Electricity Market Reform

Transcription

1 npower Roundtable on the Electricity Market Reform Contracts for Difference and the Capacity Mechanism UK business responds to consultation on secondary legislation developments

2 npower Roundtable, London 14 November 2013

3 Contents 1.0 Introduction Executive summary Roundtable 11 Presentations.0 Roundtable 17 Discussions.0 Conclusions and 25 Recommendations Next Steps 27 Glossary 29 Appendices 31 Electricity Market Reform 1

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5 1.0 Introduction Electricity Market Reform 3

6 1.0 Introduction Electricity Market Reform will impact us all and large consumers especially. npower is committed to giving businesses a voice to ensure their views and needs are effectively represented at each stage of policy design Supporting the energy needs of the future Electricity Market Reform represents the biggest ever shake up of the UK s energy sector. As we make the transition to a low carbon economy, the aim is to introduce policy that supports a market able to deliver affordable, secure and sustainable energy for the future. Timeframes are tight around 20% of our existing fossil fuel plant will close over the next few years, due to EU legislation which limits emissions. Government forecasts also suggest that our demand for electricity could increase by as much as 100% by 2050, partly due to rising demand for electrically powered transport and heat. What s more, the UK has committed to reducing carbon emissions by 80% on 1990 levels by In order to meet these challenges, around 110 billion worth of investment in new energy infrastructure is required by The aim is to draw on a diverse mix of generating technologies, from nuclear to wind, solar to biomass. Efficient gas fired generation will still play a role, but coal will be limited with no new coal power stations built unless fitted with carbon capture and storage functionality, which has yet to be developed commercially. The government is working to introduce the necessary market structure this year and next, with the aim to gain Royal Assent in December 2013 for the key elements of its proposed Electricity Market Reform (EMR), as set out in the Energy Bill. Of the four key elements of EMR, the Carbon Price Floor tax which sets a minimum price for carbon emissions released by power generators has already been introduced within wholesale prices, as of April The Emissions Performance Standard a regulatory measure which limits emissions from all new power stations is due to come into effect from Autumn The detail of the remaining two Contracts for Difference (CfD) and the Capacity Mechanism (CM) is yet to be confirmed. Secondary legislation setting out precisely how these measures will work is expected in As a precursor to this, the Department of Energy and Climate Change (DECC) published a consultation document in October, which sets out proposals for how CfD and the CM will work in practice and invites feedback ahead of the publication of secondary legislation. The deadline for input is 24 December 2013 hence the timing of this latest npower Roundtable event. The aim being to facilitate discussion with major energy consumers and enable their views to be captured and incorporated into npower s official consultation response to DECC, of which this report forms part. This event also provided an excellent opportunity for DECC to hear first hand how the policy design is likely to affect UK business. An overview of Contracts for Difference and the Capacity Mechanism can be found in Appendices II and III. 4 npower Roundtable

7 Introduction 1.0 Giving UK business a voice In order to ensure the needs of large consumers are heard, npower has engaged with customers throughout the EMR process, since its inception in 2010, presenting key findings to DECC at each stage. To date, it has held four EMR roundtable events in February 2011, October 2011, April 2013 and this latest in November 2013 and conducted regular surveys to capture the views of a wider audience. The most recent of these are the EMR Pulse online surveys, which tracked customer views on EMR between July and October The key findings include: The main concerns among businesses are the effect EMR will have on energy costs and their ability to forecast these. There is greater understanding of Contracts for Difference, while the Capacity Mechanism is less familiar, and the majority would also like to better understand the Carbon Price Floor to fully understand its impact. Businesses are also concerned about the impact EMR will have on UK competitiveness in global markets. Businesses are unsure how the introduction of EMR will impact their plans to invest in renewable energy generation, with a third (33%) saying it will encourage their business to invest and a further third (33%) saying it will dissuade them from investing. A full synopsis is presented in Appendix IV. As well as feeding customer views to DECC, npower has access to the latest developments to share directly with customers. RWE, npower s parent company, is in the unique position of sitting on all of DECC s Expert Groups for EMR, including those responsible for inputting into the design of the Capacity Mechanism and Contracts for Difference. This provides the opportunity for npower to offer expert knowledge on EMR to customers, as well as the inside track on latest government thinking. Electricity Market Reform 5

8 1.0 Introduction EMR Customer Roundtable: Secondary Legislation and Corresponding Consultation This event was attended by 19 delegates, of which 14 were major energy users or consultants. DECC Jonathan Mills Director of Electricity Market Reform, DECC npower John McElroy Director of Policy & Public Affairs, RWE npower Mary Teuton EMR Project Manager, RWE npower Jon Davies Head of Sales Development, npower Ian Preston Head of Direct and Technical Sales, npower Participants Deputy FD Large Utility Head of Procurement Construction Industry Facilities Manager Leading High Street Retailer Energy and Environment Manager Healthcare Provider Energy Procurement Manager Large Public Sector Organisation Consultant Energy Broker Utilities Director Leading Pharmaceuticals Manufacturer Manager Energy Supplies (UK) Energy Intensive Manufacturer Building Controller Leading High Street Retailer Manager UK Electricity Supplies (Power) Energy Intensive Manufacturer Environment Manager Leading Food Retailer Head of Energy Supply Large Telecommunications Provider Head of Energy Large Industrial Electricity Consumer Head of Group Energy Buying A Leading Retailer 6 npower Roundtable

