House of Commons - Draft Energy Bill: Pre-legislative Scrutiny

Draft Energy Bill: Pre-legislative Scrutiny - Energy and Climate Change Contents

9 Wider concerns about the draft Bill

Political leadership in communicating costs

217. As we noted in our previous report on EMR and our forthcoming report on the UNFCCC, a failure to communicate with the electorate about the fact that electricity prices are likely to increase in future may undermine the credibility of the entire EMR package and stifle action that consumers would otherwise take to improve energy efficiency, in order to keep bills down.[275] (It is likely that prices will increase in the short-term even without action to decarbonise because global demand for gas is pushing up prices.)

218. This theme was raised during our roundtable meeting with investors and analysts. One participant said "There is a need for political leadership. If Government wants investors we need to see the Government standing behind its decisions and to have a discussion with citizens about proposals for the energy sector. If the discussion is fair and open we will trust their word is true. If not we will put you in the same box as the European bailout countries - we won't believe what you say".[276]

219. Investors are concerned that a failure to engage properly with members of the public now creates the possibility of a backlash from consumers at some point in the future. This could result in a future government reneging on commitments (as has happened recently in Spain). Although the purpose of using long-term contracts rather than a Feed-in Tariff is to make it more difficult for future governments to renege on commitments made now, adding an additional layer of certainty by specifying what compensation might be available in the case of the CfD being dismantled at some point in the future would help to increase certainty for investors.

220. Some investors are concerned that there may not be sufficient acceptance among members of the public for the EMR proposals to be delivered successfully. There is therefore a fear that a future Government may renege on commitments as a result of political pressure from the electorate. his is driven by the perception in some quarters that the Government is failing to warn consumers about likely increases in electricity prices. In order to increase confidence, DECC should spell out the provisions for recompense should the CfD be dismantled as the result of circumstances beyond its control.

Clarity about the future role of gas

221. As we have noted previously, there is a delicate balance to be struck between ensuring there is sufficient gas capacity on the system to meet short-term security of supply objectives on the one hand, and preventing "lock-in" to a high-carbon system that does not achieve our long-term decarbonisation objectives on the other.[277]

222. It is not clear what the impact of the EMR proposals will be on the delivery of new gas-fired generating capacity or the extent to which it will be used in the future. For example, some witnesses told us that uncertainty may cause a hiatus in investment, while others told us that the EPS grandfathering proposals could encourage a rush of new build ahead of the 2015 review date (see paragraphs 177 - 183). It appears that there is the potential for different measures within the EMR package to pull in different directions and it is not yet clear which will prevail. WWF said:

We believe that the EPS and the capacity mechanism need to be looked at together as an integrated package of measures, the combined aim of which should be to ensure that the (i) UK has sufficient flexible peaking capacity to meet demand in 2030 and (ii) has sufficient safeguards in place to ensure that the generation mix in place by 2030 will comply with a carbon intensity target of 50gCO2/kWh.[278]

223. It is vital to have a clearer understanding of the likely impact of the EMR proposals on the future role for gas. We hope that the Government's forthcoming Gas Strategy will provide clarity about both the Government's vision for the role of gas in the electricity system, and how the EMR proposals will deliver this in practice. There would be merit in assessing the combined impact of the capacity market and Emissions Performance Standard on energy security and climate change objectives. We recommend that DECC conducts modelling work before introducing the Bill to investigate the combined impact of the capacity market and EPS on emissions and security outcomes under different scenarios. This should include "dash for gas before 2015" scenario and a "no new gas before 2015" scenario.

The Bill has the potential to damage low-carbon jobs and industries

224. The Secretary of State told us that he believed the Bill would help to create growth and would generate "about a quarter of a million" new jobs.[279] We also hope to see growth in the number of "green" jobs, but several witnesses told us that the proposals as they stand might damage the prospects for developing new manufacturing and supply chain industries. There was particular concern about the impact on industries associated with wave and tidal energy.[280]

225. The two main areas of concern were the proposals to move to auctioning of CfDs for renewable energy in 2017 and the lack of clarity about the strike price for marine energy after 2017. Catherine Mitchell and Bridget Woodman (Exeter University) told us that the proposals for auctioning were "reminiscent of the Non-Fossil Fuel Obligation from 1990-1998 […] - an unsuccessful mechanism for a variety of reasons, which also destroyed the British wind manufacturing base because the level of competition was so great that cheaper overseas turbines were used".[281] Aquamarine Power asked "what incentive is there for companies to invest in the £10s of millions required to support the first marine energy arrays in the run up to 2017, without a clear idea there will be a clear and consistent market for these technologies in the decades ahead?".[282] Auctioning of CfDs was explored in more detail in Chapter 3.

