Memorandum by the Office of Gas and Electricity
Markets (Ofgem)
How do and should renewables fit into Britain's
overall energy policy?
1. The 2007 Energy White Paper set out
four overall energy policy goals:
— to promote competitive markets
in the UK and beyond, helping to raise the rate of sustainable
economic growth and to improve our productivity; and
— to ensure that every home is adequately
and affordably heated.
2. More recently, the Government's Renewable
Energy Strategy consultation (RES), which was published on 26
June, focuses on two serious challenges:
— tackling climate change by reducing
emissions both here and abroad; and
— ensuring that our energy supply
remains secure.
3. Measures to achieve individual policy
objectives inevitably interact with the pursuit of other goals.
In the case of steps to meet the Government's environmental objectives,
there are synergies and trade-offs with the goals of ensuring
affordable and secure energy. It is for the Government to decide
on the appropriate level of greenhouse gas reductions and the
trade-offs it is prepared to make in order to achieve its objectives.
Given our statutory duties, our role is to provide advice to the
Government on how to deliver its objectives—and in particular
those that relate to the sectors for which we have a statutory
responsibility—seeking the best value for money, which often
means at the lowest possible cost to present and future energy
customers.
4. In general, we support using broad-based
economic instruments as the most cost-effective way of meeting
environmental challenges. We think the best approach is for the
Government to decide on its desired objective—such as a
specified reduction in greenhouse gas emissions—and then
allow the market to find the most cost-effective abatement options
and technologies. This is because Governments, and regulators,
do not have the necessary knowledge, expertise or information
to judge the most effective and cheapest ways of meeting a particular
goal. This is particularly the case for reducing carbon emissions
where there are a range of competing technologies at different
stages of development and whose costs may change rapidly over
time if, for example, fossil fuel prices change or if there is
rapid technical innovation. We have therefore argued for broad,
carbon based instruments such as the European Emissions Trading
Scheme (EU ETS) in all sectors where they are appropriate. These
instruments are essentially technologically neutral and allow
the market process to determine the most cost-effective technologies
to meet a defined reduction in carbon emissions.
5. We have recognised that other policies
may be appropriate to provide a bridge to the time until the EU
ETS has a longer time horizon and covers more carbon emitting
sectors. We also recognise that for some sectors that emit carbon,
such as domestic heating or retail petrol, the transaction costs
associated with trading schemes may be prohibitive. In such cases
it may be more appropriate to consider carbon taxes, with the
level of any tax linked to the price in the emissions trading
scheme to make sure that emissions reductions are achieved in
the sectors with the lowest abatement costs. In addition, as set
out in the Stern report, there is a need for additional intervention
directed at consumer awareness and technological development.
This is discussed further under question 3. Now that the UK Government
and other EU Member States have agreed on targets for renewable
energy, we want to help ensure those targets are met in the most
cost-effective way.
6. Meeting the 2020 renewable energy
target will not be cheap. It requires unprecedented investment
in all areas of the supply chain; financial support mechanisms
add to cost to consumers; and the increase in intermittent generation
may have an impact on price volatility. This all comes at a time
when prices are already rising and around 4.5 million households
could be in fuel poverty. It is therefore important to ensure
that the policy instruments designed to meet the target also protect
customers from facing excessive or inefficient costs.
7. The Government acknowledges that renewable
generation is not the only way to achieve a low carbon economy.
Demand side measures such as energy efficiency can achieve carbon
savings at a lower, or even negative, cost. This represents a
crucial synergy in helping to tackle climate change whilst helping
customers save money. In addition, the RES consultation recognises
the smaller, but equally important, role that other technologies
can play in facilitating this transition, for example distributed
energy and bioenergy, as well as the larger role that can be played
by renewable energy in other sectors such as heat and transport.
8. The Government's commitment to more
renewable energy is shared by other EU Member States. The European
Commission has also signalled the importance of the movement toward
a low carbon economy through the binding targets that it proposed
should be adopted in the Strategic Energy Review that it published
in January 2007. These targets specifically required:
— a reduction in Green House Gas
(GHG) emissions of 20%, compared with 1990 levels, by 2020 (binding);
— an increase in the share of renewable
generation in the overall fuel mix by 20% by 2020 (binding); and
— an improvement in energy efficiency
of 20% by 2020 (non-binding).