9 2.0 Executive Summary Electricity Market Reform 7

10 2.0 Executive summary Contracts for Difference and the Capacity Mechanism are designed to incentivise low carbon generation and ensure energy security but businesses want cost certainty and consideration of all possible impacts in policy design The Roundtable focussed in detail on two key elements of Electricity Market Reform Contracts for Difference and the Capacity Mechanism. Jonathan Mills, Director of Electricity Market Reform from the Department of Energy and Climate Change (DECC), provided an overview, with npower s Director of Policy and Public Affairs Dr John McElroy offering the supplier view. Participants then debated the policies and the possible impacts for their businesses. Contracts for Difference From DECC s perspective, Contracts for Difference (CfD) provide good support for generators by eliminating electricity price risk and guaranteeing a stabilised flow of revenue over a defined period, but at a cheaper cost to consumers than the existing Renewables Obligation (RO). DECC also offered assurances that the budget would be better controlled than under the RO, thanks to the Treasury set Levy Control Framework, which caps spending at 7.6bn in CfD costs to consumers are forecast to start in April 2015, ramping up over time from approximately 1/MWh to around 10/MWh by 2020, according to npower s own analysis. The current charging model offers a fixed unit cost (p/kwh) that s supplemented by additional funding for the CfD Counterparty Body s operating costs plus Insolvency and Reserve Funds. npower cautioned that these additional mechanisms could introduce an unwelcome element of volatility into charges. Roundtable participants shared concerns over charging volatility and also lack of visibility expressing a need for sufficient notice of charges to support budgeting requirements. The impact on the existing long term Power Purchase Agreement (PPA) arrangements some businesses have with generators is also a cause for concern, as the new CfD structure is believed to reduce existing incentives for generators to enter into these agreements. 8 npower Roundtable

11 Executive summary 2.0 Capacity Mechanism DECC explained how the Capacity Mechanism (CM) is designed to ensure the UK has sufficient generating capacity to avoid the risk of supply interruptions at times of peak demand or supply shortfall (based on National Grid forecasts). The mechanism has been designed to deliver this via an auction approach, which DECC believes will ensure the lowest cost to consumers. While the CM is expected to reduce wholesale prices by 5 10/MWh as it takes peakiness out of the market, market analysis suggests that the cost of buying capacity in this way is likely to add extra costs to consumers of between 7 20/MWh from Costs are due to be allocated according to supplier s market share during Triad periods, which are the three half hours of peak demand during the winter season. But there is the potential to reduce these costs, either by Triad avoidance or by participating in Demand Side Response, which will form part of the CM. However, some businesses are concerned that using peak demand as the basis for CM charges will greatly inflate Triad charges and this would negate any incentive to participate in Demand Side Response at peak, as it appears consumers cannot do this and benefit from Triad cost avoidance. Another concern is the impact that the CM will have on the wholesale market and how EMR related charges could shift the ratio of volatility from commodity to non commodity costs, especially among those who currently adopt hedging strategies as a pricing management tool. Electricity Market Reform 9

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13 3.0 Roundtable Presentations Electricity Market Reform 11

14 3.0 Roundtable Presentations EMR is clearly set to change the UK energy market and getting the policy detail right from all sides is crucial to its success An overview of the latest EMR developments: Jonathan Mills, DECC Jonathan Mills, Director of Electricity Market Reform from the Department of Energy and Climate Change (DECC), started his presentation by saying how good it was to be among consumers, as much of the dialogue he d had around EMR so far had been with generators and suppliers. Consumers were, after all, who EMR was really designed for, he said, creating policies that would deliver energy in the cheapest possible way. Jonathan also explained that EMR is designed to work to any level of ambition that politicians want to set regarding levels of emission reductions or amount of renewable power generated. Jonathan clarified that the main focus of the current consultation is to look in more detail at Contracts for Difference and the Capacity Mechanism. With Contracts for Difference (CfD), he explained that the government was moving from the current Renewables Obligation (RO) system, where lowcarbon generators receive a top up to the wholesale price, to a system where generators get a contract that eliminates electricity price risk and provides a stabilised flow of revenue over a defined period. The idea, he said, is to offer greater support for the large upfront investment required, thus reducing the cost of capital. That said, Jonathan pointed out that Strike Prices for each of the eligible low carbon technologies are lower than subsidies under the existing RO, however the return should be equal, if not higher, due to reduced cost of capital. On the other side, he explained the Capacity Mechanism (CM) is designed to ensure the UK has enough generating capacity so that we don t face unacceptable risks of supply interruptions. Think of it as the system paying a retainer, he said. Under the existing market structure, generators sell power into the market, so only get paid when they are generating. This is fine most of the time, said Jonathan. But the experience of markets around the world is that some additional supply is needed, so the CM provides a way of remunerating generators for having spare capacity available when we need it. Jonathan explained that DECC has done a lot of work to calculate the lowest cost of providing this capacity, and has settled on an auction approach as the best way of driving down costs. 12 npower Roundtable

15 Roundtable Presentations 3.0 While there is still some detail to be finalised about the exact role the System Operator, National Grid, is going to play, Jonathan explained that a new government owned body the Capacity Mechanism Settlement Body will be established to play a key role in the management of the CM. Jonathan then went through the timeline and said this year s aim is for the Energy Bill to become the Energy Act by the close of He explained that DECC is very much in implementation mode now, focussing on the real detail of how these key measures are going to work. That s what the current consultation is about, with the plan to get secondary legislation in place by July Jonathan highlighted that the current consultation also sets out how the budgets for CfDs will be managed. Under the RO, it is essentially open ended, where generators building new renewable plant can automatically count on support. The issue, he said, is that there is no budget control over the amount spent in any one year. CfDs will introduce more systematic control over costs each year, and the consultation outlines how consumers will be protected from costs exceeding the limits DECC has set. (It is worth noting that CfD Strike Prices for all technologies are to be published by the end of 2013.) Another key point Jonathan made is that while the government is heavily involved in the initial stages of setting up CfD, once this is achieved, the running of it will be handed over to the System Operator and Counterparty Body. This provides transparency around how it will operate and means it will take the politics out of it. Jonathan concluded by saying EMR has been structured to deliver what the UK needs in the cheapest possible way, where there is more control over the budget. Ultimately, it s a good news story for consumers. Electricity Market Reform 13