Re-regulation of the energy system

226. Although the Government is committed to a competitive market for electricity, in practice the proposed reforms will deliver a significant level of government intervention in the market.[283] For example, nuclear and renewables will fall under the CfD regime, unabated coal will be ruled out by the EPS and new gas capacity may end up in the capacity market. Greenpeace noted that "thus all forms of power generation will be receiving direct support".[284]

227. What is more, some witnesses told us that limiting the availability of CfDs under the levy cap would mean that choices will have to be made about which projects gain support. This means that in practice, the CfD awarding body will be making decisions about the nature of Great Britain's generation mix. Climate Change Capital told us:

In our view none of the allocation mechanisms proposed either work or absolve DECC from needing to make qualitative judgements as to who they will award CfDs to. […] In the (highly likely) event that the number of consented projects exceeds the available approved levy spend, then this means that the allocation body will need to make qualitative judgements as to which projects will achieve financing and hence should be awarded CfDs. We simply do not see any way around this.[285]

228. The Secretary of State did not accept this argument because "after 2017, […] there is going to be a competition for who gets the Contracts for Difference".[286]

A proper assessment of costs

229. The cost of capital offered by banks and other financial investors will determine whether projects to build new generation capacity are viable. The cost of capital is determined by the level of risk associated with the projects. The Government's rationale for introducing Contracts for Difference (CfDs) is that they will reduce risk by improving long-term revenue certainty, which will lower the cost of capital for low-carbon generators.[287]

230. However, while witnesses agreed that the Government was right to aim to reduce the cost of capital, they also suggested that the current proposals were likely to introduce new risks, which could undermine any savings achieved through reduced revenue risk. These included:

Risks associated with the proposed counterparty model, which is "new, complex and has no clear legal precedent". The creditworthiness of the counterparty and legal enforceability of contracts were cited as particular concerns.[288] (see Chapter 3)
Development risk resulting from the levy cap and use of auctions (see Chapter 3).[289] SSE pointed out that "since development is almost entirely funded by higher cost equity, increasing development risk will significantly impact adversely on overall financing costs".[290]
The potential for downgrading of credit ratings across the suppliers as a result of the counterparty arrangements, which would lead to an increase in borrowing costs for all of these organisations.[291](see paragraph 85)
Risks associated with the inclusion of contract term penalties in CfDs.[292]
The introduction of basis risk (that the generator may not achieve the market reference price) that does not exist with the Renewables Obligation.[293] (see paragraphs 118-119)
The overall complexity of the proposals increases risk.[294]
Transaction costs (such as credit and collateral requirements etc) are not considered.

231. In addition, the EMR proposals focus entirely on reducing revenue risk in order to attract new sources of finance, when in fact, other types of risk might be more influential in determining investment decisions. For example, pension funds would not be willing to take offshore wind construction risk, family office and private equity funds would be unlikely to fund projects costing more than €20 million and only utility companies would be likely to take on nuclear construction risk. This suggests a lack of proper understanding within DECC about how financing decisions are made by different types of financial institution.

232. We recommended in paragraph 102 that DECC should develop a more robust Impact Assessment methodology to account for these different types of risk.

275 Energy and Climate Change Committee, Electricity Market Reform, Energy and Climate Change Committee, The road to UNFCCC COP 18 and beyond (forthcoming) Back

276 Annex 1: Note from roundtable meeting Back

277 Energy and Climate Change Committee, The UK's Energy Supply: Security or Independence?, para 101 Back

278 Ev 187 Back

279 Q 520 Back

280 Ev 130, Ev w58, Ev 198, Ev w133, Ev w148, Ev 221 Back

281 Ev 221 Back

282 Ev w58 Back

283 Ev w11, Ev w28, Ev w106 Back

284 Ev w37, Draft Energy Bill, CM 8362, May 2012, Introduction, p 10, para 5 Back

285 Ev 167 Back

286 Q 458 Back