Planning our electric future: a White Paper for secure, affordable and low‑carbon electricity

July 2011

Planning our electric future: a White Paper for secure, affordable and low‑carbon electricity

Presented to Parliament by the Secretary of State for Energy and Climate Change by Command of Her Majesty July 2011

CM 8099

£37.00

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Planning our electric future: a White Paper for secure, affordable and low-carbon electricity

Contents
Ministerial Foreword Executive Summary Chapter 1: Chapter 2: Objectives, policy response and vision of Electricity Market Reform Decarbonisation 2.1 The Challenge 2.2 The Carbon Price Floor 2.3 Feed-in Tariff 2.4 The Emissions Performance Standard Chapter 3: Securing Future Electricity Supply 3.1 The Challenge 3.2 Capacity Mechanism Chapter 4: Chapter 5: Chapter 6: Chapter 7: Chapter 8: Chapter 9: A New Institutional Framework Paving the Way for New Entrants Future Networks and System Flexibility Costs and Benefits Managing the Transition Devolved Administrations and the European Union 9.1 Devolved Administrations 9.2 European Union Annexes A: List of respondents to December consultation B: Further detail on the proposed design of the Feed-in Tariff with Contract for Difference C: Consultation on possible models for a Capacity Mechanism D: Renewables Obligation transition Glossary 139 147 160 213 228 3 5 15 27 27 33 37 49 59 59 61 81 89 97 111 123 129 129 133

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Planning our electric future: a White Paper for secure. affordable and low-carbon electricity 2 .

And it means making the existing market fairer: ●● to consumers. in time. the current market arrangements will not deliver investment at the scale and the pace that we need. Instead. in particular by reducing risks and setting a clear and stable framework for investors. we can ensure future security of supply and build a cleaner. Around a quarter of our existing capacity – mainly coal and nuclear power stations – will close in the next decade. Traditional fossil fuels leave us open to volatile prices. and to new entrants. more sustainable electricity mix. But it cannot meet the challenges of the future. ●● ●● 3 . However. low-carbon technologies can compete against each other on a level playing field to find their place in the energy mix. keeps our schools and hospitals running. a new generation of nuclear stations. affordable and low-carbon electricity Ministerial Foreword by the Secretary of State Electricity is a fundamental part of our daily lives. It lights our homes and streets. to low-carbon generators. gas and coal plant that can capture harmful emissions. It means establishing a system where. deepen our dependence on imported energy and emit too much carbon. in time. Keeping the lights on will mean raising a record amount of investment.Planning our electric future: a White Paper for secure. That’s why it is so important that the electricity market works effectively. who struggle to sell their electricity in a market dominated by six big firms. By reforming the market. Since the market was privatised in the 1980s the system has worked: delivering secure and affordable electricity for the UK. who want investment to take place in the most costeffective way so they do not pay over the odds for their electricity. This will mean making sure we create the right conditions to attract the investment needed to transform our system. and powers our businesses. and. This will diversify supply and wean us away from imported fossil fuels. we need huge investment in renewables. This White Paper sets out how we will encourage this investment in the most cost-effective way. who currently have to compete in a market in which they are at a natural disadvantage. more diverse. That investment must build an electricity system fit for the future.

ready to lead the world in the next energy revolution. affordable and low carbon energy for generations to come. Chris Huhne MP Secretary of State for Energy and Climate Change 4 . The Rt. affordable and low-carbon electricity But this White Paper is about more than encouraging investment in new generating capacity. We have put demand reduction and energy efficiency at the heart of our policy programme – and we are committed to making the electricity system more flexible and responsive.Planning our electric future: a White Paper for secure. And they will deliver secure. securing our future electricity supplies and heralding the shift toward a low-carbon economy. The Government understands that the most cost-effective way to secure our future supplies is not just to build new power stations. Hon. These reforms will yield the biggest transformation of the market since privatisation. They will put us at the forefront of low-carbon technological development.

the future electricity system will also contain more intermittent generation (such as wind) and inflexible generation (such as nuclear). with a full part played by demand management.Planning our electric future: a White Paper for secure. increasing the likelihood of costly blackouts. powered by a diverse and secure range of low-carbon sources of electricity. In addition to this huge reduction in existing capacity. the electricity sector would have an emissions intensity in 2030 of over three times the level advised by the Climate Change Committee.  Electricity Market Reform will put in place the institutional and market arrangements to deliver the scale of change ●● 1 The de-rated capacity margin is the capacity margin adjusted to take account of the availability of plant. for example when the wind does not blow. affordable and low-carbon electricity EXECUTIVE SUMMARY 1. power sector emissions need to be largely decarbonised by the 2030s. However. our competitive market and system of independent regulation has served us well. The package of reforms outlined here will mean that by 2030 we will have: a flexible. Electricity plays a part in almost every aspect of modern life and is vital to our economic and social wellbeing. a network that will be able to meet the increasing demand that will result from the electrification of our transport and heating systems. To put us on this latter trajectory. delivering reliable and affordable electricity. smart and responsive electricity system. low-carbon and affordable. Modelling suggests that de-rated1 capacity margins could fall below five per cent around the end of this decade. It is crucial for the UK’s international competitiveness and economic development that this continues. It reflects the probable proportion of a source of electricity which is likely to be technically available to generate (even though a company may choose not to utilise this capacity for commercial reasons). This White Paper sets out the Government’s commitment to transform the UK’s electricity system to ensure that our future electricity supply is secure. Without reform. 5 . security of supply is threatened as existing plant closes: over the next decade we will lose around a quarter (around 20 GW) of our existing generation capacity as old or more polluting plant close. This raises additional challenges in terms of meeting demand at all times. and we will have made this transition at the least cost to the consumer. we must decarbonise electricity generation: it is vital that we take action now to transform the UK permanently into a low-carbon economy and meet our 15 per cent renewable energy target by 2020 and our 80 per cent carbon reduction target by 2050. specific to each type of generation technology. Since privatisation in the 1980s. we face a number of unprecedented challenges in the coming decades: ●● 2. storage and interconnection. An unprecedented challenge 3. competition between low-carbon technologies that will help to keep costs down.

High construction costs and market illiquidity make it more difficult for low-carbon generation to compete with fossil fuels and impede market access. to meet these challenges. even without factoring in the huge investment needed in new infrastructure. for example. and Ofgem’s ‘Project Discovery’ estimated that around an additional £35 billion of investment is needed for electricity transmission and distribution. heat and other carbonintensive sectors. 6 . nuclear or offshore wind. Up to £110 billion3 investment in electricity generation and transmission is likely to be required by 2020. Nor will they give consumers the best deal. ●● 4. This is in part because of the sheer scale of the investment required.Planning our electric future: a White Paper for secure. but current market arrangements do not. at the required pace. and electricity prices are expected to rise: increases in wholesale costs. ●● ●● 2 3 Business as usual means all current policies. The low-carbon and renewable energy objectives we have set reflect this approach. But it is also because the challenges of decarbonisation and security of supply are best met today through a combination of measures. with much lower fixed costs relative to their operational costs in contrast to. new low-carbon generators often have to overcome relatively high barriers to market entry. There is broad consensus that current market arrangements will not deliver the scale of long-term investment needed. more than double the current rate of investment. The cumulative benefits to the economy of Electricity Market Reform are expected to be over £9 billion higher than business as usual over the period 2010-302. including the Renewables Obligation and the Carbon Price Floor. Our analysis shows that around £75 billion could be needed in new electricity generation capacity. including the recently-adopted fourth carbon budget. affordable and low-carbon electricity in the power sector needed to meet the UK’s carbon budgets. the current market price for electricity is driven by fossil plant. such as unabated gas-fired Combined Cycle Gas Turbine (CCGT). Investors in non-gas fired generation are also disadvantaged by being exposed to more volatile and uncertain returns when compared to gas. In particular: ●● 5. the carbon price and environmental policies are likely to lead to higher bills in the future. The Government is committed to reducing the impact on consumers by making sure investment takes place in the most cost-effective way possible. Small and independent players are also particularly affected by the risk of not being able to find long-term buyers for their electricity. the social cost of carbon is not fully reflected in the market price as this does not take into account all of the damage caused by climate change. ●● demand for electricity is likely to rise: despite the improvements in household and non-domestic energy efficiency which will be generated through the introduction of the Green Deal and the roll-out of Smart Meters across the country. overall demand for electricity may double by 2050 due to the electrification of the transport.

Broadly this approach consists of four parts: ●● Our strategy 7. 6. continued grandfathering. to achieve the diverse portfolio of generation we need to meet our goals as efficiently and cost-effectively as possible. In addition. and ensuring a liquid market that allows existing energy companies and new entrants to compete on fair terms. This was announced in Budget 2011 and represents an early and long-term signal to investors that the Government is serious about encouraging investment. At the heart of our strategy is a framework that will offer reliable contracts. These new contracts could be delivered by a range of possible delivery organisations – including private sector bodies. and ●● the capacity and appetite of existing market participants to finance the unprecedented levels of investment needed is uncertain. the introduction of a Carbon Price Floor (CPF) to reduce uncertainty. institutional arrangements to support this contracting approach. there are two other complementary measures to decarbonise electricity generation. ●● 7 . These are: ●● 9. more robust mechanism than the alternative support options available and provides greater certainty that we will meet our carbon emissions targets. ●● ●● ●● Contracting for Low-Carbon Generation 8. long-term contracts for both low-carbon energy and capacity. providing clear. This is also due to the scale of investment needed and failures within the existing market. affordable and low-carbon electricity The carbon price is also volatile and hard to predict – making long-term investment decisions more uncertain. put a fair price on carbon and provide a stronger incentive to invest in low-carbon generation now. stable and predictable revenue streams for investors in low-carbon electricity generation. within a clear and rational planning cycle.Planning our electric future: a White Paper for secure. administered through delivery arrangements that are trusted by investors. This is a cheaper. There are also likely to be insufficiently strong signals to invest in the level and type of capacity that we need in order to guarantee future security of supply. At the heart of our strategy to deliver this transition is a new system of long‑term contracts in the form of Feed-in Tariffs with Contracts for Difference (FiT CfD). supporting the principle of no retrospective change to low-carbon policy incentives. and an Emissions Performance Standard (EPS) set as an annual limit equivalent to 450g CO2/kWh at baseload to provide a clear regulatory signal on the amount of carbon new fossil-fuel power stations can emit.

8 . This varies by technology but the overall effect of the cost of capital reductions from Electricity Market Reform will be a potential saving of £2. The introduction of the Green Deal7 will enable homes and businesses to 4 5 6 7 http://www.decc. In the period between 14 May 2010 to 13 May 2011.aspx Further detail is set out in the Impact Assessment. boost competition within the market as it will provide the framework for independent generators and new investors to invest in low-carbon generation. and technology-neutral auctions further in the future. introduce an appropriate policy framework in the electricity sector to contribute towards delivery of the fourth carbon budget. Together.gov. we will assess whether there are sufficient support and incentives to make efficiency improvements in electricity usage and consider whether there is a need for appropriate additional measures. this package of measures will: ●● provide a more efficient and stable framework for investors. lead to competition within and between different low-carbon generation technologies for their appropriate role in the energy mix. The ability of new entrants to come to the market will also be supported by action from Ofgem to improve liquidity. The Green Deal will predominately help to reduce costs and carbon emissions around home heating. We have already taken decisive action to reduce central Government emissions by 13. but also allow new technologies such as CCS to get off the ground and allow them to become cost-effective and compete without support. and achieve our aims at least cost to the consumer. ●● ●● ●● ●● ●● 12. 10. For the majority of homes this heating will be gas fuelled.5 billion over the period to 20305.8 per cent (exceeding our original target of a 10 per cent reduction)6. The new contracting approach and wider reforms implement the coalition agreement commitments to introduce an EPS and a new system of Feed-in Tariffs (FiT) and are consistent with the agreed position4 that new nuclear stations should receive no public support unless similar support is available to other low-carbon technologies. As such. We also recognise that reducing demand for electricity will lower carbon emissions and is likely to be more cost-effective than building additional generating capacity. 13. as we move to technology-specific auctions for contracts towards the end of the decade. affordable and low-carbon electricity This will reinforce the requirement that no new coal-fired power stations are built without Carbon Capture and Storage (CCS). encourage investment in proven low-carbon generation technologies. ensuring that the cost of capital required for new low-carbon generation capacity is lower.Planning our electric future: a White Paper for secure. This is vital to our ability to adjust to different scenarios for fossil-fuel prices.uk/en/content/cms/news/en_statement/en_statement. 11. Engaging with consumers on energy use will also be crucial.

store electricity and connect our market to others in Europe. and resource adequacy – how to secure sufficient reliable capacity to cover peak demand. 18. 9 . This will enable consumers to monitor and manage their energy consumption. The measures outlined in this White Paper to contract for low-carbon electricity generation will have the effect of making our electricity supply more secure by encouraging a diverse range of new generation capacity and reducing our reliance on energy imports. We need market arrangements that make the most of these opportunities. with businesses and public sector users having smart or advanced energy metering suited to their needs. supply matches demand. In addition. 19. we need to act now to address them. is responsible for ensuring operational security. New capacity will include renewables. Historically the UK has benefited from robust security of supply. Contracting for Security of Supply 14.Planning our electric future: a White Paper for secure. We need to take action now to address these issues and avoid problems in the future. This will be complemented by a huge programme aimed at making sure every home in Great Britain has smart electricity and gas meters. given unforeseen changes in both. Ofgem – as the independent regulator – is currently considering reform of some of the current mechanisms that ensure balance. especially gas. But these responses alone are unlikely to be enough. It does so by making sure supply balances demand at any given moment. We are seeking further views on the form this mechanism should take. 16. However the unprecedented nature of the challenge means there is a risk of uncomfortably low capacity margins towards the end of the decade. there are new opportunities from innovative technologies that will take demand off the system at times of stress. In order to ensure resource adequacy. Although we do not see security concerns until the latter half of the decade. The System Operator. 15. CCS on gas and coal and new nuclear stations. affordable and low-carbon electricity improve energy efficiency with no upfront cost. It is clear that fossil fuels without CCS. There are three primary challenges under the banner of security of supply: ●● diversification of supply – how to ensure we are not over-reliant on one source or technology and reduce our exposure to high and volatile fossil fuel prices. National Grid. the Government will legislate for a new contracting framework for capacity: a new Capacity Mechanism. will also continue to have a key role to play in the coming years. ●● ●● 17. operational security – how to ensure that. moment to moment. and pave the way for a transformation in the way in which energy is supplied and used. The Government is supportive of reform and keen that improvements are made.

we plan to ensure a fair and equivalent treatment of demand side resources such as storage and demand side response. and the development of a smarter grid. designed to address stakeholder concerns. The Government will also develop its electricity systems policy next year. working jointly. The institutional arrangements for administering FiT CfDs and capacity-based contracts will need to provide clarity and certainty and be trusted by investors. especially for consumers. looking at the future system and focusing on challenges around balancing and system flexibility.Planning our electric future: a White Paper for secure. robust and credible institutional framework is critical to ensuring investor confidence. 23. will periodically evaluate. 24. and monitoring compliance and enforcement. alongside generation. The alternative would be a market-wide mechanism in which all providers willing to offer reliable capacity are provided incentives to do so. The first is a targeted mechanism in the form of a Strategic Reserve. and on this basis consider any amendments to the future approach that may be required. The first of these assessments will be in 2016 and will also consider whether the new contract structure for low carbon is delivering all the benefits. according to a planning cycle clearly laid out in advance. Government will continue to set policy. and improvements over the existing Renewables Obligation. decarbonising the electricity sector (in line with all carbon budgets) and cost-effectiveness are met. 25. affordable and low-carbon electricity 20. This will also require better use of existing generation through the development of a more flexible electricity network. This White Paper sets out a highlevel strategy on networks and system flexibility. with the aim of securing best value investment across the power system. This comprises centrally-procured capacity which is removed from the energy market and only utilised in certain extreme circumstances. that we expect. In this White Paper we have set out two options. Other core functions to deliver the FiT and Capacity Mechanism include: translating the policy objectives into technical requirements. A New Institutional Framework 22. storage and interconnection. Under both options. managing payments. detailing work over the coming months. However there are more significant challenges ahead. their future strategy in the light of possible changes in costs. It is likely that an organisation or organisations at arm’s length from Government will administer the contracts. This will include clarifying the role of demand side response. Putting in place an enduring. in particular that being undertaken through the Smart Grid Forum. a development of the lead option from the December 2010 Electricity Market Reform consultation document. delivering the contracts. ensuring the objectives of security of supply. any 10 . 21. Government and Ofgem have made significant progress over the last few years on improving networks. technological developments and new challenges to the energy system. The Government recognises that reducing demand is likely to be more cost-effective than building additional capacity. data reconciliation. As now. The Government and the delivery organisation(s).

There is also substantial uncertainty about the outlook for fossil fuel prices. Significant improvements are essential to promote a competitive market and long-term security of supply. The economic case 32. There are a number of barriers to entry and growth in electricity generation and supply markets. as appropriate. taken together. There are several key criteria that will inform the decision on which organisation(s) is best placed to take on this delivery role. A decision on the roles and responsibilities of Government and those of the delivery institution(s). affordable and low-carbon electricity changes would be made in the light of our continued commitment to grandfathering and no retrospective change. in advance of this decision. it is likely that the environmental regulators in each part of the UK will be best placed to administer the EPS. We envisage the EPS being administered outside of these arrangements. Ofgem has set out proposals aimed at improving overall liquidity and meeting the needs of independent generators and suppliers. To the extent that there are continued barriers to entry that are not addressed through Ofgem’s actions. The package of Electricity Market Reform measures has been designed to be the most cost-effective means to meet our objectives. 30. Electricity Market Reform and the liquidity reforms deliver the necessary improvements. credit-worthiness. The Government is working closely with Ofgem to ensure that. bills are likely to rise relative to today with or without reform due to increases in wholesale costs. We will continue to engage with stakeholders. 26. Subject to more detailed implementation planning.Planning our electric future: a White Paper for secure. as well as more detail on functions. will be set out around the turn of the year. Improving Market Liquidity 29. One of the most important is the low level of liquidity in the electricity wholesale market. the Government will work with all stakeholders to identify appropriate solutions. 28. The Government welcomes the direction of travel set by Ofgem. 27. contracting and the planning cycle. This is particularly important as electricity prices and. including that there is enough liquidity to offer the means for independent generators of all sizes to compete effectively in the market. the carbon price and environmental policies. The Government also considers liquidity reform to be critical in enabling Electricity Market Reform to deliver efficiently and cost-effectively. skills and value for money. independence. particularly gas – strengthening the case in the longer term for moving away from reliance on fossil fuels with potentially volatile prices. Credible reference prices and routes to market are essential for low-carbon generation. 31. including appropriate levels of accountability. to a lesser extent. 11 .

we commit to announcing in the autumn a package of measures to reduce the impact of government policy on electricity costs for energy intensive manufacturers whose international competitiveness is most affected by our energy and climate change policies and to support EIIs in becoming more energy and carbon efficient. It is essential that the period of transition between the current and new market arrangements runs smoothly and allows investment to continue. the policies outlined above will ensure secure low-carbon energy supplies. If we continued with current policies. reform is expected to have a more substantial impact in curbing rising bills. we support the principle of no retrospective change for lowcarbon investments and have listened to industry views on the best way to transition to a new mechanism. average annual household electricity bills could rise by around £200 by 2030. There would be no advantage – both for the UK economy and in terms of global emissions reductions – in simply forcing UK businesses to relocate to other countries where carbon emissions continue unabated. 34. We will examine international best practice in determining how to do this. As part of the transition to a low-carbon economy. Therefore: ●● to ensure ongoing Renewables Obligation (RO) stability. That means making sure that there is a smooth transition from existing policies. 35. Making it happen 36. Similar figures for businesses and energy intensive industries are around seven per cent and eight per cent respectively. Average costs for households. However.Planning our electric future: a White Paper for secure. Energy efficiency measures can help reduce bills further. . towards the end of the period. we must ensure that energy intensive industries remain competitive and that we send a clear message that the UK is open for business. existing accredited generation will continue to be supported under the RO. But to be successful we need to ensure they are implemented effectively and efficiently. As such. As such. at least cost. With Electricity Market Reform. Transitional measures 37. Together. We will also work with UK-based EIIs to ensure they benefit from rapidly increasing demand for materials in low-carbon supply chains. where it would be cost effective for them to do so. businesses and energy intensive industries (EIIs) are likely to vary (either increase or decrease) against this baseline by less than one per cent over the initial period of reform. affordable and low-carbon electricity 33. and help deliver on the commitment to be the greenest government ever. the impact of Electricity Market Reform on bills is likely to be marginal compared to a baseline of continuing with the existing support arrangements for low-carbon generation. and ensuring that reforms are consistent with EU law. 12 8 Current policies include the Carbon Price Floor and the Renewables Obligation. In the short and medium term. this increase in bills could be limited to around £1608 – a saving of £40 or around six per cent. working closely and collaboratively with the Devolved Administrations to develop and deliver a coherent and seamless package of reform measures in each part of the UK.

We are working closely with the European Commission and other stakeholders to ensure our reforms are consistent with. and more details on the institutional arrangements needed to deliver these policies. ●● 42. we will work actively with relevant parties to enable early investment decisions to progress to timetable wherever possible. including those required ahead of full implementation of the FiT CfD.Planning our electric future: a White Paper for secure. to provide flexibility new renewable generation will have a one-off choice between the RO and FiT CfD. affordable and low-carbon electricity ●● once the FiT CfD is introduced and until 31 March 2017. European Union 40. and we will grandfather RO support for all technologies at the rate applicable on 31 March 2017. To ensure the continuity of all low-carbon development. and develop an electricity systems policy next year. We will publish a technical update by the end of the year. 13 . the RO will close to new accreditations on 31 March 2017. and complementary to. No generation will be able to accredit under the RO from that date. and the development of a smarter grid. In addition. we will: ●● ●● 43. ●● ●● 38. Next steps 41. the wider integration of the GB market with EU electricity markets. The Government believes that by working closely with the Devolved Administrations. We will continue to work together to design and deliver relevant elements of the policy package and ensure that reform is consistent with the devolution settlements and takes account of existing market arrangements. we will be able to deliver the level of new low-carbon generation the UK needs. We intend that this legislation will reach the statute book by spring 2013 so that the first low-carbon projects can be supported under its provisions in 2014. The Government intends to legislate for the key elements of this package through primary legislation in the second session. looking at the future system framework and focusing on challenges around balancing and system flexibility. undertake an assessment over the coming year to determine whether DECC should take further steps to improve the support and incentives for the efficient use of electricity. storage and interconnection. This will include: ●● the detailed design of the Capacity Mechanism. Devolved Administrations 39. These dates are subject to Parliamentary time being available and the will of Parliament. of which we are fully supportive. which starts in May 2012. This will include clarifying the role of demand side response.

Additional information published 14 2013 Royal Assent Renewable energy target Secondary Legislation Statutory Instruments in force 2011 2012 2014 2015 2016 2017 2018 2019 2020 White Paper Bill introduced Legislation Policy finalised Primary Legislation Institutional Framework Initial work to establish organisation Organisation receives Organisation up and running. legal delivers first contracts powers Feed-in Tariff with Contract for Difference (FiT CfD) First FiT CfD contracts signed Possible first payments made Capacity Mechanism (CM) Annual assessments of need for additional capacity CM in place Capacity procured as required Lead in time for capacity (could be compressed if necessary) Capacity in place (could be earlier) Carbon Price Floor (CPF) CPF in force CPF rising incrementally along published trajectory Figure 1: An indicative timetable for implementation and transition Planning our electric future: a White Paper for secure. affordable and low-carbon electricity Emissions Performance Standard (EPS) EPS in force Report on Decarbonisation and CCS Progress EPS applied to all new build Report on Decarbonisation and CCS Progress Renewables Obligation (RO) open to new generation Choice between RO and FiT CfD RO closed to new generation RO vintaged Transition to EMR Early low-carbon investment – enabling discussions .

outlines the scale of the investment challenge. affordable and low-carbon electricity Chapter 1 – Objectives. • A Capacity Mechanism is needed to ensure future security of electricity supply. Introduction 1. • We will introduce new long-term contracts Feed-in Tariff with Contract for Difference (FiT CfD) to stabilise revenues and reduce risks to support investment in all forms of low-carbon electricity generation.2 sets out the high-level objectives of Electricity Market Reform. This section: ●● 1.1 The electricity market needs wide-ranging reform. ●● 15 . The Government is also undertaking a series of measures to improve energy efficiency. The detailed proposals are set out in later chapters of this White Paper. these measures represent a coherent package designed to complement each other and achieve the Government’s vision for Electricity Market Reform. We are seeking further views on the type of mechanism required and will report on this around the turn of the year.Planning our electric future: a White Paper for secure. • The Government announced in Budget 2011 that it would put in place a Carbon Price Floor to reduce investor uncertainty. • This will be underpinned by a strategy for future electricity networks and work led by Ofgem to improve market liquidity. • An Emissions Performance Standard set at 450g CO2/kWh will be introduced to provide a clear regulatory signal that new coal plants must limit their emissions. while minimising costs to the consumer. The complexity of the market and the scale of our ambition means a number of policy responses will be required in order to realise our goals. including the Green Deal. put a fair price on carbon and provide a stronger incentive to invest in low-carbon generation. Together. policy response and vision of Electricity Market Reform Summary • The Electricity Market Reform package will secure long-term electricity supply and decarbonise electricity generation.

Given the importance of debt to finance new energy projects and the constraints faced by Meeting the Investment Challenge 1.3 The primary objectives of Electricity Market Reform are to: ●● ensure the future security of electricity supplies. and discusses the wider context and how the Electricity Market Reform policy package complements the wider Government agenda. stable and predictable electricity market arrangements which are attractive to investors at home and overseas. and minimise costs to the consumer.5 1.decc. Without reform. affordable and low-carbon electricity ●● reviews the package of policies as set out in the Electricity Market Reform consultation document9. at the pace that is needed. We believe the package of measures set out in this White Paper will help create long-term. describes the interaction between the various elements of the Government’s preferred policy package. ●● ●● 1.aspx 16 .uk/en/content/cms/consultations/emr/emr. provides a high-level summary of the responses to the consultation. nor will it be able to ensure that consumers get the best deal. the existing market will not deliver the scale of longterm investment. drive the decarbonisation of our electricity generation. and make investment in low-carbon generation in the UK more attractive.gov.7 1.8 9 http://www. Overcoming investment constraints will also require additional models of financing to encourage the participation of alternative sources of funding for generation and transmission projects. we need to reform the market now. ●● ●● ●● ●● Objectives 1. describes a vision of the future electricity system after market reform.4 The key to achieving these objectives will be to bring foward the level of investment needed in new low-carbon generation capacity and infrastructure at the required pace. If we are to meet our long-term carbon and security of supply objectives. Given the scale of the investment challenge (with up to £110 billion needed in electricity generation and transmission in this decade alone).6 1. This is particularly important as the existing ‘Big Six’ energy companies are unlikely to be able to finance all the investment at the scale and pace required.Planning our electric future: a White Paper for secure. it is important we attract the necessary investment in the most costeffective way possible.

12 The Electricity Market Reform Consultation 1. 1. Responses to the consultation were received from a wide range of stakeholders. the Government is creating a Green Investment Bank (GIB). and (as set out in Chapter 6) the expansion and reinforcement of the transmission system to enable the connection of generation – especially new renewable and other low-carbon generation – into the National Grid. displayed in Figure 2.13 17 .10 Figure 2: National Policy Statements for energy infrastructure. If we are to be successful in meeting the investment challenge. investors also need to have confidence in the planning system for major infrastructure projects. 1. The Government has therefore put before Parliament six energy National Policy Statements (NPSs) for approval. This means giving developers greater certainty on the policy framework for decision-making on major infrastructure projects. This set out a range of proposals to catalyse the cost-effective investment the UK needs to meet its carbon reduction and energy security goals. Overarching Energy NPS (EN-1) Fossil Fuels NPS (EN-2) Renewables NPS (EN-3) Gas & Oil Infrastructure NPS (EN-4) Electricity Networks NPS (EN-5) Nuclear NPS (EN-6) 1. the Government undertook a consultation exercise on Electricity Market Reform in December 2010.11 The NPSs set out the need for new energy infrastructure. 1. In order to develop the measures necessary to tackle this investment challenge. The GIB will need to review the market need and potential impact of different interventions.9 In recognition of these challenges and alongside the new market framework. The GIB will offer a range of financial solutions to accelerate private sector investment in the UK’s transition to a green economy. it is also important that providers of debt are able to refinance their capital commitments in the public debt markets. affordable and low-carbon electricity banks. The NPSs provide a clear framework for decision-making by setting out the strategic need for new infrastructure and how impacts associated with proposals can be mitigated to an acceptable level.Planning our electric future: a White Paper for secure. including electricity from a mixed portfolio of generation types.

A full list of non-confidential respondents can be found in Annex A.gov. in particular whether consultees agreed with the Government’s preferred option of a targeted mechanism.uk/consult_carbon_price_support. without reform.Planning our electric future: a White Paper for secure.15 whether respondents agreed with the Government’s analysis that reform of current market arrangements was required to deliver our security of supply and decarbonisation objectives. 11 http://www. in particular whether respondents agreed with the Government’s preferred package of a CPF. the introduction of an Emissions Performance Standard (EPS) to place a regulatory limit on the amount of CO2 produced by new fossil fuel power stations. ●● ●● ●● ●● ●● Consultation Responses Current market arrangements 1. a FiT (either a FiT CfD or Premium Feed-in Tariff (PFiT)). options to support investment in low-carbon generation through a system of Feed‑in Tariffs (FiT). the existing electricity market would not deliver the scale of long-term investment needed.hm-treasury.uk/d/carbon_price_floor_consultation_govt_response 18 .16 The Electricity Market Reform consultation document described the existing electricity market and explained why the Government did not believe that the current market arrangements remained appropriate to deliver our objectives.hm-treasury. The response to the HM Treasury consultation was published in March 201112. 10 All non-confidential responses will be published shortly after this White Paper. options for packages of policies to reform the electricity market.14 A separate consultation exercise11 was conducted by HM Treasury on the introduction of a Carbon Price Floor (CPF).htm 12 http://www. at the same time as that carried out on Electricity Market Reform. The Electricity Market Reform consultation sought views on: ●● 1. at the required pace. affordable and low-carbon electricity This White Paper serves as the formal Government response10 and discussion of consultation responses can be found in relevant sections.gov. an EPS and a targeted Capacity Mechanism. nor would it give consumers the best deal. 1. and issues surrounding implementation of reform. There was broad consensus from consultation respondents that. options to provide security of electricity supply through a Capacity Mechanism. in particular whether consultees agreed with the Government’s preferred option of a Feed-in Tariff with Contract for Difference (FiT CfD).

●● 1.17 The parallel consultation by HM Treasury set out the Government’s proposal to introduce a CPF.21 Emissions Performance Standard 1. including the Government’s preferred option of a FiT CfD and the leading alternative of a PFiT: ●● a PFiT: a static payment which generators receive in addition to their revenues from selling electricity in the wholesale market. The FiT CfD is a two-way mechanism that has the potential to see generators return money to consumers if electricity prices are higher than the agreed tariff. the Government also explained that this would not in itself be enough to deliver sufficient investment in low-carbon infrastructure to meet our objectives and would not be cost effective. The PFiT was preferred by a number of renewable energy companies.22 a level equivalent to 600g CO2/kWh. The Electricity Market Reform consultation proposed to set an annual limit on the total amount of CO2 per unit of installed capacity that new fossil fuel power stations are allowed to emit and sought views on whether that limit should be set at either: ●● 1. but most requested more detail on how the FiT CfD would work in practice. This was in the main because of their similarity to the current Renewables Obligation (RO). The FiT payment would be made in addition to the generator’s revenues from selling electricity in the market.20 1. which was understood by investors. and a FiT CfD: a long-term contract set at a fixed level under which variable payments are made to top-up the level of payment to the generator to the agreed tariff. A number of consultation responses sought more information on the impact which the use of long-term contracts (and in particular the FiT CfD) would have on the cost of capital for those building low-carbon generation.18 Respondents to the consultation generally accepted that a FiT CfD could be introduced. consistent with demonstrating post-combustion Carbon Capture and Storage (CCS) on a new. However. The Electricity Market Reform consultation described a number of other policy responses to achieve our aims.Planning our electric future: a White Paper for secure. affordable and low-carbon electricity Feed-In Tariffs 1. or 19 . supercritical coal-fired power station. A number of the consultation responses expressed concern about the complexity associated with the FiT CfD. Many of the consultation responses observed that the FiT CfD approach set out in the consultation may need to be tailored to different types of technology. and was felt to be easier to implement.19 1. and some believed that the FiT CfD represented the most effective mechanism to increase low-carbon electricity generation.

with a preferred option of a targeted. with some supporting the higher EPS level. In particular some felt that a targeted mechanism would lead to a ‘slippery slope’ effect13 under which an increasing number of fossil/peaking plants would be included in the mechanism rather than operate in the market. The consultation set out the Government’s view that. Others were sceptical of the need for a Capacity Mechanism and argued that the case for a significant market intervention had not been made. Others felt further regulation was unnecessary and could deter investment Consultation responses were generally split on the preferred EPS level. Most concerns related to the potential impacts of this mechanism on the way the electricity market operates. and other stakeholders advocating a more stringent EPS level. Some felt that an EPS would provide a useful backstop as part of a suite of measures intended to drive decarbonisation. 20 .26 13 If being in the capacity mechanism and receiving a capacity payment was more attractive than remaining wholly in the market. with specific exemptions for plant forming part of the UK’s CCS Demonstration Programme or benefiting from European funding for commercial-scale CCS projects.25 1. significant risks to security of supply remained.24 1. Capacity Mechanism 1. mechanism. 1. while options to improve the existing market such as improving liquidity would provide security of supply benefits. meaning that the central body would have to procure ever more generating capacity. affordable and low-carbon electricity ●● a level equivalent to 450g CO2/kWh. storage and interconnection.Planning our electric future: a White Paper for secure. The Government consulted on the introduction of a Capacity Mechanism. it could lead to lack of investment outside of the mechanism. rather than a marketwide. Some stakeholders suggested that a market-wide approach would avoid some of these problems and could be a more viable in the long term. and/or that a targeted mechanism would simply displace generating capacity which would have been available anyway. A number of stakeholders expressed strong concerns about the consultation proposal to introduce a targeted mechanism. some stakeholders took the view that capacity margins during this decade meant that a mechanism is likely to be needed.23 There was no consensus from respondents on the need to introduce an EPS. A number of respondents emphasised the importance of ensuring the Government was clear on the nature of the problem we were trying to solve with a Capacity Mechanism. A number of stakeholders highlighted the importance of the role of non-generation forms of reliable capacity such as demand side response. On the question of whether a Capacity Mechanism was required. and how it related to short-term balancing of the system. Some wanted the EPS level to reduce over time.

27 Four potential packages for reform were put forward in the consultation. The alternative package – including the PFiT – was the preferred option for other respondents. Some suggested that the System Operator’s (SO) role could be extended to cover this. A number of stakeholders also argued that a one-size-fits-all approach was not appropriate given varied characteristics of low-carbon technologies. Several responses also highlighted the need for the institution to have the appropriate expertise and skills to deal with these long-term mechanisms and the technologies involved. the Government’s preferred option was for a CPF. affordable and low-carbon electricity Packages 1.28 1. A further package. For instance. Views differed on who could deliver this function.32 1. and a targeted Capacity Mechanism. an EPS. The consultation set out the Government’s view that all four packages were capable of delivering the Government’s decarbonisation goals and ensuring security of supply. Some respondents supported the Government’s preferred package. respondents flagged the need for a credible and durable counterparty to the contracts. This was because the Government believed that this was the most coherent and most cost-effective package. which included a PFiT rather than a FiT CfD.33 . The main reasons given were that this package was the most likely to bring forward investment across low-carbon generation as a whole. particularly the institutional arrangements necessary to deliver the FiT CfD and the Capacity Mechanism. suggesting that it might be appropriate to have different arrangements for different types of technologies. In the case of a Capacity Mechanism. most respondents suggested that a central body should be responsible for delivery. and the transitional measures required to ensure there is no hiatus in investment while Electricity Market Reform is put in place. Some respondents suggested that a central agency should be established to manage the capacity contracts as this would allow for greater transparency. and that it had the potential to be the most cost-effective and thus most affordable for consumers. Respondents also stressed that anybody with obligations under FiT CfD should be creditworthy to ensure payments can be met over the long term. On the institutional arrangements for the delivery of FiT CfD.29 1.Planning our electric future: a White Paper for secure. However. 21 1.31 1. but a few respondents thought that this should be independent of other commercial activities and political influence.30 Implementation 1. The consultation also considered implementation issues. was also identified as a credible alternative. a FiT CfD. some advocated the adoption of both a FiT CfD and PFiT. The main argument given was that it was the most similar to the existing RO and that this would provide the greatest certainty to renewable generators and investors.

●● ●● ●● 1. The policy package includes: ●● Our Proposals 1. undertake an assessment over the coming year to determine whether DECC should take further steps to improve the support and incentives for the efficient use of electricity. The closure of the RO to new stations will create a closed pool of capacity which will decrease over time as we approach the end date for the RO of 31 March 2037. the introduction of a CPF starting in 2013 to reduce uncertainty. Given the size and scale of many projects under development.36 In addition.34 The Electricity Market Reform consultation also set out proposals for a transitional framework from the current Renewables Obligation (RO) system to FiT CfDs.Planning our electric future: a White Paper for secure. Further detail can be found in Annex D. They also called for RO ‘vintaging’15 arrangements to be clarified as early as possible. The Government has carefully considered the issues raised in the consultation and this White Paper contains proposals for reform of the electricity market which represent a coherent and complementary package designed to ensure the security of future electricity supply and the decarbonisation of electricity generation. we will introduce new long‑term contracts (FiT CfD) to stabilise revenues and reduce risks to support investment in all forms of low-carbon electricity generation. and a Capacity Mechanism to guarantee future security of electricity supply as a quarter of ageing plant closes during this decade and the proportion of intermittent or less flexible low-carbon generation rises.35 as announced in Budget 2011. ●● 14 Grandfathering is the policy intention to maintain a fixed level of Renewables Obligation (RO) support for the full lifetime of a generating station’s eligibility for the RO. put a fair price on carbon and provide a stronger incentive to invest in low-carbon generation. at least cost. from the point of accreditation. We will confirm our decision on the type of mechanism around the turn of the year. Most respondents supported ‘grandfathering’14 existing investments under the RO. we are also undertaking further work to: ●● develop by the turn of the year the detailed design of the Capacity Mechanism and more details on the institutional arrangements needed to deliver these policies. to provide a clear regulatory signal on the amount of carbon new fossil-fuel power stations can emit. 15 ‘Vintaging’ the Renewables Obligation (RO) system means that it will no longer be open to accreditation for new stations. affordable and low-carbon electricity 1. some concern that the 2017 cut-off date proposed for the RO may not allow a long enough lead in time for such projects. there was however. and a number of stakeholders supported a choice between the RO and FiT CfD. an EPS set as at annual limit equivalent to 450g CO2/kWh at baseload. 22 .

FiT CfD and EPS will together all drive the decarbonisation of the UK’s electricity system.41 1. the generator will receive a top-up payment to make up the difference. while the EPS provides a backstop regulatory signal. there is little interaction with the FiT CfD. Coherence of the Policy Package 1. as the CPF gradually increases the wholesale electricity price. while ensuring that the costs to consumers are minimised.Planning our electric future: a White Paper for secure. If the wholesale electricity price is below the price agreed in the contract. There are a number of options for how a market-wide Capacity Mechanism would operate. The CPF.42 23 . the generator pays the surplus back.38 1. A targeted Capacity Mechanism would require payments to be made to secure only the amount of generation capacity required to make up the expected shortfall in the market. Box 1 describes a vision of the electricity system in 2030 in which we have succeeded in attracting the necessary investment to the UK and reformed the market effectively. encouraging increasing amounts of investment as the carbon price rises and ensuring that the costs of carbon emissions are reflected fairly. The CPF and FiT CfD are economic signals which act in a complementary manner. the support needed for lowcarbon generators is reduced. 1. If the wholesale price is above the contract price.37 The Government recognises that it needs to provide the right market framework for industry to be able to deliver the necessary investment. these measures create appropriate incentives to support investment.40 1. The FiT CfD will provide low-carbon electricity generators with increased confidence in their revenues through agreement of a longterm contract. The CPF builds on the existing EU Emissions Trading System (EU ETS) and provides a transparent and predictable carbon price which will make investment in low-carbon generation relatively more attractive. affordable and low-carbon electricity ●● develop an electricity systems policy next year. This will include clarifying the role of demand side response. In this mechanism. This means that.39 1. storage and interconnection. as part of the development of a smarter grid. In designing a market-wide mechanism we would consider as a key element any potential interaction with the FiT CfD. Together. The interaction of the Capacity Mechanism with the FiT CfD will depend on the type of mechanism chosen. looking at the future system framework and focusing on challenges around balancing and system flexibility.

Wind power forms a substantial part of our generation mix with cost competitive wind turbines both on and offshore. sustainable and affordable. Consumers are engaged in their electricity consumption and have the means by which to use energy more intelligently and effectively. And we are connected much more extensively to European markets. The electricity grid has evolved to accommodate more localised and intermittent sources of generation. Plug-in vehicles and heat pumps are commonplace. Meanwhile. The changes have enabled us to reduce our dependence on imported fossil fuels and lessened the impact of global price shocks and supply interruptions from overseas. By 2030. resulting in lower bills for households and businesses than with an unreformed market. as well as being smarter and more responsive. with fewer failures and barriers to entry than would have been the case without reform. wave and tidal energy technologies have proven themselves as dependable and are becoming significant means of generation. meaning individuals save money and lower their personal impact on the planet. This range of new generation capacity is being used to power an increasing proportion of our transport and heating needs. And the benefits of this will be felt throughout the energy sector and the wider economy. 24 . A more diverse range of generation technologies has also increased our energy security and prices are being driven down by competition between technologies. We have substantially decarbonised electricity supply and also get more than one third of electricity generation from renewable sources. affordable and low-carbon electricity Box 1: The Electricity System Following Reform Achieving the objectives for Electricity Market Reform – together with other wider energy policy measures – will mean that in 2030 our electricity will be secure. we will have achieved a reduction in our greenhouse gas emissions across the whole economy in line with our carbon budgets and will be firmly on track to achieving at least an 80 per cent reduction by 2050. and Carbon Capture and Storage is widely deployed on existing and new fossil fuel plants meaning carbon is stored safely underground rather than released into the atmosphere. investment in home insulation and energy saving devices has improved energy efficiency dramatically.Planning our electric future: a White Paper for secure. And the transition has been made at least cost. The electricity market is now functioning more effectively. Demand is responsive. making efficient use of available generation and network assets. sustainable bio-energy is contributing to our electricity needs. a new generation of nuclear plants is in operation. helping to balance supply and demand by drawing on generation from across the continent when UK demand is high and exporting to other markets when there is surplus UK output.

43 The policy proposals within this White Paper form part of a much wider DECC agenda aimed at energy decarbonisation and security of supply. under its ‘Significant Code Review’. at the forefront of technological development in this area. £1 billion for the creation of one of world’s first commercial-scale CCS demostration plants – strengthening the UK’s position as a world leader in cleaner technology. the Renewables Roadmap (published alongside this White Paper). the roll-out of Smart Meters. which sets out the actions to overcome a range of non-financial barriers that could prevent the microgeneration sector from realising its full potential. which sets out our proposals for facilitating renewables deployment to 2020. the world’s first Green Investment Bank (GIB) to address market failures and help meet the low-carbon investment challenge. These include: a massive drive to improve energy efficiency through the Green Deal. or severity of a gas emergency. giving Ofgem powers to sharpen the commercial incentives on gas market participants to reduce the duration. 25 Decarbonisation ●● ●● ●● ●● ●● Security of Supply ●● . likelihood.Planning our electric future: a White Paper for secure. including up to £60 million for offshore wind manufacturing infrastructure at ports. the case for enhanced supply obligations on gas market participants (which could be implemented via legislation or licences). Wider Policy Context 1. affordable and low-carbon electricity Box 1: The Electricity System Following Reform (continued) Commitment to the achievement of the UK’s emissions reduction and renewable energy targets has provided the basis for business and economic development in these new sectors and the creation of green jobs. and the Microgeneration Strategy. the Energy Company Obligation. up to £30 million to support innovation in offshore wind component manufacture and up to £20 million for the development of marine technologies. the establishment of a new Office within DECC and a new commitment to reduce central government greenhouse gas emissions by 25 per cent by 2015. This should help underpin commercial demand for additional supply (or demand) side flexibility such as additional long-term contracts and storage facilities. Our early move has given the UK a comparative advantage in the low-carbon sector and we are a world leader. as part of the current Energy Bill. over £200 million to support new low-carbon innovation. Ofgem is also considering. A large and highly skilled workforce has developed in response to the growth in the sector.