16 3.0 Roundtable Presentations CfD costs are forecast to start in April 2015, ramping up over time from approximately 1/MWh to around 10/MWh by 2020, according to npower s own analysis The Impacts to Business: Dr John McElroy, RWE npower Dr John McElroy, who is Director of Policy and Public Affairs at npower, added some further detail around the analysis he and his team have carried out into Contracts for Difference and the Capacity Mechanism, and the likely impact for customers. Contracts for Difference While John agreed that CfD provides a guaranteed revenue stream for renewable projects that protects generators against low wholesale prices and, in theory, reduces the cost of initial capital investment he did emphasise that key policy decisions remain outstanding and introduce additional risk. At the present moment, onsite generation must export to be eligible for a CfD, but the final policy decision is not yet clear and this may change. CfD costs are forecast to start in April 2015, ramping up over time from approximately 1/MWh to around 10/MWh by 2020, according to npower s own analysis. Rates are dependent on deployment rates of technologies, strike prices and wholesale prices. Revenues will be collected from consumers through the CfD Supplier Obligation. While DECC has decided to opt for a fixed unit cost (p/kwh) based on a central forecast, John explained that a more complex charging picture has emerged than hoped for. This is because various contingencies have been introduced to manage fluctuations and other risks, which means the CfD Counterparty Body will need additional funding for a Reserve Fund and an Insolvency Fund. In addition, there will be an operational levy to cover the costs of the Counterparty Body itself and suppliers will have to post collateral. CfD cost exemptions for energy intensive users are currently being considered, with a response to an earlier consultation expected from DECC later this year. However, John explained this will be subject to State Aid Approval, and as a decision on Carbon Price Floor compensation is still outstanding, it will be interesting to see what happens. If exemptions are granted, the Department for Business, Innovation and Skills (BIS) estimates the impact to other consumers will increase CfD costs by 30 80p/MWh. John said that there is a still a lot of detail to be shared to better understand the planned offtaker of last resort that DECC is proposing to introduce for Power Purchase Agreements, the aim being to improve access to the market for independent generators. For PPAs in general, John said he believes that once the market responds, PPAs will become easier to manage going forward. However, John identified a number of hurdles still to overcome Royal Assent of the Energy Bill by year end; then secondary legislation agreed by mid 2014; and finally, State Aid Clearance from Europe for each scheme. 14 npower Roundtable

17 Roundtable Presentations 3.0 The Capacity Mechanism John explained this as an insurance premium against the lights going out, as it will result in existing plant staying open and new plant being built to supply the capacity we need in the future. Plant already in receipt of Contracts for Difference, Renewables Obligation, small scale Feed in Tariffs or Renewable Heat Incentive cannot participate as John explained this is seen to be subsidy double dipping so this volume will be netted off against total demand. John said npower had reviewed independent analysis by consultants such as Poyry and Cambridge Economics and also done its own work with LCP and Frontier Economics to determine the potential impact on wholesale price. Currently, he anticipates a reduction in wholesale prices of 5 10/MWh, which is positive for consumers but will negatively impact the income of any plant accredited under the RO. However, the cost for the market of buying capacity in this way is likely to exceed these reductions and could in fact add extra costs to consumers of between 7 20/MWh from 2018, according to market analysis. These will be allocated to suppliers via a Capacity Mechanism payment mechanism, according to market share of peak demand (Triad periods). John explained that there is the potential to avoid costs if businesses can reduce Grid consumption during peaks. But there s also an opportunity to participate via Demand Side Response (with a likely role for aggregators). However, DECC is looking at potential options to mitigate a double whammy of participating via DSR and avoiding costs by Triad avoidance. John pointed to increased uncertainty as a result of the Labour Party outlining some different proposals in their recent Party Conference, which could impact the underlying wholesale price. So he is hoping greater clarification on this emerges soon. Electricity Market Reform 15

18 3.0 Roundtable Presentations Demand Side Response John explained this will be open to all Demand Side Response plus embedded generation and small storage (including behind the meter generation). The intention is that DSR ultimately competes on equal terms with generation in the Capacity Mechanism and that a transitory period (full details of which are yet to emerge) will facilitate full integration. There will be incentives for demand side to participate in the early stages via a reduced bid bond (ie an assurance of delivery for market newcomers). This will be reduced by 90% to 442/MW but John anticipates that energy users may still think is a large number, even at 10% of the total 100% bond cost. There will initially be two types of product: 1. A load following obligation, which is really looking at securing Demand Side Response during periods of system stress. 2. A time banded product linked to winter weekdays from 9 11am and 3 7pm, which is clearly much more about addressing peak demand issues. DSR capacity providers will be required to meet their capacity obligation by reducing demand below a baseline at times of system stress, or pay a penalty. But an issue here is demonstrating you are actually delivering a baseline reduction, so setting the baseline is going to be very important. Baseline will be adjusted to take into account any Balancing Services, but not for Triad avoidance to make certain you can t double dip. John says a government funded 20m pilot is expected from 2014 for Electricity Demand Reduction (EDR) that can deliver a permanent reduction in demand, details of which are due to be published later this year alongside the government s energy efficiency strategy. However, he said he was intrigued to see how a mechanism which is about general demand reduction sits alongside a mechanism which is about system peak and stress demand reduction, but looks forward to seeing what emerges there and we will talk further about that when it does. 16 npower Roundtable

