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UK Electricity Market Reform
The engineering perspective
A Briefing provided by the Institution of Engineering and Technology
www.theiet.org/factfiles
About This Briefing
Contents
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What should be the main objectives of the Electricity Market Review?����������� 3
Requirements of Future Electricity Markets��������������������������������������������������� 3
Capacity Mechanisms���������������������������������������������������������������������������������� 3
Feed-in Tariffs with Contracts for differences (FiT CfD)���������������������������������� 3
Carbon Price Floor��������������������������������������������������������������������������������������� 4
Emissions Performance Standard (EPS)������������������������������������������������������� 4
Transitional Arrangements���������������������������������������������������������������������������� 4
Institutional framework��������������������������������������������������������������������������������� 4
Delivery timetable����������������������������������������������������������������������������������������� 5
Political Risk������������������������������������������������������������������������������������������������ 6
Will the proposed package deliver the security/carbon goals?������������������������ 6
Storage and Interconnectors������������������������������������������������������������������������� 6
Inter-connectors������������������������������������������������������������������������������������������� 6
Further Reading ����������������������������������������������������������������������������������������� 7
End notes���������������������������������������������������������������������������������������������������� 7
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The Institution of Engineering and Technology
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© The Institution of Engineering and Technology 2011
Second Edition May 2012
The Institution of Engineering and Technology is registered as
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Cover images (clockwise from top left)
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Wind turbine under construction
Bank of England and City of London Finance District
Nuclear power station
Solar power cells on house roof
Enquiries to
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UK Electricity Market Reform (an engineering perspective)
A Briefing provided by The Institution of Engineering and Technology
www.theiet.org/factfiles
2
What should be the main objectives of the Electricity Market Review?
The Electricity Market Review has two main objectives. It needs to facilitate the rapid move to deployment at scale of new
large scale generation to avoid supply shortfalls over the next ten years. At the same time, it needs to enable the transition to
a low carbon energy system by allowing demand management, inter-connection and storage to be properly rewarded by the
market for the services they provide. It would be undesirable to have to introduce further large scale reform to deliver the low
carbon energy system.
Requirements of Future Electricity Markets
In the short term, the main requirements are:
„„ To encourage demand reduction
„„ To advance construction of mainstream technologies: nuclear, gas, wind and biomass
„„ To facilitate large scale demonstration of gas and/or coal with carbon capture and sequestration, and also newer
renewable technologies, and
„„ To facilitate the development of low carbon energy solutions at community scale
Key aspects of the longer term requirement of the EMR are:
„„ Full participation of all aspects of demand in the market to allow the opportunities for management of demand to balance
supply to be fully realised
„„ Anticipation of massive scale-ups of controllable demand (such as heat pumps, electric vehicle charging)
„„ Incentivising reduced demand through efficiency and time-shifting of loads
„„ Providing sufficient clarity to allow a smart grid to be deployed with confidence
„„ Dealing with a much more volatile generation market with large amounts of highly variable wind generation, and
potentially significant contributions from sources such as solar and tidal barrages
„„ Dealing with increasing amounts of both nuclear and carbon capture-fitted thermal generation, whose dynamic
performance is currently untested
„„ Moving renewables and other low carbon technologies from special support regimes towards the mainstream as carbon
becomes properly valued
„„ Enabling the build of significant amounts of low cost peaking generation to provide cover for renewables shortfalls and
exceptional demand peaks
„„ Being adequately robust to both improvements and further degradation in the funding climate
„„ Enable the wider integration of storage in the electricity supply chain
„„ Adequately incentivise new interconnectors with other European states where these can be shown to be economically
attractive
„„ Delivering all this at costs acceptable to consumers and in ways that give sufficient confidence to investors
Capacity Mechanisms
Following consideration of a range of options, DECC has decided to introduce a capacity market mechanism whereby
capacity is provided through annual auctions. Such capacity can be offered based on traditional generation or other means
such as demand reduction and storage. The auction for a given year is envisaged to be held 4 years ahead of time. The
capacity market is currently envisaged to have its first auctions in 2015 for delivery of capacity in 2019. DECC has decided
that National Grid in its role as system operator will be responsible to deliver the capacity market.
This arrangement would seem to have potential to allow all of demand, storage and generation to play a role in ensuring
security of supply, but will need careful development to ensure this is delivered in reality. It will also be important that
investors can have confidence in the sustainability of their returns over the life of their assets and not be vulnerable to losing
out in annual auction rounds. Any shortfalls in capacity prior to 2019 will need to be considered separately. Such shortfalls
are possible, for example if there are delays to investment in new gas fired plant combine at the same time as early closure
of coal fired plant opted out of the EU’s Large Combustion Plant Directive 21, and this coincides with potentially recovering
demand as the UK economy improves.