9. In March 2007 all Heads of Government
within the EU signed up to these targets and the process to embed
these within EU legislation began in January of this year, with
the publication of the EU Green Package. This Package seeks to
put in place arrangements for Phase III of the existing EU ETS
to facilitate further abatement of GHG emissions, amend the existing
Renewables Directive to incorporate binding targets on renewables
deployment as well as improving existing provisions relating to
renewables and to examine the progress made in Member States with
respect to energy efficiency. Information on some of the different
support mechanisms used to achieve the targets in different Member
States can be found in our answer to question 4.
What are the barriers to greater deployment of
renewable energy?
10. The potential barriers to increases
in renewable electricity capacity include:
— obtaining planning consents (for
generation sites and for grid connections/upgrades);
— obtaining access to the electricity
transmission grid;
— constraints in the supply chain for
generation (eg wind turbines) and connections (especially offshore);
— sourcing finance from investors and
debt suppliers;
— cost-effective support mechanisms;
and
— achieving the best balance between
the heat and electricity sectors.
11. The planning regime remains the principal
obstacle to meeting the Government's renewables targets. The British
Wind Energy Association estimate in their evidence that, of the
15GW of onshore wind projects that have entered the planning system
since 2002, only 2GW are currently in service. We recognise that
the UK Government's Planning Bill aims to improve the planning
process for major infrastructure projects, but this legislation
would apply only to England and Wales, where planning delays are
less acute at the moment.
12. The electricity transmission networks—the
wires which carry electricity from generators to customers—do
not have enough capacity or appropriate access rules to meet the
target. New lines need to be built in order to help connect more
renewables, and better use needs to be made of existing lines.
Ofgem is playing its part by allowing a 160 per cent increase
in investment in the electricity networks and by reviewing the
arrangements for allowing generators to gain access to the networks.
The existing access arrangements do not provide appropriate signals
in sufficient time to allow the transmission companies to invest
to expand capacity when it is required. In addition, the arrangements
prevent better use of the existing capacity being made through
allowing new renewable generation to connect quickly and share
capacity with existing generators. Without major reform, as proposed
in our Transmission Access Review published this month jointly
with the Government, these problems would continue. The issues
relating to the electricity networks are explored in further detail
elsewhere in this submission.
13. Our discussions with other energy regulators
through the Council for European Energy Regulators suggest that
grid access and planning constraints for new transmission lines
are also significant issues in many other Member States.
Are there technical limits to the amount of renewable
energy that the UK can absorb?
14. We are unlikely to hit a limit on the
amount of renewable and intermittent generation that can be absorbed
given sufficient time and money. However, there could be technical
challenges in the medium term, for example to 2020, and the costs
may be excessive.
15. High wind penetration and current typical
demand patterns could lead to more volatile wholesale electricity
prices. Demand during night time in summer can fall to 30% of
winter daytime peak levels. Prices may even fall to zero at night
when there is more wind generation than demand. Suppliers will
therefore have a strong incentive to offer new services and tariffs
to encourage customers to redistribute their demand across the
day by, for example, using more time-controlled domestic appliances,
although this would require a rapid roll out of smarter metering
technology.
16. The short space of time available to
meet the target may require the use of similar technologies or
the same manufacturing design for a significant proportion of
our generation fleet. This reduces diversity and increases the
risks associated with any "type faults" being discovered
later, for example with the design of a particular wind turbine.
There are also risks associated with individual technologies that
are not yet fully tested in operational conditions, notably offshore
wind. Such issues need to be weighed against the potential carbon
savings and other benefits associated with action to tackle climate
change.