19 4.0 Roundtable Discussions Electricity Market Reform 17

20 4.0 Roundtable discussion Businesses are keen to see energy policy implemented that works for everyone but with consideration of the impacts EMR will have on costs, forecasting and competition Head of Energy Supply Large Telecommunications Provider Energy Procurement Manager Large Public Sector Organisation Mary Teuton, EMR Project Manager at npower, then led the discussion with participants, with input from DECC s Jonathan Mills and npower s Dr John McElroy. Contracts for Difference Renewables Obligation versus Contracts for Difference There was uncertainty among participants over how the funding transition will work between the RO and CfD, especially in terms of what will appear on the bill. DECC confirmed that RO and CfD, as well as the Feed in Tariff (FiT), are governed under the Levy Control Framework, which is 3.2bn in 2013, increasing to 7.6bn by Mary Teuton confirmed that CfD costs will start to appear on bills from April 2015, but as the transition from RO to CfD occurs, the amount attributable to RO will level off as the amount for CfD ramps up. Costs and visibility of charging All businesses understandably want to be able to plan for future costs. Many of the participants agreed that, where possible, they want to know not only what CfD related charges will be but also have sufficient notice of these costs to aid budgeting. We are a big energy consumer, so we need to plan ahead. The existing Feed in Tariff (FiT) has given us real problems in being able to predict future energy costs. We would like to see greater visibility of charging for CfD costs. The minimum transparency we would ask for is that prices are set in the November or December of the preceding year of the year proceeding any financial year. Clearly, we d prefer longer than that, but appreciate that with all the variabilities, that may not be possible. John McElroy reiterated the uncertainties that still exist despite DECC opting for a fixed rate charging model, with other variables now introduced in the form of Insolvency and Reserve Funds, which are designed to allow sufficient flexibility to ensure this fixed rate approach delivers. Suppliers, he said, would be expected to take on the risks should costs be higher than anticipated, so any resulting volatility will be reflected in consumer charges. I understand it will be left to suppliers to set how much they ll put aside for the extra funding. From my perspective, it would be great if DECC were setting that ie this is the fixed price per kilowatt hour to cover x, y and z. 18 npower Roundtable

21 Roundtable discussion 4.0 Manager Energy Supplies (UK) Energy Intensive Manufacturer Head of Energy Supply Large Telecommunications Provider Utilities Director Leading Pharmaceuticals Manufacturer Deputy FD Large Utility Concerns were also raised about these schemes remaining within budget, especially as FiT and RO costs caused problems due to their unexpected increase and variability. Didn t we have a Levy Control Framework for FiTs and ROs and still went over budget. So how is this different? DECC responded with clarification that there is a formal rationing system for CfDs that ensures there is a budget with restrictions in place to avoid overspending which wasn t the case under FiT or RO. So the CfD system provides better control than previous systems. Impacts of price volatility Participants were concerned not only about how price volatility could impact their own businesses, but also about how a fall in the wholesale market could impact the actual CfD scheme itself. We ve talked about how the Capacity Mechanism could reduce wholesale prices by 5 10/MWh. If the UK is successful in exploiting shale gas reserves, that could also drive down wholesale prices. What would be the impact of a drop in wholesale prices if there s still a fixed CfD cap? Would that curtail the amount of generation that can be put in and how could the scheme still deliver the government s aim of low carbon generation if prices were to collapse? It s not about just affordability it s more around how it s going to impact and when. One of the challenges is having that forward thinking so you can make the right plans. What we can t cope with is swings within that. What we can cope with is knowing what that is and planning around that. So, for us, the volatility of pricing is the uncertainty aspect. DECC pointed out that one of the biggest drivers of volatility in the CfD is the wholesale price and that a negative correlation exists here. This means that consumers who are paying more for the Supplier Obligation should then be paying less in wholesale costs, and vice versa. However, some participants were keen to point out that they use hedging strategies to manage wholesale price volatility but clearly these won t apply for CfD costs too. If the wholesale price moves, then the cost to suppliers in theory moves. But if the cost to suppliers is a fixed annual budget, then from a hedging perspective it makes it harder to offset cost changes between years. Electricity Market Reform 19

22 4.0 Roundtable discussion Head of Energy Supply Large Telecommunications Provider Head of Energy Large Industrial Electricity Consumer Head of Group Energy Buying A Leading Retailer Utilities Director Leading Pharmaceuticals Manufacturer Impact on third-party PPA market Under CfDs, renewable developers are guaranteed a minimum fixed price for generation, so if the wholesale price is lower, they ll receive a top up (and if it s higher, they must pay back the difference). Some participants feel this creates less incentive for developers to secure private Power Purchase Agreements (PPAs) with businesses. We want to be able to fix prices for the longer term, and we want access to renewable generators for our corporate social responsibility, putting aside all the carbon accounting arguments. I think this is moving away from where the market was opened up to for companies who are doing PPAs. It feels like a retrograde step that is now closing us out of that market. There s a few of us around this table who have said that venturing into direct PPAs with generators is desirable in order to bring an element of forward price stability, that is to take away the market volatility and provide our businesses with an improved basis upon which to forward plan for future energy costs. I m just not convinced the new CfD system as it s designed will work for direct PPAs going forward. I think if your motivation is to get green power, then you could pay a higher price than the wholesale price to the generator under a PPA, which would be an incentive to the generator to do it. Once CfDs are in operation, I question what the benefit of entering into a PPA will be for the end consumer. I can understand why developers may still want a PPA. But if that then doesn t help us hedge our price risk, there s no longer such a strong incentive. A greater incentive to invest in onsite generation? There was confusion over what type of onsite generation could benefit from CfD, and whether private wire (whereby a company uses its own network rather than National Grid s) would be included. The official minimum is 5MW output below this, the existing Feed in Tariff subsidy applies. Participants were confused about whether full or only part export of any power generated would be necessary to qualify for CfD. However, DECC confirmed that any generation where export arrangements are in place will qualify. 20 npower Roundtable

