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Blueprint for energy future

The government has laid out its plans for energy-market reform but Anne Harris wonders whether they are enough to keep the lights on in the UK.

Electricity plays a part in almost every aspect of modern life and is vital to our economic and social wellbeing. Since privatisation in the 1980s the UK has relied on a competitive market system with independent regulation to deliver reliable electricity. However, the UK energy infrastructure is facing unprecedented challenges over the coming decades. It will lose 20GW of generation as old and highly polluting plants shut their doors. Recent figures suggest that by the end of the decade the capacity margins will be so tight that the likelihood of costly blackouts will increase.A further twist comes from the introduction of more intermittent generation in the form of wind energy that will need to be balanced against inflexible base-load generation from nuclear power giving flexibility challenges.

Action is required now to keep the lights on, and the UK government has launched a white paper setting out its commitment to transform the electricity system.

“We have a Herculean task ahead of us,” said Chris Huhne, secretary of state for energy and climate change, on launching the Electricity Market Reform (EMR) White Paper. “The scale of investment needed in our electricity system in order to keep the lights on is more than twice the rate of the last decade. The fact is that the current electricity market is not able to meet that challenge. Without action, there is a risk of uncomfortably low capacity margins from around the end of the decade and a far higher chance of costly blackouts.

“This package will keep the lights on and bills down. It will insure us against shocks from volatile parts of the world like Libya, and end the dithering about our need for new plant.”

The aim is that within two decades the UK will have a flexible, smart and responsive electricity system, powered by a diverse and secure range of low-carbon sources of electricity, with a full part played by demand management, storage and interconnection; competition between low-carbon technologies that will help to keep costs down; a network able to meet the increasing demand resulting from the electrification of our transport and heating systems.

Despite those challenges, the drive to decarbonise electricity supply must continue apace, not least to meet the EU target of 15 per cent renewable energy by 2020, and 80 per cent by mid-century. To have any hope of meeting the latter target, the UK power generating system needs to be largely decarbonised by the 2030s.

A further stumbling block is that demand for electricity is likely to rise and that, despite the improvements in household and non-domestic energy efficiency, overall demand is predicted to double by 2050 due to electrification of transport and heating systems.

Mammoth investment

There is no firm consensus on how the UK can reach these targets but one thing that most can find common ground on is the fact that the current market arrangements will not deliver the scale of long-term investment needed, at the required pace, to meet these challenges.
The sheer scale of the investment required is staggering. Up to £110bn investment in electricity generation and transmission is likely to be required by 2020, more than double the current rate of investment.

The two key challenges of decarbonisation and security of supply will be met through a combination of measures. The conditions for meeting decarbonisation targets have been set in low-carbon and renewable energy objectives, but current market arrangements have not.

The current market price for electricity is driven by fossil plant, such as unabated gas-fired Combined Cycle Gas Turbine (CCGT), with much lower fixed costs relative to their operational costs in contrast to, for example, nuclear or offshore wind.

Investors in non-gas fired generation are also disadvantaged by being exposed to more volatile and uncertain returns when compared to gas. Renewable generators often have to overcome relatively high barriers to market entry. High construction costs and market illiquidity make it more difficult for low-carbon generation to compete with fossil fuels and impede market access. Small and independent players are also particularly affected by the risk of not being able to find long-term buyers for their electricity.

Finally the cost of polluting, the so-called carbon price, is not fully reflected in the market price as this does not take into account all of the damage caused by climate change.

Future strategy

At the heart of the government’s strategy is a framework that its hopes will offer reliable contracts, administered through delivery arrangements that are trusted by investors, to achieve the diverse portfolio of generation required.

The four-pronged approach will offer: long-term contracts for both low-carbon energy and capacity; institutional arrangements to support this contracting approach; continued grandfathering, supporting the principle of no retrospective change to low-carbon policy incentives; and ensuring a liquid market that allows existing energy companies and new entrants to compete on fair terms.

With a document covering the interests of so many with vested interests, it is not surprising that some sections have drawn praise from some stakeholders whilst others have serious objections. But among the interested onlookers there are some grave concerns.

“The white paper tries to perform a juggling act between low-carbon energy, security of supply and low cost energy that may turn out to be fundamentally irreconcilable,” Nathan Goode, head of energy, environment and sustainability at UK accountancy and advisory company Grant Thornton, says. “The government is committing to replacing a tried and tested renewable energy support mechanism with something entirely new that is highly interventionist in its approach. This is a gamble during a critical time in the transition to a low-carbon economy, but one that may ultimately pay off.

“However, it seems that support for the principal proposals in the white paper was hard to come by and therefore it is puzzling that the issues raised during the consultation appear to have had a little impact on the final proposals. The nuclear question is finally out in the open with the declaration that there will be ‘no public support unless similar support is available to other low-carbon technologies’. A significant number of key decisions have been deferred to a later stage.”

Public understanding and acceptance of both the issues and the need for a solution is vital, and Goode is critical of the communications behind an extremely complicated set of proposals. “A white paper on a subject of such crucial importance should be accessible to the general reader,” he says. “It is critical that the government gets its message across to the public, and in my view it largely fails on this front. Overall, whilst the direction of travel may be the right one, the diffidence and obscurity which characterise this document do no one any favours.”

No Plan B

Despite some misgivings there is a desire to make this happen, driven by the ‘doomsday’ scenario that failure to deliver will entail. “There is no plan B: the EMR can and must be made to work,” Volker Beckers, chief executive, RWE npower, explains. “Failure will be bad news for the environment, for industry, and, most notably, for customers. This is a positive indication of the direction of travel.

