Why Electricity Market Reform is not an unnecessary cost

When we talk to businesses about Electricity Market Reform, we encounter these three worries most often:

  1. Is it really necessary?

  2. Is it the right kind of change?

  3. Will it cost us too much?

If you’re worried about the need for and the cost of EMR, read on. I think these perspectives might help you see the UK’s electricity has to change to attract the investment it needs, and that it won’t cost too much.

1. EMR – yes, it’s necessary

No two ways about it, the UK’s electricity system needs far more investment in generation capacity. We are heading into historically low system capacity margins. National Grid’s most recent winter outlook shows a system margin of around just 4% for this winter – the lowest level in seven years.

To ensure the system can meet demand for this winter, National Grid has put into action its new powers to tender for reserve capacity. Why? The chief reason cited by National Grid is new power plants have not come online quickly enough to replace those stations that have closed down or closed for repairs.

Thankfully investment in the electricity system has risen dramatically. The chart below shows that from 2010 to 2013 £45bn was invested in networks and generation in roughly a 1:2 ratio. That’s far greater than in previous years but the rate of investment needs to increase further to meet the standard of supply the UK public expects.

The new RIIO (Revenue=Incentives+Innovation+Outputs) performance based remuneration model for network companies has driven the increase in investment in that sector. The idea is the change delivered by the Capacity Market and Contracts for Difference schemes will drive the added and necessary investment in new generation.

2. You’re not paying too much

It’s easy to criticise the prices offered to new low carbon generation technologies under Contracts for Difference (CfD). They do look high when compared against today’s wholesale power prices of around £50/MWh. Here are three reasons why that comparison is flawed.

a) Firstly, only considering wholesale power prices is simply wrong. Many of the renewable generation technologies are currently supported with Renewable Obligation Certificates (ROC) which trade around £42/MWh today. Some technologies receive more than one ROC per MWh.

b) Secondly,the CfD strike prices are not excessive, but based on the economics of different generation technologies. They are set at the level that makes building new generation attractive enough for investors to take part in the UK’s electricity market.

Sources: Committee Climate Change, Pöyry, DECC

c) Finally, the published strike prices are upper limits, not the rates that will likely be paid. Most new generators will compete for a CFD against all other projects bidding in that particular allocation round.  Only ‘less established’ technologies such as dedicated biomass will avoid open competition.

They receive ‘admin strike prices’ which are set for their technology and protected until a healthy number of similar projects come forward. Then the same competitive pressures that apply to established low carbon technologies will weed out projects that are too costly. The Capacity Market also operates around an auction-style process to ensure only the most competitive projects are supported.

Feeling more positive yet?
We believe the better businesses and energy managers understand all this change in the electricity market, the easier they'll be able to adjust and benefit in future. So how do you see these reforms from the right perspective?  With our EMR Made Simple stories:

Download this factsheet about how the Capacity Market and Contracts for Difference work

Bio

Posted by Nicholas Pender, Senior Manager of Structuring and Pricing

Nick Pender heads up EDF Energy’s B2B Industrial and Commercial Structuring & Pricing Team. The team deliver risk management services and structured contract solutions for our medium to large I&C customers, in addition to pricing and contract management. He has over ten years of experience across the energy industry with roles in B2B customer product development, trading EDF Energy’s fleet of assets (wind, CCGT, coal, nuclear), Upstream asset optimisation and hedging and Commodity research.

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