17. An increase in renewable energy supplies
could help security of supply by increasing overall generating
capacity; delivering a more diverse energy mix; and lowering Britain's
reliance on imported fossil fuels. There are potential risks to
security of supply as well. There is limited experience of the
operational challenges of running an integrated transmission system
reliably and within existing quality standards with a high proportion
of intermittent generation, mainly wind powered. The scale of
the 2020 target and the limited time available to meet it could
also impact on security of supply. Ambitious renewables targets,
especially if supported by attractive financial incentives, could
divert investment away from other generation technologies, some
of which would be needed to cover the intermittency features of
certain renewable energy supplies.
18. In the longer term, the challenges associated
with intermittency can be met through a range of established and
emerging technologies combined with behavioural changes. Intermittent
generation requires back up, for example when the wind is not
blowing, and this could be provided by pumped storage and open
cycle gas turbines as well as coal. However, as the proportion
of wind energy increases, the back up generation becomes correspondingly
more expensive as it sits idle for much of the year. Emerging
technologies including batteries and fuel cells could become economically
viable if their costs continue to fall or if electricity prices
generally continue to rise. Finally, behavioural and technological
changes can help by managing demand in response to intermittency.
For example, smart meters, time of day pricing and also new technologies
that control domestic and industrial appliances—such as
shutting down fridge motors—to manage demand in response
to intermittency. However, all of this costs money and takes time.
Are there likely to be technological advances
that would make renewable energy cheaper and viable without Government
support in the future? Should, and how could, policy be designed
to promote such technological advances?
19. Without specific support for renewables,
the major factor determining investment in renewable generation
would be current and expected prices for carbon and electricity.
A combination of a strengthened and deepened EU ETS and continued
high commodity prices could therefore make some sources of renewable
energy competitive. Many forms of renewables are in need of technological
development and there is great potential for advances in this
area to benefit future electricity customers. However, there is
a real risk that technological development is used as a residual
explanation or "catch-all" for large subsidies, even
for mature technologies. We would advocate that subsidy attributed
to technological development should be justified on the basis
of the development and potential of the technology. Perhaps as
a consequence of the lack of justification here, it also seems
that insufficient attention is focussed on customer awareness.
20. In its current RES consultation document,
the Government notes that "The current RO was designed on
the basis of wholesale prices fluctuating around a relatively
stable level of £40/MWh [Megawatt hour]. At the time of writing
the wholesale electricity prices for a year ahead are closer to
£70/MWh."[1]
As the expected long-term value of a Renewables Obligation Certificate
(ROC) would have been around £40/MWh, this implies that renewable
investments to date have been made on the basis of revenues of
about £80/MWh, not far above current prices without any subsidy.
While the costs of windfarm construction have increased recently,
we understand that well-located onshore windfarms would probably
be viable if future revenues could be locked in at today's wholesale
electricity prices.
21. In this context, the best support mechanism
for renewables is one where the level of support is inversely
linked to changes in the wholesale electricity price. This would
make sure that if wholesale prices either stay at their current
levels or increase—due to higher fossil fuel prices or a
strengthening of the EU ETS and higher carbon prices—the
consumer would not provide renewable generators with a greater
subsidy than they actually require.
Has Government support been effective in leading
to more renewable energy? What have been the most cost-effective
forms of support in the UK and other countries and what should
the balance be between subsidies, guaranteed prices, quotas, carbon
taxes and other forms of support? Should such support favour any
particular form of renewable energy over the others? For instance,
what are the relative merits of feed-in tariffs versus the UK's
present Renewables Obligation Certificate (ROC) regime?
22. There are four main types of support
schemes for renewable energy currently used in various Member
States. These include feed-in tariffs; obligations or quotas;
tenders; and tax incentives or rebates. A feed-in tariff is an
additional premium (fixed or variable) paid on top of the electricity
market price that renewable energy producers receive. An obligation
or quota system normally involves a finite set of renewable energy
generation certificates being generated and traded, with penalties
in place for not possessing them, when it is mandatory to do so.
Tenders involve inviting companies to bid for a fixed level of
subsidy to deliver defined volume of renewable generation. Finally,
tax incentives or rebates provide tax advantages for those choosing
to generate renewable energy.