23 Roundtable discussion 4.0 Head of Group Energy Buying A Leading Retailer Deputy FD Large Utility The Capacity Mechanism Controlling costs and capacity The costs of financing the Capacity Mechanism won t come under the Levy Control Framework, which governs Contracts for Difference. But DECC was keen to clarify this didn t mean there won t be cost controls. The devil is in the detail. A big criticism of the CM, from what I ve read, is the potential to over reward and create over capacity and therefore customers end up paying more than they otherwise would. Admittedly, it is a very difficult one because if we move away from it, there is the potential of under investment in capacity. So for us, it is about curbing the excesses of over rewarding and ending up with over capacity so we don t have to pay for capacity that we just don t need. DECC confirmed it was looking closely at reliability standards and a loss of load expectation of three hours to ensure consistency with international standards. The CM design sets capacity margins centrally, with calculations provided by professional organisations such as National Grid, before procuring the capacity required at the cheapest possible cost via an auction mechanism. Impact on wholesale market There were again concerns among participants who use hedging strategies about the impact of reducing the ratio between the commodity element of the bill, as a result of lower wholesale costs, and non commodity related charges, which are set to increase. If the wholesale price goes down and Capacity Mechanism costs are high, then your volatility is potentially around that cost rather than the wholesale price. Electricity Market Reform 21

24 4.0 Roundtable discussion Head of Group Energy Buying A Leading Retailer Manager UK Electricity Supplies (Power) Energy Intensive Maunfacturer Environment Manager Leading Food Retailer DSR versus avoiding peak demand CM costs will be allocated according to supplier s share of peak demand i.e. the three half hour Triad periods that occur each winter. There is therefore the potential to reduce costs by load managing during suspected Triad periods (which aren t confirmed until after the period). But the CM also provides an opportunity to participate via Demand Side Response (DSR). However, DECC is mindful to avoid a scenario of a double whammy of benefits by profiting from them both. It is expected that there will be a consultation response in late Participants therefore debated the possible merits of DSR versus avoiding peak demand. I see the point of how permanent DSR fits into the CM, setting aside the complexity of setting baselines and how we measure that to make sure it s accurate. But I don t see the point of introducing at the peak DSR when there are other mechanisms out there that already achieve this reduction. For me, it just muddies the whole CM. If the CM charge is going to be worked out by your demand during triad periods, then how that is passed through from supplier to end user is quite important. Currently, there is no clarity over this and until we know what the implications are, we cannot take any decision about whether participating in DSR at peak would be worth our while. Looking next at the design of DSR, participants discussed whether they felt there was currently sufficient incentive to participate, or whether factors such as the Bid Bond even at the initial reduced 90% level was off putting. No conclusion was reached. Without more information, it would be difficult to know what we could do. 22 npower Roundtable

25 Roundtable discussion 4.0 Concerns about pushing up Triad charges There was concern that using Triad periods as a basis for CM charges was going to create problems, and that there was a high chance peaks could move as more people load manage to avoid these charges. Some participants felt that the true cause of peaks ie surges in domestic demand was still not being addressed. There were concerns that different suppliers had different views regarding potential peak periods (although npower confirmed its forecasting accuracy was second to none in the market) and also that different suppliers charged for peak consumption differently. Manager UK Electricity Supplies (Power) Energy Intensive Maunfacturer Head of Group Energy Buying A Leading Retailer Head of Energy Large Industrial Electricity Consumer The CM could end up just doubling the Triad charge (were CM costs to be passed through on basis of demand at Triad times). Until we move away from deemed profiles for domestic customers, the issue of peak demand will never be addressed. Cost levels and visibility CM costs are more predictable than CfD costs because they are set four years in advance, with a further top up confirmed a year ahead. Participants were therefore more positive about this level of visibility. Four years notice is a huge improvement on some of the passthrough regulatory charges. So if you look at it relatively, it s probably not bad. However, the real test will be the actual level of cost and how it s going to be applied to industrial consumers we don t have visibility of that just now and that s part of the worry. Electricity Market Reform 23

26 4.0 Roundtable discussion Manager Energy Supplies (UK) Energy Intensive Manufacturer Manager Energy Supplies (UK) Energy Intensive Manufacturer Impact on international competitiveness However, regardless of visibility, a key concern among participants operating in international markets was the impact all EMR related costs could have on their competitiveness. It s all very well having cost certainty. But in the end I would suggest these costs, however certain, could be uncompetitive to consumers like us operating internationally. On the issue of carbon pricing, John McElroy pointed to some of the problems experienced in Europe recently that could further isolate the UK s position. Moves to implement back loading to shore up the EU s Emissions Trading Scheme (ETS) have been delayed by the recent German election. The EU is also still to set its greenhouse gas emissions reduction targets for 2030, with the current 2015 target set to expire shortly, so pressure is mounting for some indication to be released before the year end. State Aid Clearance The European Commission is required to grant State Aid Clearance before the CM and CfD can become law. Some participants expressed concern about whether this would go ahead in time, in view of the delays experienced approving the proposed Carbon Floor Price compensation for energy intensive users There is an issue regarding timing and method of EMR supplier levy exemption for EIU's; we are to keen to avoid a repetition of the delay and uncertainty experienced over Carbon Price Floor compensation. 24 npower Roundtable