Feed-in Tariffs with Contracts for differences (FiT CfD)
The FiT CfD is a long-term contract which stabilises revenues and reduces risks to support investment in all forms of lowcarbon electricity generation. If the wholesale electricity price is below the price agreed in the contract, the generator will
receive a top-up payment to make up the difference. If the wholesale price is above the contract price, the generator pays
the surplus back.
UK Electricity Market Reform (an engineering perspective)
A Briefing provided by The Institution of Engineering and Technology
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3
Ideally the market should determine the least cost renewable solution, however there are wider issues to consider such as:
„„ Technical maturity (mature technologies are cheaper generally)
„„ Available land for onshore renewables
„„ The desire to create new green industries and employment through supporting certain technologies
„„ The generation characteristics of different technologies (for example wind has certain intermittency characteristics, solar
different intermittency characteristics, and biomass is dispatchable to match demand)
„„ The desirability to pursue solutions at a range of scales (large plants, community energy schemes, single building
schemes), to maximise the opportunity for decarbonisation and to explore alternatives to find best options.
Given the scale of renewables deployment implied by the EU 2020 targets, all technologies will need to be pushed hard, and
as such there seems little alternative to a technology-banded approach to the FIT. In its December 2011 Technical Update,
DECC allocated responsibility for delivery of the feed-in tariff mechanism to National Grid in its role as system operator. The
FIT is envisaged to be rolled out from mid 2014.
Carbon Price Floor
It is proposed to set a carbon price floor to give confidence to investors in large scale low carbon generation projects,
particularly nuclear power plant. This is envisaged to give long term certainty of the investment case, important where
development and construction timescales are each around 5 years. This will need to be set at a level sufficient to create
a good investment case but not so generously as to over-reward generators, something that will be difficult given the
uncertainties in construction cost of new nuclear power plant.
The carbon price floor is envisaged to be in place in mid 2013.
Emissions Performance Standard (EPS)
An emissions limit of 450g/kWh of CO2 at baseload operation will be applied to new thermal power stations. This has been
set to require emissions from new coal plant to be abated whilst not restricting the construction of new gas-fired power plant,
given the importance of such plant to short and medium term supply security.
The EPS is envisaged to be in place in mid 2013.
Transitional Arrangements
Detailed proposals have been made for the introduction of the feed-in tariff, including for a transitional period when
developers of projects will be able to choose between the new feed-in tariff and the existing Renewables Obligation
mechanism. This is intended to minimise investment delays for projects currently in development.
However the overall reform package is also having an impact on investment decisions in other plant, notably the gas fired
combined cycle projects that will be key to managing supply security over the next ten years or so. The IET believes that
more clarity is required in this area to enable early investment decisions2.
Institutional framework
A transparent, enduring, robust and credible institutional framework is crucial to ensuring that Electricity Market Reform
drives investment in low carbon generation and ensures security of supply at an affordable price to consumers. DECC
believes that the System Operator (i.e. National Grid) best meets the criteria for delivering the Feed-in Tariff with Contracts
for Difference (FiT CfD) and the Capacity Market.
The institutional framework will comprise three key players:
„„ Government will be responsible for setting out the policy approach and objectives, and for taking final decisions on key
rules and parameters;
„„ The System Operator will provide expert independent advice to Government on key rules and parameters and administer
the FiT CfD and Capacity Market; and
„„ Ofgem will continue its independent regulation of the market incorporating the new instruments
The figure below shows the high level functions required to deliver FiT CfD with Capacity Market.
UK Electricity Market Reform (an engineering perspective)
A Briefing provided by The Institution of Engineering and Technology
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Setting the
policy approach
and objectives
Goverment has policy accountability
Government sets out key rules and parameters as part of
the legislative framework and publishes the delivery plan
Translating the
policy
Administering the
mechanisms
Reconciling data
and managing
payments
Monitoring
compliance and
enforcement
System Operator advises Government on rules and parameters
in the delivery plan
System Operator administers contracts and auctions and reports
annually to Government
Settlement agent manages payments, through a payment model
backed by a robust and stable legal framework
Ofgem and Government monitor the System Operator’s delivery
compliance
Ofgem and System Operator monitor suppliers’ and generators’
compliance
Figure 1The high-level functions required to deliver the Feed-in Tariff with Contracts for Difference and Capacity Market
Source: DECC, “Planning our electric future: technical update”, December 2011
Delivery timetable
DECC intends that the primary legislation for EMR is enacted by Spring 2013. Prior to that DECC intends to publish a policy
update setting out detailed transition and implementation plans and a long term vision of the market, all intended to boost
investor confidence. The effectiveness of this document and other related activity in boosting investor confidence will be key
to the management of security of supply risks over the next ten years, and should be thoroughly “road tested” with investors,
noting, of course, their inevitable desire to obtain a more generous result than strictly necessary.