Planning our electric future: a White Paper for secure. encourage necessary transitional investment in oil and gas production. and promote more reliable transit of energy. affordable and low-carbon electricity ●● maximising the economic recovery of our remaining indigenous resources of oil and gas by launching a new offshore licensing round in 2012 – subject to the outcome of the Strategic Environmental Assessment. and working internationally – with the EU and more widely – to promote low-carbon growth. ●● 26 . improve interconnection.

Decarbonisation of the economy in general and the generation of electricity in particular is a key priority. while ensuring security of supply. this means both significantly increased investment by existing market participants and attracting investment from new sources of capital. However. HM Treasury.Planning our electric future: a White Paper for secure.5 the EU Emissions Trading System (EU ETS) carbon price has not been certain or high enough to encourage sufficient investment in low‑carbon electricity generation in the UK.2 2. and keeping electricity bills affordable. in order to meet the challenges of the coming decades it is essential that the majority of new generation built is low carbon.htm 27 .gov. 2006. and that urgent action at home and abroad is required. while giving consumers some of the lowest prices in Europe. affordable and low-carbon electricity Chapter 2 – Decarbonisation 2. Our analysis shows that change is needed to meet our 2050 targets. http://webarchive.1.1. 17 The Stern Review on The Economics of Climate Change.4 2.gov. The Stern Review17 set out the case for addressing the negative 16 Our analysis shows that around £75 billion could be needed in new electricity generation capacity. and nuclear. Without incentives such as the current Renewables Obligation (RO). and Ofgem’s ‘Project Discovery’ estimated that around an additional £35 billion of investment is needed for electricity transmission and distribution.uk/sternreview_index. In a world of global competition for capital. It has delivered enough capacity to keep the lights on. Ofgem has estimated that we need at least £110 billion16 of new investment in electricity generation and transmission in the period to 2020. in particular it indicates that the majority of decarbonisation of the power sector will need to be completed by the 2030s.1. a number of factors combine to make low-carbon investment slow to come forward in the UK market and expensive to develop: ●● 2.nationalarchives. in the last decade the market invested less than half that amount.1.uk/+/http:/www. Investing in diversity is key to preserving and enhancing the UK’s security of supply. gas and coal Carbon Capture and Storage (CCS).1 2.1.3 The problem 2. The market has served us well. The UK faces a huge investment challenge to meet our targets for electricity decarbonisation.hm-treasury.1 THE CHALLENGE The Government believes that climate change is one of the gravest threats we face. To put this in context. To meet our decarbonisation targets the majority of this new investment must be in a diverse range of low-carbon generation such as renewables. and to drive the UK’s economy. Decarbonising the power sector is essential for facilitating decarbonisation of other sectors in the economy.

low-carbon generation typically has high construction (capital) costs and low operating costs. with much lower fixed costs relative to their operational costs and much lower capital costs per MW of capacity in contrast to. affordable and low-carbon electricity externalities associated with greenhouse gas emissions. These include poor market liquidity. which are a large proportion of operating costs. and that acting sooner will also ensure a more equitable distribution of the costs of climate change for future generations. It made clear that it is desirable for polluters to face the full social cost associated with the environmental damage they cause. Their generation costs will tend to fall in line with any fall in revenues as electricity prices fall. The review concluded that a transparent and predictable carbon price is the most cost-effective way to encourage emitters to invest in alternative lowcarbon technologies and change consumer spending patterns. They are quick to build and their fuel costs. are naturally hedged because the price of electricity moves in line with the price of gas. and as a result low-carbon plants are wholesale price takers. 28 . together with high regulatory burdens and off-take risk which particularly affects smaller players. Gas-fired power stations are able to run flexibly and can therefore relatively easily respond to shifting demand.18 ●● Box 2: Why investment in low-carbon technologies differs from standard investment choices Gas-fired power stations are a mature technology with low and predictable capital expenditure. and new low‑carbon generators often have to overcome relatively high barriers to market entry. since gas (or sometimes coal) is typically the price-setting (or marginal) plant. Doing nothing will lead to consumers paying more in the long term. ●● the current market price for electricity is driven mainly by gas plant.6 We cannot afford to wait any longer to address the decarbonisation challenge. Each of the low-carbon technologies the Government is considering differs materially from this standard investment choice. The costs of flexing a gas plant to respond to daily peaks in demand are relatively modest although more frequent stop/start and fast ramp-up operations do have a significant impact on maintenance costs. preserving profitability. In particular. nuclear or offshore wind. We must act now because low-carbon infrastructure requires 18 The incremental cost of providing an additional unit of electricity in the short term. for example.Planning our electric future: a White Paper for secure. even if the carbon price was high enough for their levelised costs to be similar. It is therefore difficult to make an investment case for them in a market where wholesale electricity prices are predominantly set by the short-run marginal costs18 of unabated gas and coal plant. such as Combined Cycle Gas Turbines (CCGTs). Typically this only includes variable costs (such as fuel) that are needed to provide the additional electricity. 2.1.

the Emissions Performance Standard (EPS) will act as a regulatory backstop which will limit the emissions from new fossil-fired power stations.1.1. 29 . 2.10 These two instruments are complementary. The FiT CfD will provide low-carbon electricity generators with a guaranteed price throughout the period of the long-term contract.8 2. the CPF alone will not cost-effectively drive all of the investment in low-carbon generation that we require. 2. leading to a lower cost of capital for low-carbon generation.13 In the longer term. which builds on the EU ETS. However.9 2. we anticipate there will come a point at which the electricity sector is significantly decarbonised and long-term FiTs are no longer required for new generation.14 In the Fourth Carbon Budget. current market arrangements will not deliver the scale of investment required. provides a floor for the cost of carbon and as a result helps to drive investment in low-carbon generation. 2.1.1. affordable and low-carbon electricity significant upfront capital investment as well as a number of years to build. The introduction of Feed-in Tariff with Contract for Difference (FiT CfD) is expected to drive decarbonisation. in a cost-effective manner.1. The Carbon Price Floor (CPF).Planning our electric future: a White Paper for secure.12 Together these three measures will operate as a coherent package whose constituent parts reinforce each other and deliver the level of decarbonisation needed at a lower cost to consumers. post 2030. the support needed for low-carbon generators through the FiT CfD is reduced. The CPF provides a transparent and predictable carbon price which will gradually increase the wholesale electricity price.1.1.1. the Government set a legally-binding goal for reducing greenhouse gas emissions for the period of 2023 to 2027 of 1950 million tonnes of CO2 equivalent – a 50 per cent reduction on 1990 levels. and remove exposure to the volatile gas price. These long-term contracts will provide greater revenue certainty to investors in all forms of low-carbon generation. 2. Wider Context 2. To facilitate this shift the market must be reformed.7 However.11 Alongside these two clear economic signals to the market. Together the package of measures are the most cost-effective means of achieving our aims. or deliver it at the pace needed to keep the lights on while meeting our decarbonisation targets. 2. As the price of carbon increases and gradually raises the electricity price. Decarbonisation of the power sector is also essential for facilitating the decarbonisation of other sectors of the economy as clean power generation is extended to plug-in vehicles and electric heat.

the emissions reductions in the power sector that we count against our carbon budgets are calculated by reference to the EU ETS cap. The level set equates to a 50 per cent reduction in greenhouse gas emissions on 1990 levels for each year over the Fourth Carbon Budget period.16 The Fourth Carbon Budget will put us on a pathway to our 2050 target.1. (depending on advice from the Committee on Climate Change and the views of the Devolved Administrations). 2.1.17 The Government is already committed to ensuring that the electricity sector delivers its share of the renewable energy target. 2013-17 and 2018-22 were set in law in spring 2009 and require greenhouse gas emissions to be reduced by at least 34 per cent below the 1990 baseline by 2020. 2. We will be doing further work on this. affordable and low-carbon electricity Box 3: The Government’s emissions and renewables targets The Climate Change Act 2008 establishes a long-term framework to tackle climate change.1. The Act aims to encourage the transition to a low-carbon economy in the UK through unilateral legally binding emissions reductions targets. over the coming months and beyond.15 Under current carbon accounting rules. 2. If at that point our domestic commitments place us on a different emissions trajectory than the ETS trajectory agreed by the EU. looking at feasibility of different levels of emissions reductions in the power sector. In some scenarios this could mean approximately 30 per cent of our electricity 30 . The Renewable Energy Directive sets a target for the UK to achieve 15 per cent of its energy consumption from renewable energy sources by 2020. The level of the Fourth Carbon Budget for the period 2023-2027 was set in law at 1950 mtCO2at the end of June 2011. The first three carbon budgets.Planning our electric future: a White Paper for secure. At least 10 per cent of energy used by transport is also required to come from renewables by 2020. As shown in Chapter 7. Nonetheless it is clear that significant decarbonisation of the power sector is key to our longer-term climate change goals such as our 2050 target to reduce emissions by at least 80 per cent and action in the 2020s will be key to putting us on this pathway. to revise our budget to align it with the actual EU trajectory. covering 2008-12. The Government will review progress towards the EU emissions goal in early 2014. This means a reduction of at least 34 per cent in greenhouse gas emissions by 2020 and at least 80 per cent by 2050. we propose. Government is currently carrying out further work looking at how we might deliver the necessary emissions reductions to meet the Fourth Carbon Budget and we plan to publish a report on this in the autumn. the Government’s proposed Electricity Market Reform policy package could if necessary deliver the kind of ambition in the power sector proposed by the Committee on Climate Change (CCC).

the Government recognises the benefit that decentralised supply and distributed generation can play. the Microgeneration Strategy sets out the actions that the Government is taking to tackle the non-financial barriers which could prevent the microgeneration sector from realising its full potential. The market reforms are complemented by both the Renewables Roadmap20 and the Microgeneration Strategy. 2. Taking these actions will not only help drive renewable deployment across the UK but will also be key to reducing costs for consumers and enabling mature renewables to compete on a level playing field against other low-carbon technologies in the longer term.gov.aspx. It is expected that distributed generation using eligible low-carbon technologies will be able to access the FiT CfD on the same terms as other generation types.uk/en/content/cms/meeting_energy/microgen/stragtegy/strategy.decc. 19 DECC’s 2050 analysis (http://www.aspx 21 http://www.uk/en/content/cms/tackling/2050/2050. The Roadmap focuses in particular on the eight technologies which evidence from the market suggests now have either the greatest potential to help the UK meet the 2020 renewable energy target in a cost-effective and sustainable way. particularly in the context of delivering solutions that maximise local opportunities and meet the need and demands of local people and their communities. 31 . though biomass could also play an important role. 2.18 The recent CCC advice to Government on renewable energy concluded that there is scope for significant penetration of renewable energy to 2030 and advised pursuing a portfolio approach with each of the different low-carbon technologies playing a role. As part of this work. 20 http://www.1.1.21 These documents set out positive action to tackle some of the obstacles which could otherwise slow the decarbonisation of electricity.gov.aspx) shows that power sector emissions need to be largely decarbonised by the 2030s. Alongside the Roadmap. onshore and offshore. Much of this will be from wind power.gov.pdf. Looking beyond 2020.decc. the Government believes that renewables have a strong role to play as part of our broader lowcarbon portfolio and that emerging technologies such as wave and tidal may begin to play an increasing role. affordable and low-carbon electricity being generated from renewables by 2020.uk/en/content/cms/meeting_energy/renewable_ener/renewable_ener. Box 4: The Renewables Roadmap The Renewables Roadmap is published alongside the Electricity Market Reform package.decc.19 Electricity Market Reform sets the economic and regulatory framework for meeting this challenge. It outlines specific actions to remove the barriers to renewables deployment. We will need to have largely decarbonised our electricity sector by the 2030s19. or offer the greatest potential for the decades that follow.Planning our electric future: a White Paper for secure. The Committee on Climate Change proposed that the power sector should be close to zero-carbon by 2030.

24 Alongside these steps to reduce costs through domestic action.1. As part of this we could see offshore wind projects connected to both the UK and mainland Europe. by helping to reduce overall electricity demand and support system balancing. increase integration of our markets and improve security of supply. as a result.1. This new Office will work with leading industry experts to identify ways to drive further carbon abatement across the economy and to learn from best practice in other countries. Decarbonising the supply of heat across all sectors is therefore an essential component of reducing emissions by 80 per cent. 2. we have the potential to work with our European partners on renewables deployment. 32 . Both demand side and supply side measures will be necessary. We plan to take powers to ‘trade’ renewable energy to provide this safeguard.22 The Government will also ensure that regulations around heat products. increasing our security of supply as part of an ‘All Islands Approach’22. 2. 2. By exploiting our North Seas resources together we could also provide new manufacturing and jobs in the UK. to facilitate the cost-effective exploitation of the renewable energy resources available. reducing the amount of carbon emitted through electricity generation. will study international examples to determine whether there might be appropriate additional measures we could introduce to the UK market. affordable and low-carbon electricity 2. in parallel.Planning our electric future: a White Paper for secure. efficiency standards and product lifecycle standards are properly aligned and that the UK engagement with the European Commission focuses on ensuring that devices.25 But this should not be viewed as a one-way exercise – trading also presents an opportunity for the UK. We will assess whether the existing package of efficiency measures is providing adequate encouragement for efficiency improvements in electricity usage and.21 In support of this greater focus on energy efficiency. The Government is therefore considering what actions are required now and through the next decade in order to ensure the supply of low-carbon. the Government will establish a new Office within DECC to drive a step-change in national energy efficiency in the autumn. businesses and industry.1. cheaper opportunities arise in other countries where the UK could ‘trade’ using the flexibility mechanisms set out in the Renewable Energy Directive.  2.20 Energy efficiency has an important role to play in reducing the amount of power we need and. 2.23 The Government recognises that heating and cooling accounts for a significant proportion of the UK’s total energy consumption and nearly half of CO2 emissions. This will complement work on Electricity Market Reform. The Government is keen to ensure that electricity consumers contribute an appropriate share of the UK’s overall improvement in energy efficiency. 22 The All Islands Approach will develop an approach to energy resources across the British Islands and Ireland. We have an abundant offshore wind resource and should also explore the possibility of exporting energy generated in UK waters to neighbouring Member States. as well as the way we use them.1. secure and affordable heating (and cooling) for homes.1. Such collaboration could provide an important mechanism to safeguard UK consumers in the event that the costs of domestic deployment do not come down and alternative. become more efficient.1.

1 This section sets out why we consider the CPF to be a key measure to drive the necessary investment in low-carbon technology and explains how it will work alongside the EU ETS and the wider Electricity Market Reform package. It gives an early and credible long-term signal to investors that the Government is serious about encouraging investment in low-carbon electricity generation. Introduction 2. If developers have confidence that the Government will support the carbon price over the long term.2. but alone it will not drive the required investment. investment will either not go ahead or capital could be diverted to less risky but more polluting forms of generation.3 33 . If uncertainty is too great. High levels of uncertainty over future profitability and rates of return could increase the cost of capital for investors and deter investment altogether. the Government announced the introduction of a Carbon Price Floor (CPF) from April 2013. This is designed to top up the EU Emissions Trading System (EU ETS) carbon price to a target level for the electricity generation sector.2. 2. the amount of fuel duty they can reclaim will be varied. For generators who use oil to generate electricity. rising to £70/tCO2 in 2030 (real 2009 prices).Planning our electric future: a White Paper for secure. Having certainty about the price of carbon is particularly important given the long lead times between the decision to invest in low-carbon generation and the plant generating electricity.2 The CPF is the first step to reforming the electricity market to support low-carbon investment. affordable and low-carbon electricity 2. • The CPF is the necessary first step in delivering a package of reforms for the electricity market to support low-carbon investment. Context The case for a Carbon Price Floor 2. • The CPF will be introduced by removing from the Climate Change Levy (CCL) the current exemption for supplies of fossil fuels which are used to generate electricity in the UK. • The CPF as announced in the Budget begins at around £15.2 THE CARBON PRICE FLOOR Summary • In Budget 2011. this should make a significant difference to investment decisions for new low-carbon generation.70/tCO2 in 2013 and follows a straight line to £30/tCO2 in 2020.2.

2. Thus the carbon price signal resulting from this cap has not been stable. The £30/tCO2 in 2020 CPF is shown in Figure 3.2.uk/en/content/cms/emissions/eu_ets/eu_ets. the Government announced in Budget 2011 a price floor that targets £30/tCO2 in 2020 rising to £70/tCO225 in 2030 (2009 real prices26). the Government believes that there is a strong rationale to provide greater certainty and support to the carbon price faced by the sector. the level of this cap (and associated carbon price) is not consistent with the pace and scale of decarbonisation that is needed for the UK to meet its 2050 targets. certain or high enough to encourage sufficient investment in low-carbon electricity generation in the UK. has created a market in carbon so that emissions across the EU can be abated at least cost. 25 The Government’s current estimated carbon price consistent with global action to limit the increase in temperature to 2°C is £70/tCO2 in 2030.pdf.5 Description of mechanism 2. there would have been larger impacts on existing generators and on electricity bills.gov. This estimate is subject to the progress of international negotiations and may be revised as the science of climate change develops. 34 .htm http://www.hm-treasury. Therefore. However. the Government has moved to providing a stronger carbon price to promote investment in low-carbon generation over the longer term.gov.hm-treasury.decc. Following consultation24. A price floor of £40/tCO2 in 2020 would have led to a faster decarbonisation trajectory and higher level of low-carbon investment.2. a price floor of £20/tCO2 in 2020 would not have sent a strong enough signal to encourage investment. along with a strong signal regarding the future level of the declining cap.gov.2. a cap and trade system covering the EU electricity generation sector and energy intensive industries23.4 The EU ETS.uk/d/consult_carbon_price_support. Although the EU ETS has achieved certainty over EU net emissions. To enable a secure low-carbon transition in the UK power sector and encourage investment.uk/d/carbon_price_floor_consultation_govt_response.6 23 The EU ETS will include aviation from 2012 http://www. 26 This means prices expressed in real terms after removing the effect of inflation. affordable and low-carbon electricity 2. On the other hand.aspx. to allow investors to include it as part of their investment appraisal. 24 http://www.Planning our electric future: a White Paper for secure. which could have undermined competitiveness and would have increased fuel costs unnecessarily.

2. 2. It is expected to drive investment in low-carbon electricity generation equivalent to 7. achieving the right balance of encouraging investment without undermining the competitiveness of UK industry.2. Supplies will be charged at the relevant carbon price support rate.5-9. 2009 prices 25 20 15 10 5 0 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Combined EU ETS and carbon price support Carbon Price Floor EU ETS carbon price Carbon price support 2.gov. supplies of fossil fuels used in most forms of electricity generation will become liable either to the CCL or fuel duty. These rates represent the difference between the Government’s target carbon price (the floor) and the future market price for carbon in the EU ETS in 2013. These rates will be set two years in advance to allow generators time to plan hedging strategies and avoid damaging liquidity28.9 billion of net present value benefits. A sustained increase in the carbon price would reduce the tax rate necessary to meet the floor.2. From 1 April 2013. see http://www.htm 28 Further details on the interactions between Electricity Market Reform and liquidity are set out in Chapter 5. affordable and low-carbon electricity Figure 3: Carbon Price Floor to 2020.9 27 For a detailed explanation of how rates are calculated.uk/consult_carbon_price_support.94/tCO2. a price floor targeting £30/tCO2 will provide £1.hm-treasury.3 GW of new capacity by 2030. 35 .Planning our electric future: a White Paper for secure.8 2.7 Over the period 2013-30. The carbon price support rates for 2013-14 announced in Budget 2011 are equivalent to £4. depending on the type of the fossil fuel used. Future rates will be announced at subsequent Budgets27 depending on the prevailing carbon price. The rate is determined by the average carbon content of each fossil fuel. 35 30 £/tCO2.

Devolved Administrations 2.parliament. 2. For the CPF to drive all of the decarbonisation which is necessary. long-term electricity prices (driven for example by gas prices or the carbon price) do not significantly affect the overall returns earned by low-carbon generators as they adjust automatically to differences in electricity prices. Legislation relating to specific tax reliefs for Carbon Capture and Storage (CCS) and Combined Heat and Power (CHP) will be introduced in the 2012 Finance Bill. to at least £50/tCO2 by 2020 – £20/tCO2 higher than the current CPF target). 29 http://services.e. affordable and low-carbon electricity 2. Next steps 2. Therefore while the FiT CfD and CPF together provide more certainty of revenues and make investment in low-carbon technology more attractive.2. In that respect.2.13 The Government has already consulted on draft primary legislation on the CPF.2. it needs to be combined with a Feed-in Tariff (FiT) mechanism to be able to meet the Government’s decarbonisation and renewables objectives.10 The CPF is not sufficient on its own to encourage the investment needed. the Government recognises the different structure of the Northern Ireland energy market.uk/bills/2010-11/financeno3. and Northern Ireland’s commitment to a higher level of investment in renewable electricity. Under the FiT CfD.12 The CPF is a UK-wide policy and will drive further investment in lowcarbon technologies.2.html 36 . The primary legislative powers to implement the CPF were presented to Parliament in the 2011 Finance Bill last March29. they also avoid generators making excess profits and therefore minimises consumer costs. and will work closely with the Northern Ireland Executive to monitor the interaction with the island of Ireland Single Electricity Market. to be followed by secondary legislation later in 2012. it would have to rise significantly higher than the level delivered through EU ETS (i.11 The Government’s view is that the CPF will complement the Feed-in Tariff with Contract for Difference (FiT CfD). the Government’s preferred model of a Feed-in Tariff (further detail can be found in the next section). Therefore.Planning our electric future: a White Paper for secure.

which stabilise revenues.3 FEED‑IN TARIFF Summary • Long-term contracts will be the key mechanism for encouraging investment in low-carbon generation by providing greater long-term revenue certainty to investors.3. If we are to meet our long-term carbon targets. nor will it give consumers the best deal.decc.2 As set out in Section 2. the Government proposed a FiT CfD as the lead option for driving decarbonisation. the FiT CfD reduces the cost of decarbonisation to 2030 by £2.uk/en/content/cms/consultations/emr/emr. Introduction 2. and our broad approach to wider issues relevant to the FiT CfD. ●● ●● ●● Rationale for a Feed‑in Tariff with Contracts for Difference 2. affordable and low-carbon electricity 2. Feed-in Tariffs with Contracts for Difference (FiT CfDs). reducing the risk of unnecessarily high returns being paid to generators as they might be under a PFiT. A PFiT was suggested as a fall back option.gov. without further reform the existing market will not deliver the scale of long-term investment in low-carbon generation. The ability to avoid excessive support is a key advantage of the FiT CfD. we need to reform the market now.5 billion compared to using the Premium Feed-in Tariff (PFiT) to deliver the same investment. In the Electricity Market Reform consultation document30.3 30 http://www.3. the rationale for choosing a FiT CfD as opposed to a PFiT. • In our central scenario.3.1 This section sets out: ●● an overview of consultation responses on the low-carbon generation support mechanism and further work undertaken as a result. at the pace we need. the Government will tailor the design of the FiT CfD for different generation types. • To reflect the different commercial and operational behaviour among different classes of generation. thereby reducing costs to consumers. headline proposals for the design of the FiT CfD (including on reference prices) and on the form of price discovery. • Under high fossil fuel price scenarios the FiT CfD can scale back support.1. • These long-term contracts.Planning our electric future: a White Paper for secure. should increase the rate of investment and lower the cost of capital. 2.aspx 37 . highlighting where further work is needed.

g. Under the FiT CfD. and vice versa. the generator pays back the difference. annual average electricity price) FıT CfD top-up Monthly electricity price Electricity price £/MWh Strike price Generator topped-up to strike price Generator pays back Figure 5: The operation of an intermittent Feed-in Tariff with Contract for Difference 120 100 Electricity price £/MWh Strike price 80 60 40 20 0 -20 -40 Time Market Revenue £/MWh FiT CfD payment £/MWh Monthly electricity price Generator topped-up to strike price Generator pays back 38 . when the reference price is above the strike price. generators return money to consumers if electricity prices are higher than the agreed tariff. Figure 4: The operation of a baseload Feed-in Tariff with Contract for Difference 120 100 80 60 40 20 0 –20 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Reference price (e.Planning our electric future: a White Paper for secure. affordable and low-carbon electricity Box 5: Descriptions of Feed-in Tariff mechanisms A Feed‑in Tariff with Contract for Difference (FiT CfD) is a long-term contract between an electricity generator and a contract counterparty. A ‘two-way’ FiT CfD provides for payments to be made to a generator when the market price for its electricity (the reference price) is below the strike price set out in the contract. payments can flow from the contract counterparty to the generator. That is. However. The contract enables the generator to stabilise its revenues at a pre-agreed level (the strike price) for the duration of the contract.

coherence with the rest of the reform package.3. interacting particularly effectively with the Carbon Price Floor (CPF). complementary to other elements of the reform package. because it was: ●● potentially more cost-effective than the alternatives due to lower scope for rents in high electricity price scenarios and reduced cost of capital as a result of removing long-term electricity price exposure and providing long-term revenue certainty. durability and practicality.Planning our electric future: a White Paper for secure.4 The Electricity Market Reform consultation document established four criteria against which decarbonisation mechanisms would be judged. Figure 6: The operation of a Premium Feed-in Tariff 140 120 100 Electricity price £/MWh 80 60 40 20 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Monthly electricity price Electricity price plus PFıT Fixed premium 2. i. generators will have an incentive to sell their output above the average price because they will keep any upside. but by setting the level of support according to the average price it preserves the efficiencies created by the market price signal.e. a more resilient and flexible mechanism which will operate effectively in a wider range of scenarios and can deal with unanticipated ●● ●● 39 . affordable and low-carbon electricity Box 5: Descriptions of Feed-inTariff mechanisms (continued) This is similar to the model of FiT used in the Netherlands for renewables (though they call it a ‘sliding premium’) and in Denmark for offshore wind. It provides a similar level of revenue certainty to a Fixed FiT. A Premium FiT (PFiT) is a static payment which generators receive in addition to their revenues from selling electricity in the wholesale market. These were cost-effectiveness. The FiT CfD was identified as the support mechanism for low-carbon generation which offered the best balance of results across the four key criteria.

would therefore apply.3. because the impact of uncertain future wholesale prices is removed in favour of predictable revenue.3. While a number of the consultation responses expressed concern about the perceived complexity of the FiT CfD. 2. whether we could develop a viable model for the FiT CfD which would work in the UK market.3. and ●● able to provide more certainty that carbon targets will be met than PFiTs. which was understood by investors. 2. a FiT CfD could be introduced. Similar arrangements to those in place to manage the overall impact of DECC levy-funded spending.6 the impact FiT CfDs would have on cost of capital for investors in low-carbon generation in more detail. including the existing RO. PFiTs were preferred by a number of stakeholders involved in developing renewable energy projects. we carried out further analysis to test some of the initial conclusions set out above. in principle. Respondents to the consultation generally accepted that. and which meant they would be easier to implement. this view was largely offered subject to the Government providing more detail on how the FiT CfD would work in practice. and how to manage the variability of the net costs of FiT CfDs. and ensure that there could be a manageable transition to the new framework. Decisions on the overall size of the envelope for contracts will be taken at fiscal events (Spending Reviews and Budgets) in order to consider the cost of support in the round against other pressures on Government finances. and some believed that this represented the most effective mechanism to encourage investment in low-carbon generation. ●● ●● If these issues could not be addressed then Government indicated that a PFiT mechanism could be an effective fall-back to drive investment in low-carbon generation.3. Further analysis of the preferred option 2.7 Support for low-carbon generators under Electricity Market Reform is likely to fall under the definition used by the ONS for indirect taxation and spending. This was in the main because of their similarity to the current system.Planning our electric future: a White Paper for secure. affordable and low-carbon electricity outcomes on carbon prices. However. the Government undertook further modelling to understand: ●● 2.8 40 .5 Following the consultation. fossil fuel prices or technology costs. In particular.

and impacts on individual consumer bills. These would lead to an overall saving with a Net Present Value (NPV)33 of around £2. This is explained in more detail within the accompanying Impact Assessment.e. The analysis came to a similar conclusion to that conducted previously i. that a FiT CfD could deliver a lower cost of capital than might otherwise be achieved. 32 Conducted by Cambridge Economic Policy Associates and published alongside this White Paper.3.12 Figure 7 sets out the conclusions on expected cost of capital reductions compared to business as usual.34 31 See the accompanying Impact Assessment for more detail. NPV recognises that society would prefer £1 today to £1 in the future – this is known as ‘time preference’. 41 . future cash flows are ‘discounted’ (using a discount rate) when calculating NPV.3.5 billion over the period up to 2030. 33 ‘Net Present Value’ (NPV) is a way of accounting for the sum of a project’s future cash flows in today’s terms – showing the difference between a future stream of benefits and costs.3.9 A number of consultation responses sought more information on the impact the use of long-term contracts (and in particular the FiT CfD) would have on the cost of capital for those building low-carbon generation. We have conducted further work on each of those areas. reductions to the overall cost of support to consumers. affordable and low-carbon electricity 2. This new analysis32 explicitly takes into account the views of industry participants regarding how investors make decisions.Planning our electric future: a White Paper for secure. There was scepticism from some stakeholders about the impact FiT CfDs could have on reducing the cost of capital. Therefore due to time preference. Cost-effectiveness 2. we commissioned industry analysts to undertake further work to refine our understanding of the impact long-term contracts could have on the cost of capital31. It also confirmed the conclusion that the FiT CfD should reduce the cost of capital to a greater extent than the PFiT. a) Cost of Capital 2. 2. 34 The Total net consumer cost of support to 2030 under central scenario is £25bn NPV 2009.3. The FiT CfD promotes this cost-effectiveness in three different ways: reductions to the cost of capital those building low-carbon generation face.10 The FiT CfD should deliver low-carbon generation in the most costeffective manner possible.11 Following responses to the consultation. as a result of the increased revenue certainty the FiT CfD provides.

support costs under the FiT CfD could be 30 per cent lower than under the alternative PFiT model in the period to 2030.5% to 0.5% b) Cost of Support 2.5% 0. If. and the scope for greater efficiency of the mechanism in avoiding over-rewarding generators when electricity prices are high.13 The claw-back element of the FiT CfD ensures that the mechanism stabilises the revenue of generators.4% 1.14 As a result of the lower cost of capital under the FiT CfD.8% 0% 0.5% to 0.3. as they have to pay back the proportion of support provided when the electricity (reference) price is above the strike price. 42 . affordable and low-carbon electricity Figure 7: Comparison of the impact of possible decarbonisation mechanisms on cost of capital Technology Reduction in cost of capital due to PFiT (%) 0% 0% Reduction due to FiT CfD (%) How reduction in cost of capital under FiT CfDs compares to that under PFiTs 0% to 0.3% 0.6% lower under FiT CfD 0. analysis suggests the average annual cost of FiT CfD to bill payers is around nine per cent lower than PFiT. 2.1% Coal with CCS Nuclear Biomass (power only) 0.3% lower under FiT CfD 0.8% 0. the amount of revenue paid to the generators under PFiTs will continue to rise for the whole period of the contract. as is expected. Even in a scenario where gas prices are low and the scope for excess rents in the PFiT is reduced.Planning our electric future: a White Paper for secure.9% 0% 0.8% lower under FiT CfD 0.5% to 0. the wholesale electricity price (including the price of carbon) rises over time.4% 0.5% lower under FiT CfD Onshore Wind Offshore Wind (emerging) Offshore wind (established) CCGT with CCS 0% to 0.8% lower under FiT CfD 0% (reduction is the same under each) 0% (reduction is the same under each) 0.5% to 0. FiT CfD ultimately stabilise generators’ revenues without providing support when it is not required. A PFiT in contrast pays a set top-up amount for the duration of the contract.1% 0.3.

19 These differing types of generation respond to different incentives. intermittent generation such as wind operates differently to baseload plant such as nuclear. the Government will vary the key features of the FiT CfD to develop an approach that is best suited to each of the low-carbon generation types. It will also be important to create the right conditions for the new technologies whose early commercialisation is vital if we are to achieve our low-carbon energy goals. For example.3.Planning our electric future: a White Paper for secure. and the accompanying Impact Assessment published alongside this White Paper provides further information on the costs and benefits associated with the FiT CfD.16 The consultation document emphasised the importance of developing a FiT CfD design which worked for all forms of low-carbon generation.3.18 Different types of generation have different characteristics.15 As a result of lower support costs the FiT CfD would also lead to lower consumer bills relative to the PFiT.17 Many of the consultation responses observed that the FiT CfD approach set out in the consultation may not suit all types of generation. This was echoed by responses from stakeholders. The key aspects of the FiT CfD designs are illustrated in Figure 8 and discussed in detail in Annex B. 2. Tailoring the Feed-in Tariff with Contracts for Difference to different types of generation 2. 2. 43 . and is subject to different levels of certainty regarding output. biomass. compared to the baseline. By 2030. Annex B sets out the detailed rationale supporting these proposals.3. This section gives a brief.35 In contrast. high-level overview of the Government’s design proposals for the FiT CfD. d) Developing a viable Feed‑in Tariff with Contracts for Difference 2. the FiT packages could mitigate the impact of rising bills by six per cent (around £40) on average for domestic consumers. good quality gas Combined Heat and Power (CHP) and new nuclear in future). average annual electricity bills in the PFiT package of policies for reform could reduce the increase in bill levels by between one and five per cent depending on the choice of Capacity Mechanism. More flexible plant.3. 35 The baseline bill is one which would result in the event that current policies including the Renewables Obligation and Carbon Price Floor are continued. (mainly traditional fossil fuel at present. nuclear tends to provide a steady amount of output at all times when it is operating. potentially Carbon Capture and Storage (CCS). Both now and in the future the UK will rely on a diverse range of generation to meet its electricity needs. Compared to wind.3. has the ability to vary its output to follow demand. affordable and low-carbon electricity c) Bill impacts 2. and may even turn off in response to prolonged periods where there is forecast to be either high levels of wind output or low demand. The Government acknowledges the need for more certainty and detail around how the FiT CfDs would function in order to avoid investors delaying their decisions unnecessarily. As a result.

a link between the strike price and a measure of inflation would remove the inflation risk of the investment. To be confirmed for CCS. DECC will undertake further work on the arrangements for flexible generation and will produce firm proposals around the turn of the year.Planning our electric future: a White Paper for secure. the Government signalled that it was attracted to a greater use of auctioning or tendering as a mechanism to set the level of FiT CfD support. Market Reference Price • Day-ahead price • Choice of baseload or hourly prices • Not averaged over a longer period Contract Volume • Metered output • To be confirmed.22 Since the consultation the Government has explored possible options for price discovery.21 In the Electricity Market Reform consultation document. However.20 A different structure may be required to influence investment in flexible low-carbon generation and one potential way to do this is through a one-way FiT CfD. Price discovery 2. Annex B provides further information. This was because the price discovery characteristics of an auction should enable financial support to be set at a level just high enough to promote deployment but not high enough to lead to excessive profits.3. 37 We recognise the need for investors to achieve a return reflecting real terms. 36 These proposals are subject to the final design of any Capacity Mechanism. 2. The Government is minded to move from administrative price discovery processes for low-carbon technologies to more competitive forms of price discovery such as auctions or tenders when the wider conditions in the market will support their successful deployment. working with experts to identify key challenges. affordable and low-carbon electricity Figure 8: Low-carbon Feed-in Tariff with Contracts for Difference proposals36 Intermittent Contract Form Strike price • Two-way FiT CfD • Annual inflation indexation37 Baseload • Two-way FiT CfD • Annual inflation indexation • Minded not to include fuel indexation for biomass.3. The Government is committed to making the transition to the reformed market as smooth as possible. metered output or firm volume • Year-ahead baseload price • Choice of price sources 2. 44 . the Government also made it clear that auctions would only be adopted if a practical way could be found to make them function in the UK electricity market and for newer technologies. The majority of respondents were sceptical about the use of auctions to set the level of support for low-carbon generation. with bids driven down by competition.3.

3.24 Given the challenges involved in transition we do not believe that these conditions exist in the current market. the Government believes that it should be possible to move to more competitive types of price discovery for renewables. There are a number of factors that will affect the ability of the institution to introduce auctions or tenders (see Chapter 4) and these include: ●● having confidence that there are enough potential participants in the auction or tender for there to be competitive tension. Renewables auctions or tenders 2. biomass).3.3.Planning our electric future: a White Paper for secure.23 Successful auctions or tenders minimise the risk of collusion while supporting participation from both incumbents and new entrants. The sheer scale of the capital costs associated with these projects and the risks they face mean there is lower scope for new entry in the short term. For example. affordable and low-carbon electricity 2. The move from the current price discovery system to a more competitive one will require the Government to be clear that this would not jeopardise adequate deployment of renewables.27 Other low-carbon technologies such as coal or gas CCS or nuclear have less mature markets with fewer participants. knowing that the development capacity of the potential participants exceeds the volume of new development sought by the institution in a given time period or tendering round.25 The UK electricity market already contains a wide range of firms that are able to invest in a broad range of renewable technologies. solar.3. 45 . Other low-carbon technologies 2. there are currently only three nuclear consortia with access to sites which have been identified as strategically suited to new nuclear build. however we will move towards technology-specific auctions or tenders towards the end of the decade and look for ways of introducing greater competition between technologies towards and into the early 2020s. which means that the risks and uncertainties facing investors are diminishing. and knowing that the projects or technologies eligible for the tender or auction are comparable so that the strike price is a meaningful way to discriminate between them. a number of the technologies that they invest in are mature (onshore wind) or rapidly maturing (offshore wind. ●● ●● 2. They have been widely used as a result of this (examples include the 3G Telecom Licences auction and the Offshore Electricity Transmission (OFTO) auctions).3. Furthermore. 2.26 As a result of there being a broad range of developers and diverse set of potential investments.

Tariffs for generation that will be commissioned prior to 2020 are most likely to be set through an administrative price setting process. Liquid markets enable companies to buy or sell a product without causing a significant change in its price and without incurring significant transaction costs.28 In the medium term. including to assess the impact in practice of these new contracts and to inform decisions on any necessary amendments. We are committed to continuing to develop these mechanisms in a coherent and complementary manner.31 Liquidity is a term used to describe volume of trading or ‘depth’ of the market. Liquidity 2. Consequently.30 The Government recognises that there will be interactions between FiT CfDs and the options for the Capacity Mechanism. It also gives confidence to generators that they can manage periods when they are short (or long) on electricity compared with their contractual requirements by trading electricity to manage their position. Interactions with other Electricity Market Reform measures 2. Liquid markets also provide market participants with confidence in the accuracy of traded prices. which could leave consumers paying more than is necessary. technology-specific auctions or tenders for commercially deployable nuclear and CCS generation should be possible.3.3.29 The FiT CfD will require new or existing organisations to take on additional roles and responsibilities. This in turn informs investment decisions and can help facilitate new entry. affordable and low-carbon electricity 2.33 A significant proportion of consultation respondents underlined that improving liquidity could be essential for supporting the operation of FiT CfDs.3. whichever Capacity Mechanism is chosen will be developed in a manner which works effectively with the FiT CfD. See Chapter 3 for more detail.3. Institutional arrangements 2. The ability to trade to balance a position is a particular issue for independent generators and therefore for potential new entrants. The Government acknowledges these concerns. 46 . 2. the ability to buy or sell electricity quickly and without incurring significant costs is crucial to new investors unfamiliar with the market. Chapter 4 sets out the institutional arrangements and governance principles that Government is likely to apply. The Government intends to introduce an auction or tender process for price-setting for specific technologies from 2017.3.3. The FiT CfD requires a robust reference price which is reflective of market fundamentals and cannot be manipulated. 2. and agrees that it is crucial that there is strong liquidity in the electricity wholesale market for the FiT CfD to function effectively.Planning our electric future: a White Paper for secure. This is to ensure that payments made under FiT CfD cannot be distorted.32 In the electricity market. A number of stakeholders have expressed concerns that there is currently insufficient market liquidity to support an effective FiT CfD.

47 .39 The Government will use FiT CfD as the key mechanism to drive decarbonisation. Offtake risk 2.3. 2. The Government will continue to work closely with Ofgem to ensure that Electricity Market Reform and Ofgem’s work on liquidity are effectively aligned. Their recent consultation proposes interventions to provide the electricity market liquidity that market participants.3. because electricity policy – with the exception of nuclear generation – is devolved to Northern Ireland. any Northern Irish solution can work alongside the FiT CfD in a UK-wide context. in particular independent market players. including new entrants. to ensure that. Next steps 2.3. Devolved Administrations 2. affordable and low-carbon electricity 2. offer certainty. but there are related concerns that in part may be a consequence of poor liquidity. the UK will be able to deliver the required new generation of secure low-carbon power sources. We note these concerns and are considering whether further action is necessary.36 Independent renewable electricity generators have raised concerns that poor levels of liquidity could leave them reliant on Power Purchase Agreements (PPAs) – an agreement to supply to another company – to secure finance for investment and that in the absence of a renewable obligation from 2017. alongside the CPF. and we will continue to work closely with them as we develop our proposals. could operate effectively in the electricity market. where appropriate. PPAs would only be available at a steep discount. This is because the analysis undertaken by the Government and the responses to the consultation suggest that FiT CfD are cost-effective. See Chapter 5 for more detail. Market liquidity is a key issue. However. We have been discussing the FiT CfD proposals with the Devolved Administrations. require to compete against existing firms and to encourage competition between vertically-integrated players.3.3. facilitate market entry and are resilient enough to adapt to the wide range of future scenarios. 2.37 By working closely with the Devolved Administrations. including potentially limited routes to market for some independent generation and new entrants.34 The Government welcomes Ofgem’s commitment to tackle liquidity. We will engage constructively with the Northern Ireland Executive on its preferred solution.Planning our electric future: a White Paper for secure.3.35 Chapter 5 describes some of the barriers to entry faced by independent generators.38 Our preference remains a UK-wide FiT CfD. which is conducting further analysis of options. we will work in partnership with the Northern Ireland Executive.

40 Moving forward the Government will: ●● continue to work closely with Ofgem to ensure the Electricity Market Reform proposals and their liquidity reforms are fully complementary. affordable and low-carbon electricity 2. bring forward legislative provisions in the second session.Planning our electric future: a White Paper for secure. One option might be to include an element of payment for capacity within the FiT CfD.3.3. Figure 9: An indicative timetable for the implementation of a Feed-in Tariff 2011 2012 2013 2014 2015 2016 2017 2018 2019 Legislation Policy finalised Primary legislation Secondary legislation Institutional framework Initial work to establish organisation Organisation(s) is formally tasked and empowered. rigorous and proportionate. continue to develop its thinking on contract-letting processes and consider the best means of ensuring the processes smaller developers follow are fair.41 Figure 9 sets out an illustrative timeline for implementation. and ensure that the implementation of FiT CfD allows adequate assessment of the efficiency and effectiveness of this new mechanism. developing both mechanisms in a coherent and complementary manner. consider carefully the interactions between the FiT CfD and the Capacity Mechanism. ●● ●● ●● ●● 2. becoming active at Royal Assent if through primary legislation Development of FiT CfD contracts Delivery Finalise FiT CfD contracts First FiT CfD contracts signed Possible first payments made FiT CfD contracts available Pilot auctions for Renewables 48 .

the treatment of existing plant under the EPS.Planning our electric future: a White Paper for secure.4 THE EMISSIONS PERFORMANCE STANDARD Summary • An Emissions Performance Standard (EPS) regime applicable to new fossil fuel power stations will support the UK’s decarbonisation objectives. It will not be retrospective.3 Coal and gas-fired plants will continue to play an important role in our electricity mix as the UK makes the transition to a low-carbon economy. the level at which the EPS will be set. ●● ●● ●● ●● Context 2.4.decc. Gas in particular will be needed to provide vital flexibility to support an 38 Energy Trends. • The EPS will be subject to regular reviews as part of the process of threeyearly reports on decarbonisation under the Energy Act 2010.4) http://www. except Carbon Capture and Storage (CCS) demonstration plants. • It provides a regulatory back stop on the amount of emissions that a new fossil fuel power station can emit. Introduction 2. • As set out in the Coalition Agreement. they provided around 75 per cent of the UK’s electricity38.gov.4. and the flexibilities that will apply to the EPS. May 2011 (5.2 the principles for applying the EPS.e. and in the longer term it could be used to give a clear regulatory signal to back up the economic signals provided by the Electricity Market Reform package and existing policies. Although coal may have an important role to play within the UK’s diverse generation mix. unabated coal) power stations from being built. affordable and low-carbon electricity 2. Details of this ‘grandfathering’ period will be determined following further engagement with stakeholders.aspx?filepath=statistics%2fsource%2felectricity%2fet5_4. the treatment of biomass and heat. In 2010.4. the EPS will help deliver the Government’s commitment to prevent the most carbon intensive (i. • The EPS will initially be set at a level equivalent to 450g CO2/kWh (at baseload) for all new fossil fuel plant. This section sets out: ●● 2. • Any changes in the level of the EPS will not apply to plant consented under the framework for a specified period. it is important it does so in a manner which complements the transition to a low-carbon economy.xls&filetype= 4&minwidth=true#basket 49 .uk/publications/basket.1 Unabated coal plants are one of the most carbon-intensive forms of electricity generation.