27 5.0 Conclusion and Recommendations Electricity Market Reform 25

28 Conclusion and 5.0 recommendations Greater charging visibility, clarity over additional costs and consideration of policy impacts are the main concerns among businesses Customer feedback on previous communications looking at the impact of Electricity Market Reform has centred around calls for greater clarity, certainty and steps to reduce volatility. Delegates participating in this latest Roundtable debate reflected the same requirements. In particular, participants asked for: Greater visibility of charging for Contracts for Difference (CfD) with more notice than under the existing RO and FiT schemes to allow sufficient time to budget. A desire to pin down the cost uncertainty around the additional mechanisms connected to the CfD (in particular the Reserve Fund and Insolvency Fund). A consideration in policy design of the impact that offsetting the CfD and the Capacity Market (CM) mechanisms against wholesale prices will cause to those managing costs with the support of hedging strategies and a recognition that the proportion of non commodity charges within energy costs is increasing significantly, to an estimated 50% by Clarity and consideration regarding the impact that CfD will have on the existing private PPA market that some consumers are involved with. Clarity over exactly how onsite generation can participate in CfD and how that applies where this generation is primarily for onsite use rather than export. More thought to the impact of using peak demand as a charging model for the CM, and how this could actually dis incentivise Demand Side Response activity among large consumers already Triad managing. As ever, consideration of the impact of EMR costs are likely to have on remaining competitive among those operating in a global market. npower recommendations In addition, npower would like to emphasise the need to: Ensure that the design of the EMR framework, including the payment mechanisms, is done in the most affordable manner, eg 20 year CfD contracts, equal terms for participation for new and existing power generation capacity. Ensure a disproportionate amount of risk is not transferred to suppliers as this will drive up costs for consumers. Finalise detailed policy decisions, at the level below existing levels, as soon as possible to ensure industry can implement in Continue to engage with industry to ensure that EMR mechanisms are robust and work alongside existing industry arrangements. 26 npower Roundtable

29 6.0 Next Steps Electricity Market Reform 27

30 6.0 Next Steps Further Roundtable events will follow in 2014, as well a range of other initiatives designed to give our customers a voice in energy market developments The consultation on secondary legislation for EMR, and specifically Contracts for Difference and the Capacity Mechanism, closes on 24 December This document forms part of npower s official response to DECC, but customers are also recommended to make their views known directly to DECC. npower will keep customers informed of new developments as they are announced. You can also access more information and analysis from our policy experts via npower.com/emr, including news of EMR webinars, seminars and presentations at key industry events. If you have any comments and questions as a result of reading this report, we d be delighted to hear from you please contact us via business@npower.com Further Roundtable events will follow in 2014, as well a range of other initiatives designed to give our customers a voice in energy market developments. If you wish to be keep informed, please your details to business@npower.com 28 npower Roundtable

31 7.0 Glossary Electricity Market Reform 29

32 7.0 Glossary A glossary of some of the most common terms and acronyms used throughout this report. Aggregator a single company that has a collection of energy consumers and pools their collective resources, for example to offer consumption reduction as part of a DSR initiative. Bid Bond A security measure to guarantee participation in the Capacity Mechanism. CfD Contracts for Difference is a key mechanism within the government s planned Electricity Market Reform that s designed to incentivise investment in low carbon generation by offering a guaranteed price for the electricity that s generated. CM the Capacity Mechanism the other key mechanism within the government s planned Electricity Market Reform that s designed to ensure the UK has sufficient capacity margins to avoid a supply shortage at times of peak demand or supply shortfall (based on National Grid forecasts). CPB the Counterparty Body which oversees, along with the System Operator, the running of the Contracts for Difference mechanism and is responsible for the payment mechanics and settlement process. DECC Department of Energy and Climate Change. DSR Demand Side Response, which refers to an energy consumer reducing consumption in response to a call to reduce overall electricity demand, for example during times of system stress. Electricity Demand Reduction (EDR) A scheme offering financial incentives for permanent reduction in demand for electricity. Under the pilot, businesses and other organisations which install measures that deliver verifiable reductions in electricity demand, will receive a financial incentive. EIU energy intensive user, which applies to the UK s largest industrial consumers. Load management the process of balancing the supply of electricity on the network with the electrical load by adjusting or controlling the load rather than the power station output. Offtaker of last resort a guaranteed PPA for developers at pre defined, specified conditions, funded by suppliers (design under development and due to be consulted on soon). Peak demand times of relatively high electricity demand, typically Winter weekdays between 4 and 7pm. Power Purchase Agreement (PPA) contract between a supplier and a generator (usually independent) whereby the supplier guarantees to buy the electricity from the generator and trade on its behalf in the wholesale market. RO Renewables Obligation, which is the scheme currently operating to incentivise the deployment of large scale renewable electricity in the UK and requires licensed UK electricity suppliers to source a specified proportion of the electricity they provide from eligible renewable sources. Royal Assent the process whereby a Bill becomes an Act of Parliament after completing all parliamentary stages in both Houses. SO System Operator, which is currently National Grid. Triad the three half hours of peak demand each year that fall between 1 November and 28 February, as assessed retrospectively by National Grid. Suppliers such as npower help customers forecast when these might be via a Triad Warning Service (see npower.com/triad). Levy Control Framework (LCF) The Levy Control Framework supports the control of costs to consumers arising from specific government low carbon energy policies. 30 npower Roundtable

33 8.0 Appendices Electricity Market Reform 31

34 8.0 Appendices Appendix i About the Electricity Market Reform Overview Electricity Market Reform (EMR) is the UK Government s initiative to make sure the UK remains a leading destination for investment in low carbon electricity. The main elements of EMR are: Contracts for Difference (CfDs) these guarantee a price for generators to enable investment, with a strike price associated with generation type. Capacity Mechanism (CM) a market wide mechanism designed to ensure adequate, reliable power generation capacity is in place to meet peak demand. Emission Performance Standard (EPS) Clearly defined set of emission levels to prevent investment in carbon intensive power stations (i.e. coal without Carbon Capture and Storage). Carbon Price Floor (CPF) The CPF came into effect on 1 April It is a tax on carbon emissions by generators that s designed to provide an incentive to invest in low carbon power generation. EMR Key Dates DECEMBER 2013 MID 2014 JULY 2014 NOVEMBER 2014 APRIL 2015 Royal Assent of Energy Bill Final Delivery Plan Investment Contracts (early CfDs) Contracts for Difference Counterparty Body set up Contracts for Difference Contracts available Capacity Auction Contracts for Difference Supplier Obligation first payment 32 npower Roundtable

