Reform of the UK Electricity Market – £110 Billion Investment Needed

Reforms aimed at moving the UK to the front of the global race for electricity investment, driving the growth of clean energy industries in the UK, and ensuring the best possible deal for consumers have been proposed by the British Government.

The Department of Energy and Climate Change and HM Treasury have together launched consultations on fundamental reforms to the electricity market to ensure the UK can meet its climate goals and have a secure, affordable supply of electricity in the long term.

“More than £110 billion of investment is needed in new power stations and grid upgrades over the next decade, that’s double the rate of the last ten years. Put simply, the current market is not fit to deliver this,” says Energy and Climate Change Secretary Chris Huhne. “Without investment in renewables, new nuclear and carbon capture and storage, emissions will remain too high, we will become dependent on energy imports, and increasingly vulnerable to fossil fuel price volatility. Low carbon technologies must be given the chance to become the dominant component in our electricity mix.”

Investment Challenge

There is widespread consensus that reform of the electricity market is needed. The scale of the investment challenge is huge:

* A quarter of the UK’s existing generation capacity will need replacing by 2020, as many nuclear and coal plants reach the end of their lives – that’s 19GW or around 20 large power stations. Some new gas-fired power stations will be needed to complement renewables and the first new nuclear power station.

* About 30% of the electricity must come from renewables by 2020, up from 7% today, to meet the UK’s contribution to Europe’s target on renewable energy.

* The power sector needs to lead the decarbonisation of the economy. It must be largely decarbonised during the 2030s to keep the UK on track for meeting its climate change goals.

* The 2050 Pathways show that electricity demand may double by 2050 as more heating and transport is shifted onto the grid to decarbonise the wider economy.

“Without investment in renewables, new nuclear and carbon capture and storage, emissions will remain too high, we will become dependent on energy imports."

Some measures have already delivered investment in new low carbon generation – the Renewables Obligation and the EU Emissions Trading System for example. But the bias towards fossil fuel generation remains. In the current market this is a lower cost and lower risk investment than low carbon technologies, all of which have relatively high upfront capital costs.

In addition, the reserve margin of spare generating capacity will fall during the next decade and the Government is not confident the current market will guarantee adequate electricity at peak periods.

Competitive Market

Under the reforms outlined, the competitive market will remain intact but four inter-locking policy instruments are proposed to change the returns generators can expect for the power stations they build and the electricity they generate:

* Greater long term certainty around the additional cost of running polluting plant through a carbon price floor. Proposals from the Treasury to provide greater support and certainty to the carbon price will increase investment in low carbon generation by providing a clearer long term price for carbon in the power sector.

* Long term contracts for low carbon generation will make clean energy investment more attractive still. Through a proposed ‘contract for difference’ Feed In Tariff, the Government will agree clear, long term contracts, resulting in a top up payment to low carbon generators if wholesale prices are low but clawing back money for consumers if prices become higher than the cost of low carbon generation. An alternative ‘premium’ Feed In Tariff is also set out in the consultation document.

* Additional payments to encourage the construction of reserve plants or demand reduction measures (so-called ‘negawatts’) to ensure the lights stay on. A Capacity Mechanism will ensure there remains an adequate safety cushion of capacity as the amount of intermittent and inflexible low carbon generation increases.

* A back-stop to limit how much carbon the most dirty power stations – coal – can emit. An Emissions Performance Standard will reinforce the existing requirement that no new coal is built without carbon capture and storage.

The reforms are aimed at giving existing players and new entrants in the energy sector the certainty they need to raise the more than £110 billion of investment required. Ofgem’s review into the liquidity of the wholesale electricity market will be an essential complement to the reforms.

The Government’s preferred package of reform is designed to offer a better deal for consumers over time. By 2030, the new market could deliver an electricity mix far more clean and secure, and bills lower than they would otherwise be. Reducing carbon intensity of the electricity mix from 500gCO2/kWh today to 100gCO2/kWh in 2030 can be achieved at the same time as annual household electricity bills being around 4% or £30 lower on average in the five year period 2025-2030 than they would otherwise be if we left the current policy framework in place. This is despite a higher level of ambition – current market arrangements will only deliver carbon intensity of 200gCO2/kWh. Beyond 2030, as a result of the Governments reforms, household bills will remain lower and more stable than they would otherwise have been as the electricity mix will be less exposed to gas price fluctuations and high carbon permit prices.

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