The objective of the EPS is to ensure that while fossil fuel-fired electricity generation continues to make an important contribution to security of supply. Introducing the measure now will provide a framework for this.5 Rationale for an Emissions Performance Standard 2.8 50 . 2. The mechanism will provide further clarity on the regulatory environment for fossil fuel power stations. and we expect that plant builts under this policy will retrofit CCS to their full capacity during their lifetime. but it will periodically review the impacts of the mechanism and consider whether it should be modified as part of the process of providing decarbonisation reports to Parliament under the 2010 Energy Act. it were captured and permanently stored in underground geological formations. the Government also committed. instead of its carbon being emitted into the atmosphere. Accordingly. it does so in a manner consistent with the UK’s decarbonisation objectives. to the introduction of an EPS. and in the longer term could be used to give a clear regulatory signal on emission reductions. The UK cannot.4.4. sustain investment in new.7 2. In the future it may be appropriate to use the EPS in a different way. in the Coalition Agreement.4.4. affordable and low-carbon electricity increasing amount of low-carbon generation and to maintain security of supply as we make the transition to a low-carbon electricity system.6 2. This is why any new coal plant is already required to be built with CCS on at least 300 MW (net) of its capacity. without prejudging what actions may be needed in the future. To support this and provide greater regulatory certainty. The EPS will complement the economic signals provided by the Carbon Price Floor (CPF) and Feed-in Tariff with Contract for Difference (FiT CfD). the Government considers that the measure should be introduced in a way which provides certainty on emission limits for new plant built under this framework.4 Electricity generated from coal typically produces twice the emissions of electricity generated from gas. wholly unabated coal plants if it is to meet its decarbonisation targets.4. for example to require full CCS on some or all new fossil fuel plant once the commercial and technical viability of CCS is better understood. The EPS will act as a backstop to limit how much carbon new fossil fuel plants can emit. and work alongside the other policies set out in this White Paper as part of a suite of measures to drive decarbonisation while maintaining security of supply and affordable prices. building on the requirement that new coal-fired power stations must be constructed with CCS. 2. New coal could perform a role in providing both security of supply and low-carbon electricity if. therefore.Planning our electric future: a White Paper for secure. Initially it will support the requirements set out in the National Policy Statements (NPS).

aspx 40 The appropriate definition of ‘Fossil Fuel’ for these purposes will be the subject of further consideration prior to the introduction of any legislation. and a level equivalent to 450g CO2/kWh. and whether it should be fuel-specific or technology-neutral.e. with some supporting the higher EPS level. As a first step. 2. 51 . it is also consistent with the UK’s decarbonisation objectives. with specific exemptions for plant forming part of the UK’s CCS Demonstration Programme or benefiting from European funding for commercial-scale CCS projects.9 In the Electricity Market Reform consultation document39.gov. whereas others expressed concern that applying an EPS exclusively to coal would drive investment in unabated gas. As part of the package of reforms outlined in this White Paper. consistent with demonstrating post-combustion CCS on a new. including generators. supercritical coal-fired power station.4. The level is also 39 http://www. Many stakeholders. The Government proposed to apply an ongoing principle of grandfathering. mostly favoured to help minimise the security of supply risk.13 The Government has concluded that an EPS for fossil fuel plant. 2. Others felt further regulation would be unnecessary and could deter investment. the level of the EPS on the date of consent of a new power station will apply for the economic life of the installation. set at an annual limit of CO2 equivalent to 450g/kWh (at baseload) should be introduced40. Consultation responses were generally split on the preferred EPS level.decc.11 There was no consensus among respondents on the need to introduce an EPS. the Government proposed setting an annual limit on the total amount of CO2 per unit of installed capacity that new fossil fuel power stations are allowed to emit.Planning our electric future: a White Paper for secure. There were mixed views on the scope of an EPS scope.4. Chosen Option 2. Some respondents felt that it would be a useful backstop as part of a suite of measures intended to drive decarbonisation. i.10 The Government sought views on two options for the level of the EPS: ●● a level equivalent to 600g CO2/kWh.uk/en/content/cms/consultations/emr/emr. and others advocating a more stringent EPS level. and means that typical coal-fired power stations subject to the requirement must limit their emissions by 40 per cent compared to what they could otherwise emit. An EPS at an equivalent of 450g CO2/kWh will provide a clearer regulatory signal on the need to reduce emissions. affordable and low-carbon electricity Options for an Emissions Performance Standard 2. ●● 2. were concerned that applying an EPS to gas would deter investment in new gas plants.4.4. and some in the wider energy industry. this will build on and support the requirement to demonstrate CCS as part of the consenting process.12 Consultation responses largely supported an annual EPS limit calculated at baseload.4.

It is important to provide investors with a sufficiently clear understanding of the regulatory environment that will govern their plant. It will also help minimise security of supply risks. while also providing a clear requirement that new coal plant will have to reduce emissions. In practice.15 The Government will apply the EPS to individual plant rather than across a generator’s portfolio. As part of this. The first reporting period ends in 2011.aspx?filetype=4&filepath= Statistics%2fclimate_change%2f1514-ghg-emissions-provisional-2010. or benefiting from European funding for commercial scale CCS.4. Review 2. This figure is derived from the total electricity generated by power stations in 2010: 347601 GWh (Energy Trends.2 MtCO2 (UK greenhouse gas emissions: provisional data tables 2010: http://www.xls&filetype= 4&minwidth=true#basket). a point largely supported by consultation responses. We believe that this is currently the most transparent approach to implementing the EPS. as failure to do so may push investors towards different markets that are perceived to be less risky.14 As an annual limit on allowed emissions of CO2 the EPS will offer the flexibility necessary to operate plant equipped with CCS. will provide flexibility for the UK to demonstrate the full range of CCS technologies.4: Electricity production and availability from the public supply system: http://www. are better understood (respecting the key principle of grandfathering.aspx?filepath=statistics%2fsource%2felectricity%2fet5_4. as well as costs. Table 5. the first review of the EPS will be as part of the report due by the end of 2015.4. 2.decc.uk/publications/basket. For example. but at the same time. tighter EPS for new plant at this time would not be based on adequate evidence and could add significant investment risk given that CCS has not yet been proven for commercialscale electricity generation. 2. but without restricting the new gas plant the UK needs to be built to maintain sufficient capacity.Planning our electric future: a White Paper for secure.4.17 There is already a statutory requirement under the Energy Act 2010 for the Government to report on progress in decarbonising the GB electricity system and on the development and use of CCS. and total carbon emissions from power stations in 2010: 156. However.4g/kWh.16 The EPS must provide long-term certainty to investors over regulatory measures.18 Creating sufficient certainty for investors is a key objective of the reforms.decc. see below). with further periods running on a threeyear basis starting in 2012. With this in mind the operation of the EPS will not be retrospective. this may be appropriate once the commercial and technical viability of CCS technology.4.xls&minwidth=true#basket) 52 . affordable and low-carbon electricity consistent with the current average carbon emission intensity across the electricity sector41. 2. An exemption for plant in the UK CCS Demonstration programme. It is intended that plants which are 41 The average carbon emission intensity across power stations on an ‘electricity generated’ basis in 2010 was 449. the Government considers that specifying a future.gov.gov. Grandfathering 2.4. the Government will also review key elements of the EPS (including its level) as appropriate.uk/publications/basket. we recognise that in the future it may be appropriate to use a tighter EPS.

4.4. 2.19 Furthermore. There was also a concern that it could prevent the Government from using the mechanism to require CCS (or other measures) to reduce emissions from existing power stations in the future. in order to provide sufficient certainty for investment in new plant. unabated gas in the next few years. some respondents to the consultation expressed concern that the proposals could perpetuate the relative attractiveness of investment in unabated gas.e. a principle of grandfathering will be implemented. once the technology is proven to be technically and commercially viable. 2. which is why new gas plants are required to be built carbon capture ready.22 The UK will require new gas plant to enable us to make the transition to a low-carbon electricity system while ensuring security of supply. 2.4. therefore. discouraging investment in CCS and/or other lowcarbon generation. the duration for which a plant will not be subject to possible changes in the level of EPS). 2. While the FiT CfD and CPF will be the primary drivers for decarbonisation and the use of CCS. and it is important to provide sufficient clarity for investors. in the longer term. To provide sufficient certainty for investors to build gas plants.24 In introducing the EPS.Planning our electric future: a White Paper for secure.4. there is likely to be a role for gas plant equipped with CCS.4. the Government recognises that it might not be appropriate to limit its ability to tighten the EPS for plant consented under this framework indefinitely.21 However. minded to grandfather on the basis of a clear and pre-determined period (i. 2. This would mean that the level of the EPS in place at the point that a power station is consented remains at the level which is relevant for its economic life. the Electricity Market Reform consultation proposed a principle of grandfathering for the economic life of a power station.25 Government recognises that there are a number of options on how this could be implemented in practice. to remove the risk that the EPS applicable to any given plant will be tightened while it is under construction. 2. which reduces regulatory uncertainty and enables them to proceed with investments. Therefore Government intends to apply this principle from the point of consent. the Government is seeking to strike the right balance between investor certainty and appropriate support for decarbonisation.23 Whilst we are going to need new. Respondents were also unclear on what constituted ‘economic life’. and will undertake further analysis and engage with stakeholders to clearly define the arrangements. We are.4. 2. we recognise that. affordable and low-carbon electricity consented before the EPS is legislated for will not be subject to the mechanism. it is likely that emissions from gas plant will need to reduce if we are to largely decarbonise the electricity sector and meet our climate change targets. In doing so. 53 .4.20 Many consultation respondents viewed the principle of grandfathering as an important provision.

We will therefore work with stakeholders to define what this should mean in practice.30 The Government intends to zero rate biomass under the EPS. The Government expects sustainably sourced biomass to make a significant contribution towards achieving the UK’s renewable 54 . affordable and low-carbon electricity determine the most appropriate duration for this grandfathering period (with one suggested period being around 20 years). However.4. as part of reviewing the EPS under the decarbonisation reporting process referred to above.Planning our electric future: a White Paper for secure. 2. no change to the grandfathering provisions a plant has already secured). the status of decarbonisation. the Government considers it also appropriate that plant which undergo significant life extensions or upgrades fall under the EPS regime. 2. the Government intends to consider whether the form of grandfathering available to new plant remains appropriate in light of the development and understanding of CCS technology and deployment. it may not be appropriate to continue offering it to new plant in the same form indefinitely. the ability of new plant to get a grandfathered EPS) will however be available at least until the end of 2015.28 Upgrades to comply with EU law will not trigger the bringing of a plant within the EPS. to prevent lock-in to high-carbon generation. Upgrades and life extensions of plant 2. and the need to maintain security of supply. this could include upgrading boilers to supercritical status.27 The Government intends that plant consented before the EPS is legislated for will not be subject to it. which is more efficient than the UK’s existing coal-fired power stations and could extend their lifetime by a period similar in length to the lifetime of new coal plants. For example.4.26 While grandfathering will be an important part of the EPS. it is regarded as low-carbon. However. The Government will consider the options for how to implement exemptions to the EPS for CCS demonstration plant. as the lifecycle emissions of biomass plants are significantly lower than those of fossil fuels. While biomass is not carbon neutral.e. Whilst there would be no retrospective changes (i.e. the Government recognises that there are a number of uncertainties regarding what events would constitute such significant upgrades or life extensions. To do so could act as a disincentive to improve environmental performance of existing power stations.29 The Government has made it clear that the EPS will be set in a way which does not undermine the development of coal and gas CCS technology. and determine the most practical and least disruptive mechanism to implement it. Technologies Carbon Capture and Storage 2. Grandfathering provisions (i.4.4. nor will retrofit of CCS or conversion works undertaken to facilitate the use of biomass. Biomass 2.4.

particularly for industry. choosing to effectively zero rate biomass under the EPS treats it in a manner consistent with the EU ETS. the Government believes these can be addressed through alternative tools rather than the EPS42.4.4. While we accept there are issues around biomass and wider sustainability. fuel used to produce useful heat should be subtracted before the calculations are made. Good Quality CHP will be a key technology in helping to deliver our carbon budgets while the grid decarbonises. affordable and low-carbon electricity energy targets. if the EPS only considers total fuel into a plant.31 Furthermore. installations which use biomass exclusively as the fuel in their combustion activities or any other process are specifically excluded from the EU Emissions Trading System (EU ETS). as far as is practicable. Consequently.32 Good Quality fossil fuel Combined Heat and Power (CHP) is a highly efficient process. Some consultation respondents have argued that to be treated fairly. For example. 2.   2.4. The Government also intends to apply the EPS only to plant at or over 50 MW declared net capacity. 42 The UK has introduced sustainability criteria for biomass under the Renewables Obligation. The Government will continue to apply sustainability standards to biomass and bioliquids under the new support framework.34 The Government will look to avoid structuring the EPS in a way which could act as a disincentive to investment in CHP.35 When implementing the EPS.33 An EPS which does not make allowances for the fuel used to generate useful heat when calculating the allowed emissions could penalise CHP facilities and act as a disincentive to investment.Planning our electric future: a White Paper for secure. Institutional arrangements 2. 2. Combined Heat and Power 2. Applying the EPS to any level of biomass emissions above zero could reduce the incentive to invest in sustainable biomass generation.   55 . The Government will therefore continue to promote the development of Good Quality CHP in the UK. the Government will be looking to keep any additional regulatory burden on operators or public bodies to a minimum.4.4. a gas CHP plant that emits around 380g CO2/kWh of electricity would have to sacrifice their heat supply and use their fuel predominantly for electricity generation. and plants that use it deliver a significant reduction in carbon emissions compared to the separate methods of generating heat and power via a boiler and a power station. and will still play a pivotal role in providing secure and cost-effective energy supplies. The Government will look to explore the specific complexities and technicalities with stakeholders before bringing forward detailed regulations on this issue. and believes that it can be implemented in a manner consistent with the administration of other mechanisms. including minimum lifecycle greenhouse gas emissions savings of 60 per cent compared to the use of fossil fuel.

allow coal power stations to turn off their CCS equipment without being penalised by the EPS. 2. As peaking plants only run for short periods of time during the year their annual emissions would be negligible. which only operate during the periods of highest demand (‘peaking plant’).4.36 The Government’s initial view. Interactions with the other Electricity Market Reform measures 2. opposed it and highlighted risks such as investment uncertainties and undermining the mechanism. Some.g.39 Setting the EPS at 450g CO2/kWh will ensure that there is no material impact on capacity margins. however.4. As a result the Government does not consider this will have a material impact on overall emissions from the electricity sector. and the Government will explore the extent to which such situations exist and take appropriate steps to deal with them in designing the regime.4. for example in circumstances where there are short-term or longer-term energy supply emergencies. This would allow those stations to provide additional electricity to the grid. 56 . and we are committed to minimising any risks of unforeseen impacts. 2.4. 2. to run when the system needs them.4. 2. However this will have to be matched by those stations running reduced hours at other times to compensate for their emissions during high demand periods. The Government proposed building in some flexibilities to the EPS to address short-term security of supply issues including exceptions in the event of short-term or longer-term energy supply emergencies. Setting the EPS in this way will enable very flexible power stations.38 Respondents expressed mixed views around exceptions to the application of the EPS. subject to more detailed implementation planning.4. and provide for the Secretary of State for Energy and Climate Change to be able to make limited exceptions to the EPS in order to maintain energy security. is that the relevant environmental regulators (e.41 There may be other reasons why exceptions are required. for example. affordable and low-carbon electricity 2. the Environment Agency in England and Wales and Scottish Environment Protection Agency (SEPA) in Scotland) are likely to be best placed to administer the EPS. In addition. as an annual limit the EPS will allow for power stations to operate in an unconstrained manner during periods of high demand.Planning our electric future: a White Paper for secure. Alternatively those power stations could be allowed to operate at a higher output (or load factor) than would be the case if they were always subject to EPS constraints. In such emergencies it could. Most supported the principle where there are short-term energy shortfalls to protect security of supply and considered that the situations should be set out clearly in advance.37 Safeguarding security of supply is a key consideration for the Government.40 The Government intends to build in the additional flexibilities proposed in the consultation.

operation of exemptions. Next Steps 2. including: ●● the appropriate arrangements for grandfathering provisions.4. in the second session. Wales and Northern Ireland to achieve this in a way which takes appropriate account of their policy preferences.42 The Government will ensure that these flexibilities do not undermine the benefits of the EPS. probably through a mixture of new primary and secondary legislation. as far as possible.Planning our electric future: a White Paper for secure.44 The Government will continue to work with stakeholders to develop the detail of key aspects of the implementation of the proposed EPS regime. and the best way to account for heat energy. further definitions for upgrades or life extensions that would bring a plant under the EPS regime. and seek to introduce the EPS regime. affordable and low-carbon electricity 2. ●● ●● ●● 57 .43 The Government is keen that the framework of the EPS regime should.4.4. existing market arrangements and respective devolution settlements. cover the whole of the UK and is working closely with the Devolved Administrations in Scotland. They will be shaped and controlled carefully and will strike the balance between providing certainty while safeguarding security of supply. Devolved Administrations 2.

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However.1. We need to ensure that the system is able to keep the lights on within this new context and put us on a sustainable pathway for the decarbonisation of our electricity system. Our fossil fuel generation will also become increasingly dependent on imports. 3. decarbonisation will encourage a diverse range of generation capacity and reduce the extent to which we rely on imported fossil fuels. There are also a number of market failures in the electricity market which are likely to be exacerbated by the increase in intermittent and less flexible generation43.uk/en/content/cms/legislation/white_papers/emr_wp_2011/emr_wp_2011. Historically. we will lose around a quarter of existing capacity as a result of plant closures due to ageing plants and environmental regulation.1 THE CHALLENGE The UK needs secure. and improved energy efficiency will help to limit the overall amount of electricity supply we need. Households and businesses expect there to be light and power when they need it. and demand side response (DSR) in particular can play a vital role in enabling security of supply at times of system stress. low-carbon and affordable electricity. the changes to the market also raise legitimate concerns over the security of future electricity supply. the UK has benefited from robust security of supply.3 3. Some of these changes will help make our electricity supplies more secure.aspx 59 . industry and heating systems.Planning our electric future: a White Paper for secure.4 3. particularly during extended periods of high demand and low wind. Reduced energy use has a central role to play in reducing the overall quantity of generation required. Taken together.1.1. For example. but even with increased energy efficiency we expect overall demand for electricity to increase as a result of the electrification of our transport. Over the coming years.decc.2 3. affordable and low-carbon electricity Chapter 3 – Securing future electricity supply 3. the UK electricity market will undergo profound changes.gov. It is a core function of Government to ensure that these expectations are met. Over the next decade. may not be forthcoming.5 43 These market failures are discussed in more detail below and in the accompanying Impact Assessment http://www. largely due to competitive markets underpinned by robust independent regulation. these changes and market failures mean that investment in the flexible capacity needed to ensure security of supply.1.1. We will see a significant rise in intermittent and less flexible generation to support our climate change objectives.1 3.

decc. It will help ensure that the right long-term signals are in place to enable cost-effective investment in all forms of low-carbon generation.6 A strong. However.uk/en/content/cms/meeting_energy/markets/regulation/regulation. in both the domestic and international markets. including the Strategy and Policy Statement44. This includes: ●● Wider context 3. diverse supply. 44 http://www. Gas market reform will improve our resilience to low probability/ high impact events.1. more flexible grid will help in the management of demand peaks. maximising the economic recovery of our existing hydrocarbon reserves.7 reducing our demand for energy.1. resilient market and infrastructure. in the EU and globally. will be central to achieving our security of supply aims at least cost to the consumer. These reforms sit within a wider security of energy supply agenda aimed at reducing demand and ensuring resilient. on which a significant proportion of our electricity generation depends. The development of a smarter. New import infrastructure will ensure resilient access to global energy markets. ensuring we have a strong. the Green Deal will finance household and business energy efficiency improvements at no up-front cost to consumers. given the unprecedented nature of the challenge. Implementing the conclusions of the Ofgem Review. while the roll-out of Smart Meters will enable consumers to optimise their electricity and gas demand. In particular. will help ensure that the regulatory regime is ready to meet the new challenges that we face. oil and electricity. resulting in voltage reductions and blackouts as capacity margins tighten from around the end of this decade. competitive market. and promoting more reliable supply of energy and enhanced price stability.gov. particularly for gas.8 Electricity Market Reform is an integral part of our comprehensive approach.5 billion are situated in the deepwater areas West of Shetland. and continuing to play an active role internationally. And we continue to pursue the liberalisation of energy markets.Planning our electric future: a White Paper for secure. affordable and low-carbon electricity 3. ●● ●● ●● 3. The Government therefore believes that a Capacity Mechanism will be required to ensure security of supply. business as usual is unlikely to be enough to ensure secure supply. with increasingly responsive demand and independent regulation. Without action.aspx 60 .1. Around 20 billion barrels remain. of which around 3. we face a significantly increased risk of being unable to meet our energy needs. The Green Investment Bank (GIB) will help to fund the scaling-up and deployment of green technology and clean energy projects. This means promoting low-carbon growth. while ensuring security of supply and the best possible deal for consumers. encouraging necessary transitional investment in oil and gas production.

gov. It reflects the expected proportion of a source of electricity which is likely to be technically available to generate (even though a company may choose not to utilise this capacity for commercial reasons). Respondents had mixed views on the proposals. Market arrangements need to ensure that these approaches can play their part in enabling secure supplies for consumers. 47 http://www. Introduction 3. This is due to two main factors: around a quarter of existing generation is closing.decc. Market failures mean this risk is even greater. a Capacity Mechanism. and design of. but these are unlikely to be sufficient. and a significant proportion of new generation is likely to be more intermittent and less flexible. affordable and low-carbon electricity 3. We have therefore carried out further analysis to strengthen our assessment on the need for. • Our modelling indicates that de-rated capacity margins will fall below 10 per cent around the end of this decade45.g. The Electricity Market Reform consultation document47 discussed the need for a Capacity Mechanism to ensure security of supply.2. and will significantly increase the risk of costly voltage reductions and blackouts. We present two options: – a targeted mechanism. • There are potential reforms to the current market (e. cash out46) which can help improve security of supply. • New non-generation measures such as demand side response (DSR). The Coalition Agreement emphasised our commitment to reforming energy markets to deliver security of supply.2 45 The de-rated capacity margin is the capacity margin adjusted to take account of the availability of generating capacity. We believe that a Capacity Mechanism will be needed. storage and new connections to other countries offer significant opportunities to improve security of supply and reduce the overall generating capacity that is needed. 46 Imbalance Settlement or ‘cash out’ is the process used to settle differences between the financial contracts and the physical metered volumes of market participants. and are consulting on the type of Capacity Mechanism to be introduced.uk/en/content/cms/consultations/emr/emr.2 CAPACITY MECHANISM Summary • We face increasing security of supply risks from around the end of this decade. 3.1 Ensuring security of electricity supply is a key Government priority. specific to each type of generation technology. or – a market-wide mechanism. We will set out our decision around the turn of the year and legislate to introduce the most appropriate mechanism in the second session. with a proposed model of a Strategic Reserve.2. and stated a preference for introducing a particular type of mechanism – a tender for targeted resource. • A consultation paper can be found in Annex C.Planning our electric future: a White Paper for secure.aspx 61 . and are seeking views on the type of mechanism to be introduced. in the form of a Capacity Market.

suggests that in a scenario including the Feed-in Tariff with Contract for Difference and a Strategic Reserve to provide a 10 per cent de-rated capacity margin. including a diverse mix of generation. given unforeseen changes in both. affordable and low-carbon electricity 3.2.Planning our electric future: a White Paper for secure.2.2.6 diversification of supply: how to ensure we are not over-reliant on one energy source or technology and reduce our exposure to high and volatile prices. and how it relates to short-term balancing of the system. how the introduction of a Capacity Mechanism will ensure security of supply. operational security: how to ensure that. proposed reforms to the current market and the need to go further. are set out in Annex C. A number of responses to the consultation emphasised the importance of ensuring we are clear about the nature of the problem we are trying to solve with a Capacity Mechanism. options for Capacity Mechanism design. The Electricity Market Reform package will drive the uptake of cost-effective measures to ensure security of supply – alongside Ofgem-led reforms on cash out and liquidity. However.5 The problem 3. these changes also pose challenges to security of supply – in particular. 62 . the GB electricity market is about to undergo unprecedented changes.3 This section sets out: ●● the problem we are trying to solve with a Capacity Mechanism. supply matches demand.2. Our analysis suggests that 18 GW will be wind generation which is less reliable than fossil fuel generation. storage and interconnection. As set out above.4 We are consulting on the type of Capacity Mechanism to be introduced. These changes can contribute to improving security of supply – in particular. around 35 GW of new capacity will be required to meet demand in 2020 given expected plant closures. Detailed proposals for mechanism design. and next steps in the policy development and legislative process. ●● ●● ●● ●● 3. and resource adequacy: how to ensure there is sufficient reliable and diverse capacity to meet demand. and the increased proportion of intermittent and less flexible generation on the system48. for example during winter anticyclonic conditions where demand is high and wind generation low for a number of days. and questions for stakeholders. by delivering a more diverse generation mix and more interconnection. DSR. industry can deliver the necessary investment in flexible capacity. ●● ●● 48 Our analysis. linked challenges under the general banner of ‘security of supply’: ●● Context 3. the retirement of existing plants. If we provide the right framework. moment to moment. carried out by Redpoint Energy. There are three different.

Planning our electric future: a White Paper for secure, affordable and low-carbon electricity

3.2.7

By diversifying our portfolio of generation technologies it is possible to address the first challenge. A higher level of intermittency potentially makes the second and third challenges greater. The second should continue to be addressed by the System Operator (SO), National Grid, through the current approach, including the procurement and operation of Short-Term Operating Reserve (STOR) – see Box 6. We propose that the Capacity Mechanism addresses the third problem, though interactions between a Capacity Mechanism and short-term balancing actions would need to be carefully considered. We define ‘reliable capacity’ as capacity which is able to address the challenge of delivering resource adequacy. This includes not just traditional power stations but also non-generation technologies and responses such as DSR, storage, interconnection, and other innovative approaches. These technologies and approaches have the potential to make a significant contribution to security of supply, while reducing the need for large scale infrastructure and making better use of generation assets. We intend that the proposed Capacity Mechanism would incentivise such approaches, and be compatible with a future electricity system in which consumers are engaged in their electricity consumption and demand is responsive.

3.2.8 3.2.9

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Planning our electric future: a White Paper for secure, affordable and low-carbon electricity

Box 6: Short-Term Operating Reserve
The System Operator (SO), National Grid, is responsible for maintaining the stability of the electricity system by ensuring that supply and demand are in balance at all times. Although individual market participants will have planned ahead of time for the expected demand in each half hour, there will be times when demand is greater than forecast; and occasionally a generating unit will fail, meaning that additional generation must be brought on line to replace it. In part, National Grid can balance the system by accepting offers and bids in the Balancing Mechanism. However, it has a responsibility to ensure that, regardless of the availability and commercial decisions of generators, it will always be able to meet its operating needs. To fulfil this responsibility, National Grid makes an assessment of how much reserve capacity is required to manage these uncertainties in the period about four hours ahead of real time. This requirement is about 4 GW, and is largely met by the Short-Term Operating Reserve (STOR), whereby National Grid contracts reserve capacity to be made available on demand. Demand side response can be contracted through STOR if it meets the technical requirements set by National Grid. As greater amounts of wind generation are added to the system, National Grid expects that the level of required reserve will increase, due to the need to cope with real time unexpected changes in wind generation in addition to existing challenges; this can be both the wind dropping off or blowing too hard causing generation to drop rapidly. The proposed options for a Capacity Mechanism are not intended to remove the need for this operating reserve, though interactions between the two will need to be considered.

Rationale for a Capacity Mechanism
3.2.10 In the Electricity Market Reform consultation document we outlined reasons why we cannot be confident that the current electricity market will deliver the appropriate level of reliable capacity to produce adequate security of supply in the medium to long term. 3.2.11 Some respondents to the consultation took the view that capacity margins during this decade mean that a mechanism is likely to be needed. Others were sceptical of the need for a Capacity Mechanism and argued that the case for a significant market intervention had not been made.

Modelling of capacity margins
3.2.12 Our latest modelling of the future electricity system suggests that over the medium to longer term, investment in generation will not be sufficient to avoid potentially difficult levels of energy unserved. Even without market failures, de-rated capacity margins are expected to fall below five per cent in some years, increasing the likelihood of black
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Planning our electric future: a White Paper for secure, affordable and low-carbon electricity

outs. Market failures are likely to exacerbate this risk. 3.2.13 If low capacity margins lead to energy unserved, there are resultant costs to consumers. For example, if de-rated capacity margins fall to 3 per cent in the early 2020s, in a year we could expect around 20 GW of energy unserved, with estimated costs to the economy of £200-600 million49. 3.2.14 Projections are uncertain, but suggest:
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From now to 2013: – De-rated capacity margins appear robust (but will need to be closely monitored).

●●

Mid 2010s: – Margins likely to become tighter as some plants impacted by the Large Combustion Plant Directive and then the Industrial Emissions Directive retire, and current nuclear plant closes. Some new construction, or de-mothballing, will be required to ensure security of supply.

●●

Late 2010s: – Margins tighten, intermittency grows and a Capacity Mechanism is likely to be needed to ensure security of supply; and – As can be seen in Figure 10, towards the end of the decade the de-rated capacity margin falls below 10 per cent, and below five per cent in more than one year.

3.2.15 Figure 10 shows the modelled capacity margin and expected energy unserved under an Electricity Market Reform scenario including FiT CfD but without a Capacity Mechanism. These projections do not include the market failures set out below50.

49 The cost depends on the average Value of Lost Load (VoLL), which is the theoretical value to the GB economy of preventing blackouts. It is the electricity price at which an average consumer would rather be cut off than continue paying. Estimates of VoLL are very uncertain. Oxera, an economics consultancy, published a range of estimates for VoLL. We have assumed a VoLL of £10,000/MWh for our analysis. 50 These projections assume that the electricity market delivers the economically efficient level of de-rated capacity margin. Prices are allowed to rise to consumers’ Value of Lost Load (VoLL) of £10,000/MWh and, in the modelling, investors know this. In reality, if investors do not believe that prices will be allowed to rise to VoLL because of the market and regulatory failures described below, then the security of supply outcomes could be worse than those modelled. For our future modelling, we will examine whether it is possible to reflect the impact of market failures on capacity margin and energy unserved.

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Planning our electric future: a White Paper for secure, affordable and low-carbon electricity

Figure 10: Peak de-rated capacity margin and expected energy unserved (GWh) to 2030
30%
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Historic Updated FiT CfD package without Capacity Mechanism

Historic Updated FiT CfD package without Capacity Mechanism

Market failures
3.2.16 There are a number of market failures which exist in the electricity market. These include:
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reliability is a public good – consumers cannot buy reliability for themselves without providing it for everyone else, so there is not enough demand for generation companies to provide it51; there are barriers to entry in the wholesale market – market liquidity is a key issue, but there are related concerns including potentially limited routes to market for some independent generation; and prices in the electricity market may not send the correct signals to ensure optimal security of supply.

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3.2.17 On the latter point, expectation of price caps in energy markets leads to ‘missing money’. At times of system tightness, marginal generators52 should be able to raise their prices to the point where they can cover their long-run marginal costs, and in the limit, raise their prices to very high levels – that is, to the value at which energy consumers are indifferent to being disconnected (the Value of Lost Load (VoLL)). However, there are a number of reasons why generators may not be able to realise the necessary prices and hence not cover their long-run costs. These reasons include actions taken by the SO to balance the system that are not priced correctly, as well as regulatory intervention. 3.2.18 In particular, investors are likely to be concerned that periods of high prices will lead to regulatory intervention in the form of price caps, and this concern will reduce the incentive to invest. There are examples of regulatory intervention following periods of high prices (for example, during and following the California energy shortage of 2001-02) and
51 In future a more flexible demand side, enabled by new technologies including Smart Meters, could mean consumers have more opportunity to choose individual levels of reliability. 52 Capacity that enters the market in times of high demand/system scarcity.

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aspx 54 http://www. and periods of high prices.19 We believe that the challenges posed by these market failures are likely to become more acute over the coming decade than they have historically been. 3. Many of the new low-carbon plants that will be built in the coming years will typically have very low running costs and so any new fossil plants will only run when the low-carbon plants are not running. and to increase the amount of electricity traded in the market through its liquidity project54.gov. Revenue from fossil plants will be more volatile and uncertain.2. supplied 53 http://www.uk/CustomPages/Pages/Publications. suppliers and intermediaries ends one hour before the half hour period in which electricity is generated. Cash out reform 3. and the investment decision therefore more risky. A fuller discussion of the market failures identified here is included in the accompanying Impact Assessment53.2. the situation now faced by an investor who is considering building a new fossil plant is very different to that faced by an investor in gas generation in the 1990s.2. At present.ofgem.Planning our electric future: a White Paper for secure. loss of service. 3. The reforms to the current market discussed below.22 Ofgem is undertaking two reform processes to improve the operation of the current market: to sharpen the incentives for market players to balance supply and demand through cash out reform.20 Given the drive to build low-carbon generation.21 In addition. 3. This section sets out the Government’s views on these issues in relation to security of supply. This surfeit of capacity arose largely from the ‘dash for gas’ during the 1990s when. will address some of these issues but are unlikely to fully address investors’ worries concerning regulatory intervention leading to this ‘missing money’. it may be argued that the costs of under-investing in capacity and resulting cost of blackouts means that consumers may prefer to invest more rather than less.23 Electricity is traded in half hour settlement periods.2.aspx 67 .uk/en/content/cms/legislation/white_papers/emr_wp_2011/emr_wp_2011.2. a large amount of gas-fired generation was built in an investment climate conducive to its construction. affordable and low-carbon electricity investors may believe that such intervention will be likely in any future prolonged period of high prices. following privatisation of the electricity industry.gov. This will mean that consumers pay more than they would without a Capacity Mechanism.decc. Reforms to the current market 3. Bilateral trading between generators. such as changes to the cash out arrangements. but benefit from increased reliability as a result of sufficient capacity being on the system. GB has a very comfortable margin of generation capacity and periods of scarcity are rare. in order to insure themselves against the risk that exceptional conditions result in disruption. The Government strongly supports this work.

3.2. The system can be out of balance when electricity generators or suppliers are also out of balance – that is. 3. SCRs give Ofgem a leadership. provide balancing incentives but create more than one price for what is essentially the same product. We believe the current cash out price may not fully reflect the costs of ensuring that demand and supply are in balance and at times may be too low. 68 . coordination and change initiation role where a number of code changes are necessary in order to address an issue with a significant impact on the achievement of its remit. Ofgem consulted on whether to undertake a Significant Code Review (SCR) of cash out55.2. 3.2.25 In August 2010. changing to more marginal pricing – a scheme closer to marginal pricing should result in more cost reflective prices if system balancing actions can be accurately removed from the price56. The SO incurs costs on behalf of the industry for increasing or reducing supply or demand to balance the system.24 Imbalance Settlement or ‘cash out’ is the process used to settle differences between the financial contracts and the physical metered volumes of market participants.26 Ofgem has identified a number of areas for consideration to improve cash out.2. Cash out prices are intended to reflect the costs the SO incurred when balancing the system. The list of issues below is not exhaustive and others may be brought forward before and throughout the process. more effective allocation of reserve contract costs – by targeting costs to the period in which the reserve is used this should be more cost reflective57. affordable and low-carbon electricity and consumed. ●● ●● ●● 55 Ofgem introduced the process of Significant Code Reviews (SCRs) in 2010 as a result of its review of industry code governance. as exist currently. 57 Should more accurately reflect the costs incurred by the System Operator when balancing the system to market participants that are out of balance.Planning our electric future: a White Paper for secure. 56 System balancing actions include balancing locational constraints and second-by-second balancing. We would expect this to improve incentives for market investment in new capacity. We believe that cash out prices should accurately reflect the costs of balancing the system within that settlement period and we support Ofgem’s intention to launch a cash out SCR. and these costs included in the cash out price. 3. The SO is responsible for ensuring that the electricity system remains balanced within each half hour period. and putting a price on the currently non-costed SO actions – customers could be compensated for involuntary voltage reductions and automatic demand disconnection. when market participants deviate from their declared intention to generate or supply electricity. The options are not mutually exclusive.27 In summary the options include: ●● changing to a single or fixed spread cash out price – different cash out prices for selling and buying electricity.

The Government is keen that Ofgem launches the cash out SCR as soon as possible. ‘Forward’ trading refers to buying and selling for delivery of electricity in the month ahead and after. The challenges of plants shutting as a result of environmental regulation and old age. 3.28 It will be for the Gas and Electricity Markets Authority (GEMA) to decide when and whether to launch a SCR58. a more liquid market could reduce security of supply risks.2.32 As outlined in the Electricity Market Reform consultation document. Liquidity 3. 69 . there will need to be sufficient liquidity to allow market participants (particularly smaller suppliers and generators) to trade out of imbalance positions. and may include trades for months.2. which consists of non-executive and executive members and a non-executive chair. Government view 3. Improved liquidity is also important to support effective Capacity Mechanism implementation. 3.Planning our electric future: a White Paper for secure.2. 58 Ofgem is governed by the Gas and Electricity Markets Authority. In addition. 59 ‘Spot’ trading means trading for delivery on the same day as the trade (within day). affordable and low-carbon electricity 3. and takes account of the ongoing work on a Capacity Mechanism. day ahead and forward markets59.2.29 A more accurate cash out price should make the spot market price more reliable. A more reliable spot market price will in itself improve security of supply by providing greater incentives to market players to invest in development and/or retention of capacity. raise credible concerns for the security of supply outlook in the latter part of this decade. ’Day-ahead’ trading refers to buying and selling for delivery of electricity on the day after trading takes place. 3. which could be provided directly by the cash out price or indirectly by influencing the price in the spot. but does not wait for it. We note that Ofgem’s liquidity project is ongoing. seasons and years ahead of delivery. We would expect Ofgem to consider this issue and any related negative impacts on non-vertically integrated companies as part of its Impact Assessment. we continue to believe that a Capacity Mechanism is needed to guarantee security of supply over the medium to longer term. combined with a shift to a greater proportion of low-carbon and intermittent and less flexible generation.30 There are risks to be managed in implementing cash out reform. including the risk that if cash out prices become more volatile. We strongly encourage industry to work with Ofgem to make cash out more reflective of actual costs within the settlement period.31 The interaction between Ofgem’s work to improve market liquidity and Electricity Market Reform is discussed in Chapter 5.2. and seeks to ensure that the wholesale power market better meets market participants’ needs – including those of independent suppliers and generators. some forms of Capacity Mechanism would need a reliable reference price.33 Based on current projections.2.

●● ●● Overview of December 2010 consultation proposals 3. affordable and low-carbon electricity 3. Without a Capacity Mechanism we would expect to see increased levels of energy unserved from around the end of this decade.35 A well designed Capacity Mechanism will ensure security of supply by: ●● providing a regular revenue stream to some or all providers of capacity. but our analysis of the electricity system indicates that even in a GB electricity market without the market failures identified above. capacity margins would fall throughout the next decade. reliability option – a forward auction for a financial instrument. with the level of payment set by a central organisation. loss of service and periods of high prices due to under-investment. using either a targeted or market based approach: ●● capacity payment – reimburses all providers through a payment for available capacity.36 In the Electricity Market Reform consultation document. capacity auction – the capacity is set centrally a number of years in advance.2. providing a more secure capacity margin than one that would be determined by the market without intervention.2. with the price determined by an auction and paid to all resource clearing the auction. ●● ●● Options for a Capacity Mechanism 3. market failures that apply to electricity markets in general mean that the level of investment in reliable capacity is likely to be lower than in a market not subject to these market failures. and when faced with uncertainty. and ●● ●● ●● 60 Power plants that generally only operate at times of high demand/scarcity. consumers may prefer to invest more to insure themselves against the risk of disruption. and encouraging peaking plants60 and non-generation approaches such as a DSR and storage. where providers must be available to the SO for distribution above the defined strike price.2. 70 . which in turn encourages greater investment in the types of capacity required to deliver resource adequacy. we set out a number of ways to implement a Capacity Mechanism. These market failures are likely to be exacerbated by the changes taking place in the GB market. ‘a call option’. capacity obligation – an obligation on suppliers to contract with providers for a certain level of capacity or pay a buy-out price.34 There are three arguments endorsing this view: ●● the Government supports Ofgem’s work on liquidity and cash out.Planning our electric future: a White Paper for secure.

39 We have listened to concerns from stakeholders about the options we put forward in the consultation.37 We expressed a preference for a tender for targeted resource.2.2. In particular. In response. with a proposed model of a Strategic Reserve. 71 . market-wide model in more detail. and/or that a targeted mechanism would simply displace generating capacity which would have been available anyway. In particular some felt that a targeted mechanism would lead to a ‘slippery slope’ where an increasing number of fossil/ peaking plants would be included in the mechanism rather than operate in the market61. Most concerns related to the potential impacts of this mechanism on the way the market operates.2. on the detailed design of our approach for each: ●● a targeted mechanism. Preferred Options Overview of proposals 3. Some stakeholders suggested that a market-wide approach would avoid some of these problems and could be more viable in the long term. The level of payment is set through a competitive tendering process. One form of a Capacity Market is a Reliability Market. and explored an alternative. Summary of responses 3. we have both refined the detail of the original preferred option to seek to address the concerns raised. it could lead to lack of investment outside of the mechanism. set out in Annex C. This comprises centrally-procured capacity which is removed from the electricity market and only utilised in certain circumstances. 3. We are seeking views in the consultation. and the total volume of capacity required is purchased. storage and interconnection. and sought views on various elements of design for this approach. we are keen to gain stakeholder ●● 61 If being in the Capacity Mechanism and receiving a Capacity Payment was more attractive than remaining wholly in the market. a development of the lead option from the Electricity Market Reform consultation document which aims to mitigate concerns raised by stakeholders. there are a number of ways to purchase capacity – including through a central auction or a supplier obligation. depending on the nature of the ‘capacity’ and how it is bought and sold. affordable and low-carbon electricity ●● tender for targeted resource – capacity payments are only given to resource required to make up the shortfall in the market.Planning our electric future: a White Paper for secure. There are several forms of Capacity Market. A number of stakeholders highlighted the importance of the role of non-generation forms of reliable capacity such as DSR. for which. given its innovative nature. meaning that the central organisation would have to procure ever more generating capacity.38 A number of stakeholders expressed strong concerns about the consultation proposal to introduce a targeted mechanism. in which all providers willing to offer capacity (whether in the form of generation or non-generation technologies and approaches such as storage or DSR) can sell that capacity. or a market‑wide mechanism in the form of a Capacity Market.

e. Another distinction is how the capacity is bought and sold. 72 . and the Capacity Payments mechanism discussed in the Electricity Market Reform consultation document. 3. 3. We recognise that there are other forms of market-wide mechanism.2.Planning our electric future: a White Paper for secure. affordable and low-carbon electricity feedback.40 Figure 11 shows the kinds of Capacity Mechanism that we discuss in this chapter. Figure 11: Possible models for a Capacity Mechanism Capacity Mechanism (Targeted) (Market-wide) ‘Tender for Targeted Resources’ Capacity Market (volume set centrally) ‘Capacity Payment’ (price set centrally) Strategic Reserve Other (including ‘capacity obligation’ and ‘capacity auction’) Reliability Market (including ‘reliability option’. such as those which set price in order to incentivise sufficient volume (Capacity Payments). one distinction is what is bought and sold (i. Under a Capacity Market. Could be delivered through an auction or an obligation) Notes: The Capacity Mechanism types in inverted commas are those proposed in the Electricity Market Reform consultation document. and these remain under consideration. which could be through a central auction and / or a supplier obligation.41 We will set out our preferred option in a technical update to the White Paper around the turn of the year. a regulatory definition of capacity or a reliability contract).2.

