SEM leads the way for reform – David Newbery

Leading energy economist David Newbery tells Owen McQuade how the Irish Single Electricity Market (SEM) example should influence British electricity reform and calls for the Republic to adopt the carbon price floor.

Britain can learn from the Single Electricity Market’s pool system as it reforms its own electricity market, according to a senior energy economist.

David Newbery is a professor of applied economics at Cambridge University and adviser to DECC and the House of Commons on electricity market reform. He tells agendaNi: “I would urge the Republic and the Northern Ireland regulators not to throw away the good features of the market that you’ve already designed in place of an energy-only power exchange [and a] voluntary and a potentially rather small fraction of the market.”

Electricity market reform in Great Britain, he explains, is being driven by decreasing capacity.  For example, taking coal off the system by 2016 will remove 20 per cent of peak capacity and the loss of 6GW of nuclear takes away another 10 per cent.

Newbery comments: “The idea is that if we’re to meet our long-term carbon targets, new investment should be low- or zero-carbon generation, and the market design at the moment is not well-suited to support that because the price of electricity is driven by the price of fossil fuels.”  This, in turn, makes for “volatile and unpredictable” prices in the market for any nuclear or wind generator.

Secondly, the EU emissions trading system is “demonstrably inadequate to support investment in low-carbon electricity,” having been depressed by the Renewables Directive and the global financial crash.

“It’s no longer either predictable or high enough to support investment and so the solution that the British Government was led to [was] that, in order to reduce the risk and assure the market and especially new entrants, of a future revenue stream, they would provide long-term contracts.”

To make those contracts viable, for nuclear power at least, the Government aims to raise the carbon price to £30 per tonne by 2020, when the new nuclear plant is expected to be generating.  However, the carbon price floor “quite clearly presents problems unless other countries in the European Union adopt a similar method.”  While Newbery argues that this is in their fiscal and carbon interests, the European Commission “cannot mandate taxes for member states” and any new approach must be negotiated between national governments.

The carbon price floor is also the most immediate problem for the Single Electricity Market, arising out of British electricity market reform.  If Northern Ireland energy companies were to pay the carbon tax, in line with the Treasury’s insistence, while the Republic did not, cheap gas generation in the North would be disadvantaged compared to more expensive coal and gas generation in the South.  The efficiency of the Single Electricity Market (and also the trade over east-west interconnectors) would therefore be distorted.

He adds: “The most attractive and, I would have thought, fiscally most responsible solution is [that] the Republic also adopts the carbon price floor so that there’s no disadvantage between the two.”  If the Irish Government refused, he suggests that the system operator should dispatch the plant without the carbon price floor element, add that on to transactions over the Moyle and East-West interconnectors, and charge that to Northern Ireland consumers.

“The IMF will then look at the revenue that Northern Ireland is collecting and the Republic is not, and may lean heavily on the Republic to improve its fiscal situation.”

Britain’s energy policy, in his view, is too insular: “Coming from GB, I’m very struck that first of all we tend to be an island and ignore what’s going on on the continent so we’re coming lately to the targeted electricity model.”  In contrast, the SEM participants have to deal with that straightaway as they are trading between two different jurisdictions.

“So you’re well ahead in thinking through the implications of adapting to market coupling and the capacity mechanism problem,” Newbery remarks.  “We’re slowly thinking that we should worry about these.”

During his presentation at agendaNi’s seminar on developing electricity markets, Newbery explained that as energy infrastructure is capital-intensive, driving down the cost of capital and reducing risk are the key economic elements.  Price zones in the targeted electricity market create many problems “for managing an integrated and meshed transmission system.”

Any electricity investment will have a timescale of 15-60 years (depending on the source technology) and therefore involves “incredibly long-term implications for carbon emissions”.

Reducing electricity’s carbon footprint (currently around 500g/Kwh) to 100mg/Kwh by 2030 will mean almost decarbonising the whole system.  However, neither nuclear nor renewables were economic at the current emissions trading price.

The UK Committee on Climate Change’s forecast of carbon price by 2020 fell from 60 per cent of 2008 levels (at 12.5 per cent renewables) to 50 per cent when the Renewables Directive was set and 20 per cent in 2009 after the recession.

Fixing the emissions trading system also requires political intervention by 27 member states, some of which have large coal deposits.  Newbery’s own preference is a European carbon tax but, short of that, member states should be persuaded to adopt the carbon price floor as a revenue-generator.

Long-term contracts, he explained, are the central component in reform and need careful design and a “sensible commissioning body,” not the Department of Energy and Climate Change where policy staff tend to be in post for 18 months.  The feed-in tariff for wind needs to be “highly location-specific” given the varying wind strengths around Britain.  A carbon-corrected system marginal price would remove the distortions for trade between Britain and Ireland.

Policy-makers need to be cautious about “making expensive changes that may not be permanent” but the time to make decisions is running out.  He noted: “Unless we invest, we will be short of power quite soon and the one thing politicians get unbelievably nervous about is the lights going out.”

Exclusive interview with David Newbery from the Developing Electricity Markets seminar,
22 March 2012.