UK Electricity Market Reform: Lessons from a policy and regulatory journey

UK Electricity Market Reform: Lessons from a policy and regulatory journey Michael Grubb Professor of Energy and Climate Change, University College London (UCL) Chair, UK Panel of Technical Experts on Electricity Market Reform Presentation to Fifth Green Growth Knowledge Platform Annual Conference Sustainable Infrastructure World Bank, Washington DC, 27-28 th November 2017 Broad evolution of UK policy & regulation EMR reforms: instruments & emerging results Lessons & regulatory journey

Figure 1: UK electricity generation by fuel, 1970-2016 Figure 1 The dash for gas the decline of coal, a competitive market & Elec Market Reform Source (data): Digest of UK Energy Statistics, various years

UK electricity journey overview 1990s 2000s 2010s Policy environment First liberalisation - Competition through electricity pool - System marginal price + cap y payment Dash for gas, based on Long term contracts (PPAs) with distrib n companies Some contract support for renewables Collapse of R&D Bilateral trading market (NETA/BETTA) - No pool, pure marginal cost pricing - Vertical integration of generators with supply companies; Limited investment Market certificate trading (ROCs) support for renewables Electricity Market Reform (EMR) + Climate Change Act Regulatory remit Promote competition Concerns about oligopolistic power Protect interests of consumers Growing concerns about lack of investment or new entry, transmission connection & bottlenecks, and short-termism Protect interests of present and future consumers

UK Electricity Market Reform - Background Academic struggles between idealised theory and emerging evidence around overall investability Nuclear & renewables seen as key to future Energy transition estimated to involve over 100bn investment during 2010s beyond the pockets of incumbent, terms of finance crucial Political evolution: Rising energy prices Climate Change Committee (2008) concern around all forms of capital intensive investment, amplified by inadequate C price Ofgem (regulator) concern around security

Electricity Market Reform (EMR) Controversial step for a pioneer of electricity liberalisation Ofgem s Project Discovery (2009) Regulator s detailed study of the future challenges of the electricity market Addressing key risks identified became the three aims of EMR: 1 2 3 Reduce the risks to security of supply Reduce costs to consumers Support progress towards climate change targets

What is EMR? Low Carbon Support Contracts for Difference (fixed-price 15-yr contracts) Carbon floor price 4 Key Policies Capacity Mechanism (capacity payments on availability) Emissions Performance Standard Security of Supply No new coal EMR brought major changes to the market. Main regulatory input on design of Capacity Mechanism and overall institutional 7

1. Contracts for Difference (CfDs) (structure for renewable energy & nuclear) 8

Gains from auctioned contracts Strike Price ( /MWh) Initial gain from auctions followed by huge offshore wind cost reduction 180 160 140 120 strike price for five offshore wind farms depending on completion date 155 155 150 119,89 (Inc. East Anglia 1) 140 140 2014, administered CfD prices, 140-150 /MWh* 2015, first auction, offshore wind price: 114.39/MWh 2017, second auction, two projects at 57.50/MWh Competitive CfDs drive down cost hardware, supply chain & finance (Newbery (2015) estimates CfDs reduced WACC by 3 % points saving > 2bn/yr on estimated cost of energy transition). boost to UK low-carbon supply chain, as part of government s emerging Clean Growth Plan 100 114.39 (Inc. Neart Na Gaoithe) 80 60 40 74,75 (Inc. Triton Knoll) 57,50 (Hornsea II, Moray East) prices halve 20 0 Allocation / auction rounds 2013/14 2015/16 2017/18 2019/20 2021/22 Delivery years (to first generation) Round 1 Admin Strike Price (Offshore Wind) Round 1 Contracts - Offshore Wind / ACT Round 2 Contracts - Offshore Wind 4 years difference in delivery years Source: From M.Grubb and D.Newbery (2017), UK Electricity Market Reform and the Energy Transition: Emerging Lessons, MIT working paper (submitted) * 15-yr Contract prices