35 Appendices 8.0 Appendix ii Contracts for Difference The ultimate intention of Contracts for Difference (CfD) is to promote investment in low carbon technology by guaranteeing revenue streams to low carbon generators for up to 15 years. CfDs cover all technologies covered by the Renewables Obligation (RO) plus nuclear and Carbon Capture and Storage (CCS), and will replace RO from The two will run concurrently between 2014 and Through CfDs, low carbon generators will be paid a fixed price for the electricity they generate, but will have to repay money if the wholesale price rises above the Strike Price (a reference price linked to wholesale price, plus a fixed top up). Strike prices will differ by technology, with final prices published in December These prices will initially be set administratively before moving to competitive auction. A CfD Counterparty Body (CPB) will be formed to support delivery. CfDs will be funded by suppliers via a compulsory levy (with exemptions for energy intensive users). Therefore, while CfDs provide a fixed price for electricity generators, there will be a financial impact for consumers. CfD costs are forecast to be introduced in April 2015, ramping up over time from approx 1/MWh to approx 10/MWh by DECC is looking to introduce a fixed unit cost (p/kwh) based on a central forecast to pass costs onto suppliers. However, suppliers will also have to fund a reserve fund and an insolvency fund. At present, there are a number of key policy decisions which remain outstanding and introduce additional risk. Electricity Market Reform 33

36 8.0 Appendices Appendix iii Capacity Mechanism The Capacity Mechanism guarantees that there will be sufficient reliable energy supply to meet National Grid s demand forecast. Through the auctioning of capacity four years in advance, the Capacity Mechanism will result in existing plant staying open and new plant being built to guarantee supply. There will be an annual auction to secure reliable capacity for delivery four years later, with the first auction to be held in 2014 for delivery in 2018/19 and there will initially be two types of product: load following obligation and time banded product (winter weekdays from 9 11am and 3 7pm). In addition, a year ahead auction will top up any capacity shortfall and allow Demand Side Response (DSR) participation, offering aggregators a potential role. There will be penalties for non delivery of capacity (which will be capped), but potential rewards for over delivery. The Capacity Mechanism is open to all Demand Side Response, plus embedded generation and small storage, including behind the meter generation. The intention is that DSR will compete on equal terms with generation, with DSR providers being required to meet their capacity obligation through reducing demand below a baseline at times of system stress, or face a penalty. The administration of the Capacity Mechanism will be overseen by a supporting body, the Capacity Mechanism Settlement Body. The CM is expected to lead to a reduction in wholesale prices of 5 10/MWh. However, the cost of buying capacity in this way is likely to exceed these reductions and npower anticipates it could in fact add extra costs to consumers of between 7 20/MWh from This cost will be initially recovered from suppliers according to their forecast market share of peak demand (during Triad periods). There is, however, a potential opportunity to avoid these costs, dependent on the final design of the Supplier Obligation. Capacity to procure Auction Trading Delivery Payment Forecast of Total amount Capacity Providers of Costs of peak demand of capacity providers may capacity capacity shared made, and contracted for trade between commit to between translated into from providers auction and be available suppliers, a capacity willing to delivery when needed probably in requirement provide it or face proportion through penalties to their market a central in the delivery share auction. year Includes DSR, storage etc as well as generation Implementation Bodies have clear roles and responsibilities Capacity Market can evolve as necessary Source: DECC, February npower Roundtable

37 Appendices 8.0 Appendix iv EMR Pulse Survey Results Key Findings Research overview EMR Pulse is an online survey designed to give businesses a quick and simple way to air their views on Electricity Market Reform (EMR) it tracked opinions between July and October 2013, with results being collated in August and October to identify any trends in opinions. As well as surveying business views on EMR, the first Pulse also gave businesses the opportunity to participate in the government s consultation on Contracts for Difference (CfD) exemptions. This consultation is now closed. The second Pulse continued to seek general views on EMR, but also gave businesses the opportunity to have their voices heard on the subject of renewable energy generation. Summary of EMR findings Full awareness of EMR remains low, but the majority of businesses do acknowledge that they want to know more about the effect EMR will have on them. However, a significant minority of businesses have no awareness of EMR or its impact on their operations. The majority of businesses are concerned about the impact EMR will have on them, with its effect on energy costs and the ability to forecast these key. Electricity Market Reform key findings Overall awareness of EMR Overall awareness of EMR has largely remained static over both survey periods, with around three in 20 businesses saying they are fully aware of EMR. However, more than one in 10 still have no awareness of the legislation. It is clear that further communication about EMR and its impact on UK businesses is required, as more than two thirds of businesses say they would like to know more about EMR and how it will affect them. Here, npower s EMR Explained initiative can help play a vital part in raising awareness of EMR, with its aim to help businesses understand EMR in a clear and simple way. Awareness Pulse 1 Pulse 2 Fully aware of EMR 14% 16% Aware, but would like to know more 71% 67% No awareness 12% 16% Electricity Market Reform 35