When a shortfall in reliable capacity is anticipated.2. distributed generation. 3.45 Criteria would be set to enable the appropriate reserve capacity to be procured.44 If no shortfall is expected then no additional capacity would be procured. A determination would be made centrally about the level of reliable capacity required as well as an assessment of whether the market would be likely to deliver this. A proposal for price setting is set out in Annex C. Figure 12 shows how a Strategic Reserve would operate to ensure a capacity margin. and methodology for changing the price. storage and other suitable approaches.2.43 A Strategic Reserve is an amount of reliable capacity which is held outside the electricity market apart from under certain.46 The price at which the reserve enters the market. 3.2. were of particular concern to stakeholders given the potential for this to lead to a ‘slippery slope’ (see above).2. affordable and low-carbon electricity Option: a targeted mechanism 3. DSR.2. We propose that the Strategic Reserve would be withheld from the electricity market and only be released when prices rise above a certain level – the despatch price. However these costs should be outweighed by the benefits of ensuring security of supply.42 We have refined our proposal for a targeted mechanism to a Strategic Reserve with the aim of addressing stakeholder concerns.Planning our electric future: a White Paper for secure. a central organisation would be responsible for competitively procuring the necessary volume and mix of Strategic Reserve to meet demand. 3. on the basis of independent advice. 3. These criteria would potentially allow all forms of reliable capacity – including flexible generation.2. 3.47 The costs of a Strategic Reserve would be met by consumers through revised supplier and generator pricing arrangements. exceptional conditions. 73 .

how much capacity can be offered to the market by a given power plant. which would introduce a market for capacity in addition to the existing electricity market. The required volume of reliable capacity would be determined by a central body based on forecasts of the peak demand some years ahead. Providers of capacity could operate in both markets.48 We have also considered a market-wide mechanism in the form of a Capacity Market. … unless ‘exceptional circumstances’ prevail Option: a market‑wide mechanism 3. Forms of Capacity Market 3. subject to its ability to be available when required. Central body procures reserve capacity but withholds it from the market … 2.51 The term ‘Capacity Market’ is quite broad and covers a range of models. Consumers benefit from certainty of supply and increased price stability. Providers of capacity could include existing generators. Any Capacity Market must address at least two questions: the nature of the product e.49 Figure 13 shows how a Capacity Market works.g. 3. and companies offering other forms of capacity such as distributed generation. storage and other suitable approaches. 3. DSR.2. providers of capacity in a Capacity Market substitute uncertain returns in the electricity market for long-term certainty from the Capacity Market.2.Planning our electric future: a White Paper for secure. companies that are planning to build a new power plant.2. 74 . That total amount of demand for capacity would be purchased from any provider willing to supply it. and what penalties to impose if the promised capacity is not available when required during the contract period.2.50 In effect. affordable and low-carbon electricity Figure 12: Operation of a Strategic Reserve 1.

Indiana. Revision 12. Virginia. The reliability contract provides a hedge for the holder of the contract. In the Capacity Market.53 An alternative form of Capacity Market – a Reliability Market – uses a financial instrument to incentivise available capacity. North Carolina.ashx. 63 For further detail on the ‘Reliability Pricing Model’ see. the provider receives a payment (the option premium) which provides a more reliable source of income on which to base an investment decision.2. for example. Capacity Market Purchaser of capacity (could be central body. Pennsylvania. for example. PJM Manual 18. Maryland. Tennessee. 64 The ‘strike price’ is a price agreed by the parties to the reliability contract and represents the effective maximum price that the electricity buyer will have to pay for the volume agreed in the contract. on historic data or through comparison with similar types of generation. Some Capacity Markets incentivise and regulate capacity through administrative means. If the resource is assessed as having failed to deliver the required level of capacity.2. In this market. if electricity is simply not available. PJM Capacity Market.Planning our electric future: a White Paper for secure. 75 . supplier etc) Supplier Electricity Market Supplier Supplier Note: Providers of reliable capacity participate in the Capacity Market and/or the electricity market. enabling the holder to purchase electricity at no more than the strike price (or. the capacity that a provider is able to offer into the market is calculated centrally based on a number of technical parameters such as outage rates. When the market price is higher than the strike price. to be compensated)64.52 There are a number of different forms of Capacity Market. Michigan. In return for this hedge. 3. Kentucky. 2011. 62 PJM is the electricity transmission system serving all or parts of Delaware. A series of ‘resource performance assessments’ are carried out to assess whether the resource honoured its commitments during the contract period. Illinois. West Virginia and the District of Columbia. affordable and low-carbon electricity Figure 13: Operation of a Capacity Market. the PJM system in North America operates a forward capacity market known as the ‘Reliability Pricing Model’ (RPM)62.pjm. These are estimated based. what is purchased from providers is a ‘reliability contract’ – essentially a call option. http://www. 3. then an administratively determined penalty is imposed and the revenue from charges given to resources that exceeded their commitment levels63. New Jersey.com/markets-and-operations/~/media/documents/manuals/m18. the seller of the reliability contract pays the buyer the difference in price for the total volume of electricity agreed. they are incentivised to be available (or penalised for not being available). Ohio. For example. In a Reliability Market.

In the case of a market-wide mechanism. cost-effective. can be found in Annex C. compatible with our market. some designs of Capacity Market would constitute a more innovative approach in our market. The chosen Capacity Mechanism will need to be developed to best meet all of these criteria. 76 . this model may be less effective in providing the desired level of security. 3. so would present design challenges and need further development and stakeholder input before we can be confident they will work. for the Strategic Reserve and market-wide Capacity Mechanism. A Capacity Market would also need to be carefully designed to manage interactions with the FiT CfD.54 In a Reliability Market. 3.2. and is efficient if well designed. while the ‘penalty’ for non-availability is simply the payment that is made when the option is called.2. However. has been implemented in several markets. practical and feasible. consistent with decarbonisation and renewables targets.2. and could straightforwardly be implemented here.57 The key trade-offs are: ●● a Strategic Reserve has a well understood design. since both provide support for capacity but the two offer different incentives for reliability.2. 66 For example. durable to changes in the GB market. could mitigate exploitation of market power in the electricity market.56 Annex C provides a summary of the key trade-offs and relative assessment of the Strategic Reserve and Capacity Market for comparative purposes against eight criteria65. a Capacity Market is likely to achieve the required security of supply.55 Detailed proposals around the design and areas for consultation. compatible with other Electricity Market Reform measures. It may be less effective in encouraging the wider use of non-generation approaches such as demand side participation compared to a market-wide solution. is potentially more compatible with a longer term move to a more responsive demand side. ●● 65 Criteria considered are: achieves sufficient security of supply. Comparative analysis 3. robust against the use of market power. supports supply side efficiency. and it is potentially less effective in reining in the exercising of market power66 in the electricity market. It also has potential to more strongly encourage non-generation responses to system adequacy issues such as DSR. including to the demand side. by withholding generation in times of scarcity to drive prices up. the provider offers the amount of capacity that they believe they can reliably make available when required. we have investigated a Reliability Market in more detail given its innovative nature. However. affordable and low-carbon electricity 3. but other models of Capacity Market remain under equal consideration.Planning our electric future: a White Paper for secure.

77 . In the current GB market DSR is principally used to reduce demand in periods of system stress (e. or by not using the electricity at that time.g. It enables this by shifting demand from periods where demand is greater than supply to periods where supply is more plentiful – for example. to form a central element of delivering security of supply and play a fair and equivalent role in a Capacity Mechanism. The importance of such approaches. could lead to greater participation of the demand side in the wholesale market.58 The Government is keen for non-generation technologies and approaches. Technologies and approaches such as DSR. particularly DSR. The introduction of Smart Meters could increase the opportunities for DSR. while reducing the need for large scale infrastructure and making better use of generation assets. short-term reduction in consumption whereby an energy user or aggregator guarantees to reduce demand at a particular time. by self-supplying using local back-up generation. This. as well as traditional electricity generation. To automatically respond to variable tariffs or wholesale prices. storage and interconnection have potential to contribute to security of supply. was emphasised by a significant proportion of respondents to the consultation. consumers would need equipment (to complement Smart Meters) that will reduce demand automatically by turning off non-essential electrical devices. DSR actively participates in the Short-Term Operating Reserve (STOR). in conjunction with the likely electrification of heat and transport which could significantly increase the amount of discretionary demand. It can be used to help balance supply and demand in a context of significant intermittent and inflexible generation.Planning our electric future: a White Paper for secure.2. sudden loss of generation or transmission failures). Box 7: Definition of technologies and approaches Demand side response Demand side response (DSR) is an active. contributing 445 MW in 2010. affordable and low-carbon electricity The role of non‑generation technologies and approaches 3. Response to wholesale price is currently limited to large industrial consumers that have half hourly meters and are charged the wholesale electricity price. for example through greater use of time or pricesensitive tariffs.

interconnection can increase the reliability provided by a given level of total capacity. such as: ●● trimming the peaks and filling the troughs – DSR and storage can be used to shift demand from times when there is little or no spare capacity to times of excess capacity.59 The Government believes that technologies and approaches such as DSR. It involves storing electrical energy in another form (such as heat) when supply outstrips demand. which is around five per cent of peak GB demand. electricity storage currently plays a limited but important role. 30 minutes) they can replace fossil fuelled plants that the SO has ‘warm’ on ●● ●● 78 . which allow electricity to be imported or exported in response to price signals. storage and interconnection can contribute to cost-effectively delivering security of supply in a number of ways. Currently.5 GW of interconnection. Interconnection Interconnectors are physical links between GB and other electricity grids.Planning our electric future: a White Paper for secure. installed storage capacity in GB is just under 3 GW and is largely made up of pumped storage. interconnection can be used to shift the excess capacity in one country to meet the demand in another. and reducing the need for spinning reserve – if non-generation approaches are available to respond at short notice (e. Interconnection increases competition and allows market access for a greater number of participants. Interconnection can play a role in enabling cost-effective integration of low-carbon energy by allowing for export/import at times of high/low renewable output. It also offers significant technical flexibility which can assist in the fine tuning of the network which is carried out by the System Operator (SO). Similarly. and reproducing this as electricity when the system requires it. GB currently has 3. The benefits 3.g. National Grid.2. Different countries have different peak demand times. affordable and low-carbon electricity Box 7: Definition of technologies and approaches (continued) Storage Like DSR. thereby reducing the total capacity required and increasing the proportion of energy produced by low-carbon generation. Other storage technologies are currently less mature. reducing market power – a more dynamic demand side and use of storage can reduce the market power of players on the generation side in times of scarcity. but storage has significant potential to grow (particularly with the electrification of heat and transport) as it can capture energy generated by inflexible low-carbon generation and reproduce this in times of scarcity. As periods of peak demand may occur at different times in different countries. so trade across interconnectors can support security of supply without extra investment in power plants.

Implications for Capacity Mechanism 3. 67 BM Start Up is a reserve service contracted on the day by the System Operator to ensure plants with a start-up time of several hours are available in the Balancing Mechanism at peak.2.63 Further detail on the costs and benefits of the two options is set out in Annex C and in the accompanying Impact Assessment published alongside this White Paper.2. Any differences are likely to be due to the way that either mechanism is designed. potentially interacts with the Capacity Mechanism. for example by ‘selling’ reliability contracts in a Reliability Market. 3. Implications could include: ●● a Strategic Reserve: DSR and storage which can guarantee reduced energy use in a way that meets resource adequacy needs could bid to act as part or all of the reserve.64 The FiT CfD.60 The different types of Capacity Mechanism proposed have different implications for non-generation approaches. a Capacity Market would be likely to lead to a larger flow of funds as potentially large capacity payments lead to lower wholesale electricity costs. given that both policy instruments affect the amount of capacity brought forward. Similarly greater interconnection can allow for sharing of system services. reducing requirements over a connected area. ●● Affordability 3.65 The Strategic Reserve operates outside the electricity market and it is assumed that most recipients of FiT CfD will not be directly affected. however some generating capacity. 3. We are seeking views on how different Capacity Mechanism designs might encourage the use of such approaches as part of our approach to delivering security of supply in Annex C.61 The modelled differences in cost between the two Capacity Mechanism proposals is relatively low in absolute terms compared to other Electricity Market Reform proposals. The role of interconnection is discussed in Annex C. affordable and low-carbon electricity standby (i.2. BM Start Up67). This is not surprising. for example fossil fuel plants with Carbon Capture and Storage (CCS).2. 79 .62 Despite there being relatively little difference in the net cost of either mechanism. thus reducing the generation capacity needed.Planning our electric future: a White Paper for secure. a Capacity Market: DSR and storage could potentially participate in a Capacity Market alongside other providers of reliable capacity.2. The role of interconnection is discussed in Annex C.e.2. may be able to operate flexibly enough to offer extra capacity into the market at times of peak demand. set out in Chapter 2. Interaction with other Electricity Market Reform measures 3. 3. as the two options are at least theoretically capable of producing exactly the same outcome if designed efficiently.

Devolved Administrations 3. Further details are set out in Annex C. We will continue exploring these interactions as proposals are developed.67 Further development of the scheme will include discussions with the Welsh Government and Scottish Government to determine how the Capacity Mechanism should apply in their jurisdictions.Planning our electric future: a White Paper for secure. Next steps 3. under existing market arrangements. the proposed Capacity Mechanism would apply across GB only.2.2.66 A Capacity Market could create other interactions with low-carbon support.2. Timing 3.2. Figure 14: An indicative timetable for the implementation of a Capacity Mechanism 2011 Legislation Policy finalised 2012 2013 2014 Secondary legislation 2015 2016 2017 2018 2019 Primary legislation Assessment of need Institutional framework Initial work to establish organisation Annual assessments of need for additional capacity Organisation(s) is formally tasked and empowered. The timing for the setting up and entry into operation of a Capacity Mechanism would need to be such as to provide certainty that any shortfall arising on such a timescale would be dealt with. affordable and low-carbon electricity 3. there is likely to be a shortfall in available capacity from around the end of this decade. becoming active at Royal Assent if through primary legislation Capacity procured Could be earlier if arrangements set out in Primary or if institutions become active as soon as Secondary in force (Q1 2014) Delivery Lead-in time for capacity Could be compressed if necessary Capacity in place Could be earlier if DSR/existing capacity rather than new build 80 .This will be partly determined by similar decisions in relation to the FiT CfD and by the design of the Capacity Mechanism. Figure 14 sets out our initial view of when a Capacity Mechanism could be introduced and possible milestones.69 We believe that. The UK Government and the Northern Ireland Executive have agreed that because the Single Electricity Market for the island of Ireland already uses a Capacity Mechanism.68 The Government will set out its decision on the chosen Capacity Mechanism model around the turn of the year with a view to legislating in the second session.

– delivery of the contracts. enduring. The consultation responses have informed the criteria the Government will use to design the institutional framework. an existing public body or an existing private body.1 Under the current market arrangements. • Several options for the delivery organisation are being considered including a new public body. independence. robust and credible institutional framework to deliver the Electricity Market Reform package is critical to ensuring investor confidence. the need for the contract counterparty to be credit worthy. affordable and low-carbon electricity Chapter 4 – A new institutional framework Summary • The Government recognises that putting in place a transparent. The delivery organisation would be likely to work at ‘arms length’ from the Government to administer the contracts. • A decision on which organisation will be responsible for delivery of the contracts will be published around the turn of the year once the Capacity Mechanism design has been decided. • The new institutional framework will enable the following key functions to be performed in delivering the Feed-in Tariff with Contract for Difference (FiT CfD) and Capacity Mechanism: – setting the overall policy approach and objectives. – translating policy objectives into technical requirements. Ofgem E-Serve) deliver this policy. 68 National Grid is the GB System Operator and transmission owner for England and Wales. private generators produce the electricity which is sold to consumers by suppliers. Competition between both generators and suppliers helps encourage innovation and minimise costs.Planning our electric future: a White Paper for secure. National Grid68 operates the GB transmission network. • Key considerations raised in the consultation responses include: accountability and governance. – data reconciliation and managing payments. In Scotland the transmission system is owned by SP Transmission Limited and Scottish Hydro Electric Transmission Limited. and value for money for the consumer. securing the right skills and resources. Introduction 4. the Government makes policy and a range of delivery bodies (e. 81 . and – monitoring compliance and enforcement. We will continue to engage with stakeholders as appropriate as we take this work forward. and Ofgem performs an important role as the economic regulator.g.

Respondents also stressed that the organisation with liabilities under the FiT CfD should be highly credit worthy to ensure that payments can be met over the long term. the importance of a complaints resolution process and enforcement. equitable treatment of demand side resources. providing a legislative framework and setting the delivery organisation’s objectives. It is crucial that investors have confidence that decisions are taken fairly and that there exists a stable. The aim of the Electricity Market Reform package is to ensure a secure. Some respondents suggested that a central agency should be established to manage the capacity contracts as this would allow for greater transparency. Key to this is ensuring that the right arrangements are in place to deliver the policies on the ground.2 Electricity Market Reform builds on this existing competitive market structure. The Emissions Performance Standard (EPS) is considered separately in Chapter 2. Consultation responses 4. respondents flagged the need for a credible and durable counterparty to the contracts. Other points made were: the need for significant resource given the magnitude and commercial complexity involved. Views differed on who should deliver this function and whether it should be a new or existing organisation. The range of options for the delivery of the Capacity Mechanism depend on the policy approach taken following further consultation (see Chapter 3 and Annex C).6 4.7 82 .3 4. The major new policies being introduced as part of the package will require specific delivery arrangements. Several responses highlighted the need for the delivery organisation to have the appropriate expertise and skills to deal with these long-term mechanisms and the technologies involved. with the government continuing to make decisions on policy issues. The options could include a delivery organisation performing the contract counterparty role or overseeing contracting between suppliers and generators.Planning our electric future: a White Paper for secure. Many suggested that the System Operator’s (SO) role could be extended to cover this and there were a few comments that this should be independent of other commercial activities and political influence. diverse and low-carbon technology mix at least cost to the consumer.5 Vision for the institutional design of the electricity market 4. a requirement for suitable performance incentives and service agreements. This section considers the delivery requirements for the FiT CfD and Capacity Mechanism policies.4 4. affordable and low-carbon electricity 4. Regarding the delivery of a Feed-in Tariff. predictable environment within which to make the necessary investment decisions. Most respondents suggested that a central organisation should deliver the proposed targeted Capacity Mechanism. and the need for the fundamental workings of the market to continue.

●● ●● 83 . and a mechanism to insure against generator default risk e. similar to the mutualisation fund for the Renewables Obligation (RO).g. the role of different technologies in achieving these objectives. the Government believes it is important that the institutional framework established for delivering the FiT CfD and Capacity Mechanism satisfies the following requirements: ●● accountability: ensuring that policy is designed and delivered with the appropriate accountability and thorough and transparent processes that allow public scrutiny. independence: operating at ‘arm’s length’ from the Government. the posting of credit for the Balancing Mechanism. as will understanding the Government’s objectives. affordable and low-carbon electricity 4. is equally important. or in the case of suppliers. and within the required governance arrangements. as appropriate.g. to enable effective forecasting of future demand and supply and the costs and benefits of different low-carbon generation and reliability levels will be key. This may involve: –● ●● ●● legislation to ensure that payments can be met through the collection of the necessary funds e. a mechanism to insure against counterparty insolvency which could be. and value for money: ensuring that the Government’s policy objectives can be delivered in the most cost-effective manner for consumers. which may damage investor confidence. credit worthiness: providing reassurance to investors that payment commitments will be met. similar to the special administration regime for network companies. to create the reliable market framework investors need in order to have the confidence to make important investment decisions. a consumer levy. Putting arrangements in place which do not give rise to potential conflicts of interest. if this was a central organisation.8 Based on the consultation responses. –● –● –● ●● technical expertise: knowledge of how the energy market works. Key to this is establishing appropriate mechanisms that give investors this confidence.Planning our electric future: a White Paper for secure. some other means to recover costs and meet the liabilities under FiT CfD contracts. commercial and financial skills: specialist financial and commercial expertise in order to establish effective contracting and tariff-setting arrangements as appropriate for these policies. the short and long-term investment opportunities and the interactions between different policy interventions and the impact on the electricity market.

This role will remain with the government. managing complex calculations and potentially large payments in a timely and efficient manner. to ensure that the government’s objectives. are secured. there are a number of core functions that will need to be carried out by the government and a delivery organisation or organisations.9 In order to deliver the policies successfully.10 setting the overall policy approach and objectives: defining the overall approach and strategic outcomes for the policy. by establishing detailed technical requirements in a transparent delivery plan that is understandable to all market participants. translating the policy objectives into technical requirements: setting out how the policy should be delivered. decarbonising the electricity sector and cost-effectiveness. the core functions are: ●● 4. This role will likely be given to an arm’s length organisation or organisations. This role will likely remain with the government although this could potentially be given to an arm’s length organisation or organisations.Planning our electric future: a White Paper for secure. for example.11 Figure 15 provides an illustrative model for the institutional arrangements for the FiT CfD. 84 . This could involve negotiating contracts directly with generators or it could mean overseeing contracts between third parties such as suppliers and generators. data reconciliation and managing payments: collecting large amounts of data. ●● ●● ●● ●● 4. such as security of supply. In summary. affordable and low-carbon electricity Delivery model 4. delivering the contracts: negotiating where appropriate and delivering contracts with market participants. and monitoring compliance and enforcement: ensuring compliance with the required technical standards and the monitoring and governance obligations. The precise split of functions may differ for different policies and will depend on the approach taken on the Capacity Mechanism following consultation.

will periodically evaluate. 2021 etc) and Spending Reviews. their future strategy in the light of possible changes in costs. The first of these assessments will be in 2016 and will also consider whether the new contract structure for low carbon is delivering all the benefits.Planning our electric future: a White Paper for secure. especially for consumers.12 Generators An integral part of this illustrative delivery model will be the planning and review process that enables the policy objectives and approach set by the government to be translated into policy delivery so as to assure investors that both the delivery organisation and the government are committed to delivering these objectives. A regular and pre-determined planning cycle could take place on. any changes would be made in the light of our continued commitment to grandfathering and no retrospective change. technological developments and new challenges to the energy system. working jointly. 2016. according to a planning cycle clearly laid out in advance. The Government and the delivery organisation(s). 4. for example. and on this basis consider any amendments to the future approach that may be required. that we expect. and improvements over the existing Renewables Obligation. a five-yearly basis and should be timed to be consistent with other processes such as the setting of carbon budgets under the Climate Change Act (in 2011.13 4. As now.14 85 . There could also be a framework document setting out the government’s policy objectives and other standard governance tools such as annual reports. affordable and low-carbon electricity Figure 15: An indicative delivery model for Feed-in Tariff with Contracts for Difference Setting policy objectives and approach: Government Translation of objectives into clear delivery plan ARM’S LENGTH ORGANISATION(S) Contract negotiations or tendering (in long run) Managing/overseeing payments Monitoring compliance and enforcement Contracts and payments Suppliers 4.

In this case a single organisation for both mechanisms may be appropriate. a new public corporation.16 4. affordable and low-carbon electricity Options for delivery organisation(s) 4. Potential synergies include: similarities in information technology systems. contract management. 86 . The delivery organisation(s) could be: ●● 4. There may be synergies between delivering the FiT CfD and elements of delivery of a Capacity Mechanism. and/or a private sector body. However. payment management and enforcement) could be performed by a separate entity or the same delivery organisation. This Review underlined the importance of ensuring that DECC is able to respond effectively to any future delivery challenges.g.18 An important wider consideration is the Government’s recent Delivery Review which considered the delivery undertaken by a number of DECC’s arm’s length bodies. on the chosen Capacity Mechanism.17 a new Executive Agency or Non-Departmental Public Body (NDPB). The Review’s conclusions are summarised in Box 8. an existing public body. there are also several elements of the policies which are different and could justify different organisations. generator and supplier relationships and the need to manage interactions between the two mechanisms.Planning our electric future: a White Paper for secure. Specific delivery functions (such as data reconciliation. ●● ●● ●● Wider considerations 4.15 The institutional framework may require one or more delivery organisation depending e.

and • DECC will set up a new Office which will provide a wider energy efficiency strategy and strong programme management.gov.decc. Ofgem plays a critical role as the energy market regulator.uk/en/content/cms/about/partners/review/review. affordable and low-carbon electricity Box 8: DECC Delivery Review The conclusions of the DECC Delivery Review69 were published on 19 May 2011. 4. to ensure maximum value for money and improved oversight by DECC Ministers. The Government has recently reviewed the role of Ofgem and published the full findings alongside this White Paper. the Environment Agency. • focussing delivery of our energy efficiency objectives through the Green Deal.Planning our electric future: a White Paper for secure. to provide maximum value for money. the Carbon Trust. but with aspects of delivery contracted out. competitively tendering where possible the services that will underpin it. Ofgem E-Serve. 69 DECC Delivery Review. • for new programmes. and develop a joined-up view of the customer offer. This will mean: • improved governance for the delivery of existing DECC programmes.aspx 87 . delivery will be led by DECC to ensure accountability to Ministers. where possible and appropriate. The Review outlined a number of measures to help ensure DECC is able to respond to the future delivery challenge. unless there is a clear case for placing delivery with a third party. The Review considered the delivery undertaken for DECC by a number of arm’s length bodies including the Energy Saving Trust. the Coal Authority and the Energy Development Unit (within DECC).19 It is also important to consider the wider landscape of bodies already acting on behalf of the government in the energy sector. As set out above. May 2011: http//www. summarised in Box 9.

70 The Government will continue to develop the institutional design in line with the key criteria and considerations set out in this chapter and through engaging with stakeholders as appropriate.uk/en/content/cms/meeting_energy/markets/regulation/ regulation. the precise remit it will be given by the government.gov.21 70 DECC Ofgem Review.decc. The report emphasises the Government’s continuing commitment to a framework of independent economic regulation for the energy sector and to Ofgem as the independent regulator. and other relevant bodies. Ofgem will continue to operate independently in deciding how to regulate the energy markets. 4. affordable and low-carbon electricity Box 9: Conclusions of the Ofgem Review The Government published the high-level conclusions of the Ofgem Review on 19 May 2011. A full report is published alongside this White Paper70. This document will: • set out the Government’s policy goals for the gas and electricity markets. The Ofgem Review concluded that Ofgem’s statutory duties are appropriate and reflect the issues that the regulator should consider in making their decisions. and compatibility with Government policy on the establishment and governance of arm’s length bodies.Planning our electric future: a White Paper for secure.20 Other important considerations in determining the institutional framework for Electricity Market Reform include ensuring value for money. Next Steps 4. Ofgem.aspx 88 . However. minimising the administration time and the costs of setting up any new organisation or amending an existing one. the current framework of broadly-scoped duties and weak guidance is very unlikely to be able to support a predictable regulatory environment that is coherent with Government strategy. and • define policy outcomes that Government considers Ofgem to have a particularly important role in delivering. but will be required to demonstrate how its decisions support delivery of the policy outcomes defined by Government. as the energy sector goes through a period of substantial change over the coming decades. The full details on which organisation(s) will be responsible for administering contracts. May 2011: http://www. the appropriate governance and accountability arrangements and more details on the contracting and planning cycle will be published around the turn of the year. • describe the roles and responsibilities of Government. A new statutory ‘Strategy and Policy Statement’ will be established.

the need for viable routes to market. This section sets out: ●● 5. but also to enable Electricity Market Reform to deliver efficient and cost-effective reforms. not only to ensure a competitive market and promote long-term security of supply. • Independent generators. The Government also recognises that independent suppliers face barriers to entry that need to be addressed. need viable routes to market that meet their commercial needs and allow them to achieve the relevant reference prices to enable them to benefit from the Feed-in Tariff with Contract for Difference (FiT CfD) and some Capacity Mechanism options. Electricity Market Reform and the liquidity reforms reduce barriers to entry and deliver the necessary improvements in wholesale market liquidity. including new entrants. including new entrants. the impact of low liquidity and Ofgem’s liquidity proposals. and the Government’s view on liquidity and barriers to entry. Introduction 5. and overall low levels of liquidity.Planning our electric future: a White Paper for secure. • The Government will work closely with Ofgem to ensure that. limited routes to market for some independent generators. The Government will act where necessary to introduce reforms where the structural barriers to market entry are not addressed through the actions taken by Ofgem. We focus on the issues facing independent generators.1 There are barriers to entry in the electricity generation and supply markets including the costs and complexity of participation. ●● ●● ●● ●● 89 . the importance of reference prices. The Government welcomes Ofgem’s work in addressing liquidity issues through its Retail Market Review. affordable and low-carbon electricity Chapter 5 – Paving the way for new entrants Summary • There are a number of barriers to entry and growth in the UK’s electricity generation markets. • Significant improvements in wholesale market liquidity are essential.2 the current market arrangements. taken together.

●● ●● ●● ●● 5.5 The current market climate is not as conducive as it could be to the participation of new entrants.ofgem. credit – collateral and financing risks related to wholesale market trading. These risks include: ●● offtake risks71 – it is important that generators have a viable route to market. a limited range of products that do not meet their needs and a difficulty in meeting their hedging requirements72. 71 Offtake refers to the sale of power from generation projects. viable routes to market. and basis risk – which is the risk of deviation between the market price achieved by the generator and the reference price in. a natural hedge between generation and supply activities. for example. ●● ●● Current market arrangements 5. 72 http://www. price risks – the FiT CfD proposals address the price risk for low-carbon generation (subject to achieving the reference price).3 The Electricity Market Reform package is designed to support a wide range of investors and attract new entrants to the generation market. Market liquidity is a key issue. affordable and low-carbon electricity Context 5. For other generators. including potentially limited routes to market for some independent generators including new entrants.4 All generators need to manage a range of risks in order to operate effectively in the wholesale market. Independent market players have identified a range of concerns including large trade sizes. Credit terms are a commercial matter for the parties. including gas generation.Planning our electric future: a White Paper for secure. but there are related concerns that in part may be a consequence of poor liquidity. FiT CfD contracts. the hedging of fuel purchases. balancing risks – including the need to buy and sell power in the intra-day market and avoid exposure to the cash out price (discussed in Chapter 3). and robust and reliable reference prices accessible to all generators. small and independent generators. carbon price and power sales are likely to be an important part of managing price risks. for example. Risk management can be more challenging for independent generators and suppliers than for the large vertically-integrated power companies which have.uk/Markets/RetMkts/rmr/Documents1/summer%202011%20assessment.pdf 90 .gov. but it is important that the market participants are able to efficiently manage their exposure across all their trading activities. The Government wants to see reduced barriers to entry and a market that provides: ●● sufficient overall liquidity to ensure that all market participants can readily buy and sell energy and efficiently manage their risks.

Ofgem identified a number of possible reasons for low liquidity. increasing confidence in traded prices (a large number of gas and electricity supply contracts between buyers and sellers are referenced to market prices). where the same supply group owns generation capacity and also supplies energy to the retail market. A lack of liquidity in the electricity wholesale market makes it difficult for independent suppliers and generators to buy and sell energy at the volume and in the timescales they need to operate effectively in the energy market and undermines investment signals. a generator might hedge the risk of electricity price movements: • financially by selling electricity in the forward markets or entering into long-term contracts.gov. while evidence suggests that the day-ahead markets74 tend to offer reasonably liquid trading (and are improving)75. seasons and years ahead of delivery. and facilitating new entry in generation and supply by allowing new entrants to buy and sell electricity to match their output and customer base with confidence.6 Ofgem has identified particular concerns around the low levels of liquidity in the forward markets73. and may include trades in months. 73 ‘Forward’ trading refers to buying and selling for delivery of electricity in the month ahead and after. ●● ●● Stakeholder views on Electricity Market Reform Overview of December 2010 consultation responses 5. which inform investment decisions and promote long-term security of supply. 76 Where one supply group owns two or more parts of the energy supply chain.pdf. which also inform investment decisions. affordable and low-carbon electricity Liquidity in electricity wholesale markets 5.7 allowing parties to better manage long-term risk and providing longterm price signals about future market development.Planning our electric future: a White Paper for secure.ofgem. with the objective of reducing exposure to (short-term) price movements in an asset already held. Hedges can be either financial or physical. 74 ‘Day-ahead’ trading refers to buying and selling for delivery of electricity on the day after trading takes place.gov. Liquid markets offer a range of important benefits.uk/Markets/RetMkts/rmr/Documents1/RMR_Appendices. or • physically by integrating with an electricity supply business. 77 ’Hedging’ refers to making some kind of investment. Some stakeholders argued that improved liquidity would provide a FiT CfD with reliable reference prices and could reduce the need for a Capacity Mechanism. Normally. For example. For example. There was a range of views on the measures needed to improve liquidity.pdf. 91 .uk/Markets/RetMkts/rmr/Documents1/summer%202011%20assessment. including the role of vertically-integrated76 generators who may have less need to trade and are able to hedge77 between their supply and generation activities.8 Many stakeholders considered that improved liquidity would be essential to the success of Electricity Market Reform and highlighted the importance of aligning Ofgem’s liquidity project and Electricity Market Reform. The most recent assessment can be found at: http://www. including: ●● 5. 75 http://www.ofgem. a hedge consists of taking an offsetting position in a related asset. such that any downward movement in prices resulting in a loss in revenues for the generation business is offset by an increase in revenues for the supply business. including some form of trading obligation and centralisation of electricity trading arrangements.

Ofgem announced a programme of work in June 200978 to improve liquidity in the wholesale electricity market.uk/Pages/MoreInformation. Ofgem’s March 2011 Retail Markets Review (RMR)79 showed that liquidity fell overall in the GB power market over the course of 2010 from an already low base. especially when compared to a Fixed Feed-in Tariff.9 Many independent players.10 Ofgem’s liquidity project 5. and some financial players. 92 . in particular independent market players.ofgem. 81 A new licence condition that would require large vertically-integrated players to offer buy and sell prices for specified products and volumes on a continuous basis.13 78 http://www. both a FiT CfD and a Premium Feed-in Tariff (PFiT) could help prevent any deterioration in short-term liquidity. 5.aspx?file=RMR_FINAL.gov.11 5.gov. and would need to be improved. require to compete against existing firms and to encourage competition between vertically-integrated players.aspx?docid=58&refer=Markets/WhlMkts/CompandEff 79 http://www.ofgem. Ofgem considered that its proposals would improve competition and contestability in the energy retail markets to the benefit of consumers. Ofgem concluded that the market was failing to develop and that action was required. affordable and low-carbon electricity 5. the Government feels it is essential that there is sufficient liquidity in relevant products across the whole market to offer a robust reference price and the means for independent generators of all sizes to manage their balancing and offtake risks. including wind developers.12 5. argued that current levels of liquidity were low. Others felt that current levels of liquidity would not pose significant barriers to investment or to reliable reference prices.uk/Pages/MoreInformation. It put forward two proposals for intervention (the Mandatory Auction80 and Mandatory Market Maker81) to provide the electricity market liquidity that market participants. In the context of Electricity Market Reform. There was also a recognition from many stakeholders that a FiT CfD could concentrate liquidity in markets linked to reference prices.pdf&refer=Markets/RetMkts/rmr 80 A new licence condition that would require large vertically-integrated generators to make available between 10 per cent and 20 per cent of their power generation into the market. Some stakeholders felt that.Planning our electric future: a White Paper for secure. by retaining exposure to market prices and providing incentives to trade. Ofgem’s final decision regarding intervention will be reached following the publication of an Impact Assessment by the end of 2011.

g. be transitional issues arising from the shift from the RO to the FiT CfD system that may create offtake uncertainty and/or lead to less favourable PPA terms than might currently exist. ●● 5. PPAs would only be available at a steep discount. through brokered Over the Counter (OTC) contracts or on power exchanges.Planning our electric future: a White Paper for secure. A more liquid market could play an important role in allowing independent generators. The Government anticipates that these uncertainties will stabilise over time and any price discrepancies should be eroded through competition. including new entrants. to trade directly and may encourage aggregation services from market participants who act on behalf of generators to sell power and manage risks across a portfolio. some smaller generators may still prefer to pass the risk of managing trading and balancing risks on to bigger companies through PPAs. Regardless of the depth of market liquidity. however. e. As with the current Renewables Obligation (RO).14 All generators need to be able to sell their electricity in a way that meets their commercial needs. or sell power directly in the index market(s). by providing long-term price certainty. The Government will. however. At a high level there are two routes to market: ●● sell power through a Power Purchase Agreement (PPA) with a supplier or aggregator who will manage key risks including offtake and balancing risks on behalf of the generator. have raised concerns that poor levels of liquidity could leave them with no choice but to enter into PPAs to secure finance for investment and that. Some independent renewable generators. The Government’s view is that those firms that are able to manage balancing risks associated with intermittent renewables will still find opportunities in offering PPAs.17 5. should that prove to be necessary.16 5.18 93 .15 The FiT CfD. they may not in themselves address all the issues that might make it difficult for some independent generators and a wider range of new entrants to secure a viable route to market. take action to improve routes to market. affordable and low-carbon electricity Routes to market 5. There may be new opportunities for those other than suppliers to offer aggregation services and enter the PPA market. The Government will keep the evidence under review. therefore. not least because direct market participation can be complex and may require an in-house trading capacity. 5. There may. While Ofgem’s current liquidity reforms may support both direct trading and the role of aggregators to some extent. in the absence of a supplier obligation. will help to mitigate some of the risks that can prevent generators from trading directly in the market. market economics and competition will determine the discount that generators are exposed to.

Moreover. 5.gov. Ofgem published its final proposals for a ‘Licence Lite’ regime in February 200982. Current day ahead market indices are likely to provide a sufficiently robust reference price. The current volumes traded on the day ahead market are enough to absorb initially relatively small quantities of FiT CfD supported power from 2014. it is extremely important that liquidity in this market does not deteriorate and that volumes in the market are not displaced. the participation of FiT CfD backed generation in the market is likely to further strengthen liquidity in the day ahead market.20 Reference Prices 5. but they may be deterred by the costs and complexity of acting as an energy supplier.21 5. uk/Markets/WhlMkts/CompandEff/Documents1/GB%20wholesale%20electricity%20market%20liquidity%20-%20 summer%202010%20assessment. pdf 83 Ofgem estimate four per cent in the day ahead and nine per cent in the forward market. including with the involvement of the third sector. http://www. This will allow small electricity generators to become licensed suppliers under a regime which is proportionate to their size and impact.19 For some small distributed generation there may be opportunities to supply directly to consumers. Improved liquidity is essential to ensure credible reference prices.ofgem. The Government is interested in the opportunities provided by community finance initiatives and is equally keen to ensure there is appropriate support for new investors. However. Relatively small volumes are traded on these power exchanges. while protecting consumers’ rights to switch energy supplier. The Government is closely monitoring progress made by the industry in using these proposals to gain better access to the market.pdf 94 . These relatively low volumes of traded energy and the small number of participants may make it harder for generators to secure the reference price and may lead to potential for manipulation of the indices83. Joint action on such projects can spread risk across a number of players and help to leverage investment.gov. which are a key element in investment decisions and in the operation of the FiT CfD (see Chapter 2) and some types of Capacity Mechanism (see Chapter 3 and Annex C). affordable and low-carbon electricity 5.Planning our electric future: a White Paper for secure. Reference prices can be drawn from a number of market indices reflecting bilateral trading including OTC deals arranged through a broker and activity on power exchange platforms.22 5.23 82 http://www. have proven to be successful options for supporting development of distributed generation projects that can increase diversity of supply at the same time as meeting the needs of local people. Cooperative fund structures and not-for-profit business models. including supporting local fuel poverty objectives. The costs of providing support through the FiT CfD are likely to be lower where the reference prices against which the level of support is assessed properly reflect the fair market price.uk/sustainability/environment/Policy/SmallrGens/DistEng/Documents1/DE_Final_Proposals.ofgem.

For a Capacity Market. due to low levels of liquidity. Poyry. have a viable route to market.26 The Government’s view 5. Forward market reference prices are not reliable. including new entrants. We can minimise costs by removing barriers to entry and increasing competition in the market. 95 . We anticipate that Ofgem’s work will strengthen liquidity in the forward market and help to provide credible reference prices. but this may mean trading has been displaced from other markets. Should Ofgem decide to bring forward a Mandatory Auction as is currently proposed. in particular by improving market liquidity and providing more reliable reference prices and ensuring that all independent generators. to function properly.29 84 Why we need to fix our broken electricity market.25 5. The Government’s view is that the market indices. This may pose a basis risk if platforms used by FiT CfD supported generation are out of line with the indices that make up the reference price. 5. in the form of a Reliability Market. The Government sees Ofgem’s work on improving liquidity as complementary to the Electricity Market Reform package and welcomes the clear direction of travel set by Ofgem in its recent proposals.28 5. including reporting of brokered trades and activity on power exchanges.Planning our electric future: a White Paper for secure. A more liquid market also supports security of supply through better price formation and stronger investment signals. special report. The Government will keep this evidence under review. are currently closely aligned. security of supply and affordability. affordable and low-carbon electricity 5. A more liquid spot market also reduces offtake risk and means that closing out positions in a long-term contract could be easier84.24 Some stakeholders raised concerns about the fragmentation of day ahead market liquidity between a number of trading platforms. There are also possible interactions between Ofgem’s proposed interventions to improve liquidity and a Capacity Mechanism. In particular the market that provides this reference price could see increased liquidity. The Government will act where necessary to introduce reforms where the structural barriers to market entry are not addressed through the actions taken by Ofgem. The Electricity Market Reform package seeks to address the Government’s objectives in relation to low-carbon generation. it is possible that such an auction could provide a transparent and robust reference price for the baseload FiT CfD.27 5. 2008. it would need a reference price for wholesale electricity to determine the payback required from generators.

To the extent that there are continued barriers to entry that are not addressed through Ofgem’s actions. This includes consideration of whether in combination the measures lead to sufficiently robust reference prices and to all market participants having routes to market.gov. The Government will continue to work closely with Ofgem to ensure that the Electricity Market Reform package and Ofgem’s work on liquidity are effectively aligned. 5. Ofgem expect to publish an Impact Assessment and its decision towards the end of 2011.aspx?docid=59&refer=Markets/RetMkts/rmr 96 . based on its latest full assessment and preliminary review of consultation responses. affordable and low-carbon electricity Next steps 5.uk/Pages/MoreInformation. to introduce a Mandatory Auction and Mandatory Market Maker obligation.ofgem.30 Ofgem published an updated assessment and set out their next steps in June 201185. Ofgem is minded.Planning our electric future: a White Paper for secure. the Government will work with all relevant stakeholders to identify appropriate solutions.31 5.32 85 http://www.

The future electricity network will need to be able to support the new lowcarbon generation promoted by the Electricity Market Reform package. security of supply and affordability. focusing on challenges around balancing and system flexibility. Introduction 6. The Government has a responsibility to ensure this transition. the development of the distribution network. this responsibility. changes to the energy system associated with decarbonisation will lead to increasing and new forms of demand. Ofgem. In future. will be reflected in the Strategy and Policy Statement (see 6. The reforms will change the generation mix. We will also be setting out our electricity systems policy. will be an increasing priority going forward. • The Government recognises the need for strong leadership on networks and ensuring effective balancing of supply and demand going forward. presenting a challenge as well as an opportunity for networks and the way we balance supply and demand. These changes will impact on the regulated parts of the electricity sector.3 97 . The Government and the energy regulator. in summer 2012. • Changes to the network and growth in demand side response (DSR). through the use of DSR. affordable and low-carbon electricity Chapter 6 – Future networks and system flexibility Summary • The changes driven by Electricity Market Reform will have a significant impact on future networks and the way supply and demand is balanced. have already made strong progress on the delivery of transmission networks in the context of decarbonisation. At the same time. in order to meet wider objectives around decarbonisation. leading to increased levels of inflexible and intermittent generation. storage and interconnection. storage and interconnection will need to accompany the transformation of electricity generation that is at the core of the reforms. While this important work will continue. • We are setting out future work to address network issues that will be taken forward through the Smart Grids Forum.Planning our electric future: a White Paper for secure. and any related policy trade-offs. We also need to ensure the market can deliver the right amount of flexibility.2 6. enabling the best use of generation assets. and the use of smarter approaches and technologies.1 Electricity Market Reform introduces incentives to the market to drive investment in generation. much of which will need to be built in new locations.

in the main. and the protection of consumers’ interests in these monopoly sectors. This has been achieved through Government setting a framework of independent regulation to deliver both the networks and system operation needed.4 This section sets out: ●● progress to date in addressing network challenges. 6.Planning our electric future: a White Paper for secure. Networks have delivered secure energy from generation which is responsive to the daily fluctuations in demand.decc.aspx 98 . See Box 10 for further details. at relatively low cost to consumers.6 Recent policy and progress on transmission networks 6. to consumers across the country. primarily to ensure that new generation in new locations is able to connect to the system promptly and efficiently. affordable and low-carbon electricity Chapter 5) that will be introduced through the implementation of the Ofgem Review conclusions86.5 The GB electricity network has developed to facilitate power flows.gov. while the distribution network (the local network that delivers to consumers) has developed as a more passive system.7 6. and that the system is able to deliver the necessary electricity to consumers. and the Government’s future work programme to address future challenges in this area. There has been significant activity within Government over the past two years to develop networks policy and manage the challenges to meet our 2020 renewable targets.8 86 http://www. ●● ●● Context Evolution of networks policy 6. 6. from large-scale centralised generation. The transmission network (the ‘motorways’ of the electricity system) has evolved to be relatively smart and actively managed. the implications of the changes driven by the Electricity Market Reform package for networks and balancing.uk/en/content/cms/what_we_do/uk_supply/markets/regulation/regulation. This work has focused on the transmission network.