2. Capacity Mechanism / Market (to reward firm generating capacity) Why Ensure market can deliver security of supply Payment for availability to encourage investment How Effect Market wide auction of capacity obligations, run by National Grid Successful bidders get fixed revenue additional to wholesale market Obligated to deliver capacity when needed or face penalties Technology neutral but those receiving CfDs are not eligible Pilot scheme to help Demand Side Response (DSR) Reduces price volatility Insurance against blackouts Encourages demand side - somewhat? Expected cost estimate required for new CCGTs, around 50/kw/yr Would give 2.5bn/yr into market, much expected to pass through? Less peaky prices impact on interconnector / other investment Design makes it very difficult for DSR to participate equally 10

MW Capacity: be careful what you ask for Lots of bids, low prices, new options, lots of angst.. First main capacity auction (Dec 2014) Almost 50GW awarded, clearing price 19.40/kW/year* Mix of 1-year, 3-year (refurbishment) and 15 year (2.5GW of new build out of 10GW bid) contracts Mainly existing nuclear, gas and coal generators One new CCGT (1,650MW) wins an agreement but failed to raise final investment Only 174MW of demand side response 2.5GW of capacity reserved for 2017 1-year ahead auction (b) Successful New Build capacity by fuel and technology type in the T-4 auctions 3500 New build in Capacity Auctions 3000 2500 2000 1500 1000 500 0 2014 for 2018 2015 for 2019 2016 for 2020 Battery Reciprocating engine CHP Waste CCGT OCGT CCGT Withdrawn Second main capacity auction (Dec 2015) Clearing price 18.00/kW/year 46.35GW awarded new options replace retiring coal Interconnectors, 1GW of small reciprocating engine Concern about diesel Third main capacity auction (Dec 2016) Clearing price 22.50/kW/year 52.43GW awarded, inc 3.4 GW new capacity over 500MW batteries New diesel largely excluded, but wider concern about embedded benefit exemptions from transmission

Carbon price floor compelling economics Combined with the Emissions Performance Standard, effectively bans new coal and improves economics of gas vis-à-vis existing coal plants Floor price designed to give market value to the government s Social cost of carbon, through top-up to EU ETS price - Quickly renamed Carbon Price Support (CPS)

Generation from coal, TWh/yr Bigger support than anticipated, but.. Beihang: Planetary Economics and the Political Economy of Energy & Climate Change Mission accomplished? Dramatic (80%) fall since 2012: first hours / days without coal power for over a Century Driven as declining gas price meets rising carbon price, and renewables + (2016) gas Nov 2017: carbon price about right till coal phased out 45.00 40.00 35.00 GB coal power generation, 2012 - Q2 2017 C-Price support doubled to 18/kWh Carbon Price Support /tco2, added to EU ETS 30 30.00 25.00 18/tCO2 15 20.00 15.00 9.55/tCO2 10.00 5.00 CPS 4.94/tCO2-0

UK Electricity Market Reform - Key lessons For Strategic ( Third Domain ) investments eg security and sustainability inc emerging renewables - a role for government is inescapable The public benefits exceed any risk-adjusted return in spot market Can shifting some risk to government (eg. long term contract) be good? Yes if the risks arise from private perception of policy risk; markets (particularly capital markets) are myopic; or the benefits are partly public (eg. Due to inadequate environmental pricing, or innovation / learning, etc) Do we need a Capacity Mechanism in addition to low carbon supports? Yes in UK conditions but scope is crucial, so too is design Auctions are very valuable competitive pressures remain important Better than government decision at cutting costs / finding options Institutional complexities contracting bodies and their governance

EMR - Some outstanding questions Does the EMR takes us back towards public control or new forms of competition arising from auctions? More State involvement but still using competition, in more efficient way? Some risks of perverse incentives remain (eg. Metered output) Subsidising coal (CM) whilst trying to phase it out (C price) As renewables grow, will need more time- and location- market signals Exit Strategy? - Revolution or evolution? May be an evolving revolution New market structures needed for time and locational signals for investment and distributed service providers? Can / should we move towards a contracts market (eg. long term green consumer contracts, community energy, bundled service contracts) as renewables costs fall?

Regulatory dimensions include Remit (future consumers?) and metrics Three Components of Impact Assessment Monetised aggregate Cost- Benefit Analysis Social & distributional impacts Explicit consideration of strategic & sustainability issues Impact Assessment Strengthening analysis of these issues is designed to more systematically represent issues related to the interest of future consumers, complementary to a monetised CBA Improved consistency Increased transparency