“However, it is vital that both customers and investors can see where their money is going. The scale of investment required in the UK is unprecedented: £200bn by 2020 is equivalent to £8,000 for every household in the country. The EMR White Paper shows progress on climate change and security of supply, but we must have more focus on affordability.

Beckers is another who is concerned about the complexity of what is on offer. “I am still concerned that government is trying to pull too many legislative levers at once and, in doing so, is running the risk of losing focus on what matters for UK energy now,” he adds. “We must maintain a diverse range of technologies and a level playing field where they can compete. Further clarity on the details of the key proposal, the CfD [contract for difference] mechanism, is vital to avoid losing momentum.”

Responsible for moving this generation around the country will be National Grid, and its chief executive, Steve Holliday is comfortable leaving the market, that he describes as “the most powerful tool at our disposal” to ensure secure, affordable, sustainable electricity to support the low-carbon economy.

“The White Paper takes us in the right direction, but it will be crucial to get the remaining details on market reform right over the coming months,” he continues. “National Grid, with our central role in the industry, will continue to play a key role in helping this to happen.

“So many critical developments depend on the right market incentives. We need a diverse mix of generation built in the right timescales. We need new technologies like Carbon Capture and Storage (CCS). We need to ensure that demand-side, interconnection and storage can make a bigger contribution to security of supply. And all of this will drive National Grid’s future investment in the transmission system. Energy is society’s life blood. The status quo is not an option and getting this right will be vital for all our futures.”

Delivery mechanisms

Standing front and centre is a system of feed‑in tariffs with contracts for difference (FiT CfD), providing clear, stable and predictable revenue streams for investors in low-carbon electricity generation.

Backing this up will be the introduction of a Carbon Price Floor (CPF) to reduce uncertainty, put a fair price on carbon and provide a stronger incentive to invest in low-carbon generation now. This was announced in Budget 2011 and represents an early and long-term signal to investors that the government is serious about encouraging investment.

With hearty measures included to promote and support the growth of renewable energy it is no great surprise that both of the UK’s two major renewable energy organisations – Renewable Energy Association and Renewable UK – are firmly on side.

“Around a third of our electricity needs to be renewable by 2020, yet this stands at less than ten per cent today,” Gaynor Hartnell, chief executive of the Renewable Energy Association, explains. “We are encouraged that the transition measures set out in the white paper, demonstrate intent that the Renewables Obligation (RO) should remain robust and bankable. We are also delighted to see the ambition for biomass and energy from waste substantially increased. These cost-effective baseload technologies are an essential part of the mix and bring wide benefits.”

There are concerns, however, that potential industrial and commercial on-site generators are in danger of falling through the gap between feed-in tariffs and the RO/EMR. “These sites have the potential to make a substantial contribution, yet don’t have incentives to encourage them to develop on-site generation,” Hartnell explains. “The current feed-in tariff is now being recast as a measure intended only for householders and community projects, and so these larger onsite users are being squeezed out. The RO and the EMR arrangements that will eventually replace it are complex mechanisms, suitable for professional project-development companies. Larger on-site generators should have an extension of the current fixed FiT if they are to play a role in the future. Government should do all it can to ensure that industry can benefit from, as well as help pay for, the financial incentives available for renewables.”

The growth of the wind industry will also provide a boost to employment in the sector, which is expected to employ around 100,000 by the end of the decade, a point picked up Maria McCaffery, Renewable UK’s chief executive. “The Secretary of State’s announcement provides a huge boost to the wind industry,” she says. “It will increase investor confidence, allowing the sector to expand more rapidly.

“This will enhance the UK’s capacity to generate clean, green energy to meet our CO2 reduction targets, creating a low-carbon economy. There will be massive growth in jobs as a result of this expansion. Our evidence-based studies show that 90,000 people will be working in the wind and marine energy sector in ten years’ time.”

One renewable energy developer is broadly supportive of the support mechanism but cautions that prices may rise. “The white paper’s proposals outline important steps to encourage vital market investment, in order for the UK achieve a stable, secure, low-carbon future,” Green Energy Parks’ managing director, Chris Williams, says. “The proposed carbon floor price and the introduction of longer term contracts for green energy companies are essential to ensure that the monopoly of the big six is reduced, and that clean electricity is integrated as a genuine and viable part of the mix.

“Reforms or not, we must accept the inevitable fact that energy prices will rise – either from mounting fossil fuel costs, or through initial up-front investments to aid a transfer to a low-carbon future. We must be determined to push forward now and recognise that investment at this point will cost everyone far less in the long term – both financially and environmentally.”

Providing some rigour to the decarbonisation effort will be an Emissions Performance Standard (EPS) set as an annual limit equivalent to 450g CO2/kWh at baseload to provide a clear regulatory signal on the amount of carbon new fossil-fuel power stations can emit. This will reinforce the requirement that no new coal-fired power stations are built without CCS.

The future

The next steps are a technical update, which the government will publish by the end of the year along with a report from DECC on current support incentives, to be followed early next year by an electricity systems strategy focussed on flexibility and balancing challenges. The Spring of 2012 will see the government begin to legislate for key elements in the white paper that it is hoped with enter the statute books the following year allowing the first of the low-carbon projects to be supported to begin in 2014.

Not exactly a sprint start then, but it may provide a solid platform to develop the future generation system that will serve the UK well into the next century. *

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