UK electricity market reform: the local input

Alex McLean and Alan Bissett consider how the changes could skew the merit order for local generators and end ROCs in Northern Ireland.

It is an extremely dynamic time for the Single Electricity Market (SEM) with significant domestic regulatory uncertainty around critical issues such as priority dispatch, review of the Capacity Payment Mechanism, constraints and curtailment and transmission loss adjustment factors. At the same time, external influences are playing an unprecedented role on the domestic regulatory landscape with the emergence of the EU target model for regional market integration and the UK electricity market reforms having particular significance for the SEM. This article will focus on the impact of the proposed UK electricity market reforms and, in particular, their impact on the merit order in the SEM and Northern Ireland Renewable Obligation Certificates.

Reform proposals

The UK Government White Paper on the reform of the electricity market follows the Electricity Market Reform consultation from the Department of Energy and Climate Change and is expected to result in the largest shake-up of the UK electricity sector since privatisation in the 1980s and early 1990s.

This process provides both a challenge and an opportunity, as increasing demand and a move to cleaner generation are set against the backdrop of the closure of existing generation plants. The proposed new regime aims to tackle the disparity in cost between traditional coal and gas generation and low carbon options, overcoming their relatively high barriers to market entry including high construction costs in the face of market illiquidity. The proposals are also hoped to encourage investment in generation and transmission, which is expected to be in the region of £110 billion by 2020, more than double the current rate.

Key elements of the proposed reforms include a shift from the current renewables obligation (RO) system to a new system of long-term contracts which are intended to provide clear, stable and predictable revenue streams for investors in low carbon technologies and increase security for investment. Other proposals include the introduction of a carbon price floor and emission performance standards which will place an annual limit on the amount of carbon that new fossil fuel power plants can emit.

The proposed carbon price floor and the SEM

The carbon price support commitment being considered as part of a HM Treasury and HMRC led proposal to reform the climate change levy across the UK, including Northern Ireland, suggests the introduction of a carbon price support mechanism, or carbon floor. By putting a price on carbon for UK electricity generation, it is hoped that the result will be the further incentivisation of investment in low carbon electricity generation by improving the economics of low carbon investment.

It is proposed that the carbon price support mechanism will be implemented from 1 April 2013, which will involve making changes to the way that the Carbon Change Levy (CCL) and fuel duty are levied so that they are paid on all fossil fuels used to generate electricity in the UK. Currently, fossil fuels used to generate electricity are generally exempt from the CCL. Electricity generators can reclaim the duty charged on oils in full and it is proposed to reduce the amount of fuel duty that electricity generators can reclaim.

In Northern Ireland, increased costs due to the changes in CCL are likely to form part of the short run marginal cost of Northern Ireland generators and be reflected in wholesale prices within the SEM pool, distorting the merit order and increasing prices to consumers.

The ‘Renewables Obligation’ system in Northern Ireland

Suppliers in the UK are currently obliged to supply a certain percentage of electricity from renewable sources through the RO. To date, the percentage RO requirement in Northern Ireland has been a lower percentage than is required in other parts of the UK.

Suppliers meet their obligations by surrendering Renewables Obligation Certificates (ROCs) in respect of electricity obtained from eligible renewable energy sources in the relevant period. Where suppliers do not have sufficient ROCs to cover their obligation, they may purchase additional ROCs from the marketplace. Alternatively, electricity suppliers can satisfy the RO by making a payment into a buy-out fund. The proceeds of the buy- out fund are paid back to suppliers in proportion to the number of ROCs they have surrendered.

The RO systems for England and Wales, Northern Ireland and Scotland currently operate in unison. Whilst there are some minor differences in support levels, all three obligations are implemented in the same way and the buy-out funds are unified.

Proposed feed-in tariff with contract for difference Under the reforms proposed in the White Paper, it is proposed that the RO system in England and Wales will be phased out in favour of a new mechanism to encourage investment in renewable facilities called the feed-in tariff (FIT) with contract for difference (CfD).

Under the FIT with CfD model, generators sell their electricity into the market and receive a top-up payment if the wholesale prices are low. If prices become higher than the cost of low carbon generation, the Government could recover money from generators. The top-up payment or repayment would be calculated as the difference between the average market wholesale price and the agreed tariff level. In effect, the CfD provides a government hedge against fluctuations in the wholesale electricity price.

It is proposed that the current RO in England and Wales will be maintained until 2017 for new projects and 2037 for existing projects. Although the date is to be confirmed, the new FIT with CfD mechanism would be introduced in 2013 or 2014.

The end of a unified system in the UK?

Scotland and Northern Ireland have control over their own RO mechanisms and can decide whether to follow the proposed changes in England and Wales. The White Paper acknowledges that energy is a devolved matter and states that the Government’s preference is the introduction of a UK-wide FIT with CfD regime.

It is understood that Scottish ministers have publicly stated their support for the current RO system but will consider their position on the wider market reform proposals. In Northern Ireland, the Department of Enterprise, Trade and Investment is concerned that the carbon floor price proposals, together with the EMR proposals for a FIT with CfD regime and ‘vintaging’ of the RO from 2017, have not been developed with due consideration of the potential adverse implications for either the NIRO or Northern Ireland’s 2020 target.

Northern Ireland represents an overlap between the all-island and UK energy markets. There has always been a tension between participation in the SEM and the UK RO and CCL regimes. The UK energy market reforms represent a critical point for Northern Ireland to make decisions about its energy future.