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Electricity Market Reform


The Department of Energy and Climate Change (DECC) released a white paper outlining changes to regulation of the electricity market. The goal of this policy is to provide certainty for low carbon electricity generation to encourage investment. The policy also aims to avoid the risk of energy shortages due to the planned closure of power stations over the next decade. Released on the 12th of July, the paper introduces a new system of Feed in Tariffs, with Contracts for Difference (FiT CfD), a Carbon Price Floor, and an Emissions Performance Standard to start coming into place in 2013.

Picture: Arnoldius via Wikipedia
The paper predicts that demand for electricity will rise over the coming years, even if we become more energy efficient, as electricity replaces oil and gas in areas such as transport and heat. The government predicts that £110bn of investment in low carbon energy generation and transmission is needed to keep to our target of 80% carbon reduction by 2050. The government wants to encourage investment spending from the current energy generators, and also from new entrants.

Carbon Price Floor
The Stern Review highlighted a Carbon Price Floor as one of the most effective ways of reducing emissions. The UK is currently subject to the EU Emmissions Trading Scheme (EU ETS), a cap and trade system which sets a carbon price level. Historically this price level has been volatile, and too low for our carbon budget. This white paper sets out a Carbon Price Floor (CPF), a tax which raises the cost of carbon to a specified amount. This amount is set to rise over time, and will be part of a package with FiT CfD to keep us in line with the carbon budget.

EDF energy had lobbied for a CPF, which should benefit the nuclear industry. Dr Paul Golby, Chief Executive of Eon UK, however, has previously voiced concerns over CPF: "I'm not a great supporter of a carbon floor price, because it seems to me to be a tax”. The CPF will also benefit gas over oil, as gas has lower carbon content.

CPF Risks for Green Investment
Research from the Institute for Public Policy [PDF 930.74KB] highlights the risks for clean energy investment of the Carbon Price Floor. The CPF is meant to increase certainty for investment into low carbon technology, but this depends on whether investors believe the policy has credibility, and will be supported by governments of the future. Research by Redpoint Energy [PDF 1.59MB] suggests that without credibility, this policy may actually reduce investment in renewables. However, CPF is likely to raise money for the government, as mentioned in the 2011 Budget, which may reassure investors that future governments will stick to the policy.

Feed in Tariffs with Contracts for Difference
The FiT CfD scheme is a contract between the government and an energy generator, to guarantee a price per unit of energy, known as the Strike Price, this price will depend on the form of low carbon generation. If the wholesale price is below the strike price, then the government will pay a “top up” of the difference. Similarly, if the wholesale price is higher, then the company will pay the government. FitT CfD may be cheaper than a fixed Feed in Tariff such as those used in the Solar industry, and should interact well with the Carbon Price floor. This policy will work slightly differently for “baseload” energy generation such as nuclear and biomass, and intermittent generation such as wind or solar. Eddie O’Connor of Mainstream Renewable Power Ltd said of the FiT CfD: “Whereas it’s quite suitable for nuclear, in its present form, it’s completely unsuitable for wind”.

Electricity prices are in general set by fossil fuel electricity generators. They have an inherent advantage because as carbon prices rise, so do electricity prices, which increases their revenues. Low carbon energy such as wind and solar are often price takers, so this policy will reduce risks to clean energy investment of volatile electricity prices.

Nuclear power stations are likely to benefit the most from this system as they have low carbon emissions and will be able to produce when the price is the lowest. Wind farms and Solar generation can only be used at certain times: i.e. when there’s sun, or wind. So they may lose out on the highest FiT CfD “top up”. These problems have been pointed out by the Energy and Climate Change Committee, and the government is planning to outline more detailed policy later in the year, which addresses the issue of differences between types of low carbon generation.

Emissions Performance Standard
The EPS is a limit on the level of emissions for new power station, it will be set at 450gCO2/kWh, but because the government wants to promote investment into Carbon Capture and Storage (CCS), an exemption will be made for plants with CCS on some of their plant. This is likely to affect coal stations the most, as they have high emissions, but with the CCS exemption, many plants may not be subject to the EPS. The government wants to reassure investors, and so EPS will not be retroactive, and will remain the same throughout a plant’s “economic life”. This reduces risk, and benefits gas energy production, as this has lower carbon emissions.

Capacity Mechanism
The reforms also aimed to maintain security of supply, to make sure that we have enough energy to “keep the lights on”. This includes improving energy efficiency whilst also securing supply. The white paper outlines potential solutions, such as having a Strategic Reserve, where a supply of energy is kept in case of emergencies, or “a mechanism in which all providers willing to offer reliable capacity are provided incentives to do so”. This is likely to benefit nuclear energy which has low carbon emissions but also produces a large amount of energy consistently. Nuclear accounted for 17% of electricity supplied in 2009 compared to just 6.7% for renewables, which produce energy more intermittently.


Niall Stuart, Cheif
 Executive of Scottish Renewables
Impact on Green Investment
Investment Funds in the Worldwise Investor Clean Energy Benchmark have not performed well over recent months. However, UK electricity companies have reacted mostly positively to the reforms, with Dr Paul Golby of Eon commenting: “We welcome today’s publication of the Electricity Market Reform White Paper and believe that it makes a good start in stimulating the growth in low carbon generation”.

The policy seemed to be good news for companies focussed on renewable energy.Niall Stuart of Scottish Renewables said : “The statement confirms that renewables are a major part of our future energy mix and the sector will be a significant driver of investment and employment over the coming decades as we replace ageing and polluting power stations with cleaner alternatives.”

The paper outlines a “grandfathering” scheme to smooth the transition to the new policies, which means that the level of support given by previous policies will not change throughout the life of a power station. This is to increase confidence in low carbon investment by reducing risks. However, investors may need more detail and clarity on these reforms and further legislation may be needed before investment into low carbon technology strongly improves.

The policy will not directly reduce emissions, as any reduction in the UK will allow higher emissions in the EU through the EU ETS. The UK carbon price will be higher than in the EU, and this is likely to make us less competitive as businesses will pay more for their electricity. However, the policy may achieve success in promoting investment into low-carbon electricity generation. The system of reforms aims strongly to reduce risk to clean energy investment, with strong incentives for investment in nuclear energy.

Fund context:

Funds that invest in renewable energy include those in the Worldwise Investor Clean Energy theme, such as Pictet Clean Energy. Natural gas is avoided by some of our Clean Energy funds such as Guinness Alternative Energy, while others have natural gas holdings such as ETFX Dax Global Alternative Energy and Vontoled New Power. Funds that avoid nuclear include Pictet Clean Energy and Henderson Global Care Growth, whereas the Environmental fund Schroders Global Climate Change fund has nuclear energy companies in its investment universe.

Related funds:

ETFS DAX Global Alternative Energy GO UCITS ETF
Guinness Alternative Energy
Henderson Global Care Growth
Pictet Clean Energy
Schroder Global Climate Change
Vontobel Fund New Power

Useful links:

Worldwise Investor: Clean Energy Theme

Worldwise Investor: National Grid provide the background to the energy challenge
DECC: Electricity Market Reform White Paper
FT: Huhne aims for ‘cleaner energy future’

Tags: UK | Clean Energy |

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Louise Fallonall articles

Louise Fallon starting working for Worldwise Investor as an intern over the summer and has written a number of articles during that time.

Louise is studying for a degree in Mathematics and Economics BSc at London School of Economics and Political Science, and graduates next summer.


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