It will also make funding available to ensure more investment is directed towards network innovation.uk/Networks/Trans/PT/Pages/ProjectTransmiT.uk/en/content/cms/meeting_energy/network/ensg/ensg. ‘Connect and Manage’ has to date reduced connection times for 69 large generation projects by an average of six years and has also benefitted 74 small-scale generation projects. affordable and low-carbon electricity Box 10: Government projects on networks a) Transmission Access Review87: in order to improve access to the network. helping to facilitate the achievement of our 2020 targets. 91 http://www. Progress by the regulator on the investment framework878889 6.gov. from April 2010: http://www.aspx 88 http://www.decc. c) Electricity Networks Strategy Group (ENSG)89: the Government has worked with Ofgem and industry through this group to produce analysis on the transmission upgrades that might be necessary to meet the UK’s 2020 renewables target. The Government is also keen to see the positive activity being taken at the transmission level fed into future thinking in the context of distribution networks. the Government implemented the ‘Connect and Manage’ regime on an enduring basis in August 2010. 6. b) Offshore Transmission88: the Government has worked with the regulator to implement an innovative regime for offshore transmission. Ofgem has also initiated Project TransmiT92.gov.uk/en/content/cms/meeting_energy/network/deliv_access/deliv_access.gov.aspx 89 http://www. The Government will continue to work closely with Ofgem to ensure that its objectives are taken into account. The Government and Ofgem are also undertaking the Offshore Transmission Coordination Project with industry to maximise opportunities for coordination of transmission infrastructure.decc.ofgem. Ofgem has also developed a new regulatory regime for investment in the electricity and gas networks through its ‘Revenue = Incentives + Innovation + Outputs’ (RIIO) framework.uk/networks/elecdist/lcnf/pages/lcnf. which finances projects to show how the distribution network could work in a low-carbon context.decc.Planning our electric future: a White Paper for secure.aspx 90 The Low Carbon Networks Fund made up to £500 million available to distribution network operators over five years. Network companies will be encouraged to play a greater role in facilitating decarbonisation.ofgem.ofgem.gov. We plan to refresh this analysis and extend the scope to 2030.gov.aspx?docid=120&refer=Media/FactSheets 92 http://www.9 Ofgem began to increase incentives on network companies to innovate with their Low Carbon Networks Fund90. Both of these projects are owned and led by the regulator. which will consider whether the current transmission charging arrangements are suitable to deliver low-carbon generation while maintaining secure and affordable supply. RIIO91 sets a framework to encourage network companies to take a more strategic and longer term approach to network investment.uk/Pages/MoreInformation.aspx.10 87 http://www. This built on successful interim arrangements introduced by Ofgem.uk/en/content/cms/meeting_energy/network/offshore_dev/offshore_dev.gov.aspx 99 .

At the same time networks will also be bigger to cope with increasing electrification and to connect up generation in new areas. reducing their overall energy bills in the process. will also interact with the network. such as widespread charging of electric vehicles and use of heat pumps. Information and communications technology will provide greater visibility of the flows on their networks. and making the best use of available distributed energy resources. directly contributing to managing challenges on the network. helping us make the most efficient use of energy resources across countries. At the transmission level. with diversity in generation and demand across Europe and potentially even beyond. Since then the Government has undertaken further work to develop our understanding of the transition that the whole system connecting generation to demand will need to undergo. DECC set out its initial view of future networks in ‘Smarter Grids: the Opportunity’93 in December 2009.decc. storage and interconnection. in innovative ways. which will enable them to match their consumption to times when there is more generation available.uk/en/content/cms/what_we_do/uk_supply/network/strategy/strategy. Consumers will be engaged in how they consume electricity and will have access to a range of tariffs and offers. we will be much more integrated with other markets. This has included analysis of the future balancing challenge and the role of DSR. both onshore and offshore. and distributed energy storage. helping to manage local network constraints and balance supply and demand. Distributed energy.gov. allowing operators to make the most efficient use of available network capacity. shifting from times when prices are high to those times when prices are lower. Distribution network operators will be playing a more active role. and therefore cheaper.Planning our electric future: a White Paper for secure. affordable and low-carbon electricity Network development in the long term 6. As a result.11 The Government has also begun work to establish how the network may need to adapt to future challenges. reducing the pressure on centralised generation. 93 http://www. demand will be more responsive to changes in the electricity price. Box 11: A vision for future networks and system flexibility By 2030 electricity networks will be delivering to consumers in the context of a significantly decarbonised economy both on the generation and demand side.aspx 100 .

the pressures on the network are increasing. At the same time. interconnection and electricity storage. as we go through the 2020s. but daily fluctuations in demand could be much larger. Potential changes to the demand side are shown in Figures 16 and 17. Not only is overall demand likely to increase by 2030. There could also be increased levels of localised and community-based energy.12 Looking ahead. such as DSR. The reforms set out in this White Paper will drive increased levels of intermittent renewable generation. we will derive the flexibility we need from other sources. affordable and low-carbon electricity The challenge ahead 6. Increased demand with different load patterns. which would make managing the local network more complex than it is today.14 101 . will pose significant challenges to local networks and the balancing of the system. as well as an expected increase in population. Ofgem’s Low Carbon Networks Fund is beginning to trial how some of these technologies could interact with the network. due to the electrification of heat. new low-carbon technologies will present an opportunity for networks and balancing. as they will enable significantly more demand shifting. and higher levels of inflexible generation. such as nuclear. In the medium term this flexibility could come from fossil fuel based plant. These changes mean that there will need to be more flexibility in other parts of the electricity system. 6.13 6. the period up to 2030 is likely to see significant new challenges.Planning our electric future: a White Paper for secure. in particular. but the challenges will grow looking forward. In the longer term. transport and industrial processes.

uk/en/content/cms/tackling/2050/2050. before any demand side response is taken into account.aspx 102 . Figure 17 shows an illustrative scenario of how this could look on an average week in November 2030.gov. 94 http://www. Note: Figure 16 shows the shape of current national demand.Planning our electric future: a White Paper for secure. affordable and low-carbon electricity Figure 16: Illustrative example of a seven-day demand profile in 2010 100 80 2010 Demand (GW) 60 40 20 0 Mon Industrial Tue Wed Commercial Thu Domestic Fri Sat Resistive heating Sun Figure 17: Illustrative example of a seven-day demand profile in 2030 100 80 2030 December (GW) 60 40 20 0 Mon Industrial Heat pump Tue Wed Commercial Plug-in vehicle Thu Domestic Fri Sat Resistive heating Sun Source: Based on DECC’s 2050 pathways analysis ‘spread effort’ pathway which shares ambitious efforts on decarbonisation over all sectors including demand and generation94.decc.

Without guidance from the Government. along with Ofgem.aspx 103 . in particular DSR. transport and other sectors is a key challenge.19 6. This will complement the ongoing Low Carbon Networks Fund trials. will provide an important mechanism for Government to set out any strategic policy trade-offs that it considers need to be made to develop the future network and deliver the flexibility we need. A bigger. In the future.18 Smarter distribution network development 6. We will set out our electricity systems policy next year. However.decc. Current thinking suggests that a gradual increase to 2020 will need to give way to a significant ramp-up in deployment in the period to 2030.uk/en/content/cms/meeting_energy/markets/regulation/regulation. 6. storage and interconnection.16 Future Work Programme 6. there is a risk that uncertainty over the rate of change could lead to insufficient or inappropriate investment. the Government will need to consider the overall framework through which supply and demand is balanced. as detailed in the conclusions of the Ofgem Review95. the Government will lead work through the Smart Grids Forum. This will focus on trajectories for the take-up of electrified transport and heating as well as distributed generation. the Strategy and Policy Statement. and is planned for publication in early 2012.Planning our electric future: a White Paper for secure. smarter distribution network will need to be developed. Therefore. The Government has begun work through the Smart Grids Forum. This will include the role we expect different sources of flexibility to play in the future. a cross-industry group that it leads with Ofgem. affordable and low-carbon electricity 6. to develop a set of shared scenarios and assumptions to act as a guideline for network companies and the regulator in making decisions about future network investment. Core to meeting these challenges will be the development of a smarter distribution network. significant uncertainty over the rate of electrification means it is difficult for distribution network investment to anticipate and prepare for changes elsewhere in the system. scale and nature of developments in networks that will be required. The Government believes that all these challenges may require a fundamental transformation in the way the network links generation and demand and in how the system operates to keep demand and supply in balance. There is uncertainty over the speed.17 6. In addition. resulting in the network being unable to deal with future challenges. particularly in response to greater electrification of heat and transport and increasing distributed generation.gov.15 Uncertainty over the rate of electrification of heat. The Government can help by providing some clarity about what might be expected from networks in the future. to consider how future network challenges can be addressed. We will need to understand what changes might be required to the system framework and the incentives within it to ensure secure system balancing.20 95 http://www.

Distributed generation is electricity generation that is directly connected to a local distribution network.aspx. . particularly in the case of heat.uk/en/content/cms/consultations/microgen_strat/microgen_strat. While these options can have high upfront capital costs. Box 12: Distributed Energy Alongside the Electricity Market Reform. such as waste to energy plants. In some cases such technologies are also able to export any excess electricity to the distribution network. distributed energy commonly takes the form of individual building-scale installations such as micro wind and solar photovoltaics96. The economies of scale and efficiencies of the larger installations in commercial and industrial sectors means they can provide additional benefits over domestic installations. which generate useable heat consumed locally. where properties are connected to local electricity networks or district heating schemes. Because distributed generation often involves the simultaneous generation of useable heat. to develop a framework for understanding and evaluating the value drivers for smart grid solutions. This will also aim to identify the factors that influence these drivers and how these change over time. it is often referred to as distributed energy. A final report is planned in spring 2012. affordable and low-carbon electricity 6. 96 104 96 For further information see the DECC Microgeneration Strategy: http://www.decc. rather than to the high-voltage electricity transmission system. The framework should facilitate discussion between Ofgem and network companies in the business planning process. The viability of such district systems. thus helping to reduce demand. allowing them to consider pay-back periods in excess of those that may be acceptable to individual consumers. either through district heating schemes or for industrial use. which can generate electricity for local consumption. This is particularly true of combined heat and power schemes. This greater scale can also open up a range of additional options.21 In addition Ofgem will be leading work. These options currently require electricity and gas respectively to operate. particularly where heat distribution infrastructure is required.Planning our electric future: a White Paper for secure. but are more efficient than traditional electricity and gas heating.gov. with the Government’s help. there is a parallel challenge to unlock the potential of distributed energy. At the domestic scale. Domestic properties can also benefit from community or direct-scale distributed energy. potentially creating revenue for the owner. is often dependent on the density of demand and the proximity of low-level demand to ‘anchor loads’ like hospitals or commercial/industrial users. larger organisations are usually better placed to take a longer term view of their energy needs. Domesticscale distributed energy technologies that generate heat include heat pumps and micro-Combined Heat and Power (CHP).

To ensure proposals in this document and changes taking place across the sector deliver in practice on our ambition. In particular. They can also be an important tool in engaging consumers in their energy use. affordable and low-carbon electricity Box 12: Distributed Energy (continued) Used in the right ways and as part of an evidence-based approach to energy planning. How does distributed energy fit within the context of the Electricity Market Reform? The Government recognises the need to facilitate action at the distributed scale and. since the electricity produced by distributed electricity generation is normally consumed locally. and • Ofgem is taking action to improve market liquidity. These include the following: • both types of Feed-in Tariff (FiT) and the Capacity Mechanism will encourage distributed generation in different ways (see Chapter 2 and 3). local-level distributed energy systems could be an important step towards a more coordinated approach that includes. and therefore help manage demand on the electricity system. as an alternative to heat being generated from electricity. In the context of this White Paper. There is also potential for this heat storage to be charged by excess electricity generation resulting in further opportunities for demand side response (DSR). we will convene a Government Industry Contact Group on Distributed Energy. and it can also reduce the need for transmission network reinforcement. we recognise that integrated. so contributing to the decarbonisation of electricity and security of supply. Distributed energy and local generation could have a much greater role to play in the future energy system and the Government recognises the need to put in place the conditions to unlock its potential. • as it is local. it lends itself to community involvement and investment. and • distributed energy can act. which should help smaller players access the market. and will involve a small number of key industry representatives. for example. distributed energy technologies have the potential to complement both each other and the wider centralised energy system.Planning our electric future: a White Paper for secure. our proposals have been developed with consideration of all scales of generation. 105 . distributed energy provides a number of potential benefits: • distributed energy can harness a wide range of smaller-scale renewable and low-carbon energy sources. The group will be chaired by Ministers. transport and waste. especially when combined with communityscale heat storage. the Government will act where necessary to introduce reforms where the structural barriers to market entry are not addressed through the actions taken by Ofgem. As described in Chapter 5. following feedback from the Electricity Market Reform consultation.

DSR helps balance supply and demand in the context of significant amounts of intermittent and inflexible generation. this could involve charging a plug-in vehicle or switching on a washing machine when electricity prices drop below a certain level.25 6. For example. Changes to the way the network is operated. there will be a need for increased flexibility. beyond 2020. Increasing the flexibility of the electricity system will be important both to deal with increasing amounts of intermittent and inflexible generation and to manage constraints on the network.22 As well as ensuring appropriate network investment. This is likely to be important in the short term for larger consumers in the industrial and commercial 6. we will need to ensure that energy suppliers and other providers of services are more broadly enabled and encouraged to engage consumers in DSR. Up to 2020. including the introduction of new Time of Use Tariffs.gov. it appears that most potential for DSR comes from the commercial and industrial sectors. storage and interconnection. As well as rolling out Smart Meters.uk/en/content/cms/consultations/emr/emr.decc. ultimately leading to demand reductions.aspx 106 . increasing electrification of heat and transport means the domestic sector could also play more of a role. However. and growth in solutions such as DSR. and potential for more dynamic shifting of demand. in particular by shifting demand from periods where supply is limited to periods where it is more plentiful.Planning our electric future: a White Paper for secure.27 97 http://www. is an important first step for DSR in the domestic and commercial sectors. Smart Meters will engage consumers in their electricity use by allowing them to better control their electricity consumption.23 6.24 Demand side response 6.26 6. The Capacity Mechanism will play an important role in ensuring resource adequacy and will be designed to enable flexible solutions. There are also technology-specific barriers which potentially require Government intervention. As outlined in the Electricity Market Reform consultation document97. affordable and low-carbon electricity System flexibility 6. in particular DSR. the Government acknowledges the potential for more responsive demand as one of the most cost-effective ways to manage future balancing challenges. storage and interconnection will be needed. smart meters will facilitate innovation in the supply of electricity. We will consider the issues and set out our conclusions as part of the development of our electricity systems policy next year. The following sections look at the issues and potential for action on DSR. The mass roll-out of smart and advanced meters. which we expect to complete in 2019. Chapter 3 and Annex C explore how the Capacity Mechanism could encourage demand side solutions. These flexible solutions will be vital in ensuring we have an electricity system that maximises the use of our low-carbon generation and network assets. As well as stimulating energy efficiency.

from individuals and district heating schemes to heavy industry. while also ensuring consumer protection. will be necessary to maximise DSR potential.31 98 ‘Settlement’ is the process which ensures that suppliers pay for the electricity used by their customers. Further. and providing additional resource when there is a shortage. we will continue to support research and development in storage technology. However. 6.29 Storage 6. The Government will need to make sure that the broader policy framework supports the development of appropriate consumer offers and incentives to participate in demand response. Data from Smart Meters will be important to managing the network in an efficient way. alongside industry.28 It is currently not clear how consumers will respond to greater incentives to shift demand. In particular. combined with uncertainty over future revenues and inexperience in the market. particularly with regard to network and system operation. to develop understanding of the role storage should play in the future electricity system.30 6. Storage can provide benefits to the electricity system by storing electricity in a different form when it is in surplus. and that generators are paid for what they produced. it will be important that the settlement system98 rewards suppliers that shift demand. Positive engagement of consumers at all scales. which may lead to reduction in costs over time. Over the coming months the Government will need to consider whether it has a role in this process. The Government is working with stakeholders to examine the level of data required for these purposes. We also need to ensure that there is a mechanism through which network operators are able to influence demand to manage constraints on the network and maintain security of supply.Planning our electric future: a White Paper for secure. affordable and low-carbon electricity sectors. 6. 107 . high capital costs. At the same time. Storage also has strong potential in system and network operation. The regulator and industry have already commenced work to drive forward some of the necessary changes so that the system is ready to enable DSR. There is a considerable global research and development effort into storage technology. mean that commercial deployment of electricity storage may be limited in the short term. the Government will need to ensure that the broader framework is appropriate to realise the full benefits of storage as part of a low-carbon electricity system. but will be increasingly important in the domestic sector as electrification occurs. It will also be important for the Government.

• The Government has over £200 million100 of innovation funding for low-carbon technologies over four years from April 2011. In addition. interconnection also contributes to security of supply and provides greater competition. and Supergrid99100101 6. when the wind blows heavily on the continent. affordable and low-carbon electricity Box 13: Government activity on research and development into storage • The Government funded two electricity storage projects through the Low Carbon Investment Fund to trial and demonstrate the contribution storage can make in managing distribution networks in the context of decarbonisation.32 Interconnection provides a link between two different electricity markets. This difference in regulatory regimes has created challenges in the development of some projects.uk/Home/Technology-Programmes/EnergyStorageandDistribution. reducing costs to consumers. but are able to capture the financial rewards. For example.decc.uk/en/content/cms/funding/funding_ops/innovation/innov_fund/innov_fund. along with CREG (the Belgian regulator).gov. prices may drop.gov. The winner will be announced before the end of this year. several investors have signalled that they are unwilling to build interconnection under the merchant approach. Diversity in demand and generation results in differences in price between different markets. Ofgem is consulting. on a proposed regulated interconnector investment regime based on a cap and collar approach.Planning our electric future: a White Paper for secure.aspx 101 http://www.33 6.uk/networks/elecdist/lcnf/pages/lcnf. Interconnection.aspx 100 http://www. Interconnectors would then deliver cheaper electricity into the GB market. As well as offering potential for cost-effective integration of renewables.co. The benefit of interconnection in allowing efficient use of available generation will increase with greater levels of inflexible and intermittent generation. Electricity storage is being considered as part of our planning for innovation support. • There are also opportunities to demonstrate and trial energy storage technologies through Ofgem’s £500 million Low Carbon Networks Fund101. This is in contrast to many other EU countries where interconnection is part of the regulated asset base. using project NEMO (proposed interconnection between GB and Belgium) as a pilot 6.aspx 108 . those developing interconnectors under the merchant approach have had to apply for an exemption from the relevant requirements of European legislation.energytechnologies. For instance CE Electric is trialling energy storage in its Customer-led Network Revolution project. • The Energy Technologies Institute99 has launched a competition for the design. In response to these challenges. In light of this. take on the risk of investment.34 99 http://www.ofgem. introducing a level of uncertainty in the regulatory process. build and demonstration of a large-scale electrical energy storage technology. Offshore Transmission. Interconnection in the GB market has traditionally been built on a merchant basis under which investors. rather than consumers.

The work done under the OTCP will be an important input to the Government’s approach in this initiative.102103104 Box 14: Government and regulator initiatives a) The Offshore Transmission Coordination Project (OTCP)102.energy-regulators.uk/en/content/cms/news/pn11_050/pn11_050. This will facilitate the cost-effective exploitation of the renewable energy resources available. but if most current proposals were realised we could have 8-10 GW by the 2020s. As well as the regulatory regime for interconnection. ensure effective exploitation of the renewable resources we have. d) The French-UK-Ireland (FUI) Region regulators forum104. and how compliance with relevant EU legislation might best be achieved. affordable and low-carbon electricity project. there are broader questions around how to coordinate the development of interconnection with the offshore transmission network to: ●● ensure effective trading with other countries. is investigating options for cost-effective market integration. 8-10 GW would be equivalent to around 10 per cent of installed capacity. led by Ofgem and the Government. associated regulatory. c) The All Islands Approach103 will develop an approach to energy resources across the British Islands and Ireland.aspx 104 http://www. ●● ●● 6. and increase integration of our markets and improve security of supply. 6.5 GW of interconnection. technical and planning barriers.gov.decc. and there has been a significant upsurge in proposals for new interconnectors since plans have been announced. b) The North Seas Countries’ Offshore Grid Initiative will consider different configurations for interconnection and offshore transmission. and maximise the benefits of offshore transmission and interconnection.36 The Government and the regulator are engaged in a number of initiatives with domestic stakeholders and neighbouring countries to consider these issues.aspx 103 http://www.eu/portal/page/portal/EER_HOME/EER_ACTIVITIES/EER_INITIATIVES/ERI/ France-UK-Ireland 109 .decc. how the maximum benefits of greater market integration can be captured in each case. taking account of the different market designs in each Member State. 102 http://www. returns above the ‘cap’ would be redistributed to users of the electricity network. and the need for better coordination with EU partners. Currently GB has 3.gov. Though interconnection is not a direct substitute for domestic capacity. Under the cap and collar approach. is considering the need for further measures to allow the potential for coordination within and between different generation zones and with interconnectors.Planning our electric future: a White Paper for secure.35 Ofgem’s cap and collar regime appears to have broad support from industry. Conversely interconnection owners will be refunded by the system if returns are below the ‘collar’ and a project fails to deliver expected benefits.uk/en/content/cms/meeting_energy/network/offshore_dev/offshore_dev.

indicates that de-rated capacity margins fall below 10 per cent towards the end of the decade. alongside domestic capacity. The shared scenarios and assumptions developed through the Smart Grid Forum and set out early next year will act as a guideline for networks companies and Ofgem in planning the next round of distribution network investment. The processes outlined above are a first step in considering how we might approach the development of a European Supergrid in an objective. We will set out our electricity systems policy in summer 2012. storage and interconnection will need to play.41 6. See Chapter 3 and Annex C for further details of how a Capacity Mechanism could integrate with interconnection. In the longer term.39 Next Steps 6.40 6. The development of a framework for understanding and evaluating the value drivers for smart grid solutions. for example via a European Supergrid (a grid which operates across countries and links low-carbon generation with centres of demand). affordable and low-carbon electricity 6. focusing on challenges around balancing and system flexibility. as part of the development of a smarter grid.42 110 . including discussion of the future system framework and how it will need to adapt to deal with future challenges.38 Electricity systems policy 6. to maximise the efficiency of generation and network assets while ensuring security of supply.37 Our analysis. The Government will develop its electricity systems policy next year. further integration of electricity markets. 6. meaning that a Capacity Mechanism is needed. This will facilitate discussion between Ofgem and the network companies as part of the business-planning process. is likely to require a much deeper level of coordination between countries.Planning our electric future: a White Paper for secure. The policy will also address the role that flexible solutions such as DSR. will be led by Ofgem and published in spring 2012. evidencebased manner. We will look at the future management of the electricity system and will set out different options for responding to the changing demands that will be made of the electricity network as a whole. which includes the contribution of current and expected interconnection. also through the Smart Grids Forum. We expect that interconnection will continue to make an important contribution to security of supply. and potentially below five per cent in more than one year.

Average consumer bills are estimated to rise by around £200 from 2010 to 2030 without reform.Planning our electric future: a White Paper for secure. It is essential that the changes to the current electricity market arrangements are costeffective. The Government can enable an efficient market by removing barriers to entry – intervening only to resolve identified market failures where necessary. • The Electricity Market Reform packages under a Feed-in Tariff with Contract for Difference (FiT CfD) offer the greatest benefits to society.1 The proposals presented in this White Paper will help to meet the UK’s decarbonisation targets and reduce the risks of a future security of supply problem for the GB electricity market. with long-term economic and sustainable growth. a saving of £40 per customer on the average bill. 111 ●● ●● ●● . and a discussion of the impact of the policies on the wholesale market. sensitivity analysis of the Electricity Market Reform policy proposals.2 7. To achieve this affordably markets need to function efficiently. an assessment of the packages against each of the Government’s energy market objectives.3 the alternative reform packages. These reforms will also facilitate a green economy. The preferred option for reform should therefore be the one which results in the least cost to the economy and in particular minimises any cost to consumers. while ensuring security of supply. Introduction 7. costs to business and to the consumer will be lower than without reform. compared to continuing with current policy. according to the principles of better regulation. at least cost to the consumer. • Electricity prices and bills could rise slightly in the short term but over the long term. Electricity Market Reform will limit this increase in bills to around £160. This section sets out: ●● 7. around £9 billion for the period to 2030. and are complementary to policies such as Green Deal. to ensure the packages are robust against different scenarios. affordable and low-carbon electricity Chapter 7 – Costs and benefits Summary • The Electricity Market Reform package will help ensure that we meet renewable energy and environmental targets.

including a targeted mechanism or a market-wide mechanism as set out in Chapter 3. Strategic Reserve. EPS. The impacts of the packages are considered against a ‘do nothing’ baseline108.6 We have compared the FiT CfD with the Premium Feed-in Tariff (PFiT). as discussed in Chapter 2. EPS. suggests that all four of the packages set out above are capable of delivering the targets for power sector decarbonisation by 2030 if the incentives are set at the right levels.decc. This includes. 112 . in terms of their relative costs and benefits.uk/en/content/cms/consultations/emr/emr. and option 4 – PFiT.9 Overall impacts of Electricity Market Reform on our energy market objectives Decarbonisation 7. among other policies. the Carbon Price Floor (CPF).gov. ●● ●● ●● 7.4 In the Impact Assessment published alongside this White Paper. The Government intends to implement one of the FiT CfD packages. 106 The figures presented in this White Paper are based on the ‘central assumption’ compared to the baseline. and the Renewables Obligation (RO).7 7. The FiT CfD and PFiT are both assessed with each of the two options for the Capacity Mechanism.8 7. We are consulting on the type of Capacity Mechanism.10 Our analysis. option 2 – FiT CfD. we have assessed in detail the Electricity Market Reform measures under four different packages105. a Reliability Market. affordable and low-carbon electricity 7. 7. a Reliability Market. The Emissions Performance Standard (EPS). 105 These four packages are distinct to those packages presented in the Electricity Market Reform consultation document.Planning our electric future: a White Paper for secure. High and low analytical scenarios are set out in the accompanying Impact Assessment. set out in Chapter 3 and Annex C for views. 109 We commissioned Redpoint Energy to update the electricity system analysis carried out for the Electricity Market Reform consultation document published in December 2010. carried out by Redpoint Energy109. For the purposes of this analysis we assess a Capacity Market in the form of a Reliability Market. EPS.5 option 1 – FiT CfD. option 3 – PFiT.aspx 108 The baseline in this instance refers to the current market arrangements. the fall-back option from the Electricity Market Reform consultation document107. Strategic Reserve. is also included in the package analysis described below. 107 http://www. following its announcement in Budget 2011. EPS. The four packages considered in detail in the accompanying Impact Assessment and summarised in this White Paper are106: ●● 7.

based on meeting the more ambitious decarbonisation target of 50gCO2/kWh in 2030.theccc.13 110 http://www.12 The Committee on Climate Change (CCC) in its Fourth Carbon Budget Report110 of December 2010 recommended a more challenging decarbonisation target for the UK electricity sector than their previous recommendation of 100gCO2/kWh by 2030. Figure 18: Decarbonisation trajectory to 2030 – central price assumption 600 CO2 emissions intensity (G/kWh) 500 400 300 200 100 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Updated baseline Option 1 – FiT CfD. is smaller under this scenario.11 Figure 18 shows that the FiT CfD options are likely to lead to a more rapid decarbonisation trajectory than the PFiT options. 111 The comparison is made between the Feed-in Tariff with Contract for Difference and Premium Feed-in Tariff proposals (both these packages include the targeted capacity tender and EPS). EPS 7. affordable and low-carbon electricity 7. 113 . and therefore brings on low-carbon generation plant sooner. EPS Option 4 – PFiT. a Reliability Market. EPS Option 2 – FiT CfD. the FiT CfD package still shows faster decarbonisation in the medium term compared to the PFiT package. Strategic Reserve. EPS Option 3 – PFiT. Figure 18 presents the profile of decarbonisation for the packages111. This is because the FiT CfD provides increased revenue certainty for low-carbon technologies. Strategic Reserve. a Reliability Market. in terms of decarbonisation trajectories. The difference between the two packages.Planning our electric future: a White Paper for secure.org. 7. However.uk/reports/fourth-carbon-budget.

Strategic Reserve.Planning our electric future: a White Paper for secure. 114 . Both packages were modelled to ensure a minimum derated capacity margin of at least 10 per cent112.14 The analysis undertaken for this White Paper suggests that both the Reliability Market and the Strategic Reserve options for a Capacity Mechanism will have a significant impact on the capacity margin (see Figure 20). EPS (50g) Security of supply 7. This is a result of a very small amount of capacity remaining outside of the Reliability Market and therefore raising the de-rated margin just above the desired 10 per cent level. affordable and low-carbon electricity Figure 19: Rapid decarbonisation path to 2030 – central price assumptions 600 CO2 emissions intensity (G/kWh) 500 400 300 200 100 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Updated baseline Option 1 – FiT CfD. 112 De-rated capacity margins in the Reliability Market package are marginally higher than 10 per cent in the modelling. Strategic Reserve. EPS (50g) Option 3 – PFiT.

future cash flows are ‘discounted’ (using a discount rate) when calculating NPV.15 This analysis was carried out by Redpoint Energy using a dynamic economic model of the GB electricity market. The baseline for the assessment of policies includes the current Renewables Obligation (RO) and has been updated to include the Carbon Price Floor (CPF) announcement at Budget 2011.113 Our analysis shows that all the Electricity Market Reform packages should lead to a large gain in net benefit compared to the updated baseline (based on current policies including the Renewables Obligation).Planning our electric future: a White Paper for secure. This is also true. NPV recognises that society would prefer £1 today to £1 in the future – this is known as ‘time preference’. Detailed results. a Reliability Market. as shown in Figure 21.1 billion Net Present Value (NPV)114. including policy developments since consultation. Net benefits 7. EPS Net Present Value of packages 7. All analysis is presented relative to this updated baseline. Our analysis shows that the highest gain in net benefits is under the CfD package with a Strategic Reserve Capacity Mechanism. There is an overall positive net benefit from the introduction of both FiT CfD packages. for PFiT packages. to a lesser extent. which simulates investment and generation behaviour. key assumptions and limitations of the model are presented in the accompanying Impact Assessment. EPS Option 2 – FiT CfD. the baseline is not a ‘do nothing’ option of no decarbonisation policies. at £9.16 113 For clarity. This model is a simplification of how investment decisions are made in reality. Strategic Reserve. affordable and low-carbon electricity Figure 20: De-rated capacity margin 30% Peak de-rated capacity margin (%) 25% 20% 15% 10% 5% 0% 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Updated baseline Option 1 – FiT CfD. 114 ‘Net Present Value’ (NPV) is a way of accounting for the sum of a project’s future cash flows in today’s terms – showing the difference between a future stream of benefits and costs. Therefore due to time preference. 115 .

Electricity Market Reform proposals encourage investment in low-carbon plant which typically have higher capital costs in comparison to fossil fuel plant.8 billion). real 2009 (2010-2030) Net benefit 7.2 PFiT (Reliability Markets) 7.17 FiT CfD (Strategic Reserve) 9. a low-carbon generation mix is also associated with relatively lower generation costs and there are savings in carbon costs (as measured by the cost of EU Emissions Trading System (EU ETS) Allowances).Planning our electric future: a White Paper for secure. 7. 116 .19 7.9 Note: A positive number represents a gain in net benefit to the economy. 116 This is because under current market arrangements. there is an overall positive net impact of both the FiT CfD (£11. However. the Electricity Market Reform packages lead to a net benefit. The estimated change in net benefit as a result of the proposals is primarily driven by the impacts on construction costs.20 115 ‘Economic rent’ can be simply explained as excess profitability.18 Sensitivity Analysis 7.3 billion) and PFiT packages (£5. There are also important differences between the packages in terms of economic rents115 to new generation plants. 100gCO2/kWh carbon intensity in 2030 NPV. where oil prices could reach around $120/barrel in 2020. generation costs and carbon costs. because the level of support to generators under FiT CfD automatically adjusts to the level of the wholesale electricity price. fossil fuel plant set the wholesale prices. compared to the baseline. affordable and low-carbon electricity Figure 21: Net benefits of the packages Central fossil fuel and carbon prices. Future fossil fuel prices are inherently uncertain and any change in fossil fuel prices has a significant impact on the costs and benefits of the packages116. it is important to test the reform packages against different fossil fuel price scenarios and carbon price scenarios to ensure that our policy is robust under different future scenarios. In a high fossil fuel price scenario. compared to the baseline scenario which has a higher share of conventional fossil fuel plant and higher costs associated with the current Renewables Obligation. In the FiT CfD package in particular.1 FiT CfD (Reliability Markets) 8. Rents are expected to be significantly lower for generators under the Government’s preferred choice of FiT CfD compared to the PFiT. compared to £9. If fossil fuel prices rise higher than our central projections. this would increase rents to over £27 billion – potentially more than three times the level under a FiT CfD package. Therefore. Rents for new plant under central assumptions could have an NPV of £17 billion in a PFiT package. These savings mean that overall.5 billion under FiT CfD. there are significant savings in carbon costs as decarbonisation is much more rapid.9 PfiT (Strategic Reserve) 7. £ billion. relative to current policies. In this case we have defined economic rent as the additional revenues earned by investors above the level required to cover long-run marginal costs of their plant.

the difference between the packages and indeed the baseline in the low fossil fuel price world is comparatively small compared to the high fossil fuel price scenario. we expect this cost to be lower under a FiT CfD than a PFiT117. as the introduction of Electricity Market Reform increases the amount of low-carbon generation. the change in net benefit in the FiT CfD package is slightly negative in NPV terms at -£0. 117 . the carbon price. Electricity Market Reform support costs are around five per cent of consumer bills in 2030. The support cost is greater under the PFiT packages than under the FiT CfD packages. the net benefits of the packages are reduced. our analysis suggests that on average the impact on the wholesale electricity price is broadly similar between the packages. electricity bills are likely to rise relative to today with or without reform. and through the low-carbon (and Capacity Mechanism) support costs passed on to consumers by suppliers. This is due to increases in wholesale costs. However.23 Electricity Market Reform measures have an impact on consumer electricity bills both through their effect on wholesale electricity prices. Due to the costeffectiveness of the CfD instrument. In this scenario. With an illustrative decarbonisation target of 100gCO2/kWh in 2030. affordable and low-carbon electricity 7. As Figure 22 shows.24 7. we have assumed that the low-carbon support costs will be paid for by consumers via a levy on their electricity bills. In estimating the impact of Electricity Market Reform packages on bills. wholesale electricity prices should demonstrate a downward trend.2 billion. the FiT CfD packages (including either Capacity Mechanism option as well as the EPS) will result in a period of higher investment in low-carbon plant in the 2020s and as a result could lead to slightly increased bills in the short term.7 billion and the PFiT package is slightly positive at £1. network costs and environmental policies.25 7. 7. compared to that required under central fossil fuel price assumptions.26 117 This is based on a central fossil fuel price scenario.21 In a world with low fossil fuel prices where oil prices are assumed to stabilise at approximately $60/bbl in 2020. compared to the increase in bills in the absence of the Electricity Market Reform package. Consumer and business prices and bills 7. In the longer term. However. In this scenario. both packages become more expensive to fund as more support needs to be provided to low-carbon plant to compensate for relatively lower electricity prices. For the period to 2030.22 Impact on bills Wholesale prices 7.Planning our electric future: a White Paper for secure. year on year volatility remains driven by market dynamics and changes in capacity margins that are not directly a result of the choice of Feed-in Tariff mechanism.

27 Average consumer bills are estimated to rise by around £200 from 2010 to 2030 without reform. Smart Meters. CERT Extension. affordable and low-carbon electricity Figure 22: Illustrative breakdown of bills for option 1 700 600 Average electricity bill (£) 500 400 300 200 100 0 2011-2015 2016-2020 2021-2025 2026-2030 Wholesale cost (excluding carbon price) Carbon price cost Network costs. supplier costs and margins and VAT Other energy and climate change policy costs (including FiTs. CESP Better Billing. Electricity Market Reform will limit this increase in bills to around £160. 118 . EMR support costs 7. a saving of £40 per customer on the average bill. CERT. future SO. energy security) .Planning our electric future: a White Paper for secure.

Figure 24: Impact of Electricity Market Reform packages on average annual electricity bills for domestic consumers (real 2009 £). average household bills under the FiT CfD packages could be approximately four per cent. For the period to 2030 as a whole. consumers could benefit from relatively lower bills by the late 2020s and beyond. 7. average bills could be around one to two per cent (or £6 to £10) lower under the FiT CfD packages.Planning our electric future: a White Paper for secure. lower in the five-year period up to 2030 than they would be under current policies. relative to an estimated baseline bill Consumer bills – domestic 2011-2015 2016-2020 2021-2025 2026-30 Average 2010-30 Baseline bill FiT CfD (Strategic Reserve) – –1% (–£4) 0% (£2) –4% (–£24) –1% (–£6) FiT CfD (Reliability Markets) – 0% (–£1) –3% (–£16) –2% (–£10) PFiT (Strategic Reserve) 0% (£1) 1% (£4) 0% (£2) 0% (1) PFiT (Reliability Markets) 0% (£1) 2% (£11) 1% (£3) 2% (£10) 1% (£6) £468 £486 £560 £648 £538 –4% (–£27) –1% (–£4) Note: negative figures show a reduction in bills. around £25 per year. 119 .28 Baseline bill FiT CfD (Strategic Reserve) £485 £643 £532 FiT CfD (Reliability Markets) £485 £642 £527 PFiT (Strategic Reserve) £485 £647 £538 PFiT (Reliability Markets) £485 £674 £544 £485 £682 £538 As shown in Figure 24. relative to the baseline. while positive figures show an increase in bills. affordable and low-carbon electricity Figure 23: Snap-shot of average annual domestic consumer electricity bills Consumer bills – domestic 2010 2030 Average 2010-30 7. Individual bill impacts in any given year are less insightful because they are affected by other issues such as the capacity margin which also affects wholesale prices.29 Overall.

For the period to 2030 as a whole. As with the other consumers. Under the FiT CfD packages for reform. electricity prices for an EII user could be £2/MWh lower under the FiT CfD with Strategic Reserve and £3/MWh lower under the Reliability Market package. Electricity prices and bills go up slightly (less than one per cent) in the shorter term. business bills119 could be four to five per cent lower in the five-year period to 2030 in the two FiT CfD packages compared to baseline bills. A detailed breakdown of the price impacts is presented in the accompanying Impact Assessment. will be published alongside DECC’s Annual Energy Statement later this year. This is because they spend a larger proportion of their income on electricity than the average household. The combined impacts of all Government climate change and energy policies on electricity prices and bills. compared to the baseline. In the longer term. Further details on the impact on EIIs bills are presented in the accompanying Impact Assessment. Electricity prices for domestic and business users. this impact on energy consumption has not been included in the estimates of energy bills. Changes to average annual electricity bills are similar in percentage terms between non-domestic consumers and energy intensive industries (EIIs). The impact on prices for EIIs is also the same in percentage terms as the impact on bills. In general.Planning our electric future: a White Paper for secure. including bills of EIIs. 7. However. while also delivering a higher level of decarbonisation.31 Impact on energy intensive industry 7. affordable and low-carbon electricity 7. relative to baseline prices for the period to 2030 as a whole.35 118 We anticipate that demand side response will participate through the Capacity Mechanism.000 MWh. average EII bills120 could be around two to three per cent lower on average for the period to 2030. the impact on EIIs could be greater than on less energy intensive sectors as their energy costs are a more significant share of their operating costs. EIIs will benefit from relatively lower bills in the late 2020s and beyond.30 As our analysis does not model an impact on electricity consumption118. for the period to 2030. the price impact of policies are the same in percentage terms as the impact on bills. 120 Energy intensive industries are assumed to have an annual baseline electricity consumption before energy efficiency policies of 100.32 7.34 Distributional analysis of impact on bills 7. compared to what they would be without the package.33 7. However. 120 .000 MWh. increases in average domestic electricity bills can have disproportionate impacts on consumers on low incomes. 119 Non-domestic users are assumed to have an annual baseline electricity consumption before energy efficiency policies of 11. could be £2/MWh lower under the FiT CfD with a Strategic Reserve and £3/MWh lower under the Reliability Market package. On average business prices and bills are one to two per cent lower.

As such.39 7. although only marginal. trading and operational timescales.decc. and we expect that around 2 million households will be supported annually. the highest impact – either positive or negative – is on households in the lowest income deciles. with the potential to influence activity across investment. and therefore the saving in terms of expenditure as a proportion of income on electricity. The packages influence generation investment decisions. Impacts in the initial years of reform are expected to be negligible. in the Government’s chosen Electricity Market Reform package (under FiT CfD) consumers could save money on bills relative to the baseline. Trading strategies and operational incentives within the market will also be affected by the packages. Similarly. would be greatest for the lowest income group. altering the generation mix that currently operates within the wholesale market. trigger increased investment in low-carbon generation technologies. patterns of trading activity are expected to be affected by the choice of reference prices within the individual policy instruments. they do have implications for and interactions with the wholesale market. potentially diverting trades into these markets. operational behaviour will be affected by the nature of the low-carbon support mechanisms and the incentives they create.1 billion over the next four years. the six largest energy suppliers are required to provide support with energy costs to eligible households worth up to £1. However.uk/en/content/cms/legislation/energy_bill/energy_bill.decc. although the impact compared to the updated baseline is very small (less than one per cent increase in expenditure on electricity). To varying degrees and differing extents across technologies.gov.000 lower in 2030 compared to what could otherwise be without Electricity Market Reform. Under the latter scheme.aspx 121 . This reduction in uncertainty should.gov. For instance. The Government is also taking steps to help mitigate the impacts of energy costs on the low income and vulnerable households through initiatives such as the Energy Company Obligation (ECO)121 and the Warm Home Discount122.38 7. the packages provide reduced exposure to wholesale price volatility and/or improved price certainty for non-energy products (such as capacity). which will run alongside the Green Deal.000300. affordable and low-carbon electricity 7. The Government is also taking action to ensure low income and vulnerable households are able to heat their homes affordably and access energy efficiency measures through the ECO.aspx 122 http://www. 7.37 Implications for the wholesale market 7. if coupled with adequate revenue expectations. However.Planning our electric future: a White Paper for secure. the FiT CfD package will mean that the number of households in fuel poverty could be between 175.40 121 http://www.36 In each of the scenarios within our analysis. The Electricity Market Reform packages do not seek to directly change wholesale market rules.uk/en/content/cms/consultations/warmhome/warmhome.

Planning our electric future: a White Paper for secure.41 While there are multiple interactions. affordable and low-carbon electricity 7. in principle. be developed to work effectively alongside the wholesale market. This will require careful development of the detailed design features during the next phase to ensure that the packages and the wholesale market. are complementary to the Electricity Market Reform package. as well as related initiatives such as cash out and liquidity (see Chapter 3 and Chapter 5). the arrangements contained within the packages can. 122 .

●● ●● Context Transition arrangements for renewable investments 8. including those required ahead of implementation of the FiT CfD. • To secure this objective. • To ensure the continuity of all low-carbon development. Introduction 8. we will work actively with relevant parties to enable early investment decisions to progress to timetable wherever possible.2 transitioning renewables funding from the RO to FiT CfD. we support the principle of no retrospective changes for all low-carbon investments. and an indicative timetable for implementation and transition. Maintaining stable market conditions and industry confidence throughout this period of change is a key objective. • Annex D sets out the detailed conclusions on the RO transition. We recognise the importance of maintaining industry confidence and creating stable conditions for investment. This section covers the transitional arrangements for: ●● 8. in order to deploy renewable electricity to the levels needed to meet our 2020 targets and beyond. • We have developed detailed proposals to provide new renewable generators with a period of choice between the existing Renewables Obligation (RO) and the new Feed-in Tariff with Contract for Difference (FiT CfD).3 Renewable electricity is key to our low-carbon energy future and is a vital component of the UK’s diverse energy mix. affordable and low-carbon electricity Chapter 8 – Managing the transition Summary • Electricity Market Reform will mean significant changes to the electricity system. projects requiring final investment decisions ahead of implementation of the FiT CfD. 123 .Planning our electric future: a White Paper for secure.1 The Government is keen to ensure that the period of transition between the current and new market arrangements set out in this White Paper runs smoothly and allows investment to continue.

