While the energy market has served us well for many years, it is clear that the current arrangements are unlikely to deliver the level of investment that is needed to meet our energy security and climate change objectives. The Government's proposed Electricity Market Reform (EMR) therefore has a crucial role to play in securing a clean and reliable electricity system for the future, at the minimum cost to consumers. The pre-legislative scrutiny process has identified some serious concerns with the proposals as they currently stand, which could make the reforms unworkable if they are not resolved. But the perfect should not be the enemy of the good and we believe that it is difficult but possible for the Government to revise the plans into a workable model.
DECC's stated objectives for reforming the electricity market (to move to a secure, more efficient, low-carbon energy system in a cost-effective way) are uncontentious but vacuous; very few people would seriously object to these aims. However, the lack of specific outcomes means that there is still uncertainty about exactly what the Government is hoping to achieve through these reforms. The Bill would benefit from the inclusion of a set of much clearer and more specific objectives. In particular, providing greater clarity about the role that the electricity sector is expected to play in contributing towards the UK's long-term decarbonisation target would help to boost confidence amongst the investment community. We believe that an explicit reference to the carbon budgets in the Bill, as well as making the Committee on Climate Change a statutory consultee on the delivery plan, would help to create greater certainty about the UK's commitment to meeting its statutory obligations.
As with many aspects of energy policy, the Government has fallen into the trap of focusing far too closely on the supply side of the energy system, while neglecting to consider the contribution that demand-side activities could make to security and climate change objectives. Thinking about the demand-side needs to be given a much higher priority in the Bill, not least because it is likely to deliver much more cost effective solutions than building ever greater levels of generating capacity.
At the heart of the reforms is the proposal to establish a Feed-in Tariff with a Contract for Difference (CfD). There is a great deal of merit in the idea of CfDsmost notably the principle of revenue certainty provided by a long-term contractbut the implementing arrangements have become so complex that the proposal has now arguably become unworkable.
There are three major problems with the CfD model that is currently proposed by DECC. First, the payment model based on a "synthetic" counterparty is not bankable because there is genuine uncertainty about whether any contracts would be legally enforceable. Second, the impact of "rationing" CfDs under the Treasury's levy cap will be to increase development risk, possibly to the point that the project pipeline could dry up. Finally, the removal of an obligation to buy renewable energy could compromise the ability of independent generators to take part in the market, which could lead to fewer players and greater levels of vertical integration. Indeed, the Bill and associated documents do not give sufficient consideration to the risk of negative impacts on smaller scale players in general.
Although these are significant concerns, we believe that it is still possible to make the proposals work. We recommend that the Government abandons the multiparty concept and reverts to a single counterparty model. We believe a single counterparty that is underwritten by the Government would be the best way to reduce the cost of capital, but if the Government does go ahead with a model that is not underwritten by the Government, it must specifically assess the effect of this decision in a new impact assessment. In addition, we believe that there may be merit in the two-step registration process for allocating CfDs that has been proposed in some quarters, as it appears to strike a balance between awarding a contract to anyone and everyone (possibly resulting in under delivery) and waiting so late in the development process that the risk of not getting a CfD becomes unacceptably high. Finally, we recommend that the eligibility threshold for small-scale Feed-in Tariffs should be extended to at least 10MW in order to allow smaller scale generators and community-owned schemes to continue to operate. We also suggest that DECC should consider options such as introducing a buyer of last resort or introducing an incentive to source energy from low-carbon generation to ensure that there is access to market for larger scale projects from independent generators.
A further problem with the CfD proposal relates to the treatment of nuclear power. The proposed process for agreeing the strike price for nuclear lacks transparency (both under the Investment Instruments process and CfDs when they are introduced) and any perception that decisions are being made "behind closed doors" could be hugely damaging to the low-carbon agenda. In order to help preserve confidence and trust in the process, a committee of independent experts should be appointed to oversee the negotiation process.
The Government is right to identify that there may be a risk to security of supply if investment in new capacity does not come forward to replace the existing generating plant that is scheduled to close down towards the end of this decade. It is unfortunate, therefore, that talk of the possibility of a capacity mechanism appears to be having the unintended consequence of freezing new investment. As a matter of urgency, more clarity is needed about the circumstances in which a capacity mechanism would be introduced. In addition Government must carry out a more rigorous analysis of the problem that the capacity mechanism is intended to address, with a specific consideration of the likely impact of integrating a large volume of intermittent generation on to the system.
The Emissions Performance Standard as currently proposed would be at best pointless. At worst, the decision to grandfather the initial level until 2045 may undermine our ability to meet long-term carbon targets and so the length of the grandfathering period should be reduced.
We do not believe that it is appropriate for a private company (National Grid) to act as the EMR delivery body and fear that this decision may lead to unnecessary additional costs to consumers.
The importance of ensuring a timely delivery of electricity market reform cannot be overstated: reform is vital if we are to meet low-carbon and energy security aspirations for 2020. It is therefore vital that DECC's timetable does not slip. We do not underestimate the scale of the challenge that the Government is facing in preparing a Bill that is fit for purpose in time for introduction in the autumn but every endeavour must be made to avoid further delays to the process.