23. These schemes have had varying levels
of success in encouraging renewables and at very different costs
to customers and costs per tonne of CO2 emissions avoided. A recent
evaluation of their relative effectiveness concluded that feed-in
tariffs were generally more effective at encouraging larger volumes
of renewable generation at generally lower costs than the other
options.[2]
However, these studies are very context specific and a policy
that is ineffective and/or expensive in one Member State may be
more effective and cheaper in another Member State if, for example,
there are fewer planning constraints and more spare transmission
capacity.
24. The mandatory nature of obligations
means that is the costs are largely passed through to business
and domestic customers. This has been the case in Britain, where
the Renewables Obligation currently adds around £10 to a
domestic electricity bill per year and is set to rise to around
£20 a year by 2015. Lessons can be learned from the British
experience with the RO. Its advantages have been that, first,
it is market-based in that certificates can be traded. Second,
it is technology neutral and so investment is incentivised in
the most cost-effective technology at any given time. Third, it
was designed to sit alongside the competitive wholesale market
and allow subsidies to fall away as technologies became competitive.
25. However, in practice, the RO has not
been as effective as the Government had hoped. The proportion
of Britain's energy coming from renewables has increased but by
far less than is required to meet the target. It is worth noting
that the two principal reasons for the relative failure of the
RO were not predicted at the time it was introduced. First, the
principal barrier to the expansion in renewables has been the
planning regime. Second, the existing arrangements for giving
generators access to the electricity grid have not provided the
appropriate early investment signals or allowed for the best use
to be made of existing capacity. These factors have inhibited
the cost-effectiveness of the RO. For example, in 2006-07, the
cost of carbon abatement through the RO was in the range of £65-140
per tonne of CO2 depending on the fuel that is assumed to have
been displaced, compared with just £18/tCO2 under the UK
Emissions Trading Scheme. The high cost of abatement under the
RO could at least partly be addressed either by replacing the
RO with a feed-in tariff or tender system or simply by reforming
the RO arrangements.
26. The Government is now considering what
form the RO should take in the future. Given the risks and uncertainties
in meeting the very challenging EU target, any new policy instrument
needs to be robust to any future obstacles. There could be continued
problems with planning if the Government's reforms take time to
implement or are unsuccessful. In addition, for the next few years
there may be bottlenecks in the renewable manufacturing supply
chain—for example for wind turbines—as European and
global demand surges and manufacturers seek to increase their
manufacturing capacity. Finally, there is a risk that the Government's
proposed approach for the RO could exacerbate these difficulties.
Although "banding" the level of support for different
technologies could reduce costs to consumers by cutting the level
of support to forms of generation that are increasingly viable,
it would meaning losing the advantage of having a technology-neutral
support system. The introduction of a headroom or "ski slope"
is likely to mean that if wholesale electricity prices remain
high, and if the planning regime remains a constraint, then customers
could end up paying a bigger subsidy than is necessary. This problem
could be addressed by linking the level of support inversely to
the electricity price, thus ensuring the subsidy only goes where
it is needed. Another option would be to capture the money that
is currently recycled to generators through the "buy out"
fund and use it for other purposes—such as tackling fuel
poverty—instead of adding further to the profits of existing
renewable generators.
On top of the costs of building and running the
different types of electricity generators, how much investment
in Britain's transmission and distribution networks will different
renewable energy sources require compared to other forms of generation?
Are the current transmission and distribution systems capable
of managing a large share of intermittent renewable electricity
generation and, if not, how should they be changed? Are the rules
about how we connect capacity to the grid supportive of renewables?
Funding to renew the energy networks
27. Ofgem has played its part in providing
the necessary funding for the transmission companies to invest
to increase capacity to connect new renewable and other low carbon
generation. In recent price reviews Ofgem has allowed an unprecedented
100% increase in investment in the energy networks to upgrade
the existing pipes and wires and connect new generation, much
of it from renewable sources. The Transmission Price Control Review
for 2007-12 allows the electricity transmission companies to invest
£3.8 billion to maintain and upgrade their networks. The
funding is flexible and transmission companies' funding will increase
automatically if more generation seeks connection than was assumed
when the price control was set.