No generation will be able to accredit under the RO from that date. 124 . new renewable generation will have a choice between the RO and FiT CfD. 123 http://www. there was however some concern that a 2017 cutoff date proposed for the RO may not allow a long enough lead-in time for such projects. The original capacity however will continue to be supported by the RO. existing accredited generation will continue to be supported under the RO and will not be permitted to transfer to the new scheme.4 The Electricity Market Reform consultation document123 set out proposals for a transitional framework from the current RO system to FiT CfD. Generation for which a FiT CfD is in place will not be eligible to accredit under the RO. The aim of our proposals was to protect existing investments under the RO. This choice will extend to any FiT CfD eligible additional capacity commissioned at RO-accredited generating stations in the period from the introduction of the new scheme to 1 April 2017.aspx 124 ‘Vintaging’ the Renewables Obligation (RO) system means that it will no longer be open to accreditation for new stations. the level of obligation under the RO will continue to be calculated annually on the present basis. affordable and low-carbon electricity 8.decc. and we do not intend to extend the lifetime of the RO beyond the current 2037 end date. and provide investors with confidence that projects currently under development would not be delayed and that investment would be able to continue in the transition period. once the FiT CfD is introduced and until 31 March 2017.5 8. The Government has listened to these concerns and Annex D gives more detail about our proposed arrangements for renewable generation. Given the size and scale of many projects under development. The desirability of avoiding triggering change in law clauses or other default provisions was one of our considerations when designing these transition arrangements.Planning our electric future: a White Paper for secure.8 The proposed arrangements for the operation of the RO during the transition include: ●● Calculating the obligation: during the transition period to 2017. In summary these arrangements are: ●● 8. and a number of stakeholders supported a choice between the RO and FiT CfD.7 to ensure ongoing RO stability. ●● ●● ●● 8.uk/en/content/cms/consultations/emr/emr. the RO will close to new accreditations (and additional capacity commissioned at existing stations) on 31 March 2017. Most respondents to the consultation agreed that these were the key issues and therefore supported ‘grandfathering’ existing investments under the RO.gov. The closure of the RO to new stations will create a closed pool of capacity which will decrease over time as we approach the end date for the RO of 31 March 2037. They also called for RO ‘vintaging’124 arrangements to be clarified as early as possible.6 8.

to projects wanting to accredit under the RO before 1 April 2017. no new offshore wind turbines will be able to register under the RO after 31 March 2017. The 20-year support period will begin from the point of registration. Further details. generators who add additional capacity that is greater than 5 MW will be eligible to participate in the FiT CfD mechanism. at the same time. Once the RO has closed to new accreditations. Operators of accredited generating stations will be able to register some or all of their remaining unregistered turbines that constitute the consented capacity of the generating station under the RO by 31 March 2017. reducing the costly administration burden. This is consistent with our intention to close the RO to new generation after 31 March 2017. by either a change in grid connection date instigated by the transmission or distribution operator. The Government is minded to ensure that any generation which is ineligible for smallscale FiT. We intend that these generators may accredit under the RO and will remain subject to the 2037 end date for the RO. or a delay in the agreed installation of radar. Developers would be required to demonstrate that they have met a number of criteria if these grace periods are to be exercised. are still being considered. We are still considering whether any uplifts not covered by our grandfathering policy as at 31 March 2017 should be grandfathered in a similar way. but which was delayed through no fault of their own. This will remove the need for further banding reviews.Planning our electric future: a White Paper for secure. will be eligible to access the FiT CfD on the same terms as other technologies. Additional capacity of less than 5 MW which is. under certain conditions. We intend to offer some limited grace periods to generation which was due to accredit on or before 31 March 2017. Offshore wind generators accredited under the RO will be able to sign a FiT CfD for any turbines that on 1 April 2017 are not registered. in order to receive support under the RO mechanism for those turbines. will be grandfathered at the support level applicable on 31 March 2017. affordable and low-carbon electricity ●● Grandfathering: all technologies currently grandfathered will remain grandfathered in the vintaged RO. Offshore wind phasing: consistent with our intention to close the RO to new accreditation from 31 March 2017. Additional capacity added after 2017: we want to continue to provide support to stations that add new capacity after 31 March 2017. ●● ●● ●● 125 . and is intended to provide industry with revenue certainty. and Grace periods: some respondents to the consultation suggested grace periods should apply. eligible for the small-scale Feed-in Tariff (FiT) will not be eligible for a FiT CfD. including the evidence requirements for exercise of the grace period. Support for any technology that is not covered by our grandfathering policy.

We support the principle of no retrospective changes to low-carbon investments. affordable and low-carbon electricity Devolved Administrations 8.11 8.9 The Northern Ireland RO is a devolved matter in Northern Ireland. In addition. We recognise these concerns and our transition plans and timetable are aimed at providing stability for investors and building confidence in the new regime quickly. potentially through a FiT CfD in combination with other funding approaches.12 provide reassurance for current renewables projects through the detailed transitional arrangements for the RO set out above and in Annex D. ●● ●● Next Steps 8. The proposals for RO transition have been discussed by a Steering Group comprising policy advisors and technology experts from the UK Government and the Devolved Administrations.Planning our electric future: a White Paper for secure. supply chain manufacturers and existing and potential investors.13 We will work closely with relevant parties to explore the means by which we can provide early certainty to low-carbon projects that are intended to benefit from the FiT CfD scheme. We have also discussed the proposals with a wide range of industry stakeholders. some Round 3 offshore and Scottish Territorial Waters (STW) wind farms and Carbon Capture and Storage (CCS) demonstration projects. including utility companies. An indicative timeline for transition and implementation of Electricity Market Reform is presented in Figure 25. This work will include assessing the feasibility of supporting CCS demonstration projects. such as some new nuclear. institutional framework and other factors. A large number of consultees raised concerns around uncertainty for large capital projects that require final investment decisions ahead of implementation of the FiT CfD. and provide a high-level implementation timetable to full implementation of FiT CfD and other Electricity Market Reform measures. We will continue to work closely with the Devolved Administrations to ensure that the transition arrangements are simple and transparent across all three RO schemes. State Aid. independent generators. give as much certainty as possible on how the FiT CfD will operate. The proposals have been broadly welcomed.10 8. This White Paper aims to: ●● Arrangements for early projects: enabling investment to continue 8. Scottish Ministers have executively devolved functions in respect of the RO in Scotland. 126 . but that require a final investment decision before the scheme is implemented. The timeline may need to change to reflect future work on the legislative timetable.

127 . any options proposed will clearly need to be compliant with existing domestic law.Planning our electric future: a White Paper for secure. In addition. affordable and low-carbon electricity 8.14 Any arrangements reached as a result of this work will be subject to the Government’s obligations under EU law. including the terms of any necessary state aid approvals.

legal delivers first contracts powers Feed-in Tariff with Contract for Difference (FiT CfD) First FiT CfD contracts signed Possible first payments made Capacity Mechanism (CM) Annual assessments of need for additional capacity CM in place Capacity procured as required Lead in time for capacity (could be compressed if necessary) Capacity in place (could be earlier) Carbon Price Floor (CPF) CPF in force CPF rising incrementally along published trajectory Figure 25: An indicative timetable for implementation and transition Planning our electric future: a White Paper for secure.Additional information published 128 2013 Royal Assent Renewable energy target Secondary Legislation Statutory Instruments in force 2011 2012 2014 2015 2016 2017 2018 2019 2020 White Paper Bill introduced Legislation Policy finalised Primary Legislation Institutional Framework Initial work to establish organisation Organisation receives Organisation up and running. affordable and low-carbon electricity Emissions Performance Standard (EPS) EPS in force Report on Decarbonisation and CCS Progress EPS applied to all new build Report on Decarbonisation and CCS Progress Renewables Obligation (RO) open to new generation Choice between RO and FiT CfD RO closed to new generation RO vintaged Transition to EMR Early low-carbon investment – enabling discussions .

and Scottish and Welsh Governments. Where aspects are devolved they will be legislated either through Legislative Consent Motions or through Parallel Legislation across the four legislatures in the UK. ensure security of supply.1 Devolved Administrations Summary • Electricity Market Reform is important for all parts of the UK. as well as ensure the continued successful functioning of the GB electricity market. Scottish and Welsh Governments and Northern Ireland Executive are committed to continue to work closely to ensure that Electricity Market Reform is consistent with devolution arrangements. Scottish and Welsh Government officials will continue to sit on the Electricity Market Reform steering group. We are therefore strongly committed to working closely with the Devolved Administrations as we develop our proposals for Electricity Market Reform with the shared aim of delivering a coherent package of reforms across the whole of the UK. In particular. devolution issues will be respected in the legislation needed to implement Electricity Market Reform. Recognising this.1. Northern Ireland Executive. we have been working closely and collaboratively with the Devolved Administrations in developing this policy.Planning our electric future: a White Paper for secure. • Together. As part of this commitment. affordable and low-carbon electricity Chapter 9 – Devolved Administrations and the European Union 9.2 . 129 9. We will continue to work closely on developing the details of implementation to ensure that the proposals will operate across the different parts of GB to deliver effective and enduring reforms to the GB electricity market. which is in the interest of all four nations of the UK.1 Electricity Market Reform is vital for helping the UK increase low-carbon generation. The Government recognises the importance of devolution in the UK and is concerned to ensure the proper functioning of devolved arrangements. and protect UK consumers. • Whether or not aspects of the Electricity Market Reform package are devolved or reserved will only become clear once the details of implementation have been decided. the UK Government. Introduction 9. These proposals have been developed following detailed discussion with the Northern Ireland Executive.1.

●● Northern Ireland 9.7 Electricity is essentially a devolved matter in Northern Ireland. and the finance and development communities are committed to developing future lowcarbon generation in each of these nations of the UK. The Northern Ireland Executive is conducting further analysis of options. We will therefore continue to work together to design and deliver relevant elements of the Electricity Market Reform package. Our preference remains a UK-wide Feed-in Tariff with Contract for Difference (FiT CfD). Successful delivery of the Electricity Market Reform package will come through the different governments working towards a set of shared goals. As part of this discussion.1. and we will engage constructively with the Executive on its preferred solution. and balance these considerations against wider fuel poverty goals. Significant parts of the UK’s generation capacity are located in Northern Ireland.4 9.5 9. However we recognise that this will require working in partnership with the Northern Ireland Executive. This section sets out: ●● 9.9 130 . They also have significant potential onshore and offshore renewable resources.1. the four nations of the UK aim to deliver the required new generation of secure low-carbon power sources. and we are therefore working closely with the Northern Ireland Executive to consider the best approach for increasing low-carbon generation and improving security of supply at least cost to the Northern Ireland consumer. which takes account of existing market arrangements and is at least cost to the consumer. any Northern Ireland solution can work alongside the FiT CfD in a UK-wide context. affordable and low-carbon electricity 9. It is only by harnessing natural resources and technical expertise from across the UK that we will be able to deliver the required new generation of secure low-carbon power sources.Planning our electric future: a White Paper for secure.6 interaction between Electricity Market Reform and the Devolved Administrations. 9. Scotland and Wales. how it can best meet its aspiration that 40 per cent of electricity consumed will come from renewable sources by 2020.3 We are also working closely with the Northern Ireland Executive to consider the best approach for increasing low-carbon generation and improving security of supply in Northern Ireland.1.8 9. By working together. and next steps. and ensure that where appropriate.1. Northern Ireland will also give consideration to how any mechanism can operate within the island of Ireland Single Electricity Market (SEM).1.1.1. We also undertake to have further discussions on how any Northern Ireland mechanism will work alongside the Electricity Market Reform institutions.

16 As part of our future work on options for a Capacity Mechanism. certain aspects of Carbon Capture and Storage (CCS) policy are also devolved.1.1.1. Further details are set out in Chapter 8 and Annex D.1.1.15 The Scottish Government is committed to working in partnership to deliver a coherent and seamless package of reforms across the UK.11 The Government is keen that the framework of the Emissions Performance Standard (EPS) should. environment policy is broadly devolved.10 The UK Government and the Northern Ireland Executive have also agreed that because the SEM already uses a capacity mechanism. we will involve the Scottish Government in further discussions on how the mechanism should apply in Scotland. The Northern Ireland Executive has said that it would. 131 . in so far as they relate to the environment. 9. 9. cover the whole of the UK. The UK Government will continue to involve the Scottish Government in further work on Electricity Market Reform. in particular on our work on institutions. 9. 9. in principle. We will also continue to discuss with the Scottish Government the application of the EPS in Scotland. Scotland 9. affordable and low-carbon electricity 9. and a number of aspects of energy policy are executively devolved (for example certain aspects relating to consents of electricity generation and transmission infrastructure under Section 36 and Section 37 of the Electricity Act 1989).14 Scottish Ministers have also been given executively devolved powers in respect of the Renewables Obligation (RO) in Scotland and we have been working closely with the Scottish Government regarding how transitional arrangements for the RO in Scotland would apply.1.12 The interface between reserved and devolved areas of competence for Scotland is not straightforward. While the Scottish Government is supportive of the need for reform of the GB electricity market. in the design and operation of the FiT CfD and in managing a smooth transition from the RO to the FiT CfD. 9. Detailed consideration of the Scottish Government’s devolved competence will be needed as details of the mechanisms are developed. We will continue working closely with the Northern Ireland Executive alongside the other Devolved Administrations to achieve this in a way which takes account of their policy preferences and the devolution settlements as appropriate. Similarly. consider participating in a UK-wide EPS regime. as far as possible. discussion of these considerations will be important in regard to how we finalise details of the operation of the mechanism and the associated institutional arrangements.1. the Capacity Mechanism proposed in this White Paper would apply across GB only.Planning our electric future: a White Paper for secure.13 While energy policy is reserved in Scotland.

In particular this will mean: ●● Coordinating further work with the Northern Ireland Executive and Scottish Government on transition arrangements for the RO.1. we will continue to work closely with the Devolved Administrations as we develop more detailed design of the proposals. and Involving the Devolved Administrations in further discussions on Electricity Market Reform. 9.17 The Welsh Government is supportive in principle of the Electricity Market Reform proposals. Next steps 9.1. ●● ●● 132 . we will involve the Welsh Government in discussions on how the mechanism should apply in Wales. and sees that the Electricity Market Reform package has the potential to support this expansion.19 As part of our further work on options for a Capacity Mechanism. It would like to see significant amounts of new low-carbon generation developed within Wales. Supporting the Northern Ireland Executive as it considers options for how a FiT CfD could be successfully integrated within a UK-wide FiT CfD. including institutions. affordable and low-carbon electricity Wales 9. We will also continue to discuss with the Welsh Government the application of the EPS in Wales.18 We will continue to work closely with the Welsh Government to drive a successful low-carbon economy transition which delivers secure and affordable energy for all.1.20 Following publication of this White Paper.1. the design of the FiT CfD. 9.Planning our electric future: a White Paper for secure. the Capacity Mechanism and the EPS.

developing EU energy policy. while seeking to minimise costs to consumers and ensuring security of supply. • We support full integration of the UK energy market with the broader EU electricity market and consider that. 133 . transparent and competitive European markets. the EU considers that an approach based on innovative solutions to mobilise investment is appropriate125. In line with this. In seeking to radically reduce emissions in the electricity sector by 2050. The internal energy packages126 have led to more open. Interconnection between Member States has also integrated our markets further. in principle.htm 126 The 1998 First Package Directive 96/92/EC (concerning common rules for the internal market in electricity) and Directive 98/30/EC (concerning common rules for the internal market in natural gas). The 2003 Second Package Directive 2003/54/EC (concerning common rules for the internal market in electricity and repealing Directive 96/92/ EC) and Regulation 1228/2003 and the Directive on Gas 2003/55/EC and the Gas Regulation 1775/2005. and will do so even further in the future. the challenges the UK energy market faces are best addressed through European efforts. resulting in the potential for lower prices and greater choice. Communication from the Commission entitled “A Roadmap for moving to a competitive low carbon economy in 2050”.2 125 See.1 The EU and the UK share common energy policy objectives around delivering sustainable electricity generation.2.2 European Union Summary • The EU and the UK share common energy policy objectives. 9. using competition to ensure least cost to consumers. and complementary to.eu/clima/policies/roadmap/index_en. • We are working with the European Commission and other EU stakeholders to ensure that the Electricity Market Reform package is consistent with. for example. March 2011: http://ec. bringing potential for increased liquidity and lower prices.europa. We consider that the approach being adopted under the GB Electricity Market Reform is broadly in line with the EU vision for decarbonisation and security of supply. Introduction 9. policies such as the EU Emissions Trading System (EU ETS) and the EU’s Climate Action and Renewable Energy package (the Green Package) have provided a framework for investment in sustainable forms of energy.2. in principle. affordable and low-carbon electricity 9. the challenges the UK energy market faces are best addressed through European efforts. Indeed. the Electricity Market Reform package is providing incentives to industry to deliver an appropriate generation mix. the Government fully supports further integration of the EU electricity market and believes that. EU efforts to promote liberalisation and sustainability in Europe’s energy markets are proving successful. As recognised in the Electricity Market Reform consultation document.Planning our electric future: a White Paper for secure. Similarly.

5 an overview of Electricity Market Reform consultation responses on EU issues. We will ensure that the Electricity Market Reform package supports these developments. provides reliable market signals in choosing between different generation types and/or interconnection. affordable and low-carbon electricity 9. and the new European network codes128. and the design of the Feed-in Tariff with Contract for Difference (FiT CfD) in particular. 128 The Third Package provides for new European network codes which will set minimum rules for cross-border arrangements for gas and electricity. These are intended to cover issues such balancing.2. how the EU ETS and the Carbon Price Floor (CPF) will help us deliver our decarbonisation goals. 134 . and the relationship between EU law and the Electricity Market Reform package.2. capacity allocation for interconnectors and transparency. The EU Third Internal Energy Package127.7 9.Planning our electric future: a White Paper for secure. This section sets out: ●● 9. while another respondent suggested that the proposals are. Some respondents argued that a Capacity Mechanism could weaken the stimulus for interconnector investment and distort cross-border flows. Further interconnection with other markets. likely to promote interconnection. ●● ●● ●● Consultation Responses 9. Regulation (EC) No 715/2009 on conditions for access to the natural gas transmission networks (the ‘Gas Regulation’) and Regulation (EC) No 713/2009 establishing an Agency for the Co-operation of Energy Regulators (the ‘ACER Regulation’)). and market coupling (which links separate wholesale markets to determine efficient cross-border power flows). A number of respondents stressed that it will be important that the package in general.2.4 9. will lead to more competition and liquidity in GB markets.2. many stakeholders recognised that consideration of the interaction between European developments and the Electricity Market Reform package is increasingly necessary as implementation issues are considered.2.8 127 The 2009 Third Package comprises two Directives (Directive 2009/72/EC concerning common rules for the internal market in electricity (‘the Electricity Directive’) and Directive 2009/73/EC concerning common rules for the internal market in gas (the ‘Gas Directive’)) and three Regulations (Regulation (EC) No 714/2009 on conditions for access to the network for cross-border exchanges in electricity (the ‘Electricity Regulation’).2. will provide a new and deeper framework for cross-border interactions. the role of non-GB electricity generation. 9.6 In responding to the consultation. overall. which we expect to be facilitated by Ofgem’s new investment regime for interconnection (see Chapter 6).3 We welcome the fact that further efforts towards an integrated EU electricity market are continuing. and will be working closely with the European Commission and other European stakeholders to help ensure this.

developed outside the UK.2. we intend to provide for two-way trade in renewable energy with other Member States.2.12 We are considering the role low-carbon generation from outside the UK can play in delivering our carbon emission reduction targets. and possible. we could provide new manufacturing and jobs in the UK. Decarbonisation 9. Similarly we will need to consider whether there may be circumstances in which it is appropriate to allow other forms of low-carbon generation. we recognise that GB is becoming increasingly interconnected.2.13 As set out in Chapter 2. We will look to ensure that we have powers that will enable the UK to potentially export renewable energy for the purposes of the renewable energy targets set under the Renewables Directive. 9. Within this context. affordable and low-carbon electricity 9. Impact on interconnectors and cross-border flows 9.uk/en/content/cms/meeting_energy/renewable_ener/renewable_ener.14 It may be possible to have offshore wind projects connected to both the UK and other Member States. Exploiting our North Seas resources together.gov. the trading of renewable effort presents opportunities for the UK.aspx 135 . where appropriate.9 Respondents expressed some concerns over the CPF. to be supported by our package of reforms. As set out in our Renewables Roadmap published alongside this document129.11 We consider that current and future interconnection will continue to play a key role in providing secure and sustainable sources of electricity.2. We also have an abundant offshore wind resource and should explore the possibility of exporting energy generated in UK waters direct to neighbouring Member States.10 A few respondents highlighted state aid rules as a potential risk. 129 http://www. We recognise the value that generation based outside the UK could have in meeting domestic UK needs.2. which can play an important role in contributing towards our energy security.Planning our electric future: a White Paper for secure. This should allow interconnectors to be used fully and efficiently. 9.2. We would expect that crossborder flows – under market coupling arrangements – would continue to be determined by the price difference between the two energy markets. arguing that it could incentivise electricity to be imported into GB or that it could increase the risk of carbon leakage due to higher electricity prices. for the purposes of the renewable energy targets set out in the Renewables Directive. increasing our security of supply. Security of Supply 9.decc.2. 9.15 In Chapter 3 we describe two potential Capacity Mechanisms designed to ensure security of supply.

2004/29/EC. and will engage closely with the European Commission to ensure the policy is consistent with the appropriate rules.17 We remain fully committed to the EU ETS. but we recognise that there may be potential technical constraints with this.2. European Union Emissions Trading System 9.19 As set out in Chapter 2.21 Furthermore. which we expect to be amended to next year. and to meet the long-term EU objective of reducing emissions by 80-95 per cent by 2050.2.2. we need to reform the market now. The Government supports an increase in the EU carbon emission reduction target to 30 per cent by 2020. which we also share with the EU.Planning our electric future: a White Paper for secure.2. 136 .2. Financial regulations 9. We will continue to ensure consistency with EU excise and energy tax Directives. the CPF complements the EU ETS by strengthening the carbon price signal in the UK electricity generation sector. As such.2. we envisage that a Capacity Mechanism could allow non-GB generation (for example. the current level of the EU ETS cap (and associated carbon price) is not consistent with the lowcarbon investment required for the UK to meet its 2050 targets. as set out in Chapter 2.18 However. there are no plans to impose a surcharge on imported electricity. there will be more cross-border trading and a corresponding need for strong cross-border market monitoring. and Markets in Financial Instruments Directive (MIFID). State Aid 9.2.22 We are considering how the Electricity Market Reform package interacts with State Aid rules.16 Furthermore. where relevant. a generator based in France) to participate and could potentially encourage interconnection. we would support an EU-wide tightening of the EU ETS in order to meet ambitious carbon emission reduction targets in the EU.2. If we are to meet our long-term carbon and security of supply objectives. Further detail can be found in Annex C. and make investment in low-carbon generation in the UK more attractive.23 As wholesale energy markets become increasingly integrated. enabling higher levels of investment in low-carbon infrastructure and therefore a faster rate of decarbonisation. This is no different to measures put in place by other EU Member States to encourage investment in line with their domestic priorities. 9. COM (2010) 726).20 Going forward. affordable and low-carbon electricity 9. 9. and consider it the primary vehicle through which to deliver our carbon emission reduction targets. 9. which was recently agreed by the European Parliament and European Council Representatives. 9. we await new rules130 on 130 The new rules relate to REMIT (The Commission Proposal for a Regulation of the European Parliament and of the Council on Energy Market Integrity and Transparency. All mechanisms will need to be compliant with State Aid rules.

  9. Environmental law 9. and on financial markets. We are considering closely what impact these rules may have on the Electricity Market Reform proposals.Planning our electric future: a White Paper for secure. which will be designed to make the European energy wholesale markets less vulnerable to market abuse. We will continue to engage with the European Commission over the coming months to help ensure that the EPS is implemented in a way that fully complies with EU law.2.25 In the Government’s view. undermine the EU ETS (which in our view it will not). for example.24 The Electricity Market Reform package will need to be consistent with relevant EU environmental law and we will ensure that all of the implications of this are fully worked through. 137 .2. provided that it does not. the provisions of EU law do not impose any bar in principle to the implementation of an EPS of the kind outlined in this White Paper. affordable and low-carbon electricity wholesale energy market integrity and transparency.

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Annex A – List of respondents to December consultation
DECC received 274 responses to the December 2010 consultation on Electricity Market Reform, of which 13 are confidential, 18 are from individuals and 1 is anonymous. Consultation responses sent by the 242 respondents listed below will be available on the DECC website around the end of July. Figure A.1: List of Electricity Market Reform consultation respondents. 2020 Renewables 2Co Energy Advanced Plasma Power Advanced Power Generation Technology Forum AES Ballylumford and AES Kilroot Power Aggreko Agri Energy Air Fuel Synthesis Air Products Alstom AMEC Anaerobic Digestion and Biogas Association Aquamarine Power arc21 Argus Media ASDA Association for the Conservation of Energy Association of Energy Producers Association of UK Coal Importers ATH Resources Atkins AvVail UK B9 Energy Offshore Developments and THETIS Energy (Joint Response) Banks Group BG Group Biofuelwatch Blizzard Utilities
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Planning our electric future: a White Paper for secure, affordable and low-carbon electricity

Blue-NG BOC BP British Ceramic Confederation British Glass Manufacturers’ Confederation British Hydropower Association British Sugar Group BT Calor Gas Campaign to Protect Rural England Carbon Cycle Carlton Power Caroline Lucas MP CCS TLM CE Electric UK Centrica Ceres Power ClientEarth Climate Change Matters and Transform UK (Joint Response) CO2DeepStore CO2Sense Coal Forum Combined Heat and Power Association Committee on Climate Change Confederation of British Industry Confederation of Paper Industries Confederation of UK Coal Producers ConocoPhillips Construction Products Association Consumer Focus Cornwall Development Company Cornwall Energy Costain Country Land and Business Association Covanta Energy Croydon Council Cumbria County Council
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Planning our electric future: a White Paper for secure, affordable and low-carbon electricity

Department of Enterprise, Trade and Industry Northern Ireland Deutsche Bank Climate Change Advisors DimWatt DONG Energy Power (UK) Drax Power Durham Energy Institute E.ON Ecotricity EDF Energy EDP Renováveis EEF and UK Steel Eggborough Power EirGrid Electricity North West Electricity Storage Network Element Power ELEXON eMeter Corporation Endesa Ireland Eneco Wind UK EnergieKontor Energy Curtailment Specialists Energy Developments (UK) Energy Industries Council Energy Institute Energy Intensive Users Group Energy Services and Technology Association EnerNOC Environmental Services Association ESBI International European Federation of Energy Traders Expansion Energy Limited ExxonMobil Fichtner Consulting Engineers First Utility Flexitricity Food and Drink Federation
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Planning our electric future: a White Paper for secure, affordable and low-carbon electricity

Fred Olsen Renewables Friends of the Earth Friends of the Earth Scotland Gaelectric Electricity Storage Gaia Power Gas Strategies Gazprom Marketing and Trading GE Energy Good Energy Grantham Institute for Climate Change and Centre for Energy Policy and Technology, Imperial College (Joint Response) Green Alliance Greenpeace GreenPower GrowHow UK Hampshire County Council HES Biopower HgCapital Highlands and Islands Enterprise Highview Power Storage Independent Generators Group INEOS Chlor INEOS Manufacturing Scotland Infinis Institute for Security and Resilience Studies Institute of Directors Institution of Civil Engineers Institution of Engineering and Technology, the Royal Academy of Engineering and the Institution of Chemical Engineers (Joint Response) Institution of Engineers and Shipbuilders in Scotland Institution of Mechanical Engineers InterGen UK International Power Invesco Perpetual Irish Wind Energy Association Isle of Anglesey County Council Isle of Man Government
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Planning our electric future: a White Paper for secure, affordable and low-carbon electricity

John Muir Trust J R Power Kelda Group [and Yorkshire Water] KiWi Power KTI Energy Lloyds Bank London Analytics Low Carbon Finance Group Low Carbon Group Low Carbon Innovation Centre, University of East Anglia Macquarie Infrastructure and Real Assets (Europe) Mainstream Renewable Power Major Energy Users’ Council Marine Current Turbines McGrigors LLP MGT Power Microsoft Mineral Products Association National Grid National Offshore Wind Association of Ireland National Rights to Fuel Campaign New Earth Energy Newcastle University, Sir Joseph Swan Centre for Energy Research NIE Energy Non-Fossil Purchasing Agency North East Process Industry Cluster North London Waste Authority Northern Ireland Federation of Housing Associations Northern Ireland Renewables Industry Group Norton Rose LLP Nuclear Free Local Authorities Nuclear Industry Association Office of Gas and Electricity Markets Oil & Gas UK Orchid Environmental and Hargreaves Services (Joint Response) Partnerships for Renewables

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Peabody Energy Peel Energy Poyry Prospect REG Bio-Power REG Windpower Regen SW Regulatory Policy Institute Renewable Energy Association Renewable Energy Systems Limited Renewables UK Respect Energy RLtec Royal Bank of Scotland Royal Institution of Chartered Surveyors RWE npower Scotch Whisky Association Scottish and Southern Energy Scottish Coal Scottish Enterprise Scottish Environment Protection Agency Scottish Government Scottish Industrial Advisory Group on Thermal Generation and CCS Scottish Power Scottish Renewables Scottish Resources Group Scottish Water SeaEnergy Renewables Limited Sheffield Forgemasters Shell Siemens Smartest Energy Statkraft AS Statnett SF Statoil Summerleaze

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Supporters of Nuclear Energy Sussex Energy Group, University of Sussex Tata Steel UK Tees Valley Unlimited Tesco The Common Good Party The Co-operative Group The Crown Estate The Green Company Trade Union Congress Trade Union Congress Clean Coal Task Group UK District Energy Association UK Energy Research Centre UK Hydrogen and Fuel Cell Association Ulster Farmers Union Unison University of Edinburgh University of Exeter, Energy Policy Group Utilita Electricity Utility Regulator Northern Ireland Vattenfall AB Veolia Environmental Services Viridian Power and Energy Viridor Waste Management Wärtsilä Corporation Water UK Welsh Assembly Government Welsh Power Wessex Water West Coast Energy Westinghouse Wood Panel Industries Federation World Coal Association WWF (World Wildlife Fund)

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Planning our electric future: a White Paper for secure. affordable and low-carbon electricity 146 .

The proposed design needs to recognise and satisfy a number of other important objectives reflecting wider policy goals and market impacts.Planning our electric future: a White Paper for secure. In summary. For example.3 Design principles B.1 This annex sets out the rationale behind the proposed design of the Feed-in Tariff with Contracts for Difference (FiT CfD). In many cases it is necessary to find an appropriate balance between different objectives. this annex outlines those elements of the design that Government is minded to adopt (such as different contract structures for different generation types) as well as others which are at an earlier stage of development (including the contract volume for ‘baseload contracts’). and retaining normal commercial incentives for generators (and suppliers) to sell electricity in a way that best reflects their operational models. Further information on the costs and benefits associated with the FiT CfD are set out in the accompanying Impact Assessment. and different aspects of the proposed design are at different stages of development.4 efficiency: including promoting cost-efficient low-carbon investment. affordable and low-carbon electricity Annex B – Further detail on the proposed design of the Feed‑in Tariff with Contract For Difference Introduction B. The proposals outlined below are still being refined. and the costs to consumers on the other. the key principles which have informed our proposed FiT CfD design are: ●● B.2 B. recognising that commercial and operational behaviour varies across different generation classes. 147 . Accordingly. the basic structures of FiT CfD in each case. The primary objective of the FiT CfD is to stimulate investment in lowcarbon generation technologies at the lowest cost to the consumer. DECC will continue to engage with Ofgem. and areas for further work. in addition to the high-level criteria set out in Chapter 2 of this White Paper. industry and other stakeholders in order to further develop these proposals prior to bringing forward legislative provisions early in the second session. the FiT CfD needs to strike a careful balance between the amount of risk removed from investors on the one hand. our proposed approach to different generation classes. It presents a comprehensive overview of the principles that have informed our design proposals.

an economic rather than technical choice. They tend to choose to run baseload in order to maximise their revenue. coherence: including the need to ensure consistency between the FiT CfD and other elements of Electricity Market Reform. i. and practicality: including the need to. barriers to entry: including the need to ensure an open and competitive process for awarding contracts. 148 . and more widely to avoid arrangements which favour a particular corporate structure. ●● ●● B. We have distinguished between three classes of plant: ●● intermittent: plant which has little or no control over when it generates or at what level of production (beyond a decision to be available or not) and for which fuel costs are not a consideration. This class therefore includes wind as well as other renewable technologies such as wave and solar. 1 Most biomass plant has the ability to vary output.6 These different characteristics mean that the cost and benefits of different FiT CfD structures vary.e. and flexible: plant which has the ability to control its output (within certain maximum and minimum parameters) and respond to shifts in demand in different timeframes. on wholesale market liquidity.5 While a FiT CfD can be applied to all types of generation. mitigating the potential for windfall profits/excessive rents. enable contracts to adapt to a changing market environment (for example. affordable and low-carbon electricity ●● cost to society: including providing for an efficient allocation of risk between generators and consumers. as far as possible. ●● ●● ●● Tailoring the support mechanism to reflect the characteristics of different types of electricity generation B. Low-carbon technologies include biomass as well as.Planning our electric future: a White Paper for secure. as well as parallel Ofgem reforms e. This class will in general be associated with variable fuel costs. Which reference price to use and whether to average the reference price (over a period of time) are the key design choices that affect the efficiency of the FiT CfD for different generation types. In addition to nuclear generation. this class may also include some biomass plant1 and Carbon Capture Storage (CCS) plant. and mitigating the risk of gaming and contract manipulation at the expense of the consumer. the specific design needs to recognise the characteristics of the plant being supported by the instrument. either for economic reasons or because the plant has limited ability to vary output at short notice to respond to shifts in demand. baseload: plant which operates at a constant level of generation. potentially CCS.g. including an in-built mechanism for revising the reference price to ensure it remains the best representation of market prices). in the future. but also has the ability to run baseload.

●● ●● B. and the price source (the index of the electricity price on which the reference price is based): for the contract to function operationally. The scale of this effect depends on the amount of wind generation on the system.g. In principle. prompt (e. Averaging in this way can provide an additional incentive on some generation types to operate optimally (see below). day-ahead) or forward markets2. averaging therefore introduces risk for intermittent plant that is difficult for them to manage. for example.g. this in turn means that high winds can drive electricity prices down and as such reduce wind generators’ revenues. ●● 2 The spot market refers to the wholesale market for electricity that is traded for delivery on the same day. In Great Britain. This means that there are a number of aspects to consider in formulating a reference price. affordable and low-carbon electricity B. including: ●● the market segment from which the reference price is drawn: this could be the spot.Planning our electric future: a White Paper for secure. or a basket of some or all of these. the prompt market refers to the market for electricity that is traded for delivery on the following day. taking the average of 30 consecutive day-ahead prices to form a one month average of the day-ahead price. a month or a year later. but the maintenance schedule for intermittent plant is already largely driven by other factors such as wind patterns.8 There are two key effects to consider before determining whether to average the reference price: ●● averaging the reference price provides strong incentives for generators to carry out maintenance at the right time and ensure plant is generating when prices are higher – this is a signal that baseload can respond to. 149 . Output from wind turbines tends to be correlated. Therefore. The forward markets refer to markets for electricity that is traded for delivery at a future point. e. in different volumes and at different periods of time before it is actually delivered. the Government considers that FiT CfD for all generation types should include an in-built mechanism for revising the reference price to ensure it remains the best representation of the market price for the relevant market segment. the efficiency benefits of averaging are significant for baseload plant but not for intermittent. electricity can be bought and sold on different trading platforms. which in turn is driven largely by renewables targets. the averaging period: in essence whether the prices taken from a given market segment should be used individually or averaged over a longer period. the data source must be robust and credible. Generators cannot predict how much wind generation will be on the system in the future and therefore would find it hard to predict how the price they receive from the market relates to the average price.7 The reference price is a key component of the FiT CfD as it is used (alongside the strike price) to determine the payments to be made under the FiT CfD. and averaging also creates additional risks for intermittent plant.

In particular. The Government is therefore minded to adopt different FiT CfD structures for intermittent and baseload technologies. This option broadly consists of a fixed payment to cover a generator’s fixed costs combined with a one-way FiT CfD that is structured in a way that provides generators with an incentive to generate when the electricity price is greater than their marginal costs. A reference price taken from a market for electricity to be delivered later than the following day would therefore expose the generator to increased risk. This would detract from investor attractiveness and increase cost of capital without providing any additional benefits to the power system or the consumer. The instruments will be less effective in catalysing investment in low-carbon generation if the generator does not feel confident that it can sell its output at a price which is at least reasonably close to the reference price. beyond a short delivery timeframe. The FiT CfD structure for flexible technologies is at an earlier stage of development. For example.9 It is also important to recognise that a FiT CfD has the potential to influence a generator’s commercial incentives and operational behaviour.Planning our electric future: a White Paper for secure. so can be exposed to volume and price risk within this timeframe. in order to stabilise its revenues. however we describe one option below. intermittent generation can forecast its output with a reasonable degree of accuracy a day ahead of delivery. the level of output an intermittent plant will generate becomes increasingly uncertain. B. a FiT CfD supported plant is likely to decide to sell its electricity in the market segment from which the reference price is sourced. affordable and low-carbon electricity B.11 150 . These structures are summarised in the table below and then discussed further in the rest of this Annex. However. Selecting a market for the reference price that retains the normal commercial incentives on a generator to sell electricity in the way that best reflects its operational model also minimises the likelihood of market distortions.10 B.

Payments will only be made under the FiT CfD if the plant is generating electricity. The Government is minded to introduce a FiT CfD that pays intermittent low-carbon generators on the basis of their actual output (in MWh).Planning our electric future: a White Paper for secure. • Year-ahead baseload price • Choice of price sources Market Reference Price • Day-ahead price • Choice of baseload or hourly prices • Not averaged over a longer period Contract Volume • Metered output • To be confirmed. For example.13 The Government considers that this arrangement delivers the appropriate balance between providing long-term revenue certainty for the generator. Intermittent Contract Form Strike price • Two-way FiT CfD • Annual inflation indexation4 Baseload • Two-way FiT CfD • Annual inflation indexation • Minded not to include fuel indexation for biomass. 151 . the payment received by the generator is based on the actual amount of electricity it has delivered over the period in question. where a generator is due for payments under the FiT CfD (the strike price in the contract is higher than the market reference price). We recognise the need for investors to achieve a return reflecting real terms. ●● B. while ensuring that consumers are not overcompensating developers. the generator: ●● receives a top-up payment up to the strike price when the electricity (reference) price is below the strike price. affordable and low-carbon electricity Approach to different generation types Figure B1: Overview of proposed3 Feed-in Tariff with Contracts for Difference design.14 3 4 These proposals are subject to the final design of any capacity mechanism. metered output or firm volume Intermittent generation4 Contract form B.12 The proposed FiT CfD for intermittent generation adopts a two-way contract form. and passes back revenues to the consumer when the electricity (reference) price is above the strike price. To be confirmed for CCS. Contract volume B. a link between the strike price and a measure of inflation would remove the inflation risk of the investment. In other words.

As set out in Chapter 6 of this White Paper.19 5 6 7 8 9 As intermittent generators choose to generate even when the electricity price is lower than their marginal costs. negative prices may only occur for around 70 hours a year in 20309. All of these solutions will help to reduce the likelihood of negative prices through shifting demand to utilise output from wind farms when required. it could for example offer its electricity at its opportunity cost – the support level6. we recognise the concerns raised by a number of stakeholders that payment for metered output does give rise to the prospect of negative prices for electricity in the future and the corresponding distortions that this creates5. The support level in this case refers to the difference between the strike price in the CfD and the market reference price. Given the inherent variability of intermittent generation. The Government notes Poyry’s 2009 study on the effects of intermittency. Implications of Intermittency: A multi-client study. However. affordable and low-carbon electricity B.18 B. the Government will give further consideration to the likelihood and impact of negative prices in the future and examine the case for taking action to either limit or prevent negative prices from occurring. Generators would have no way of ensuring their level of output matched the level specified in a firm volume contract. the actual amount of electricity produced. Based on an assumption of existing wholesale market arrangements and the continuation of the Renewables Obligation. 152 . it is conceivable that there will be a need to constrain wind.16 B. The Government therefore considers that payment for metered output. B. Making payments to intermittent generators based on availability or capacity could also remove the incentive on generators to find the best locations for their plants and would also require extensive monitoring. making payments based on a pre-agreed level of output (firm volume) would place a risk on generators that they could not effectively manage.17 B. As a wind generator could only receive payments under the FiT CfD if it generates. In other words a wind generator could sell its electricity at a negative price (pay a supplier to take it) up to the level of its support payment.15 This mirrors the current arrangements for intermittent generators under the Renewables Obligation. Pöyry Energy (Oxford) Ltd (2009) Installed wind capacity of 43GW by 2030 providing around a third of total generation. electricity storage (including from plug-in vehicles) and interconnection (which if all current proposals are realised could increase to 10 GW by 2020).Planning our electric future: a White Paper for secure. With more significant penetrations of wind generation and inflexible plant such as nuclear. is likely to be the most efficient way to bring forward the maximum amount of low-carbon electricity and also to encourage optimal siting decisions for new lowcarbon plant. the Government is clear that there will increasingly be a need for balancing solutions such as demand side management.7 which suggests that with significant levels of wind8 and a range of balancing solutions in place. However.

The Government is mindful of the possibility that the System Operator (SO) may increasingly need to take action to constrain wind power for grid balancing reasons. the day-ahead market reduces the risk10 that would be introduced if a market for a period further ahead were used. First of all. the within-day market is characterised by buyers and sellers seeking to avoid exposure to the Balancing Mechanism.e. In such cases the generator would not receive payment under the FiT CfD for the volume that has been constrained. It is likely that the SO would want to turn down intermittent generation before turning off nuclear plant (both on cost grounds and due to the time nuclear takes to start up again). This is discussed further below. B.Planning our electric future: a White Paper for secure. 153 . including for example paying some intermittent generators on the basis of availability rather than metered output to prevent wholesale prices going below zero. In a future scenario with much higher penetrations of intermittent and inflexible generation it will be important that the SO is able to turn down generation at least cost to the system. affordable and low-carbon electricity B. but generators would have no incentive to actively manage any of their output into the market.20 There are a number of potential approaches.23 10 This risk is sometimes referred to as ‘basis risk’. As noted above.21 Reference price B. The impact and likelihood of negative prices also needs to be considered in relation to the contract volume for baseload generation. intermittent generators are generally unable to forecast output with much accuracy until relatively close to the point of delivery and so longer dated options could lead to a mismatch between the price a generator receivess for its electricity in the market and the reference price in its FiT CfD. In addition. The Government considers that the day-ahead market should be the market segment from which the reference price for intermittent generation is drawn. A half hour ahead spot price would completely remove this risk.22 B. their declaration to National Grid prior to being constrained). It is the risk that the generator achieves a price in the market which is lower than the reference price. The Government is minded that for these periods intermittent generation should be paid under the FiT CfD on the basis of their availability (i. which means it is likely to be volatile and not a robust representation of the value of ‘prompt power’ across the industry. rather they would sell power very close to delivery which would increase system balancing challenges for the SO. There are a number of reasons for this.

the day-ahead market: ●● is a market on which an intermittent generator should be able to confidently sell power. 154 . B. the chosen reference price for intermittent generation is in general a dayahead market price. given existing wind forecasting techniques11.25 The Government recognises that there will be some inaccuracy between day-ahead forecasts and actual output delivered. industry and other stakeholders before coming to a firm view on this aspect of FiT CfD design. As described above. The Government has considered different options for determining the volume in the contract. but not deliver the benefits (in terms of optimal maintenance and operating decisions) that should arise for other types of generation. and is relatively liquid. See also Alternative Trading Arrangements for Intermittent Renewable Power: A Centralised Renewables Market and Other Concepts (2010) by Hesmondhalgh et al. Finally. of which the lead two are outlined below.28 The proposal for the FiT CfD for baseload generation is to adopt a two-way contract form. In other European countries (for example. already used extensively by intermittent generators. 2nd Edition (2011) by Giebel et al. for example by developing better forecasting techniques. Denmark) that have applied either CfD or variants of Premium FiT with a link to electricity prices. ●● B. As is the case for intermittent generation. affordable and low-carbon electricity B. the Government considers that the price source (the market price index used to provide the reference price) should be the best representation of day ahead market prices at the time the FiT CfD is allocated to the generator. but considers that this ‘basis risk’ should remain with the generator as it is unlikely to be particularly large and it provides an incentive for generators to adapt to manage it. The Government will continue to engage with Ofgem. and provides clip sizes (volumes available to trade) which are small enough to meet the needs of smaller generators.24 In contrast.27 Baseload generation Contract form B.Planning our electric future: a White Paper for secure. this is because to do so would increase the revenue risk to generators. Contract volume B. while also providing sufficient depth for larger deals to be struck. the principal reason for proposing this contract form is to protect the consumer from price scenarios in which the generator could receive significantly more revenue than required to deliver a commercial rate of return over the lifetime of the investment.29 11 See The State-Of-The-Art in Short-Term Prediction of Wind Power: A Literature Overview.26 B. The Government considers that day-ahead prices should not be averaged over a longer period to generate a reference price for intermittent generation.

in particular. concerns that this option could distort the ‘despatch decisions’12 of baseload plant and increase the likelihood of negative prices. There are. and 12 The decisions made by power plants on when and when not to generate. and therefore directly to the generating plant itself.Planning our electric future: a White Paper for secure. For example. consumers could be paying for plant that is not generating (for example a long-term forced outage of a nuclear plant). as with intermittent generation. the extent to which a two-way metered output FiT CfD would affect the allocation of risks to CCS plant (see also section on fuel costs below). 155 .33 the extent to which a metered output FiT CfD would genuinely distort the operating (despatch) decisions of. The alternative option is to base the contract volume on a pre-agreed fixed number of MWh (‘firm volume’). however.32 B. the likelihood and impact of negative prices in the low-carbon transition. The Government recognises that there are trade-offs between these two design options. as opposed to actual generation. rather than in order to access a FiT CfD payment (which it will receive/pay regardless of whether it generates or not).34 The Government is minded to use the year-ahead market as the market segment from which the reference price for baseload generation is drawn.31 B. There are a number of reasons for this preference: ●● year-ahead prices effectively represent an average of market prices across the year of delivery. As previously described. There are however potential risks with firm volume contracts for baseload generation. nuclear plant. on metered output.30 The first option is to base the contract volume. if the strike price is above the reference price. averaging prices to derive the reference price in this way sends a strong signal to baseload plant to carry out maintenance when market prices are low and ensure it is operating when prices are high. and considers that further analysis is required to provide greater clarity on: ●● B. This retains the advantages set out above in terms of linking the support payments directly to the actual amount of low-carbon electricity produced. ●● ●● ●● Reference price B. and the likelihood of portfolio generators using fossil fuel generation in order to meet obligations under a firm volume FiT CfD. The main advantage of a ‘firm volume’ contract is that the generator continues to base its decision on whether to generate (despatch) on the electricity price relative to its production costs. affordable and low-carbon electricity B.