38 8.0 Appendices Appendix iv EMR Pulse Survey Results Key Findings continued Sources of information on EMR Most businesses receive information on EMR from a variety of sources, with most organisations saying DECC and energy suppliers supply them with information. Industry bodies are the least common source of information on EMR for businesses, with only around a quarter of organisations receiving news on EMR from their relevant trade bodies. Here, energy suppliers can play a part in engaging further with trade bodies in the industries affected to help educate their members. Also, a third of businesses do not receive information on EMR from any source. npower s EMR Explained initiative aims to rectify this, communicating directly with organisations through social media, webinars, and face to face to help them find out more about how EMR will impact their business and encourage them to act now to overcome its impact. Source of EMR information Pulse 1 Pulse 2 Energy supplier 42% 24% DECC 37% 47% Industry bodies 28% 24% Do not receive information from any source 31% 33% Awareness of the different elements of EMR Contracts for Difference Contracts for Difference continues to be the element of EMR businesses are most comfortable in understanding, but more than half still want more information to be fully up to speed with the policy. Following the submission of respondents thoughts to a government consultation in August 2013, news is still awaited on the final shape of how energy intensive industries could be exempt from this policy. Capacity Mechanism Capacity Mechanism remains the element that respondents are least familiar with, with a third of businesses not aware of this component. The government is currently consulting on detailed design proposals for the Capacity Market, so further information on the ultimate form of this will be able to be shared with businesses in due course. Carbon Price Floor Carbon Price Floor is another area businesses would like to know more about to feel comfortable they understand its impact. Nearly half say they need more information. 36 npower Roundtable

39 Appendices 8.0 Appendix iv EMR Pulse Survey Results Key Findings continued The impact of EMR Just under half of businesses understand how EMR will impact their organisation, with three quarters asking for more information and support to manage this impact. However, a significant minority (three in 20) do not understand its impact, despite the fact that EMR will affect all energy consuming businesses, and has been increasingly covered in the media over recent months. More than half of organisations are concerned about the impact EMR will have on them. In terms of the specific concerns of businesses, cost remains top. More than four in five businesses are worried about how EMR will affect the cost of energy, with a similar proportion concerned about how EMR will impact their ability to forecast costs. Businesses are also considering how they can measure up on a global scale, with the effect EMR will have on UK competitiveness in global markets a key worry. Additionally, more than half of businesses are concerned about the administrative burden EMR will place on them and how it will affect their organisation s plans to invest in its energy strategy. Summary of Renewable Energy Generation findings Businesses are somewhat confused about how EMR will impact their plans for investment in renewable energy generation. Opinion is split, with a third (33%) saying it will encourage them to invest and a further third (33%) saying they will be less likely to invest in renewable energy generation as a result. Perhaps tellingly, one in five businesses (20%) admit they do not know enough about EMR to say either way. Renewable Energy Generation key findings Plans to invest in renewable generation Businesses are unsure how the introduction of EMR will impact their plans to invest in renewable energy generation, with a third (33%) saying it will encourage their business to invest and a further third (33%) saying it will dissuade them from investing. This split could perhaps be because of confusion around the impact EMR will have on renewable generation, as one in five (20%) admitted they did not have enough information to say either way. Impact of EMR on PPA netting agreements Nearly a third (29%) of businesses said they will be more likely to contract with third party renewable generators following the introduction of EMR, with less than half this amount (14%) less likely to contract with third parties. However, (36%) did not know enough about EMR to say what effect it will have on the likelihood of the contracting with third party renewable generators. Uncertainty around CfD policy The uncertainty associated with CfD policy has not affected the plans of 40% of businesses to invest in renewable energy generation. Of those it has affected, 50% have brought forward plans for renewable energy generation so it will be implemented before the introduction of CfD in A further 50% have put plans on hold. Electricity Market Reform 37

40 8.0 Appendices Appendix iv EMR Pulse Survey Results Key Findings continued Benefits of PPA netting The benefits most associated with contracting with third party renewable generators are: Price certainty (53%) Demonstrating a business green credentials (47%) Demonstrating the social responsibility of a business (47%) However, 13% do not think there are any benefits for setting up PPA netting agreements, with a further 13% not understanding what benefits there might be. Research sample Pulse 1: 65 respondents: 75% are energy consumers 25% are energy consultants/brokers Pulse 2: 51 respondents: 77% are energy consumers or generators 33% are energy consultants/brokers 30 respondents contributed to the CfD consultation questions in Pulse respondents contributed to the PPA questions in Pulse npower Roundtable

41 Appendices 8.0 Appendix v Slides from DECC s Jonathan Mills Presentation Context The EMR framework Electricity Market Reform (EMR) Consultation on the detailed implementation of EMR November 2013 PAGE 3 PAGE 4 Context: Summer 2013 Policy development We set out key outstanding parts of the EMR framework We are now moving to implementation (1) Collaborative Development with Industry Draft Strike Prices and key contract terms Capacity Market Detailed Design proposals (alongside Ofgem & National Grid security of supply consultations) Engagement with industry and delivery partners Implementation Steering Board working groups Capacity Market and Contracts for Difference workshops Draft EMR Delivery Plan CfD design package PAGE 5 PAGE 6 We are now moving to implementation EMR Consultation (2) Consultation on detailed implementation of Contents EMR launched October 2013 EMR implementation consultation published alongside key secondary legislation Sets out overall picture across EMR Secondary legislation due to be in force July 2014 Chapter Description 1 Aims of the consultation 2 Implementing EMR 3 Implementing Contracts for Difference 4 Capacity Market Detailed Design Proposals 5 Ensuring effective and transparent delivery of EMR 6 EMR in the Devolved Administrations 7 Next Steps The Contracts for Difference (Allocation) Regulations 2014 The Contracts for Difference (Supplier Obligation) Regulations The Electricity Capacity (Payment) Regulations 2014 The Electricity Capacity Regulations 2014 Annexes & Capacity Market Rules: consultation draft supporting Modifications to National Grid Licence: special condition N of NGET transmission licence material Background on supporting and transitional policy arrangements Impact Assessment measures to address potential conflicts of interest Impact Assessment: Contracts for Difference Impact Assessment: Supplier Obligation Impact Assessment: Capacity Market CfD eligibility criteria PAGE 7 PAGE 8 Electricity Market Reform 39