28. Prior to that, in 2004 Ofgem approved
£560 million of additional investment in transmission capacity
outside the normal price control process to avoid delay in the
upgrade work necessary to connect renewables The main project
affected was the upgrade to the line running from Beauly, west
of Inverness, to Denny, west of Falkirk: a key part of transmission
network in Scotland where much proposed renewable generation is
located. Most of this allowance has not been used because of major
difficulties in gaining planning permission. In 2006 the Scottish
Executive referred the project to a public inquiry.
29. There is the potential for more investment
as more generation comes forward. For example, we are facilitating
more "localised energy" (smaller-scale distributed energy
and household-scale microgeneration) which we are addressing through
our work on the next Distribution Price Control Review for the
period 2010-15.
A new offshore electricity transmission regime
30. Offshore, there is the potential for
over 30GW of renewable offshore wind generation to connect to
the system, potentially operating at a load factor higher than
35%. Together with the Department for Business, Enterprise and
Regulatory Reform (BERR), we have been developing and implementing
a new regulatory regime for offshore transmission to make sure
this generation can access the onshore market. Offshore transmission
has different technical characteristics and it costs much more
to build lines offshore than onshore. The transmission costs for
the initial two rounds of offshore sites currently being developed,
which could connect approximately 8GW of offshore wind generation
to the onshore network, are estimated at £2.5 billion. This
figure could potentially rise to around £10 billion if a
further 25GW is connected through the "round three"
process recently launched by the Crown Estates. These figures
are indicative at present and they do not take account of any
onshore network reinforcement costs that may be needed, or the
costs of connections to the Scottish Islands.
31. BERR and Ofgem have therefore decided
to base the arrangements around competitive tenders for major
offshore transmission projects. Ofgem will organise tenders and
appoint the most competitive bid to build, own and maintain the
offshore transmission lines. Subject to the Energy Bill becoming
law, the first tenders are likely to commence in April next year.
32. The challenge lies in rebuilding the
transmission system to accommodate this major change in the location
and nature of flows across the transmission system. Funding of
onshore reinforcement works should not present difficulties since
Ofgem can allow the expenditure provided it is efficiently incurred.
However, the sheer magnitude of the task will place an immense
burden on the planning system.
Reforming access to the grid
33. A vital requirement for meeting the
Government's renewable energy target is to change the rules governing
access to the electricity transmission network. The long overdue
reform of the access regime has, however, been blocked in the
past by the electricity industry. The Commons Innovation, Universities
and Skills Committee recognised this in its recent report on renewables.
"[Our] frustration is compounded by the knowledge that Ofgem
attempted to pilot transmission access reform in 1999 and 2000
but, under threats of legal action, was unable to proceed."
At the time, many in the industry argued that reform was unnecessary.
In addition, existing conventional generators have had an incentive
to oppose reform as they do not want to share their access rights
with, for example, new renewable generators.
34. We want a new grid access regime which
requires all generators to make a clearer financial commitment
of their future demand for capacity—or else give up their
access rights to new renewable generators who may be more willing
to make such a commitment. This approach has two significant advantages.
First, it gives National Grid a lot more information about generators'
demand for access to the network, which in turn allows them to
invest in new capacity to meet that demand where necessary. Second,
it allows for much greater sharing of capacity, for example between
renewable and conventional generation. Much renewable generation
is intermittent, and so wind farms could share capacity with conventional
generators which can start running when the wind is not blowing.
35. We are pleased that the industry is
now making much more positive comments about access reform and
we hope they will follow these with real action to amend the industry
rules. As the joint Ofgem/BERR transmission access review draws
to a close, National Grid has raised a suite of proposed changes
to the key industry codes to reform the current arrangements based
around three distinct models of reform. The proposals are now
being analysed and discussed and National Grid will present its
recommendations to Ofgem in September. We will then carry out
an impact assessment on the proposals before reaching our final
decision on which model to implement. We aim to have new arrangements
in place by April 2010, which will also allow time for the necessary
IT system development, although the timetable may be threatened
if any of our decisions are subject to legal challenge. The Government
has made clear that it will consider primary legislation if the
industry does not improve its performance and bring forward appropriate
reforms quickly. Ofgem is doing all in its power to facilitate
the reforms.