37 13 A liquid market is one in which participants are able to quickly buy or sell a product without causing a significant change in its price and without incurring significant transaction costs. The Government will continue to discuss the merits of this approach with Ofgem. If the plant is not operating.aspx?docid=1&refer=Markets/RetMkts/rmr. The Government notes that in the current GB market the longest contract. is a season-ahead. ●● ●● B. but more importantly they are exposed to the market price.Planning our electric future: a White Paper for secure. using a year-ahead market retains the existing incentives for generators to sell ahead of delivery. Therefore. and also some flexible power to flex up and down in line with shifts in demand and to offset the intermittency of some renewables.uk/Pages/MoreInformation. The Government considers that a different structure may be required to bring forward investment in flexible low-carbon plant that is likely to run at lower load factors than baseload. which may have benefits for small or independent suppliers. the generator does not receive payments under the FiT CfD (in the case of metered output rather than firm volume). Flexible generation General B. B. An alternative option may be to use an average of the clearing prices of Ofgem’s proposed Mandatory Auctions14. generate at times of high demand and turn down/off when demand is low. for this FiT CfD an average of the summer and winter prices is likely to be most relevant as a reference price. Calendar contracts are now quoted more often in GB.35 The price source should be the best representation of year-ahead market prices at the time the FiT CfD is allocated to the generator. affordable and low-carbon electricity ●● by selling electricity ahead of delivery.gov. and using a forward market such as the year-ahead market would enhance liquidity13 in that market. it is likely that the future low-carbon generation mix will need to provide both firm baseload power to meet the core.36 In order to largely decarbonise the electricity sector. which allows suppliers to meet the needs of their customers who are looking for longer-term stability.ofgem. If the plant cannot generate. but the market remains dominated by season-ahead. 14 http://www. steady demand for electricity. It also allows suppliers to smooth their purchasing costs. the generator has to buy power from elsewhere to meet this obligation. 156 . the generator is incentivised to ensure reliability. the generator improves revenue by avoiding high priced periods for such repurchasing needs. The Government’s initial view is that in this case the FiT CfD should incentivise the generator to fully respond to short-term market signals. with adequate liquidity. Evidently. See also the Impact Assessment that accompanies the White Paper for more information. This is because the generator has already sold power forward and is obliged to deliver this power.

The Government is not committing to introduce a FiT CfD for flexible plant at this stage but will continue to consider the optimum arrangements for this type of generation. for electricity that is traded for delivery on the same or following day.42 Reference price B. The Government will continue to engage with industry on this and alternative options. Peak-load generation is used to satisfy short periods of maximum demand. 16 Baseload generation is that used to meet continuous demand and non-baseload generation is brought in progressively as demand increases. a generator receives a fixed payment (for example at the start of each month or year) to cover its fixed costs.43 15 This should result in efficient despatch. This is achieved through the design of the one-way FiT CfD. which is a requirement for plant operating in the mid-merit/peaking tranche of the merit order16. Mid-merit generation is that which falls between baseload and peak. when demand is high). affordable and low-carbon electricity B.Planning our electric future: a White Paper for secure. The generator would therefore cover its variable costs from the revenues it receives from selling its electricity – any excess profits it made from selling power would be returned to the institution. Contract form and volume B.38 A FiT CfD for flexible plant may not need to be issued until some time in 2020s given the continued role played by conventional gas-fired generation. In principle the reference price would be based on a short-term index17 to ensure that the generator responds to short-term market signals and ensures security of supply. 17 Index of prices from the spot or prompt markets. One advantage of this contract form is that the generator is incentivised to operate at periods of high prices when the system is under stress. 157 .39 B. The generator then has an incentive to generate only when the electricity price is greater than its marginal cost15 (i.40 B. The Government recognises that a possible contract form for flexible generation is a one-way contract form with a contract volume based on firm volume rather than metered output. Under a one-way FiT CfD.41 B. There would be no incentive to generate when the price is lower than a generator’s marginal cost because the generator does not receive any support payments linked to output (as for any generation plant that does not receive support).e. The generator is required to pay difference payments to the institution if the power price exceeds the marginal cost of generation (the strike price in the contract).

biomass and CCS generators need to purchase fuel for the production of electricity.47 B. given the additional risks involved with investment in CCS demonstrations.49 B.45 B. We expect support for these early projects will need to be different to that for commercially-proven CCS and other low-carbon baseload options.50 158 . We are therefore assessing the possibility of greater certainty of payment in the FiT CfD making up part of the support package for CCS demonstration projects. Fuel prices can vary over the commercial life of a power station. This is because. In particular.Planning our electric future: a White Paper for secure. As such it could mean that the FiT CfD strike price could be lower than if the fuel price risk were retained by generators. we are considering several funding options for providing financial support including potentially through the FiT CfD alongside other approaches. Unlike wind (which has free fuel) and nuclear (which has a low fuel input cost coupled with stability in that fuel price). For plant with variable fuel costs such as biomass or coal or gas for CCS. biomass and CCS operators have a fuel price element to consider in their generation process. the Government is mindful of the need to provide for an efficient allocation of risk between generators and consumers. Linking the strike price to fuel costs would leave B. taking into account impact on overall affordability. In line with this. in contrast to other forms of low-carbon generation.48 B. there are also arguments against linking the FiT CfD strike price to fuel costs. Linking the FiT CfD strike price (or possibly the reference price) to the fuel costs for these plants (so. for example. the strike price would rise as fuel costs rise and vice versa) would increase long-term revenue certainty for generators. affordable and low-carbon electricity Additional considerations Carbon Capture and Storage demonstration projects B. The Government will continue to engage with stakeholders on how best to support CCS demonstration projects. there is an option to adjust the level of support to compensate for fuel price fluctuations. A two-way FiT CfD would prevent generators from recovering variations in the cost of fuel through the electricity market. Budget 2011 set out that CCS demonstration support would come through general taxation. However. and is considering the best mechanisms for supporting CCS demonstrations. As a consequence there is greater revenue risk when compared to other low-carbon generation options if support is delivered through a FiT CfD based on output. and the Government acknowledges that this could present an appreciable risk to generators. these projects are likely to be less reliable and predictable.46 Fuel costs for biomass and Carbon Capture Storage B. As noted above.44 The Government is committed to demonstrating CCS quickly to encourage rapid investment and deployment.

contract duration: the length of the contracts.Planning our electric future: a White Paper for secure. which may affect the type of FiT CfD to be offered. including the case for providing a link to fuel costs.54 settlement period: the frequency with which payments are made/ received under the FiT CfD. affordable and low-carbon electricity consumers (rather than generators) exposed to the risk of high fuel prices. For CCS. The Government will carefully consider the interactions between the FiT CfD and Capacity Mechanism in developing both mechanisms in a coherent and complementary manner. B. the Government recognises that the market circumstances may be somewhat different when it moves from demonstration to commercial deployment. In general the Government considers that generators are better placed than the consumer to manage this risk. established biomass price index and the diversity of feedstocks would make it extremely difficult to calculate a single price. not linking the FiT CfD strike price to fuel costs would enable better price comparison between different low-carbon technologies.53 Next steps B. enforcement of contract obligations: in order to ensure effective operation of the contract and that conditions associated with contract award are carried out to achieve the goals of Electricity Market Reform. The Government will therefore continue to consider the best arrangements for supporting commercial CCS. and payment mechanisms: the design of the mechanism or mechanisms for ensuring that generators can receive and make payments under the FiT CfD. indexation: the approach to linking the FiT CfD strike price to a measure of inflation to remove inflation risk from the investment. 159 ●● ●● ●● ●● ●● .51 For biomass. In addition. terms for credit and collateral: the credit terms including requirements for security and credit-worthiness of the developer. the lack of a single. It would not be possible to directly compare a strike price that fluctuates with fuel costs with another that does not. As such the Government is currently minded not to link the two-way FiT CfD strike price to fuel costs for biomass.52 Payment for capacity as part of the FiT CfD B. the Government will develop further the design of the FiT CfD including the following: ●● B. The Government will therefore consider including an element of payment for capacity within the FiT CfD. It is not clear at this stage if CCS will be commercially deployed as baseload or intermediate load/flexible generation. In addition to those areas already identified in this annex.

mechanism@decc. This includes a Welsh version.Annex C – Consultation on possible models for a Capacity Mechanism Purpose of this consultation The Government is seeking views on alternative approaches to a potential Capacity Mechanism for the GB electricity market. 4th Floor.uk/consultations.decc. SW1A 2AW Tel: 0300 068 5101 Email: DECC. Please contact us under the above details to request alternative versions.gov.gsi. Other versions of the document in Braille. further development of the scheme will include discussions with the Welsh Government and Scottish Government to determine how the Capacity Mechanism should apply in their jurisdictions. affordable and low-carbon electricity. London. However.capacity. 160 . Territorial extent: The Capacity Mechanism proposed here would be GB-wide. An electronic version can be found at http://www.uk Command number: 8099. Issued: 12 July 2011 Respond by: 04 October 2011 Enquiries to: Matt Wieckowski Department of Energy & Climate Change. large print or audio-cassette are available on request. How to respond: Direct responses to the questions posed will be most useful. The scheme set out here would not apply in Northern Ireland. Responses are welcome by email or post to the addresses above. Area D 3 Whitehall Place. please identify the relevant sections. Additional copies: You may make copies of this document without seeking permission. but if including any long reports as part of your response. Evidence to support your answers will be particularly helpful. though comments are welcome on any aspect of the proposals set out in this annex.gov. URN 11D/823 – Planning our electric future: a White Paper for secure.

If you want information that you provide to be treated as confidential please say so clearly in writing when you send your response to the consultation.decc.uk/consultations. Quality assurance: This consultation has been carried out in accordance with the Government’s Code of Practice on consultation. affordable and low-carbon electricity Confidentiality and data protection: Information provided in response to this consultation. may be subject to publication or disclosure in accordance with the access to information legislation (primarily the Freedom of Information Act 2000.pdf If you have any complaints about the consultation process (as opposed to comments about the issues which are the subject of the consultation) please address them to: DECC Consultation Co-ordinator 3 Whitehall Place London SW1A 2AW Email: consultation. including personal information. An automatic confidentiality disclaimer generated by your IT system will not. If we receive a request for disclosure of the information we will take full account of your explanation.gsi. It would be helpful if you could explain to us why you regard the information you have provided as confidential. addresses or other contact details.gov. but we cannot give an assurance that confidentiality can be maintained in all circumstances. of itself. which can be found here: http://www. This summary will include a list of names or organisations that responded but not people’s personal names.uk 161 .Planning our electric future: a White Paper for secure. We will summarise all responses and place this summary on our website at www.coordinator@decc.gov. the Data Protection Act 1998 and the Environmental Information Regulations 2004).gov.uk/files/file47158. be regarded by us as a confidentiality request.bis.

price response and interconnection Functional groupings Triggering the Capacity Mechanism 4. Market-wide mechanism: Capacity Market Overview Setting the required level of capacity How and by whom capacity is bought Contract duration How far ahead should contracts be purchased? Primary and secondary markets Determination of capacity credit and penalties for non-availability Reliability Market Overview Financial flows Choosing the reference market Setting the strike price Extent of physical and financial back up required from providers of reliability contracts Interaction with short-term balancing Impact of vertical integration on availability signals Other considerations in designing a Capacity Market Interaction with Feed-in Tariff with Contract for Difference The role of demand side response.Planning our electric future: a White Paper for secure. affordable and low-carbon electricity 1. Consultation Questions 162 163 165 165 166 167 168 168 169 170 176 176 176 177 178 180 180 181 182 183 183 184 185 186 186 188 189 191 192 193 193 194 194 195 197 199 200 200 201 202 202 202 208 211 . storage and other non-generation technologies and approaches Setting the reserve despatch price Into which market should Strategic Reserve be sold? Interaction with short-term balancing Interaction with Feed-in Tariff with Contract for Difference Functional groupings Financial Flows 3. Introduction 2. Targeted Mechanism: Strategic Reserve Overview Addressing stakeholder views Setting the required level of capacity Procuring the necessary reserve Criteria that providers of Strategic Reserve would need to meet The role of demand side response. Comparison of Capacity Mechanism options Summary Assessment against criteria Cost-benefit analysis of Capacity Mechanism options 6. storage. International comparisons Strategic Reserve Capacity Market 5.

we are keen to gain stakeholder feedback and have included detailed design questions. and the Capacity Payments mechanism discussed in the Electricity Market Reform Consultation Document.3 C1. the Government is seeking views on alternative approaches to a potential Capacity Mechanism: ●● C1. Under a Capacity Market. In particular. a development of the lead option from the consultation document which aims to mitigate concerns raised by stakeholders. and these remain under consideration. This annex sets out the detail of the Strategic Reserve and Capacity Market options.6 1 As noted in Chapter 3 of this White Paper. and the total volume of capacity required is purchased. in which all providers willing to offer capacity (whether in the form of generation or non-generation technologies and approaches such as storage or demand side response (DSR)) can sell that capacity.gov. or a market‑wide mechanism in the form of a Capacity Market. This position builds on that set out in the Electricity Market Reform Consultation Document2. We recognise that there are other forms of market-wide mechanism. Respondents to the consultation set out a wide range of views. depending on the nature of the ‘capacity’ and how it is bought and sold. with a proposed model of a Strategic Reserve. there are a number of ways to purchase capacity – including through a central auction or a supplier obligation. a Capacity Mechanism is intended to address the challenge of ensuring resource adequacy (i.2 C1. To address the issues raised.decc.e. given its innovative nature.5 For reference. and concludes that a Capacity Mechanism is required to ensure future security of supply1. This comprises centrally-procured capacity which is removed from the electricity market and only utilised in certain circumstances.1 C1. Sections 2 and 3 describe some of the design C1. such as those which set price in order to incentivise sufficient volume (Capacity Payments). where the Government indicated a preference for a targeted Capacity Mechanism under which an obligation would be placed on a central body to maintain a set capacity margin.1 Introduction Chapter 3 of this White Paper sets out the Government’s view of the security of supply challenges faced in the GB market. that there is sufficient reliable and diverse capacity to meet demand. Figure C1 shows the kinds of Capacity Mechanism that we discuss in this annex.aspx 2 163 .uk/en/content/cms/consultations/emr/emr. One form of a Capacity Market is a Reliability Market. http://www. there are a number of ways to purchase capacity – including through a central auction or a supplier obligation. for which. for example during winter anti-cyclonic conditions where demand is high and wind generation low for a number of days).4 a targeted mechanism.C. A significant number expressed strong concerns about the introduction of a targeted mechanism. There are several forms of Capacity Market. ●● C1.

and while responses to these would be particularly helpful. a regulatory definition of capacity or a reliability contract). Under a Capacity Market.Planning our electric future: a White Paper for secure. Could be delivered through an auction or an obligation) Notes: The Capacity Mechanism types in inverted commas are those proposed in the December consultation document. 164 . Figure C1: Possible models for a Capacity Mechanism Capacity Mechanism (Targeted) (Market-wide) ‘Tender for Targeted Resources’ Capacity Market (volume set centrally) ‘Capacity Payment’ (price set centrally) Strategic Reserve Other (including ‘capacity obligation’ and ‘capacity auction’) Reliability Market (including ‘reliability option’. The options are then compared against a set of criteria in Section 5. A number of questions on areas where we are seeking stakeholders’ views are included throughout.e. and some international examples are included in Section 4. affordable and low-carbon electricity considerations for each. which could be through a central auction and/or a supplier obligation. one distinction is what is bought and sold (i. comments are welcome on any aspect of these proposals. Another distinction is how the capacity is bought and sold. The questions are compiled in Section 6.

2 C2. Central body procures reserve capacity but withholds it from the market … 2. We have further refined this to a Strategic Reserve.3 Figure C2 shows how a Strategic Reserve would operate to ensure a capacity margin. The despatch price would be set above the highest long-run marginal cost in the electricity market. and the Strategic Reserve would be withheld from the electricity market and would only be despatched when prices rise above a certain level – the despatch price.2 a central determination would be made of the required reliability level and whether the market is likely to deliver this. but below the theoretical value to the GB economy of preventing blackouts – Value of Lost Load (VoLL)3. It would therefore constitute a cap on market prices4. as the most suitable targeted mechanism to address the security of supply challenge.Planning our electric future: a White Paper for secure. Figure C2: Strategic Reserve mechanism in practice 1. no additional capacity would be procured. as opposed to other approaches such as an extension of Short-Term Operating Reserve (STOR). The key elements of this approach are: ●● Overview C2. if no shortfall is expected. a central body would be charged with competitively procuring the necessary volume and mix of Strategic Reserve. … unless ‘exceptional circumstances’ prevail 3 4 VoLL is the theoretical value to the GB economy of preventing blackouts. ●● ●● ●● C2. The proposal for price setting is set out in more detail in ‘Setting the reserve despatch price’. It is the electricity price at which an average consumer would rather be cut off than continue paying. affordable and low-carbon electricity C. where there is a shortfall in forecast reliability. 165 .1 Targeted Mechanism: Strategic Reserve The Electricity Market Reform Consultation Document included a preference for a ‘tender for targeted resource’.

• Strategic Reserve could be included in the cash out calculation. and • have a despatch price that would be lowered following pressure at times of system stress/high wholesale prices. and • the operation of Strategic Reserve would be reviewed periodically. when there is a large difference between supply and demand) and the costs of balancing the system are greater. Figure C3 outlines stakeholder concerns and summarises how the proposed design of a Strategic Reserve aims to address them. Strategic Reserve would not be available to the electricity market and would be despatched at a fixed despatch price which is high enough above the highest long-run marginal cost in the electricity market to minimise distortion. 5 Cash out exists to reflect the cost of balancing the electricity system onto organisations which are out of balance at that point.Planning our electric future: a White Paper for secure. affordable and low-carbon electricity Addressing stakeholder views C2. • not feed into wholesale market electricity prices. The review would consider the impact of Strategic Reserve on the electricity market and whether the fixed despatch price is correctly set. 166 . thus preventing prices correctly rising at times of system stress when the reserve is used. thus allowing cash out prices to correctly rise to reflect the cost of using Strategic Reserve when it is used5. • lead to an ever-increasing need for reserve. • reduce incentives for investment. • the despatch price would have a defined change process to ensure any change is properly considered and not subject to short-term pressures. but below VoLL. We have sought to mitigate these concerns in the proposed design of the Strategic Reserve.e. Figure C3: Stakeholder concerns and the Government’s proposed mitigation approach5 Concern Market distortion Respondents felt that a tender for targeted resource would: • undermine effective operation of the market.4 A number of stakeholders reported concerns with the tender for targeted resource Capacity Mechanism described in the Electricity Market Reform Consultation Document. Mitigation To address these concerns we have developed a Strategic Reserve with the following proposed features: • to minimise electricity market plants being displaced from the merit order. In a normally functioning electricity market we would expect cash out prices to rise when the system is under stress (i.

This would include considering the appropriate length and structure of contracts.g. and the likely cost of providing different levels of reliability (over and above that which the market will provide).g. Primary legislation is being sought through the current Energy Bill to enable this. ●● ●● C2. This assessment would include consideration of: ●● the level of electricity demand over the next four years (considering peak demand and demand variability). providing it has the necessary physical characteristics (e. Question 1: Does this table capture all of your major concerns with a targeted Capacity Mechanism? Do you think the mitigation approach described will be effective? Setting the required level of capacity C2. DSR. interconnection).6 To assist this central assessment.5 Each year a determination would be made centrally of the required level of reliability – the percentage of time that the electricity market is expected to have adequate resource to meet demand. 167 6 Ofgem is governed by GEMA. the level of generating capacity over the next four years (considering peak generation. ramp-up and down rates). Eligibility and innovation A tender for targeted resource may fail to recognise the importance of resource flexibility. affordable and low-carbon electricity Concern Transparency and independent oversight A tender for targeted resource needs to be administered by a body independent of commercial and political conflicts. The reserve procurement functions would procure the most efficient Strategic Reserve. intermittency and variability). including DSR.Planning our electric future: a White Paper for secure. and which works to a transparent and stable methodology. The Strategic Reserve methodology would be described in legislation allowing market participants to understand how and when Strategic Reserve would be used. which consists of non-executive and executive members and a non-executive chair. Mitigation The procurement and despatch functions would be regulated activities with the legislation setting out how these functions should operate. Contract flexibility A tender for targeted resource may be inflexible and lock customers into paying for reserve regardless of need. and may not incentivise innovative and/or non-generation approaches (e. storage and interconnection.  . The Strategic Reserve procurement function would procure a mix of Strategic Reserve based on criteria designed to allow flexible capacity. the Gas and Electricity Markets Authority (GEMA) would provide an annual report on security of electricity supply6.

C2. both existing and proposed. and would procure an appropriate volume and mix through a competitive tender process. The criteria would apply to all forms of reliable capacity (including DSR and storage). availability fees – the fixed costs paid to generation and nongeneration for being available. whereas National Grid would retain responsibility for operational shortterm security through existing arrangements (such as STOR) (though the relationship between the mechanism and STOR would need to be carefully considered).7 Once the level of reliability has been set. the procurement function would need to consider the lead time between the procurement of Strategic Reserve and its availability (particularly for generation that has yet to be constructed) and the appropriate contract duration.10 Strategic Reserve is focused on ensuring there is sufficient resource to meet extended periods of high demand and/or low generation. affordable and low-carbon electricity Procuring the necessary reserve C2. and a determination made that the market will not deliver this level of reliability. 168 . The procurement function would have the scope to set the appropriate contract length based on the requirements for Strategic Reserve7. We envisage that the four-year forward looking reliability level would provide adequate time for the procurement function to procure new plants if required. When procuring Strategic Reserve. We would welcome your views on the criteria that providers of Strategic Reserve would be required to meet.8 C2. ●● 7 More discussion on contract lengths is included in ‘How far ahead should contracts be purchased?’ in Section 3: ‘Capacity Market’. The procurement function would consider the required reliability level and the shortfall which Strategic Reserve would need to fill.Planning our electric future: a White Paper for secure.11 The procurement function would need to consider appropriate criteria to ensure the desired mix of Strategic Reserve.9 Question 2: How long should the lead time for Strategic Reserve capacity procurement be and why? Question 3: Should the length and nature of contracts procured by the Strategic Reserve procurement function be constrained in any way? Criteria that providers of Strategic Reserve would need to meet C2. C2. responsibility for procuring the necessary reserve would sit with the Strategic Reserve procurement function. Examples of potential criteria include: ●● ramping rates – rate at which capacity can change its generation or demand.

making efficient use of available generation and network assets. would be able to participate in the Strategic Reserve in the same way as generation capacity. by self-supplying using local back-up generation. The introduction of Smart Meters could increase the opportunities for demand side participation. storage and other non‑ generation technologies and approaches C2. We accept that there may be a number of 8 For more information on demand side response see Chapter 3. and be compatible with a future electricity system in which consumers are engaged in their electricity consumption and demand is responsive. for example through greater use of time or price-sensitive tariffs8. C2.13 DSR is an active. Role of storage and other non-generation technologies and approaches C2. ●● Question 4: Which criteria should providers of Strategic Reserve be required to meet? The role of demand side response.15 We envisage that other technologies and approaches. Market arrangements need to ensure that they can play their part in enabling secure supplies alongside flexible generation. Question 5: How can a Strategic Reserve be designed to encourage the cost‑effective participation of DSR.16 In principle. we would want to allow providers outside GB to participate in a Strategic Reserve through interconnection. Role of demand side response C2. and length of sustained running – sustained period capacity can be run. affordable and low-carbon electricity ●● availability periods – period capacity is available. short-term reduction in consumption whereby an energy user or aggregator guarantees to reduce demand at a particular time. providers outside GB would need to meet the same criteria as other reliable capacity. such as electricity storage. provided they meet the required criteria. It enables this by shifting demand from periods where demand is greater than supply to periods where supply is more plentiful – for example. or by not using the electricity at that time.12 Non-generation technologies and approaches such as DSR.14 We envisage that DSR which can guarantee reduced energy use according to the specifications required could bid to act as part or all of the Strategic Reserve. 169 .Planning our electric future: a White Paper for secure. storage and other forms of non‑generation technologies and approaches? Role of interconnection C2. storage and new connections to other countries offer significant opportunities to improve security of supply and reduce the overall generating capacity that is needed. in order to participate. However.

Planning our electric future: a White Paper for secure, affordable and low-carbon electricity

technical constraints to including providers outside GB in a Strategic Reserve. For example, providers outside GB may not be able to provide additional capacity if flows to GB are limited by interconnection capacity during scarcity situations.

Setting the reserve despatch price
C2.17 A key part of the design of a Strategic Reserve is deciding the rules governing when it would be used or ‘despatched’. In the Electricity Market Reform Consultation Document we considered two potential options for despatching the Strategic Reserve:
●●

last‑resort despatch: the Strategic Reserve is only used after all other resource has been exhausted and is despatched at VoLL; or economic despatch: the Strategic Reserve is despatched when the market price reaches a certain level and sold into the market at this price9.

●●

C2.18 We have considered both options and prefer a form of economic despatch intended to address concerns expressed by stakeholders. In particular, we propose setting the despatch price high enough to avoid significant distortions to the market. However, we note the arguments are finely balanced and seek views on the most appropriate despatch model.

Economic despatch
C2.19 For our preferred economic despatch model, Strategic Reserve would be despatched at a fixed despatch price. This would be transparent, and set high enough above the highest long-run marginal cost in the electricity market to minimise distortion, but below VoLL. When the price rises above this fixed price, the necessary quantity of Strategic Reserve is despatched. C2.20 The operation of Strategic Reserve with economic despatch is shown in Figure C4.

9

In the Electricity Market Reform Consultation Document, we defined economic despatch as despatch ‘when it is cost-effective to do so…’. The phrase ‘cost-effective’ was ambiguous and so we have revised the definition here. We would not intend that the reserve be despatched at its short-run marginal cost as this would severely distort the energy market.

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Figure C4: Operation of Strategic Reserve with economic despatch
Electricity price £/MWh

Strategic Reserve

VoLL Despatch Price Shoulder Base

Peak

DM’ DM
Notes:

DP

GW

DP is the maximum demand which can be served by a market which has a Strategic Reserve, and the capacity of the Strategic Reserve itself, combined. DM is the maximum demand that could be served by a market with no Capacity Mechanism. Once a Strategic Reserve with a despatch price lower than VoLL is introduced, it will replace some electricity market generation, since it effectively caps the revenues that can be earned from times of peak demand. DM’ is the demand at which prices rise to the despatch price. When DM’ is reached the Strategic Reserve is despatched.

Last-resort despatch
C2.21 The operation of last-resort despatch is shown in Figure C5. Under a last-resort despatch model, the Strategic Reserve would be despatched once all other capacity has been despatched. It would be priced at VoLL. It should be noted that calculating this value is difficult, and the result not necessarily representative, as consumers are likely to attribute different values to electricity depending on their particular circumstances at any one moment. For example, a consumer with electric heating is likely to be prepared to pay more for this heating on a cold winter night than a mild spring day.

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Figure C5: Operation of a Strategic Reserve with last-resort despatch
Electricity price £/MWh Strategic Reserve Voll Despatch Price Peak Shoulder Base

DM

DP

GW

Comparison of economic despatch and last-resort despatch
C2.22 Respondents to the December 2010 Electricity Market Reform consultation were concerned that a Strategic Reserve would distort the electricity market, depress wholesale prices and reduce the incentives for investment. It could do this if the Strategic Reserve displaces plants that would otherwise have run. In considering the merits of last-resort despatch and economic despatch we have looked to address these concerns, considering the extent to which each model might:
●●

distort the electricity market; affect the potential for generators to exercise market power; increase certainty for investors; and provide the best value for consumers.

●●

●●

●●

C2.23 Market distortion: economic despatch could distort the market more than last-resort despatch if the fixed despatch price results in the displacement of significant volumes of electricity market capacity. However, it should be possible to set the total volume of Strategic Reserve and the despatch price so as to minimise this distortion. C2.24 By setting a cap under economic despatch, generators lose some revenue (sometimes called ‘scarcity rents’) which they would ordinarily receive at times of scarcity, when prices could potentially rise as high

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as VoLL10. However, to the extent that the Strategic Reserve replaces some generation, the price will rise to the despatch price more frequently than it would otherwise have done. C2.25 In principle, there is a despatch price (and related volume of Strategic Reserve) at which the impact on the investment incentives in the remainder of the market is neutral. At this price, the revenues lost to the remaining electricity market generators because the price no longer rises above the price cap are replaced. Replacement revenues would be earned during times when the price previously would have been lower than the cap but now rise to the cap price. The precise volume of Strategic Reserve that is required given the despatch price may be difficult to determine. In particular, this determination depends on a detailed knowledge of the load-duration curve which may not be readily available. Figure C6: Illustrative price duration curve, showing how the introduction of Strategic Reserve could impact on electricity market revenues
Electricity price £/MWh

Lost electricity market revenue (from prices that no longer rise above PSR) Additional electricity market revenue (from prices that now rise more frequently to PSR) Point at which demand=DM’

PSR

DM’

Half hourly periods

Notes: DM’ is the demand at which prices rise to the despatch price. When DM’ is reached the Strategic Reserve is despatched. PSR is the price at which the Strategic Reserve is despatched.

C2.26 Market power: under economic despatch there is a reduced incentive for generators to withhold capacity and drive prices up, as prices cannot rise beyond the despatch price. A last-resort despatch model does little
10 Electricity generators earn scarcity rents when there is not enough electricity supply to meet demand. At that these times the electricity price is not being set by the short-run marginal cost of the most expensive generator running, as it is ordinarily. Instead, the electricity price is being set by the price which the most expensive peaking plant is able to charge.

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and would allow Strategic Reserve to provide greater economic benefit to consumers than last-resort despatch. when compared to last-resort despatch. for example. affordable and low-carbon electricity to address the potential incentive on generators to exercise market power by withholding generation at times of scarcity because there is still a lot to gain from shortage – namely bidding prices up to VoLL. the value to consumers of despatch if the electricity from this Strategic Reserve were sold at VoLL would be questionable because this means pricing the Strategic Reserve at a level where consumers are by definition indifferent between paying for extra capacity and accepting blackouts. On balance we believe that economic despatch is the better solution as. when compared to last-resort despatch at VoLL. Hence both despatch models have been considered to mitigate this concern. First. prices may rise higher than they would have done otherwise. at times of moderate scarcity. because investors could be concerned that a last-resort despatch model with a high associated price for electricity generated (i.e. However.27 Investor certainty: in comparison with economic despatch.28 Furthermore. This could. C2.31 Conclusion: we are keen to ensure that the design of a Strategic Reserve does not undermine investors’ incentives to invest in reliable capacity. while ensuring that security of supply is maintained at least cost to consumers. would be more likely to lead to pressure for regulatory intervention. economic despatch could result in potentially more predictable. Second. However. C2. provides a more stable investment environment. last-resort despatch at VoLL could lead to increased investor uncertainty. C2.30 Economic despatch. C2.29 Value to consumers: last-resort despatch Strategic Reserve should limit the distortion to the electricity market.Planning our electric future: a White Paper for secure. more frequent. it: ●● is more likely to reduce the incentive to withhold generation during periods of scarcity. should provide greater economic value to consumers who would pay less for the lights to stay on than the cost of a blackout at times of extreme scarcity. VoLL). ●● ●● 174 . with a despatch price below VoLL. the effective price cap. but flatter peak prices. wholesale prices had risen to VoLL. C2. Investors may have greater certainty on their investment decisions if there were an economic despatch model with a lower price cap. because reliance on such volatile prices means that investment may be perceived as risky. be the case where following a number of uses of Strategic Reserve.

32 A number of respondents to the December 2010 consultation argued that during periods of high prices. we propose that the Strategic Reserve methodology and despatch price would be governed by a defined change process.33 The proposed model of economic despatch is intended to mitigate this concern. there could be increased pressure to lower the despatch price as a lever to reduce wholesale prices. C2. generators should be able to raise their prices to the point where they can cover their long-run marginal costs. In addition. Respondents were also keen that the Strategic Reserve methodology should be clear and transparent. It is important that the despatch price is as independent of such pressure as possible in order to provide investors with a stable environment. We welcome views on how this would best be accomplished. As noted above. who would be best placed to carry out the review and how often should it be reviewed? 11 The expectation of price caps in energy markets leads to ‘missing money’. generators may not be able to realise the necessary prices and hence cover their long-run costs. However. Question 7: How would the Strategic Reserve methodology and despatch price best be kept independent from short‑term pressures? Should Strategic Reserve be periodically reviewed? C2. In addition. consultation and review of any proposed changes before they are made. and this worry (even if it never materialises) will reduce incentives to invest. investors are likely to worry that periods of high prices will lead to regulatory intervention in the form of price caps. Reasons for this include actions taken by the System Operator (SO) to balance the system that are not priced correctly. we are keen to ensure Strategic Reserve minimises this potential distortion and have developed the proposed design to assist this. 175 . This change process would require sufficient time for assessment. This concern could damage investor confidence as reducing the despatch price would also lower the cap to which wholesale prices could rise. At times of system tightness.34 A number of respondents to the December 2010 consultation were concerned that a tender for targeted resource could distort the market. Which of the proposed despatch models do you prefer and why? Where is the despatch price set out and how could it be changed? C2. In particular. a periodic review process could be introduced to consider the impact of Strategic Reserve on the market and assess whether the despatch price is correctly set. Question 8: Do you agree that a Strategic Reserve should be periodically reviewed? If so. affordable and low-carbon electricity Question 6: Government prefers the form of economic despatch described here. as well as regulatory intervention. and ultimately to Value of Lost Load. increasing the ‘missing money’ problem11.Planning our electric future: a White Paper for secure.

The exception could be where biomass generation or fossil fuel generation 12 See the Short-Term Operating Reserve box in Chapter 3. 13 This terminology and some different security of supply challenges are discussed in Chapter 3.40 A major component of the Electricity Market Reform package is support for low-carbon generation through Feed-in Tariff with Contract for Difference (FiT CfD). although we recognise that selling forward would provide useful signals of the need for the reserve. and operational security is the problem STOR will need to continue to address in future. The offer price of Strategic Reserve would then be included in the cash out calculation. a decision would need to be taken on the market into which the Strategic Reserve should be sold. This offer would be considered by the SO as with any other offer. so our initial view is that there would be limited interactions between Strategic Reserve and FiT CfD.41 The Strategic Reserve would operate ‘outside’ the electricity market. 176 .35 In designing the operation of the Strategic Reserve. C2.38 Strategic Reserve could be sold into the Balancing Mechanism. since this appears to be the most straightforward option. There is likely to be potential for intelligent links between the mechanisms. Question 9: Into which market should Strategic Reserve be sold and why? Interaction with short‑term balancing C2. C2. This could be accomplished by offering the Strategic Reserve to the market at the despatch price. We would carefully consider these interactions if implementing a Strategic Reserve.g. There may be interactions with the proposed Capacity Mechanism given that both policy instruments affect the amount of capacity that will be brought forward.Planning our electric future: a White Paper for secure. We consider there are at least two options: the Balancing Mechanism or a day-ahead market. Interaction with Feed‑in Tariff with Contract for Difference C2.37 An alternative is also to offer the Strategic Reserve in a forward market. Resource adequacy is the problem we intend to address with a Capacity Mechanism. a day-ahead market. sustained period. affordable and low-carbon electricity Into which market should Strategic Reserve be sold? C2. For example. C2. e. C2. We assume that most participants in the Strategic Reserve would not be plants eligible for a FiT CfD.39 There may be some interactions between a Strategic Reserve and short-term balancing arrangements such as STOR12. this capacity could be considered to help with the problem of resource adequacy rather than short-term operational security13. where a STOR contract is for capacity capable of running for a longer.36 If Strategic Reserve were sold into the Balancing Mechanism then it would be included as an offer at the despatch price.

42 Figure C7 shows six key sets of functions involved in the delivery of a Strategic Reserve. Figure C7: Key sets of functions involved in the delivery of a Strategic Reserve Central Determination Sets level of reliability required Procures reserve Advises on level of reliability Advisory Function Despatches reserves according to predetermined trigger Procurement Function Delivery of reserve (providers of capacity) Despatch Function Oversight Function Strategic Reserve advisory function C2.43 The advisory function would provide advice enabling a central determination on the required level of reliability to be made. affordable and low-carbon electricity with Carbon Capture and Storage (CCS) wanted to participate in the Strategic Reserve. It would also monitor the activity of the delivery function to check providers of reliable capacity are available when required and deliver the required volumes. Strategic Reserve procurement function C2. The annual report by GEMA on security of electricity supply provided for in the Energy Bill 2011 would form a key element of this advice. 177 . Strategic Reserve despatch function C2. We will continue exploring potential interactions as the proposals are developed.45 The despatch function would despatch the Strategic Reserve when required according to the methodology.Planning our electric future: a White Paper for secure. Functional groupings C2.44 The procurement function would procure the required volume and mix of Strategic Reserve.

Strategic Reserve oversight function C2. storage and interconnection) procured by the procurement function to deliver the Strategic Reserve. C2. The Government will announce details of organisational arrangements for Electricity Market Reform around the turn of the year. Question 10: Do you have any comments on the functional arrangements proposed for managing a Strategic Reserve? Financial Flows C2. DSR. 178 .47 The payment function would calculate the payments due to organisations in the delivery function and manage the financial settlement of those payments. Strategic Reserve payment function C2.49 Chapter 4 of this White Paper sets out the Government’s position on institutional arrangements. The despatch of the Strategic Reserve delivery function would be controlled by the despatch function.46 The delivery function comprises all providers of reliable capacity (generators. affordable and low-carbon electricity Strategic Reserve delivery function C2.48 The oversight function would monitor the activity of the procurement function and despatch function.Planning our electric future: a White Paper for secure.50 Figure C8 sets out the main financial flows associated with the operation of the Strategic Reserve Capacity Mechanism.

In return for this. affordable and low-carbon electricity Figure C8: Financial flows of the Strategic Reserve Delivery Function Strategic Reserve payments (via industry charging and settlement arrangements) Procurement Function Despatch Function Suppliers and Generators Consumers C2. Question 11: Given the design proposed here and your answers to the above questions. based on market share through industry charging and settlement arrangements.51 The principal and administrative costs of the mechanism would be met by market participants. which would help reduce the risk of blackouts.Planning our electric future: a White Paper for secure. consumers would benefit from the higher capacity margins provided by a Strategic Reserve. do you think a Strategic Reserve is a workable model of Capacity Mechanism for the GB market? 179 . The costs of the Strategic Reserve would eventually be passed to end consumers by adjusting the prices in retail markets.

and companies offering other forms of capacity such as DSR or storage. Figure C9 shows how a Capacity Market works.6 The term ‘Capacity Market’ is broad.1 Market‑wide mechanism: Capacity Market In light of responses to the December 2010 consultation concerns on the potential impacts of a targeted mechanism.5 Figure C9: Operation of a Capacity Market Capacity Market Purchaser of capacity (could be central body. 180 .3 C3. C3. they are incentivised to be available (or penalised for not being available). The required volume of reliable capacity would be determined centrally based on forecasts of the peak demand some years ahead. Government has considered the merits of a market-wide mechanism in the form of a Capacity Market in more detail. affordable and low-carbon electricity C. companies that are planning to build a new power plant. supplier etc) Supplier Electricity Market Supplier Supplier Note: Providers of reliable capacity participate in the Capacity Market and/or the electricity market. providers of capacity in a Capacity Market substitute uncertain returns in the electricity market for long-term certainty from the Capacity Market. Overview C3.4 C3. That total amount of demand for capacity would be purchased from any provider willing to supply it. the nature of the product they can offer). In the Capacity Market. subject to its ability to meet the necessary criteria.Planning our electric future: a White Paper for secure. This section outlines some of the general design features of a Capacity Market. Consumers benefit from certainty of supply and increased price stability. Providers of capacity could include existing generators. In effect.2 C3. which we refer to as a Reliability Market. Such a mechanism would introduce a market for capacity in addition to the existing electricity market and providers of capacity could operate in both markets. Any Capacity Market must address at least two questions: how to decide how much capacity can be offered to the market by a given power plant (that is.3 C3. and describes in more detail a particular form of a Capacity Market. and what penalties to impose if the promised capacity is not available when required during the contract period.

So because of retail competition. ●● C3. it is not necessary to predict the level of capacity the market will bring forward. An alternative approach is to use market-based incentives for availability. and provide penalties for unavailability.Planning our electric future: a White Paper for secure. a decision will be needed on the desired level of capacity in the GB market14. We have included detailed questions on a Reliability Market given its innovative nature in the GB market. This section first considers design features that are common to all Capacity Markets. C3. set the conditions under which the plant must be available. affordable and low-carbon electricity C3. it would be necessary to estimate the reliable capacity offered by such generators and contract for what is left after subtracting that capacity from the target capacity level15. Primary legislation to enable this is being sought through the Energy Bill 2010–11. before concluding with a discussion of other issues relevant to all types of Capacity Market. Further independent advice could be commissioned if necessary. The capacity which they would purchase is therefore less than the required amount.8 C3.14 For a Capacity Market it is possible that in future consumers could be more engaged in the decision about the minimum level of supply they require based on the cost to them of differing levels of capacity.7 These questions could be addressed by defining an administrative process to determine the appropriate amount of capacity for each power plant. 15 See ‘Interaction with Feed-in Tariff with Contract for Difference’ for more detail.9 Setting the required level of capacity C3. C3. suppliers are not credible counterparties for contracts for capacity. 181 . a financial incentive – such as a financial call option – is put in place to incentivise availability. companies that did not sign contracts for capacity can offer energy more cheaply than suppliers that bought contracts for capacity. and impose penalties when the plant is not available.10 For a Capacity Market. In contrast to a Strategic Reserve. 14 This is because reliability is a public good. then considers those relating to a Reliability Market in more detail. however.13 It should be noted that. known as a Reliability Market. but other forms of Capacity Market remain under equal consideration. Consumers will switch and may cause the company that bought contracts for capacity to become insolvent. C3. if low-carbon generators receiving a FiT CfD are excluded from the Capacity Market. GEMA would provide an annual report on security of electricity supply.12 To assist this central decision. C3. and the likely cost of providing different levels of reliability. Under this approach. When prices are falling.11 We propose that the decision about the required level of capacity would be taken centrally each year based on annual advice on: ●● the level of electricity demand over the next four years (considering peak demand and demand variability).

