9 Wider concerns about the draft Bill |
Political leadership in communicating
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. (It
is likely that prices will increase in the short-term even without
action to decarbonise because global demand for gas is pushing
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".
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
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.
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.
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"
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.
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.
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".
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?".
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.
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".
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.
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".
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.
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
(see Chapter 3)
- Development risk resulting from the levy cap
and use of auctions (see Chapter 3).
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".
- 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
- Risks associated with the inclusion of contract
term penalties in CfDs.
- The introduction of basis risk (that the generator
may not achieve the market reference price) that does not exist
with the Renewables Obligation.
(see paragraphs 118-119)
- The overall complexity of the proposals increases
- 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
Annex 1: Note from roundtable meeting Back
Energy and Climate Change Committee, The UK's Energy Supply: Security
or Independence?, para 101 Back
Ev 187 Back
Q 520 Back
Ev 130, Ev w58, Ev 198, Ev w133, Ev w148, Ev 221 Back
Ev 221 Back
Ev w58 Back
Ev w11, Ev w28, Ev w106 Back
Ev w37, Draft Energy Bill, CM 8362, May 2012, Introduction, p
10, para 5 Back
Ev 167 Back
Q 458 Back
Ev w37, Draft Energy Bill, CM 8362, May 2012, Introduction, p
28, para 52 Back
Ev 117, Ev 123, Ev 137, Ev 151, Ev w58, Ev w101, Ev w112, Ev 206 Back
Ev w112, Ev 117, Ev 172, Ev w139 Back
Ev 151 Back
Ev 151, Ev w71 Back
Ev w98, Ev 130, Ev 161 Back
Ev 151, Ev 172 Back
Q 142 Back