Short term measures to bridge the gap
36. The signs of progress on transmission
access reform are promising. However, the 2020 target is too pressing
for us to wait for a new regime to be in place. A lot can be done
in the meantime to help bridge the gap. For example, we have encouraged
National Grid to move away from a "first come first served"
approach to dealing with the queue for grid connections. At present,
generators who have finance and planning permission may be further
down the queue than generators who do not have either in place
but who approached National Grid first. National Grid is now taking
a more robust approach to removing unviable or purely speculative
projects. National Grid is also progressing an amendment to the
industry codes which would make it easier for existing and new
generators to share access to the grid.
37. We estimate that these shorter term
measures are capable of bringing forward 1GW of new renewable
connections including just under 600 MW of projects that already
have planning consent. We remain open to any other ideas which
will accelerate longer term investment in the grid to meet the
target.
Longer term measures looking to 2020
38. Even with transmission access reform,
there are still significant challenges ahead. For example, the
Government is committed to providing support mechanisms to help
deliver the 2020 targets but it has not yet confirmed the precise
form these will take. This means that renewable generators may
not be able to signal their future capacity needs to National
Grid and sign contracts because of the uncertainty over what financial
support they will receive. By the time the subsidy mechanism is
clear, there may not be sufficient time to build the capacity
early enough to meet the target.
39. Ofgem is engaged in several projects
to help ensure the grid can be properly configured for the renewables
challenge. We have asked the transmission companies to produce
an investment study to identify the options to invest to provide
the extra transmission capacity that will be required to deliver
the 2020 targets. For example, National Grid have suggested investing
around £2 billion in two offshore subsea cables that could
transmit electricity from renewable generators in the north of
Scotland, where there is a surplus of electricity, to the main
demand centres in England. Another option would be to focus on
incremental onshore grid reinforcements which National Grid estimate
could cost around £1.8 billion. We are working with the transmission
companies and will implement a new investment incentive framework
that will allow them to reach decisions on the necessary investments
given the long lead times for significant transmission investment.
This will make sure, subject to the planning regime, that we have
the necessary grid capacity in place in time to meet the 2020
targets. The framework will allow this investment to take place
whilst protecting customers from the risk of having to pay for
substantial investment in new transmission that is not required.
This is clearly important given the context of rising energy bills.
40. All this is in addition to Ofgem's existing
work through our price controls. In the current transmission price
control, we are allowing a 160% increase in investment in the
onshore electricity grid, with flexibility for the network operators
to go beyond this amount in response to demand for additional
capacity. We are also implementing, with BERR, the new offshore
electricity transmission regime which will allow the potential
of marine renewables to be fully and quickly achieved.
41. These contributions should allow a significant
expansion in renewables by eliminating undue network barriers.
Protecting consumers
42. The measures needed to meet the renewables
target will not be cheap. This raises particularly important choices
at a time of high energy prices and rising fuel poverty. The companies
understandably wish to protect their shareholders from as much
risk as possible, and to transfer the risk and potentially more
of the costs to the consumer. However, at a time when around 4.5
million households could be in fuel poverty, we believe it is
vital that consumers are protected from excessive or inefficient
transmission costs.
43. That is why, for example, our new incentive
package encourages the transmission companies to manage some of
the stranding risk, ie that there is not enough demand from generators
to use the new capacity once it has been built. In return for
taking on more of this risk, the companies will be allowed to
invest early and earn higher returns. Measures such as this allow
us to be more confident, on customers' behalf, that the investments
requested by the transmission companies are genuinely required.
At the same time, we want to see more long term commitments from
generators to use their capacity rights—or else make way
for new renewable generators who are ready and willing to connect.