In parallel with this work, in summer 2012 DECC expects to publish updates on:
„„ Electricity demand
„„ Electricity system policy (related to networks and supply/demand balancing)
Implementation will be staggered between mid 2013 (carbon price floor and EPS), mid 2014 (FITs) and late 2014 (capacity
mechanism). This will create uncertainty over a period of time with transitional periods when not all reforms are in place, and
this will need careful management by DECC, Ofgem and the system operator in the way policy is implemented.
Actual implementation of the market reform process should be considered on the basis of a comprehensive risk analysis.
There are market confidence reasons for doing most or all of it at once, but the enabling IT and other infrastructure will carry
implementation risks that need to be recognised and managed or mitigated.
UK Electricity Market Reform (an engineering perspective)
A Briefing provided by The Institution of Engineering and Technology
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Political Risk
The UK has always been at the forefront of electricity market reform and has over time made a number of major market
changes that have created substantial winners and losers, and thus a perception of political risk. This latest EMR proposal is
no exception.
The extent to which the result decreases confidence depends on how it is implemented; avoidance of significant financial
loss for disadvantaged market participants is important, as is very clear signalling of intent. As stated above, it is important
that the detailed design of EMR addresses long- as well as short-term issues to avoid a further revisiting of the rules and
additional perceptions of political risk in the future.
On the positive side, this reform, if carried through well, has the potential to be seen as a global template and to be creating
the clarity needed to invest the large amounts necessary.
Will the proposed package deliver the security/carbon goals?
This will depend very much on how it is implemented. The right issues are being considered and sensible solutions
proposed. The main risks seem to be excessive complexity resulting in a lack of transparency and/or unforeseen
consequences. DECC is aiming to strike a balance between giving investors confidence and not over-rewarding them. In
the IET’s opinion, the economic and political costs of insufficient capacity to cover times when demand is high and wind
and other variable generation is low seem to be rather higher than the costs of slight over-provision. We are moving into a
technologically uncertain world given the high levels of variable renewables, demand participation and other changes and
the IET believes it wise to err on the side of caution.
Affordability will be an issue into the future, whichever forms of generation are built. All forms of power plant, all fuels and
also carbon emission will become much more costly. In addition, network infrastructure will need heavy investment to
become smart and potentially to meet new demands from heat pumps and electric vehicles. The only mitigant available is
efficient use of energy, which will need continuing strong emphasis. There are potentially large impacts on the fuel poor as
prices rise, which will need significant attention.
Storage and Interconnectors
Neither storage nor interconnectors seem to have been given strong consideration during the DECC work so far, though it
does seem that storage is being at least considered in the design of the capacity market. Both have potentially large roles to
play in the longer term, and we would suggest that a range of storage and interconnector scenarios are tested against the
proposed reforms before they are firmed up.
Storage is essential to the secure operation of the power system and has the potential to play a bigger role in the future. It is
recognised that storage can offer multiple benefits to the power system. Examples include helping to manage intermittency,
meeting shorter-term peak demands, reducing the need for new network capacity and enhancing security of supply. At
present there is not a storage technology available that has the price/performance characteristics that will ensure widespread
deployment. However, a number of technologies are under development and as the value of the ancillary services that
storage can provide increases, they may well prove to offer economic solutions.
Storage can supply multiple services to different parties in the disaggregated supply chain. There is therefore a risk that the
current market structure may make it difficult for storage owners to be properly rewarded for the services they can provide.
Inter-connectors
Under the EU Third Legislative Package on Energy there is a requirement to form a single EU energy market but one in
which the electricity supply systems of each member state will continue to have their own characteristics. Furthermore all
members, UK included, are obliged to significantly increase the renewable component of their generating portfolio.
With different levels of security of fuel supply, proportions of variable renewables and generation costs, increased
interconnection within the EU seems inevitable. Interconnection with the UK is, of course, a special case because of the
need for submarine connections with higher costs. Nevertheless, interconnectors have potentially large roles to play in the
longer term and we would suggest that a range of interconnector scenarios are tested against the proposed reforms before
these are finalised. It should be noted that both political and technical risk underlying the development of interconnectors is
likely to remain low.
UK Electricity Market Reform (an engineering perspective)
A Briefing provided by The Institution of Engineering and Technology
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Further Reading
„„ IET, Evidence to Energy and Climate Change Select Committee, Jan 2011
http://www.theiet.org/policy/submissions/s884.cfm
„„ DECC, Electricity Market Reform (EMR) White Paper 2011, July 2011
https://www.gov.uk/government/news/electricity-market-reform-keeping-the-lights-on-in-the-cheapest-cleanest-way
„„ DECC, Technical update to the White Paper on Electricity Market Reform, Dec 2011
http://www.decc.gov.uk/en/content/cms/legislation/white_papers/emr_wp_2011/tech_update/tech_update.aspx
End notes
1
The EU Large Combustion Plant Directive allows such plant 20,000 running hours from 2008. A number of coal fired
plants are now close to this limit.
2
Note that DECC is currently consulting on the role of gas in the energy system, including on these issues
UK Electricity Market Reform (an engineering perspective)
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