Oh sweet irony of life. A conservative-led U.K. government last year legislated the Electricity Market Reform (EMR), reversing almost three decades of a liberalized quasi-competitive energy market that the same party initiated in the 80s. The post-EMR market is one driven entirely by the state.
To be fair, the EMR framework was originally introduced in 2010 by the then Labour governments secretary for energy and climate change, Ed Miliband. The EMRs motivation lies primarily within recommendations from the U.K.s Committee on Climate Change, its various green targets linked to 2008s Climate Change Act, and other domestic and EU laws. In other words, policymakers were forced to rethink the design of its liberalized electricity market sectors mainly due to the shortcomings in decarbonizing the economy and attracting new investment. According to the Department of Energy and Climate Change (DECC), the EMRs aim is to decarbonize the electricity generation, keep the lights on, and minimize the cost of electricity to consumers. The EMR introduced a number of new market mechanisms aimed at achieving these three tenets, the main two being the Capacity Market and Contracts for Difference (CfD) scheme. The Capacity Market provides a regular retainer payment to non-intermittent forms of capacity in return that such capacity will be available when the energy system is stretched. CfDs, on the other hand, aim to provide long-term revenue stabilization for new low carbon generation investments.
In December 2014, the U.K. ran its first capacity market auction leading to the procurement of 49.26 GW of fossil fuel-based capacity at a gross cost of GBP 960 million ($1.48 billion). Rather disproportionately, the main bulk of the inaugural auction winners were existing plants (22.3 GW of gas, 9.2 GW of coal/biomass, and 7.9 GW of nuclear facilities) and only 2.6 GW or 5% of the capacity auctioned will be new plants. In December 2015, the U.K. will hold a second auction for capacity, with auctions set to be repeated each year on a rolling basis and always four years in advance of delivery.
The inaugural allocation of CfDs has also been initiated. Applicants for the CfDs were invited by the National Grid, the U.K.s grid utility and the appointed CfD delivery body, to submit sealed bids for renewable energy projects between January 29 and February 4. According to the time frame for the allocation of the CfDs, the National Grid will notify the successful bidders to the Secretary of State for Energy and Climate Change, Ed Davey, on February 20, while successful applicants and the Low Carbon Contracts Company (LCCC) the governments CfD management body will be notified on February 26. Successful applicants will have until March 27 to sign and return the contracts to the LCCC.
The EMR critique
There is a logic behind the EMR, suggests Michael Pollitt, Professor of Business Economics and Assistant Director of the Energy Policy Research Group (EPRG) at the University of Cambridge. Under the CfD scheme, renewable types of energy are encouraged, while fossil fuel plants get pushed to the margin and have low utilization. Still, conventional types of power plants are required to backup intermittent sources such as wind and solar, and therefore need an availability payment via the capacity market.
But in practice, Pollitt argues, the EMR is a mishmash of unworkable mechanisms that will dismantle the competitive character of the U.K.s electricity sector. In legislating the EMR, the government removes a number of important market functions, including the ability to react quickly to new information, long-term commodity price risk management, decentralized portfolio optimization, competition in planning for the future, the reduction of technology-based lobbying, and private responsibility for long-term planning failures, said Pollitt.
Renewables subject to lobbying
Technology-based lobbying has specifically been targeted by Dieter Helm, Professor of Energy Policy at the University of Oxford. Dieter is explicitly hostile towards renewable energy subsidies, but is undecided on whether he would accept an energy system with no renewable types of energy at all.
Despite this uncertainty, Helm takes an interesting stance against the government. Renewables policy, he claims, started with a single subsidy value, and renewables would get contracts paying them one unit of Renewables Obligation Certificate (ROC), which is the renewables remuneration scheme that preceded the CfDs. However, the DECC happily bowed to various technology-based lobby interests in introducing subsidy banding and including a larger number of technologies.
Offshore wind led the way. It is an order of magnitude more expensive than onshore wind, and early on its corporate interests lobbied for two ROCs, said Helm. It was a masterly demonstration in lobbying techniques, combining direct advocacy, the threat to withdraw investment from a large offshore wind farm, and a supporting media strategy with lead articles in the key newspapers. And it worked. Offshore wind is the biggest winner of the CfD mechanism. Under the CfD design, public subsidies are spread across three different Pots of technologies. Solar PV projects larger than 5 MW have been grouped in Pot 1, where they must compete with onshore wind, small hydro and conventional-waste-to-energy technologies for the GBP 65 million ($99 million) per year allocated to it. Pot 2 has been allocated the main bulk of the subsidies and comprises offshore wind and wave power. DECC announced at the end of January a GBP 25 million ($38 million) increase in this Pots annual budget, which has now reached GBP 260 million ($396 million) in total. Pot 3, comprising biomass conversion plants, has not currently been allocated any funds.