How do the costs of generating electricity from
renewables compare to fossil fuel and nuclear generation? What
are the current estimates for the costs of "greener"
fossil fuel generation with carbon capture and storage and how
do these costs compare to renewable generation?
44. We favour the use of market mechanisms
and broad-based carbon trading schemes to determine the most cost-effective
technologies to reduce carbon emissions. We do not forecast their
respective future prices as this is the role of the commercial,
competing generating companies. A range of estimates has thus
far been provided to the Committee by several witnesses who are
engaged in this market. What is clear from these forecasts is
the great uncertainty about what the most cost effective technologies
are and how this is likely to change over time as some technologies
become established and reduce their costs, others prove not to
be viable and as the price of fossil fuels and uranium change.
Given this, we think it is all the more important to use market
mechanisms wherever possible to determine investment in new capacity
as markets are the most effective way of dealing with this uncertainty.
If the UK is to meet the EU target that by 2020
15% of energy consumed will come from renewables, will most of
this come from greater use of renewable sources in electricity
generation? If so, why? Should British support for renewables
in other countries be allowed to contribute towards meeting the
target for the UK?
45. This is principally a political question
for Governments to decide. Considered purely from an environmental
and economic point of view, ie how to meet the target in a way
that is effective and on time, whilst avoiding unncessary cost
to consumers, it makes sense to allow the necessary investment
to be made where it is most cost-effective. This may mean a greater
share coming from particular sectors or particular Member States.
How would changes in the cost of carbon—under
the European emissions trading scheme—affect the relative
costs of renewables and other sources of energy? Would a more
effective carbon emissions trading scheme remove the need for
special support of renewable energy?
46. Expected levels of coal, gas, carbon
and power prices are the major factor driving investment in new
capacity. Higher carbon prices will tend to skew investment towards
lower carbon generation plant, such as gas and nuclear. As noted
by both the Government and the European Commission, the renewable
targets will tend to deflate the carbon price, eg from €49
to €39 on one scenario.
47. However, market participants are unable
to predict the future. In addition, they value diversity, particularly
if market and political signals are uncertain. As a result, generators
are likely to favour a diverse mix of generating assets in the
future, including some new coal.
48. We favour broad-based instruments which
place a price on carbon, and ensure generators face the costs
of the associated externalities, whilst allowing the market to
find the cheapest way of reducing carbon emissions. Carbon trading
provides the purest way of achieving this. In practice, there
are ways to improve the cost-effectiveness of the European Emissions
Trading Scheme. The free allocation of permits under phase II
of the EU ETS, which runs from 2008-12, has led to a windfall
for generators. At the start of phase II in January this year,
we estimated on the basis of prices at the time that the windfall
of emissions allowances could be around £9 billion pre-tax
over the five year compliance period. This is because generators
seek to recover the costs of these permits through the price at
which they sell their generation, either in the wholesale market
or to their own supply business. Even though they receive some
of the permits for free they will still seek to recover the value
of the permit, since otherwise it would be more profitable not
to generate and to sell the permit in the EU ETS market. The impact
of this increase in the carbon price accounts for about an extra
£9/MWh in wholesale electricity prices. Under the UK's National
Allocation Plan, large electricity generators receive slightly
less than half of their emission allowances free of charge, so
the resulting increase in the price of power represents a windfall
gain for these generators.
50. Even with a more effective carbon trading
scheme, there may still be justification for support for some
renewable technologies to help develop options for meeting future
targets more cost-effectively. However, support for these reasons
would probably take a very different form from the RO. The Government
has already developed some policy interventions targeted in these
areas, such as establishment of the Energy Technologies Institute.
The costs involved are, however, orders of magnitudes lower than
the subsidies to relatively mature technologies, over and above
the cost of carbon, through the Renewables Obligation.
51. We hope that this information is useful.
We would be happy to provide any further information that the
Committee may require.
Alistair Buchanan
Chief Executive
July 2008
1 UK Renewable Energy Strategy: Consultation Document,
BERR, June 2008, page 94 Back
2
Feed-in Tariffs and Quotas for Renewable Energy in Europe,
CESifo DICE Report, April 2007, link) Back
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