The key measure of the Energy Bill will be to introduce a government-owned entity that will buy electricity at an agreed "strike price" from low carbon generators and recover the costs from electricity customers via electricity suppliers. The government-owned entity will buy the electricity under a contracts-for-difference mechanism feed-in-tariff (CfD FiT) that will top-up revenues for low carbon generators if the wholesale electricity price is below the strike price and claw back revenue if wholesale prices rise above the strike price. The CfD FiT scheme will replace the Renewables Obligation (RO) although the two will run in parallel from 2014 until 2017.
Offering an explanation and analytical insight into the Bill, Jonathan Lane, head of consulting for power and utilities for GlobalData, says: The amount of spending to support low carbon generation, through both the RO and the CfD FiT scheme, will be capped under the Levy Control Framework (LCF).
This also covers the small scale feed-in-tariff scheme for microgeneration such as solar and the Warm Home Discount, the costs of which are also recovered from consumers via energy suppliers. The government has already announced that the LCF budget will grow from £2 billion in 2012 to £7.6 billion in 2020 in real terms, or £9.8 billion accounting for inflation. The policy objectives are twofold: to decarbonise the UKs electricity generation; and to reduce the UKs exposure to imported fossil fuel prices, particularly natural gas.
Whilst there is no doubt that this spending will have an impact on customer bills, says Lane, it is far too simplistic to simply add £7.6 billion on top of current bills in order to calculate the impact by 2020. Here, he cites four unknowns that make this calculation misleading:
1. What fossil fuel, particularly natural gas, prices will be in 2020;
2. How much electricity the LCF will be able to buy;
3. What impact energy efficiency measures such as the Green Deal and the Energy Company Obligation (ECO) will have on overall demand; and
4. The impact electrification policies such as the Renewable Heat Incentive (RHI) and support for electric vehicles will have on both electricity and gas demand.
Lane warns that the government and consumer groups should be careful about how they portray the impact on bills as they could go up, down or stay the same, stating: We just dont know. For low carbon generators the policy is largely very positive but significant risks remain. The government would ideally like competition to set the strike price. This approach has worked successfully in, for example, Brazil where the government has an annual auction amongst developers to meet anticipated electricity demand growth for three and five years hence. Competition amongst developers for projects, and amongst equipment suppliers for contracts, has helped to force auction prices down in successive years. Consequently, onshore wind projects agreed an average price of £30/MWh in the 2011 auction, far below the current UK wholesale electricity price.
However, Brazil has targeted its auctions at mature technologies onshore wind and CCGT whereas the UK will be targeting generation technologies with more cost uncertainty such as nuclear and offshore wind. Lane speculates: Whilst the acquisition of the Horizon Nuclear Power by Hitachi will give EDF Energy/Centrica some competition in nuclear new build, in reality the strike price will have to be set by negotiation, and developers hold most of the cards.
The effective rationing of CfDs via the LCF cap will also raise risks for some developers, particularly offshore wind. The UK government is very keen to encourage nuclear new build for baseload, low carbon generation and is likely to look to reserve CfDs for nuclear new build. Therefore, unless the government is willing to authorise large step changes in the LCF budget post-2020 to account for new nuclear plants opening, it may transpire that the entire budget cannot be used before 2020. Offshore wind developers have raised concerns about the risks associated with this rationing and their ability to make development investments of hundreds of millions of pounds if their CfD is in doubt due to rationing and competition from favoured nuclear. The government will have to address these concerns.
GlobalData says that the amount of low carbon electricity that the LCF budget will buy is also highly uncertain, dependent upon the spread between wholesale prices and the negotiated strike price. Increasing the amount of intermittent generation in the UK via onshore and, to a slightly lesser extent, offshore wind, will lead to increasing price volatility. In Germany, where wind accounted for 20% of electricity generation in 2011, negative electricity prices have been observed when supply exceeds demand. Lane reflects: Imagine a situation on a windy night where electricity demand is low, wind output high and nuclear running at baseload. Low, or even negative prices, would cause the costs of CfDs to rocket, again a scenario the contracts must address.
The government aims to agree strike prices by the middle of 2013, and have contracts signed from 2014, so there is still time to address these challenges. GlobalData would recommend the inclusion of price re-opener clauses in the contracts, like those seen in long-term, oil-indexed gas import contracts, in order to protect both parties from unforeseen developments that could result from the interaction of so many policy initiatives, states Lane. Whilst the rewards of the Energy Bill are high in terms of decarbonisation and energy security, the risks for developers and government, in particular, are also high and numerous. Who said energy policy was boring?