Some within the industry believe solar PV has been singled out for unfair treatment by the DECC. Leonie Greene, Head of External Affairs at the U.K.s Solar Trade Association (STA) believes as much: We did everything we could to promote solar but a major problem is that the budget allocated to renewables under the Levy Control Framework (LCF) was nearly exhausted and solar had to fit in a very small portion of it. [The] DECC, she told pv magazine , has been strongly criticized by the Public Accounts Committee for allocating nearly 60% of its budget to just eight projects, most of which are more expensive than solar. Pollitt also made a similar point. I think that the idea that the market cannot deliver, even with suitable carbon pricing, is now a pervasive one. This immediately subjects the government to all sorts of lobbying interests for particular technologies.
Picking winners and losers
Under the EMR, the U.K.s energy generation mix is clearly defined by the state, subject to pressures from the various lobbying interests. For renewables specifically, overall spending needs to remain within the LCF, so that total subsidy to the sector is capped at GBP 7.6 billion ($11.7 billion) in 2020/21, in real 2011/12 prices.
The EMR framework, says Greene, favors big international players, while solar PV in the U.K. is dominated by new entrants and small-to-medium investors who are less able to cope with the increasing risk the CfD introduces. As a result, some of our quality members have chosen not to bid in the inaugural auction, while other members were forced not to because they didnt meet the set criteria, said Greene.
We anticipate that the results of the first CfD auction will offer the solar PV industry next to nothing, unless the big international players step in. By default, big investors, like the Big Six utilities [British gas, E.ON, EDF, Scottish Power, Scottish and Southern Energy, and Npower] that the EMR favors have massive resources and sophisticated bidding strategies that allow them to shoulder risks. The solar industry doesnt ask for special treatment. We ask for a level-playing field. Greenes quest for a level-playing field is highly contested across the energy industry. Helm says that if the DECC honestly intends to return to a technology-neutral policy, it needs to let the subsidies go. And with them, many of its pet technologies. It looks particularly bleak for offshore wind. It would be a brave politician to face down all of the vested interests and lobbyists, but then that person is unlikely to be around to face the consequences. Although Helms stance towards subsidies is rather radical, given the flawed emissions market, his querying of a subsidy-free future is not entirely alien to the U.K. solar industrys plans. In fact, the STA has modeled the entire solar budget under all schemes (FIT, ROCs and CfDs) out to the financial year 2020/21 aiming to provide a path towards zero subsidies by then. STA understands the importance of reaching grid parity fast so that solar technology is freed from political interference. If we are able to survive in the next two years, hopefully PV costs will decrease providing the industry a competitive advantage, Greene said. But this is far from secure if investors cannot keep projects going. We surveyed our members last year and half of them are planning to lay staff off in 2015.
A new model of cooperation?
The emerging question is whether going backwards towards the vertically integrated model of the energy industry is preferable to the DECCs piecemeal energy policies and continuous market interventions. Both Helm and Pollitt discourage it.
There is still a choice between a form of managed competition, and the picking of winners by the government, says Helm. The choice of the competitive route would require an emphasis on carbon pricing, a willingness to have a renewables/low carbon-wide auction, and open capacity contract auctions, he argues.An obstacle to Helms suggestions is that no country alone can easily build a successful carbon pricing system. Pollitt rather addresses this difficulty in saying: Other countries should note that the EMR is the well-intentioned, but misguided, result of a failure of the EU Emissions Trading System to deliver a pathway to significant decarbonization. Nevertheless, Pollitts work suggests that public involvement in the electricity sector is on the way back and can coexist with liberalized markets. The challenge, he suggests, is not between full state and full private ownership, but to maintain the benefits of both and encourage innovation in new organizational forms.
I think that an obvious example is the area of government involvement in extra-large energy projects. Thus, the Hinckley Point C nuclear plant is receiving large financial guarantees from the U.K. government to support investment by French and Chinese government-owned companies. A better sharing of both risk and return would have been a joint venture between EDF and a U.K. government special purpose company. This would have allowed the U.K. taxpayer to better share in the upside if the project was completed as planned, and would have reduced appropriation risks for other investors.
By contrast, more local authority shareholder involvement in local energy projects would ensure more public engagement with, and local sharing of, benefits from small-scale renewable projects, said Pollitt.
The major reform still to come
Those who believe that the EMR represents a major redesign of the electricity market, as the government suggests, are misguided. Markets have always been evolving and will continue to do so. But specifically in the electricity sector there are some groundbreaking changes that have taken place, and which continue to unfold, that a major reform will soon be needed to address them.
The current market design is based on marginal cost electricity pricing, the absence of electricity storage and a passive demand side, Helm says. But all three characteristics are now rapidly changing. New generation technologies, notably next generation solar, are overwhelmingly zero marginal cost ones.
Large-scale storage will also disrupt the current energy market design, which requires a central grid backed up by large, often idle, power plants. And finally, IT may soon alter the electricity consumer from a passive player to an active demand-side manager. Electricity policy in the coming years will require a real, fundamental reform that addresses these challenges and not just combines existing tools in a piecemeal way. But one thing remains certain: Solar PV will be part of this new reality.
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