty to the base price over the Investment period;
b.    It is intrinsically a market mechanism;
c.    Those with balancing capability i.e. the vertically integrated incumbents with diversified portfolios are doing the balancing;
d.    As the lowest price is set at zero this gives complete knowledge about the base price;
e.    Investors achieve an assured price by removal of uncertainty about the base pricing mechanism.

We note that Eon have asserted a new principle of “good” and “bad” balancers.  It is outrageous to suggest that anyone other than those with the balancing capability should be expected to assume this role.  Why?

I.    The vertically integrated utilities (“VIUs”) – have been doing it as part of their core business, long before there were ever any wind farms.  A recent study by National Grid in response to a Scottish Government consultation on the achievability of its 2020 renewable energy targets showed what has to be done is largely accomplished by the plant already held in reserve to account for existing variations in customer demand.  By having to hold dispatchible generation in reserve to meet customer demand, VIUs cover wind variability as well;
II.    VIUs gain hugely by having wind in their portfolio.  The price of wind is largely fixed whereas fossil fuel is displaying increasing volatility.  They adjust the systemic risk of their portfolio by including wind, much as ‘risk-free’ assets perform in a financial portfolio.  The risk reduction in time adds to the attractiveness of their profit streams through enhanced stability – a major appeal to their investment constituency.
III.    Independent Power Producers (IPPs) can only offer a balancing service by buying a financial hedge from the VIUs.  This additional cash outflow has to be factored into the Investment Case and tends to reduce the level of cheaper debt available to projects – so the cost of power from a wind farm goes up.  It is entirely inappropriate to ask IPPs to pay for what the VIUs accomplish almost entirely by default (as explained above in I). The costs of similar activities in markets such as Spain and the Nordpool show if the rules are got right, the consumer will not be penalised by this ‘stealth margin’.
In conclusion the GPAM is a truly effective mechanism for allocating risk efficiently and thereby reducing the price of wind-generated electricity.  It is literally the key enabler to facilitate more IPPs to enter the market and so enhance competition.

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