17 An obligation is placed on suppliers to buy capacity in an auction: the desired quantity of capacity could be bought in a central auction by individual suppliers. Michigan. affordable and low-carbon electricity How and by whom capacity is bought C3. 182 . New Jersey. or by suppliers. individual suppliers would need to re-adjust their positions in secondary markets to match changes in their customer base up until the delivery period. The key questions are whether capacity is purchased by a central institution. Tennessee. Ohio. Question 12: How and by whom should capacity in a GB Capacity Market be bought and why? 16 See ‘Primary and secondary markets’ for discussion of the different markets for reliability contracts. This would incur further transaction costs. Under this approach it is straightforward to ensure that the desired quantity of capacity has been bought. In the Reliability Pricing Model (RPM) Capacity Market of the North American PJM system. With this approach it is straightforward to ensure that the desired quantity of capacity is bought. Financial counterparty risk (the risk that the seller of capacity would be unable to provide the capacity or to pay the required unavailability penalty) would be held by the central agency. Illinois. Virginia.17 suppliers can. 17 PJM is the electricity transmission system serving all or parts of Delaware. Indiana. C3. C3. Suppliers would need to re-adjust their positions in secondary markets to correct for changes in their capacity obligations due to customer switching up until the delivery period. Pennsylvania. If a central institution buys capacity the allocation of cost to suppliers could wait until the customer base for the delivery period is known.18 An obligation is placed on suppliers to buy capacity in bilateral markets: the desired quantity of capacity could be bought by suppliers in the form of bilateral contracts. We have considered three options for addressing these questions.16 A central institution buys capacity in an auction: the desired quantity of capacity could be bought in an auction by a central institution. and whether it is purchased through an auction. With this approach it would be necessary to monitor whether suppliers purchased the right amount of capacity. C3. North Carolina. Kentucky. which passes on the cost and the paybacks (if any) to consumers during the delivery period. which could limit the secondary market transaction costs that suppliers would face for re-trading to reflect changes due to customer switching. in addition to participating in the auction. As above. or through bilateral markets.15 Once the desired quantity of capacity has been determined there are several ways capacity could be purchased in the ‘primary capacity market’16. Maryland.Planning our electric future: a White Paper for secure. West Virginia and the District of Columbia. which would incur further transaction costs. also ‘self-supply’ capacity and purchase capacity bilaterally.

Question 13: What contract durations would you recommend for a Capacity Market? How far ahead should contracts be purchased? C3. affordable and low-carbon electricity Contract duration C3.24 In principle there are the following options for lead times for purchasing contracts: 18 These markets are referred to in Section 4 ‘International Comparisons’.19 The maximum duration of a contract for capacity determines how long the payment can be locked in by generators or non-generation providers of capacity such as DSR or storage. the contract duration for existing plants is one year. the payment will not be influenced by future developments such as lower demand. This could lead to over or under-procurement and investment. ●● C3. C3. C3. C3. the greater the potential margin for error in projections of future peak demand. while plants that have not yet been built can optionally increase the contract duration (and thus lock in the payment) for longer periods of up to twenty years18. On the other hand. Longer lead times will therefore provide a greater potential role for new entrants.23 The longer the lead time. and it leads to market foreclosure because market participants can lock in payments for a longer time in the future (by choosing a longer contract duration).Planning our electric future: a White Paper for secure. the more project risks are reduced (including construction risks for new plants being built) and investment incentivised.21 The principal goal of a Capacity Mechanism is to ensure that sufficient capacity is available to achieve a required level of reliability. which would have led to lower prices. For the contract duration.20 In the capacity markets in New England and Colombia. 183 .22 For both a Strategic Reserve and a Capacity Market. the further in advance capacity is sold. In particular. For plants that require additional investments. consideration needs to be given to the lead time between procurement and capacity being required to be in place. there are considerations associated with longer or shorter lead times in relation to the construction of new plants. This should reduce the overall costs of providing capacity. an intermediate solution is used. including the ability to meet peak demand. A longer contract duration has two main implications: ●● it reduces uncertainty for market participants because they can lock in the payment for a longer time and are not exposed to the impacts of more frequent changes in the prices set in the Capacity Market.

They are needed for two reasons: ●● providers of capacity may need to reallocate their obligations. where capacity could be re-traded once allocated through the primary capacity market. and c. Consequently it is not clear there would be additional benefit in terms of investor certainty from taking a longer term approach.27 If the physical back-up requirements in the primary capacity market are sufficient to ensure the required amount of capacity is constructed. are used in some existing systems. special arrangements for plants with long construction times: plant requiring longer construction times could be allowed to agree later starting dates. affordable and low-carbon electricity a. This may tend to incentivise DSR ahead of new construction. longer than longest construction time: demand projections would be very uncertain. in the forward capacity market of PJM and the reliability market of Colombia. 184 . between the shortest and longest construction time: demand projections would be less uncertain than for the longer term. Question 14: How long should the lead time for capacity procurement be? Should there be special arrangements for plants with long construction times? Primary and secondary markets C3. there might be a case for opening up the secondary market to financial players to increase liquidity. The secondary market should provide a much greater opportunity for participation of DSR. and/or d. b. The promised payment could be used as a security to finance the construction of plants with shorter construction times. C3. because of planned maintenance or unexpected breakdowns. The operating characteristics of DSR are typically such that it can run only for short periods of time (which may be one reason why only a limited number of DSR providers have STOR contracts). Options for this are discussed in ‘How and by whom capacity is bought’ above. shorter than shortest construction time: demand projections are likely to be more accurate for these nearer-term timescales. but the payment for capacity could not serve as a security to finance construction of new plants.25 The primary capacity market is where capacity is first allocated. this requires careful assessment to avoid undermining the efficiency of the Capacity Mechanism to incentivise investments. for example. ●● C3.Planning our electric future: a White Paper for secure. However. which could lead to higher prices in the Capacity Market.26 Secondary capacity markets. it will make the market more accessible to DSR providers. for example. which could lower the prices in the Capacity Market.

It reflects the expected proportion of a source of electricity which is likely to be technically available to generate (even though a company may choose not to utilise this capacity for commercial reasons). for example. These are estimated based. for example the challenge of setting an appropriate penalty level.32 In several existing Capacity Markets a central approach is taken to address these issues. Revision 12. C3. PJM Capacity Market. providers of capacity receive a payment for providing capacity.Planning our electric future: a White Paper for secure.30 The nature of the product being traded: Not all capacity is equivalent. PJM Manual 18. This is why the capacity of a generator is sometimes quoted as ‘de-rated capacity’. on historic data or through comparison with similar types of generation.pjm. e.31 Penalties for non availability: In a Capacity Market.28 The products which will be traded in the secondary market are the same products that are sold in the primary market. a figure that attempts to capture the capacity that can be relied upon at times of peak demand19. and the penalties for nonavailability.ashx. http://www. the capacity that a provider is able to offer into the market is calculated centrally based on a number of technical parameters such as outage rates. However. For example. and the contract duration much lower. 19 The de-rated capacity margin is the capacity margin adjusted to take account of the availability of power plants. C3. all market-wide capacity mechanisms must define the nature of the product that is being traded. affordable and low-carbon electricity C3. 20 For further detail on the ‘Reliability Pricing Model’ see.com/markets-and-operations/~/media/documents/manuals/m18. the contract lead time in secondary markets could be much shorter. e. C3.33 This approach is relatively straightforward but does face a number of complexities.29 As discussed above. 185 . to treat a 1 GW Combined Cycle Gas Turbine (CCGT) power station as equivalent to a 1 GW wind farm – the CCGT can be relied upon to provide reliable capacity when needed in a way that the wind farm cannot. It would be inappropriate. in the RPM of the PJM system. there need to be penalties for providers who are not available when required. If the resource is assessed as having failed to deliver the required level of capacity. specifying when availability is required. down to a single balancing period.g. 2011. A series of ‘resource performance assessments’ are carried out to assess whether the resource honoured its commitments during the contract period.g. In return. Question 15: Should there be a secondary market for capacity? Should there be any restrictions on participants or products traded? Determination of capacity credit and penalties for non‑availability C3. C3. then an administratively determined penalty is imposed and the revenue from the charges given to resources that exceeded their commitment levels20. for example. specific to each type of generation technology. down to a single day. and resolving potential disagreements over whether the provider was ‘at fault’ when unavailable. for example.

what is purchased from providers (which could be generators or non-generation approaches such as storage or DSR) is a ‘reliability contract’. In either case. When the market price is higher than the strike price. at most. the provider receives a payment (the option premium) which provides a more reliable source of income on which to base an investment decision. to be compensated for the missing energy22. is discussed in the section below. the seller of the reliability contract pays the buyer the difference in price for the total volume of electricity agreed. 21 A call option is a contract that gives the buyer of the option the right (but not the obligation) to purchase an agreed quantity of a commodity from the seller at an agreed time for an agreed price. a central. which is what we do here. (ii) the criteria for being available. and (iii) the penalties for non‑availability? In outline.Planning our electric future: a White Paper for secure. The reliability contract provides a hedge for the holder. regulatory decision is made concerning the capacity that can be relied upon for each type of generation and non-generation technology. a Reliability Market. the agreed price. or • hysically by integrating with an electricity supply business. In return for this hedge.35 In some existing Capacity Markets. For example. Hedges can be either financial or physical. a generator might hedge the risk of electricity price movements: • financially by selling electricity in the forward markets or entering into long-term contracts. C3. administrative determination of (i) the capacity that can be offered into the market by each generator. essentially a call option21. Normally. It is slightly easier to discuss the financial case. If there is a liquid market in the underlying commodity with a well-defined price. the buyer of the option receives the commodity and pays. rather than through physical delivery: the buyer purchases the commodity themselves in the market and is paid the difference between the agreed price and the market price. affordable and low-carbon electricity C3. such that any downward movement in prices p resulting in a loss in revenues for the generation business is offset by an increase in revenues for the supply business. C3. relies on financial incentives rather than centralised monitoring and administration. C3. enabling the holder to purchase energy at no more than the ‘strike price’ or. then the option may be settled financially. The ‘strike price’ is a price agreed by the parties to the reliability contract and represents the effective maximum price that the electricity buyer will have to pay for the volume agreed in the contract. 22 ‘Hedging’ refers to making some kind of investment. how would you suggest making these determinations? Reliability Market Overview C3. 186 .36 A possible alternative approach. using incentives in the form of financial call options. Question 16: What are the advantages and disadvantages of making a central. a hedge consists of taking an offsetting position in a related asset. and there are penalties for not being available during the contract period (as discussed above).38 In a Reliability Market: ●● the provider is able to make a decision about how much capacity they can reliably supply (there may still need to be some checks). The buyer of the option therefore knows the maximum price they will have to pay for the commodity (up to the agreed quantity).37 In a Reliability Market. with the objective of reducing exposure to (short-term) price movements in an asset already held.34 An alternative approach to this challenge. if energy is simply not available.

derivatives contracts are commonly used for hedging in many commodities markets (including electricity in e. providers of reliable capacity that sold a reliability contract will receive a fixed premium from suppliers (arrows a). but pay suppliers back the difference between the reference price and the strike price when the reference price rises above the strike price (arrow c). C3. ●● C3.39 As far as we are aware. 187 .g.Planning our electric future: a White Paper for secure.40 Overview of cash flows: to illustrate the principles behind a reliability contract. Customers a Reliability contract premium – regular fixed payment for the contract Revenues in existing electricity markets Reliability contract payback – payback depending on the price in reference electricity market b c Note: In addition to the revenues from the electricity market (arrows b). If the provider of reliable capacity is available. Figure C10: Payments for reliability contracts if the provider is available Providers of Reliable Capacity Reference Price b c Generators’ Net revenue Strike Price b a time Suppliers. Australia) so the principles underlying a Reliability Market are not new. affordable and low-carbon electricity ●● the times when availability is required are defined just as times when prices are high. reliability contracts have only been introduced in two electricity markets: Colombia and New England (and the New England variant caps the option payments). Figures C10 and C11 give an overview of the cash-flows involved after the contract has been sold. An overview of the cash flows if the provider of reliable capacity is unavailable is shown in Figure C11. and there are no regulatory decisions over whether the provider is at fault. However. the flows are as shown in Figure C10.

The first one is the reliability contract premium which is paid from electricity suppliers to providers of reliable capacity.42 Figure C12 sets out the financial flows associated with a Reliability Market. However. generators cannot increase their revenues by bidding strategically to increase prices above the strike price. A Reliability Market would introduce two new payments. ●● ●● ●● Financial flows C3. C3. and all providers of reliable capacity are incentivised by market prices to be available. These payments could be merged into a single payment stream.Planning our electric future: a White Paper for secure. 188 . Customers a – c Reliability contract premium – regular fixed payment for the contract Revenues in existing electricity markets Reliability contract payback – payback depending on the price in reference electricity market Note: If generators are not available. if they sold a reliability contract they still receive the same premium from suppliers (arrows a). generators exchange part of their volatile revenues for more certain income. and the second is the reliability contract payback of any revenues above the strike price from generators to suppliers.41 This means: ●● consumers are hedged against the risk of high prices in return for paying a reliability contract premium. they do not incur any revenues from electricity markets. affordable and low-carbon electricity Figure C11: Payments for reliability contracts if the provider is unavailable Providers of Reliable Capacity Reference Price S Strike P Price a Penalty time c Suppliers. and pay to suppliers the difference between the price in the reference market and the strike price. when the reference price rises above the strike price (arrow c).

or at least wait until the reference price is known.Planning our electric future: a White Paper for secure. Figure C12: Overview of Financial Flows for reliability contracts 1 Central Auction Body 1 Generators/ Capacity Providers 2 Suppliers 2 3 Consumers 4 1 2 3 4 Reliability contract premium – regular fixed payment for the contract Reliability contract payback – payback depending on price in reference electricity market Revenues in existing wholesale markets Revenues in existing retail markets Choosing the reference market C3. before deciding whether to sell in the reference market or speculate on higher prices in markets closer to real time.44 Reliability Contracts oblige providers of reliable capacity to pay back the difference between the price in a reference market and the strike price specified in the contract if the reference price rises above the strike price.46 Impacts on liquidity: The choice of reference market for a Reliability Market could have impacts on the liquidity of forward markets. Whenever there is a chance that prices in the reference market might rise high enough for this to happen. generators have an incentive to sell their power in the reference market. the reliability contract payments do not flow through the central auction body as in Figure C12. the paybacks which providers of reliable capacity have to make depend entirely on the price in the reference market.43 If reliability contracts are bought in bilateral markets instead of a central auction. affordable and low-carbon electricity C3. 189 . but directly from suppliers to contract providers23. providers of reliable capacity that sold a reliability contract will have to pay back the difference to the counterparty.45 Once a reliability contract is signed. C3. C3. The choice of the reference market is therefore central to the design of a Reliability Market: it has important implications for liquidity in different markets and the extent to which reliability contracts could mitigate market power. providers of reliable capacity may prefer to sell their electricity in the 23 See ‘How and by whom contracts are bought’. To protect against the risk of having to pay back more than they earn. If the price in the reference market rises above the strike price.

Until the price in the reference market has been determined. the holder of the contract would determine the appropriate reference market. the impact of liquidity in forward markets may be greater. which would be settled through a normal bilateral contract for electricity delivery at the strike price. and the possibility for generators outside GB to access these markets. This model has the advantage of working coherently with our system of bilateral contracting but would be an innovative solution that has not been tried in other markets. Regulator specifies the reference market for all contracts: the reference market could be specified by the regulator. 190 . However. Hence. Presumably. there is a tradeoff because of the potential for reducing liquidity in earlier markets. C3. buyers of reliability contracts are never forced to pay more than the strike price as long as they purchase the electricity no later than the reference market. this limits the opportunity for generators to increase prices through strategic bidding in those markets24. suppliers could buy reliability contracts that require physical delivery (rather than financial settlement).48 Impacts on market power in the electricity market: A reliability contract effectively caps the net price that the buyer has to pay for electricity in the reference market at the contract’s strike price. In effect. so will not affect the trading strategy (and resulting liquidity) in subsequent markets.Planning our electric future: a White Paper for secure. the supplier would decide the appropriate time to ‘call’ the contract. affordable and low-carbon electricity reference market to hedge against the risk of these paybacks. C3.49 The following options are available for specifying reference markets: a. In principle this could be any market – from bilateral forward markets to real-time prices in the balancing mechanism. In addition the decision should take into account the transparency and robustness of prices in different markets. or b. there is always a chance that it might rise above the strike price. 24 This could include overstating the price for providing energy or withholding supply from the market to increase prices. it may be argued that the reference market should be as close to real time as possible. if the market chosen is close to real time. Once the price in the reference market has been determined. This means that. the payback is a sunk cost. in particular since shortterm adjustments will become more important when there is more intermittent wind generation in the market. C3. due for example to a demand spike or an unforeseen outage of a plant. Given the impacts on market power described above. though such opportunities may still exist in markets which occur after the reference market.47 Providers of reliable capacity therefore have an incentive to not sell their electricity in markets before the reference market. Suppliers specify the reference market for individual contracts: as an alternative to centrally specifying the reference market. Under this model.

52 There is also a choice to be made in the detailed design of a Reliability Market about whether the strike price is fixed for the duration of the contract or indexed to some other reference price. C3. a decision would be needed on the strike price for reliability contracts. Market participants know what to expect. they can hedge these risks in commodity markets. An advantage of fixing the strike price would be transparency.Planning our electric future: a White Paper for secure.50 For a Reliability Market. C3. Question 17: How should the reference market for reliability contracts be determined and what would be an appropriate reference market if it is set by the regulator? How could any adverse effects of choosing a particular option be mitigated? Setting the strike price C3.54 The strike price could be updated during the delivery period by indexing the strike price to fuel costs or other input factor costs affecting the marginal costs of a particular plant. C3. However. and should therefore take account of factors such as the cost to consumers. it may not be compatible with high levels of vertical integration25.55 However. this approach removes the risk caused by variations in these costs (at least in respect of reliability contract obligations). For operators of this type of plant. especially fuel costs. and the ability of the demand side to respond to wholesale prices. the updating of an indexed strike price involves administrative costs and introduces a bias towards the technology whose costs are used as the reference index.51 We propose that the decision about the level of the strike price would be taken by an appropriate organisation either in preparation for each auction (if the contracts were purchased in a central auction) or on a regular timetable. such as annually (if the contracts were purchased bilaterally). C3. C3. The strike price represents a view of the boundary between normal system operation and scarcity conditions. 191 . affordable and low-carbon electricity In particular. 25 See ‘Impact of vertical integration on availability signals’ for more detail.53 The strike price could be fixed for the whole delivery period. A fixed strike price exposes generation companies to the risk of changes in variable costs. which in turn would determine the required contract premium.

as they will be financially penalised when the promised capacity is unavailable. This approach would not guarantee that reliability contracts actually result in provision of reliable capacity. For a Reliability Market. affordable and low-carbon electricity Question 18: For a Reliability Market. it is possible to allow providers of capacity to sell as much capacity as they wish. With this approach it would not be possible to allow different contract durations for new and existing plants because the contract is not linked to actual physical generation or demand adjustments27. 27 See ‘Contract duration’. there would have to be financial liquidity requirements to ensure that auction participants are credible counterparties. In the absence of physical back-up requirements.Planning our electric future: a White Paper for secure. no physical backing: no ownership of reliable capacity or credible investment plans have to be proven for participation in the Reliability Market. However. b. consumers would receive appropriate financial compensation for outages or high prices. ●● C3. To encourage investment in the necessary capacity. However. or enough DSR or storage is enabled. a number of design options are available: a. how should the strike price be determined? If using an indexed strike price. which index should be used? Extent of physical and financial back-up required from providers of reliability contracts C3. less reliable power plants and sell more reliability contracts than they back up with investment. it might be more profitable for speculative investors to sell contracts without investing in the necessary capacity. if reliability contracts are merely financial instruments. investors could still build cheaper. or 26 See ‘Determination of capacity credit and penalties for non-availability’. This would bring the capacity that is provided closer to the target capacity while keeping the cost of monitoring low. and generators are producing electricity and responsive customers are reducing consumption when needed. 192 . companies have to prove that they will construct or own plants or DSR capacity with a name plate capacity larger than or equal to the amount of reliability contracts they sell. However.56 The goal of a Reliability Market is to ensure that: ●● enough generating plants are in operation. name plate capacity: to sell reliability contracts. Providers would therefore be incentivised to build capacity to the extent that they think this is cheaper than to provide a financial compensation.57 Some forms of Capacity Market involve central administration of the capacity that generators can offer26.

58 In addition. Contract paybacks would increase the profits of the supplier part of a vertically-integrated company by the same amount as they decrease the profitability of its generation business. However. 28 See ‘Choosing the reference market’ for further detail. what level of physical back‑up (if any) should be required for reliability contracts and how should it be monitored? Interaction with short-term balancing C3. in the GB electricity market. If reliability contracts are procured through a supplier obligation it is therefore likely that a large proportion of the contracts will be between the supply and generation arms of the same company. 29 Vertically integrated organisations control businesses on several levels along the supply chain. In the GB market there are currently six large vertically-integrated companies29.62 Reliability contracts are signed between providers of capacity and a central buyer or suppliers (on behalf of consumers). careful consideration will be required of whether this would lead to double payments or gaming if a plant that signed a reliability contract is also allowed to sign a STOR contract.60 If reliability contracts are referenced to the Balancing Market. However. C3. 193 . As long as the contract paybacks don’t leave the company. C3. they cannot replace STOR contracts. For example. This ensures that the capacity target is met. affordable and low-carbon electricity c. companies have to prove that they will construct or own plants with a de-rated capacity larger than or equal to the amount of reliability contracts they sell. STOR contracts include information about the location of the plant and the minimum capacity it is able to provide which is useful for National Grid to determine the optimal despatch plan. This risks reducing the effectiveness of reliability contracts for ensuring capacity is available when needed. consideration needs to be given to the degree of evidence required for financial back-up – that is.61 If reliability contracts are referenced to earlier markets. so the profits of the company as a whole are not affected. since contract paybacks would simply be a transfer of money within the same company. regulatory de‑rated capacity: to sell reliability contracts. the large electricity generating businesses are often owned by the same organisations that own electricity supply businesses. C3. the determination of de-rating factors by the regulator would significantly increase the cost of monitoring. they might not influence decisions to construct new capacity and/or make capacity available when required by the contract. Question 19: For a Reliability Market. Impact of vertical integration on availability signals C3. to ensure that participants selling reliability contracts are credible counterparties.Planning our electric future: a White Paper for secure.59 Reliability contracts are very similar to STOR contracts for flexible service used by National Grid. they would probably remove the need for some of the STOR contracts28.

C3. Question 20: Do you agree that a vertically‑integrated market potentially raises issues for the effectiveness of a Reliability Market? If so. purchased by suppliers on behalf of consumers and therefore that any payments made to the supplier during times of high prices should be passed directly to those consumers. C3. C3. as a baseload 30 Discussed in ‘Extent of physical and financial back-up required from providers of reliable capacity’.63 We see two potential solutions to this problem.69 A Capacity Market could interact with low-carbon support since both provide support for capacity but the two offer different incentives for reliability. consider the interaction between a Reliability Market and a FiT CfD for nuclear plant. However. The remainder of this section deals with other considerations to be taken into account in designing all forms of Capacity Market. as with other aspects of the reliability contract model in the GB system.66 Ensure reliability contract paybacks to consumers: It would be possible for reliability contracts to be. C3. we are open to the possibility that there may be other solutions that are more straightforward or less costly. this proposal is novel. as well as a process for penalising companies who did not supply the level of reliability promised31.65 Of course. Interaction with Feed‑in Tariff with Contract for Difference C3. this would require a monitoring process. This incentive is not affected by vertical integration. The other is to ensure that the option payments eventually leave the company and flow to consumers (on whose behalf the contracts have been purchased). There may be interactions with the proposed Capacity Mechanism given that both policy instruments affect the amount of capacity that will be brought forward. in effect.68 A major component of the Electricity Market Reform package is support for low-carbon generation through FiT CfD. 194 .64 Physical back‑up requirements: To participate in a Reliability Market providers of capacity could have to meet a variety of requirements in the form of proofs of reliable physical capacity30. how should these issues be addressed? Other considerations in designing a Capacity Market C3. 31 See ‘Determination of capacity credit and penalties for non-availability’.Planning our electric future: a White Paper for secure.70 For example. More stringent entry requirements would improve the incentives to provide reliable capacity by increasing the cost of selling contracts without reliable physical backup. One is to monitor the physical backing of any market participant selling reliability contracts. C3.67 The section above deals with specific considerations in designing the Reliability Market form of a Capacity Market. We expect that nuclear.  In this way the vertically-integrated company would face the appropriate availability incentives. affordable and low-carbon electricity C3. However.

it is possible to address these interactions by prohibiting generation that is in receipt of a FiT CfD from participating in the Capacity Market. though it should be noted that it is likely that these solutions may impact on the efficient design of a Capacity Market. for intermittent plants such as wind we expect generators to receive a FiT CfD referenced to the day-ahead price. for example during the scheduled maintenance of a power plant. In some circumstances this forgone consumption can be treated as equivalent to generation. storage. affordable and low-carbon electricity plant. both contracts would require a payment from the generator. C3.Planning our electric future: a White Paper for secure. may receive a FiT CfD that uses the year-ahead forward price as the reference price.74 In a Capacity Market. Now. and/or include in secondary capacity market: DSR measures could be included in secondary capacity markets. when the price is high both in the reference market for FiT CfD and in the reference market for reliability contracts. Question 21: What could we do to mitigate interactions between a Capacity Market (especially if a Reliability Market) and Feed‑in with Contract for Difference without diluting the effectiveness of either? The role of demand side response. there is a risk of overpayment. Therefore if a generator sells a reliability contract in addition to having signed a FiT CfD (referenced to dayahead prices). C3. Secondary markets could be used by providers to reallocate their obligations from the primary capacity market during shorter periods. However. price response and interconnection Role of contracted demand side response and price response C3. Under this FiT CfD the generator will be exposed to the short-term price and could in principle sell a reliability contract. They therefore offer a ●● 195 . The following options could be used for enabling DSR measures within the Capacity Market (note that more detail on primary and secondary markets is included in ‘Primary and secondary markets’): ●● include in the primary capacity market: DSR measures could be included by offering the flexibility they provide in the primary Capacity Market. However. we would need to forecast the amount and reliability of FiT CfDsupported generation we expect to come forward. part of the remuneration the generator receives from this reliability contract is required to provide compensation for lower wholesale prices and. this raises additional concerns: for example. since the FiT CfD already does this.72 Clearly.71 Conversely. the capacity would effectively be sold twice. C3. a party offering DSR offers to forgo a certain amount of consumption in return for a payment.73 We propose to continue working on these issues as the options are developed.

provided they meet the required criteria.77 The goal of allowing this participation would be the same as for generation: to ensure that. storage and other non‑generation technologies and approaches? Role of interconnection capacity and providers outside GB C3. we will need to take into account the provisions of the EU Third Package that concern interconnection. and/or ●● reduce capacity obligations: DSR measures involving reductions at peak times could be included by subtracting them from suppliers’ capacity targets in the primary capacity market. an adequate amount of capacity is built in the most cost-effective form possible. the full amount of capacity required is purchased by (or on behalf of) consumers.75 We envisage that other technologies and approaches. we would in principle want them to be able to participate in a Capacity Market.78 The alternative to allowing participation of interconnection and nonGB generation in the Capacity Market would be to forecast the amount of capacity that would be expected to be reliably supplied via interconnection and compensate for any overall shortfall in supply meeting demand in the GB by the delivery of additional capacity domestically. such as electricity storage. taking all forms of capacity together. we could in the long run arrive at an inefficient level of interconnection. affordable and low-carbon electricity good platform for trading DSR measures that typically cannot offer reliability for long periods. Question 22: How can a Capacity Market be designed to encourage the cost‑effective participation of DSR.76 In a Capacity Market. C3. Under this approach. in a Reliability Market) it would be desirable for this to be true also of capacity provided by means of interconnection. would be able to participate in a Capacity Market in the same way as generation capacity. 196 .Planning our electric future: a White Paper for secure. Where participants in a Capacity Mechanism make their own assessment of the level of reliable capacity each can supply (as is the case. C3. for example. and that this capacity has the desired level of reliability. Role of storage and other non-generation technologies and approaches C3. C3. Since interconnectors – and the non-GB sources of capacity to which they connect – do contribute towards total capacity.79 In considering the role of interconnectors in a Capacity Market.

On an ongoing basis this would include the total capacity requirement including any desired margin (that is. ●● ●● ●● ●● ●● C3. for a Reliability Market. for a Reliability Market.Planning our electric future: a White Paper for secure.81 For simplicity these detailed functions are shown as falling into three main categories: ●● functions to set the key outcomes of the scheme – i. the key institutional functions required are set out below. These could involve setting the high-level parameters. the level of capacity that can be offered by different types of provider. C3.e.85 The required level of capacity and other key technical parameters would need to be centrally determined. operational functions to carry out the administrative delivery of the scheme – including contract management and providing for market participants to engage with the Capacity Market as required i.80 The institutional and delivery functions required for a Capacity Market are dependent in part on the detailed design of the mechanism. ‘operating the scheme within the rules’. and if contracts are bought by suppliers. However. ●● ●● C3. ‘setting the rules’. Functions to set outcomes and key technical parameters of the scheme – i. the level and nature of the penalty for a supplier holding insufficient contracts. and could also involve an advisory function providing technical advice. and oversight functions – i.e. for some forms of Capacity Market. such as required level of capacity. the total volume of contracts to be purchased).83 A Capacity Market would require a number of determinations to be made. C3. and the regime for administering penalties. which we are consulting on in this annex. and/or reviewed periodically. drawing on technical advice as necessary.84 On a one-off basis. ‘ensuring the rules are adhered to’ by all relevant market participants and the operational function.e. the technical parameters could include: ●● the volume of contracts to be held by each supplier. affordable and low-carbon electricity Functional groupings C3. the choice of the reference market. the lead time and duration for the contracts.e. ‘setting the rules’ C3. and any associated appeals mechanism. and any index used for updating the strike price.82 These functions are described in more detail below. 197 . the level of the strike price.

Planning our electric future: a White Paper for secure.87 Governance arrangements would be needed to ensure there was appropriate oversight and accountability of the above organisations (including organisations carrying out the central and operational functions). financially settling the contracts and passing on the costs and paybacks to consumers. or where a licensing regime exists or could be created. affordable and low-carbon electricity Functions to ensure the scheme is delivered effectively – i.86 Operational functions concern operational interaction with the market and practical delivery of the scheme. if penalties are administered centrally. and providing clearing services for the financial settlement. monitoring to ensure suppliers purchase the required number of contracts. 32 See ‘How and by whom capacity is bought’. In principle such a framework could be established by placing duties. rather than through call options. and recovering primary and secondary market administration costs from market participants.e. This involves checking assumptions that a provider has made about de-rating of capacity (as it appears in the contract) are reasonable. running a central auction function to establish the buy-out price. For illustrative purposes. if there are financial or physical back-up requirements. if contracts are bought by suppliers in bilateral markets. running a central auction function to establish the buy-out price. administering a secondary market to allow trading in contracts for capacity as suppliers adjust their demand forecasts nearer to real time. ‘ensuring the rules are adhered to’) C3. responsibilities and obligations on relevant organisations through a combination of statutory duties. 198 . if contracts are procured by suppliers in a central auction. checking that contracts are backed up by physical and/or financial back up as required. ●● ●● ●● ●● ●● ●● Oversight functions (i. Detailed operational requirements are particularly dependent on the detail of scheme design. and rectifying this if not. ‘operating the scheme within the rules’ C3.e. procuring the required contracts from providers of capacity. they could include: ●● if contracts are procured by a central institution32. including monitoring to ensure suppliers have taken out the required number of contracts. through licence conditions. placing and enforcing an obligation on suppliers to hold a certain number of contracts (as determined by the organisation carrying out the central functions). the administration of incentives/penalties.

and how should it be activated? Question 25: What is the most appropriate design of Capacity Market for GB and why? 33 Note a Strategic Reserve has an ‘in-built’ trigger in that reserve is only procured if the market is forecast to bring forward less reliable capacity than ministers deem desirable (see ‘Setting the level of required capacity’ in Section 2: ‘Strategic Reserve’). It should be noted that each of the functions could be split between one or more organisations. how do you think the trigger should be established.90 Including a trigger mechanism has pros and cons. C3.88 Further discussion of the nature of the institutions required to deliver these functions is provided in Chapter 4 of this White Paper. the Government is minded to make detailed legislative powers for the chosen type of Capacity Mechanism as early as possible. it could lead to uncertainty and investment hiatus.89 There is a question of whether a Capacity Market should be introduced immediately. However. affordable and low-carbon electricity C3. Question 23: Do you have any comments on the functional arrangements proposed for managing a Capacity Market? Triggering the Capacity Mechanism C3. C3. It gives the option of not triggering a mechanism if it is not perceived to be required at the time. 199 .92 An annual decision on whether or not to trigger the mechanism could then be taken in time to cost effectively allow the implementation of the chosen Capacity Mechanism. or whether its introduction should be triggered – either when a central organisation considers it appropriate to do so. C3.Planning our electric future: a White Paper for secure. Question 24: Do you think that a trigger should be set for the introduction of a Capacity Market? If so.91 Given the long lead times associated with establishing a Capacity Mechanism. or when a certain pre-set level of forecast capacity is reached33. The detailed institutional functions would need to be decided in the light of consultation responses if we decide to proceed with a Capacity Market model. prompting pressure to trigger the mechanism to give industry greater investment certainty.

the vast majority of electricity is traded on the day-ahead spot market. purchases capacity to be used at times of extremely high demand where the electricity market alone will not deliver adequate capacity. which makes it less attractive for investors in new plants and so less susceptible to the slippery slope. and that in Sweden. Legislation also specifies that PLR can only be used between November and March. The current PLR comprises mainly oil-fired plants and some DSR (mainly paper mills). and addresses them in a number of ways. and PLR is envisioned to run very infrequently (in fact it has only ever had to be activated three times).4 C4.2 C4. Legislation requires that the Transmission System Operator. This. It was designed from the beginning to be time limited (although it has been extended to 2020). Svenska Kraftnät (SvK). as Swedish electricity demand peaks during the winter months. Examples of Strategic Reserve were identified in Finland. The PLR was conceived to ensure adequate capacity at peak times. The proposals for Strategic Reserve described in this annex suggest that the price at which the Strategic Reserve is despatched would be Strategic Reserve C4. The maximum level of PLR is set in law at 2 GW. Sweden has recently passed legislation that requires a proportion of the PLR to be made up of demand side resources and will phase out the PLR altogether by 2020. New Zealand and Australia.3 C4. The example that most closely matches that discussed in this annex is the Swedish Peak Load Reserve (PLR).4 C4. Sweden. though SvK can purchase less than this if it considers it appropriate. The maximum quantity of PLR is specified in legislation. The main concerns raised with the use of a Strategic Reserve in the GB market are around possible market distortion and the ‘slippery slope’.5 200 .1 International comparisons We have looked at international examples of Capacity Mechanisms in use (or previously used and now discontinued) in various countries around the world.Planning our electric future: a White Paper for secure. PLR is made available to the market at times of tightness at a price just above the most expensive cleared bid in the Nord Pool day-ahead spot market. The PLR was introduced following the liberalisation of the Swedish market in 1996. Key among these are that the Strategic Reserve proposed for GB is not intended to be a temporary measure (though it would be reviewed in future). where more and more capacity is included in the reserve and removed from the electricity market. affordable and low-carbon electricity C. There are a number of differences between the Swedish system and that being proposed in this annex. Various types of Capacity Mechanism were studied. The Swedish PLR was developed with these issues in mind. together with the fact that it is priced above the highest bid in the market. minimises the risk of market distortion. and concerns that a number of ageing peaking plants (mostly oil) would no longer be able to cover costs and would close leading to shortages.

There are also some similarities with the Swedish system. Colombia is therefore exposed to different issues to those a GB capacity mechanism would need to address. The initial auction is followed by ‘incremental’ auctions for each demand year to allow for changes in market dynamics34. Specifically. or to contract for capacity bilaterally or through PJM’s capacity market auctions. There is a capacity obligation requiring suppliers to have the resources to meet customers’ peak load and provide a reserve. with the remainder being made up of mainly fossil fuel thermal generation. The closest example to the Reliability Market described in this annex is the one used in Colombia. and whether reliability contracts should have firm physical back-up. Contracts are bought in a descending clock auction by a central authority on behalf of all consumers and are referenced to the price in a day-ahead spot market similar to the previous England and Wales Pool.com/markets-and-operations/ rpm/~/media/markets-ops/rpm/rpm-auction-info/rpm-incremental-auction-faqs. In particular. the key challenge for any future GB Capacity Mechanism will be providing enough generation to cover relatively short periods of high demand and low wind.6 The North American Reliability Pricing Model (RPM) model used in PJM is an example of a Capacity Market. Colombia makes use of reliability contracts with mandatory physical back up in the electricity market and a secondary market.Planning our electric future: a White Paper for secure. Capacity auctions are held three years in advance to allow time for new capacity construction. The contracts have a lead time of between three and seven years and a delivery period of between one year (for existing plants) and 20 years (for new plants).ashx 201 . we envisage DSR being able to participate fully in a GB Strategic Reserve as long as it can meet the necessary technical criteria.7 C4.8 C4. Examples of markets for reliability contracts were identified in Colombia. In addition to the system differences. In Section 3: ‘Capacity Market’ above we are consulting on the reference price that might be used in a Reliability Market. The RPM allows suppliers to meet this capacity requirement through their own generating capacity. New England and to an extent in Brazil (although those used in Brazil were significantly different from the Reliability Market proposal discussed in this annex). The Colombian Pool is the key difference between the Colombian system and the Reliability Market described in this annex and provides a convenient reference price for reliability contracts in Colombia.   Capacity Market C4. In contrast. Colombia requires sufficient capacity to provide electricity during prolonged dry periods caused by the El Nino phenomenon. C4. affordable and low-carbon electricity set at a fixed price to avoid distorting the market. it is worth noting that Colombia has a large proportion of hydro power in its generating mix.pjm.9 34 The rules for the RPM’s incremental auctions are available here: http://www.

including De Vries. Durable to changes in the GB market. 8. Here. this section identifies the relative merits of a Strategic Reserve and a Capacity Market. and a quantitative assessment of costs35. 6. though we recognise there are other forms a market-wide mechanism could take and these remain under consideration. This is because the investment case for such plants. We have assessed these two Capacity Mechanism options against eight criteria. However. practical and feasible. For a Strategic Reserve. Robust against the use of market power. particularly in an electricity market with high levels of intermittent generation. affordable and low-carbon electricity C.2 C5.3 Assessment against criteria C5. the key concern – highlighted by a wide range of stakeholders – is that it will undermine the incentive for the market to invest in flexible peaking plants. The Capacity Mechanism we decide to proceed with will need to be based on assessment of the pros. cons and risks associated with each. 5. Supports supply-side efficiency. These criteria will also form the basis of our further analysis in the second half of the year: 1. 7. for comparative purposes.5 C5. Compatible with our market. L. If a Strategic Reserve were in place. Consistent with decarbonisation and renewables targets. 3. note that the evaluation presented here is the Government’s view and does not necessarily reflect that of any particular author.1 Comparison of Capacity Mechanism options The particular characteristics of the GB market mean there is unlikely to be a perfect Capacity Mechanism for our circumstances. Achieves sufficient security of supply.6 A central goal of a Capacity Mechanism is to ensure that the required reliable capacity is in fact created.Planning our electric future: a White Paper for secure.4 Criterion 1: Achieves sufficient security of supply (including investment incentives) C5. Summary C5. this creates two problems: 35 This analysis is based on several sources. Cost-effective. including to the demand side.J. Compatible with other Electricity Market Reform policies. 4. 2.5 C5. The following sections include a qualitative assessment of these two potential mechanisms against eight criteria.: Securing the public interest in electricity generation markets (2004). is based on its ability to secure high prices in times of market stress (scarcity rents). 202 .

10 The other key challenge in ensuring security of supply relates to the estimates that are required for operating each Capacity Mechanism. but below VoLL. to mitigate concerns that the despatch price would be reduced at times of high prices due to short-term pressures.Planning our electric future: a White Paper for secure. it is inefficiently displacing existing capacity from the market.8 C5. there would be heavy pressure to reduce the price at which the reserve entered the market during extended periods of high prices.7 In principle. Importantly. In addition. Both of these estimates are subject to error. leading to under-investment and the need to procure ever more reserve – the ‘slippery slope’. provide sufficient security of supply and investment incentives. This would be set high enough above the highest long-run marginal cost in the electricity market to minimise distortion. A Strategic Reserve also requires an estimate of the capacity that would be brought forward by the market. practical. and feasible C5. a Capacity Market would only require an estimate of future demand – though this would not be the case if FiT CfD plants were excluded from the market (see Criterion 8). If the reserve is despatched appropriately. In principle. 203 . increasing the scope for procuring the ‘wrong’ amount of reliability/ capacity. However there are caveats to this – in particular. the risk of over-procurement. Stakeholders’ concern is that. and should not lead to the ‘slippery slope’ challenge faced under a Strategic Reserve. All Capacity Mechanisms require an estimate of future demand. the mere perception of this risk will tend to disincentivise investment. if well designed. the adverse impact of market distortions could in principle be kept to a minimum. We have developed the Strategic Reserve option to address this concern as far as possible.11 A Strategic Reserve appears to be a practical and feasible option. and the ‘slippery slope’. affordable and low-carbon electricity ●● at what price does the Strategic Reserve enter the market.9 C5. if this were the case. Criterion 2: Cost effective. C5. Strategic Reserve would only be despatched when prices rise above a certain level – the despatch price. and how can the price at which the Strategic Reserve enters the market be changed? ●● C5. we propose to ensure any changes could only be made via a defined change process. the Strategic Reserve should only enter the market when all other capacity has been exhausted – otherwise. In this way a Strategic Reserve minimise displacement of any capacity in the electricity market which would otherwise have been made available. An organisation could be mandated to purchase the required reserve capacity through a commercial tendering process similar to the way National Grid currently procures STOR. We envisage that a Capacity Market should.

17 A Strategic Reserve could allow DSR to bid to form part of the reserve if it fits the necessary characteristics. by providing an external source of reliability which is outside the market. which they could do bilaterally or through exchanges. and that. a Capacity Market would require the creation of what is. by requiring repayment of revenues above a strike price. this analysis is not necessarily correct. in the case of a Reliability Market. since it involves paying for all capacity. both in the sense that it incentivises the appropriate use of flexible generation and non-generation approaches (including DSR. a new market.15 We consider it an essential feature of any Capacity Mechanism that it be robust to these changes. although a reserve could in principle be reduced. Criterion 3: Durable to changes in the GB market. it would presumably take some time for all participants to become familiar with the implications of trading in a Capacity Market. on the demand side. in that the organisation charged with procurement can choose the technical characteristics of the reserve to reflect changing needs. by inflexible consumption. C5. C5.Planning our electric future: a White Paper for secure. However. A Strategic Reserve retains some potential for high prices. affordable and low-carbon electricity C5. whereas a Strategic Reserve means paying for only the incremental capacity needed. in either case. so in theory the overall costs of either Capacity Mechanism should be the same (though this does require effective detailed design).16 A Strategic Reserve is robust to some of these changes. by a significant proportion of flexible coal and gas thermal generation and. 204 . on the supply side. In addition. including increased role for demand side and interconnections C5. This balance will change dramatically over the next few decades to one of more inflexible and intermittent generation on the supply side but also more responsive demand (including both formal arrangements to reduce demand when required. essentially.13 It may be felt that a full Capacity Market would necessarily cost more than a targeted mechanism.12 In contrast. but makes them lower and more frequent. Finally. and a demand market which is more responsive to short-term fluctuations in price). a Strategic Reserve may reduce the broader incentives for consumers to respond to changes in real-time electricity prices. it can be removed or evolved into something more reflective of the new demand side market. and even eliminated if no longer required. If the market were created through a supplier obligation. if and when it is no longer needed. C5. storage and interconnection). However. there is a concern that the central organisation tasked with procuring sufficient reserve to ensure a reliable system would find it difficult to decide in a particular year to procure nothing. then suppliers would need to purchase contracts for capacity. A Capacity Market exchanges steady income from the contract premium for reduced revenue elsewhere – for example. there would need to be new machinery to support this trading. C5.14 GB’s electricity generation system is characterised.

these markets offer the potential to be effective in the presence of interconnection. In the example of a Reliability Market. C5. a Capacity Market is plausibly more compatible with a future market which has a more liquid and responsive demand side. on the other hand. affordable and low-carbon electricity C5.23 The exact extent of the robustness depends upon the level of the strike price. providing the incentive for the interconnector flows to arrive when they are needed.22 Both a Capacity Market and a Strategic Reserve could be designed in a way that removes the incentives for generators to artificially increase prices.Planning our electric future: a White Paper for secure. Reliability contracts can therefore use a lower strike 205 . by selling contracts for capacity where they met the necessary characteristics. This could occur because in scarcity conditions the withdrawal of a small amount of capacity can have a significant impact on the market price. Smart Meters could help to enable such a transition. In certain forms of Capacity Market. such exercising of market power would be difficult to identify and could have significant implications for security of supply. energy could ‘leak’ or simply not be available if the price in the other market rose sufficiently high. Consumers are hedged against this because a reliability contract obliges the plant that had an outage to pay back the difference between the strike price and the price in the reference market. Criterion 4: Robust against the use of market power C5. however. for example. In order to avoid significant impact on the electricity market the despatch price would be chosen at a high level (discussed above). Since the energy flows in coupled markets are determined by prices. a Strategic Reserve (and some forms of Capacity Market) may not be effective in the presence of significant interconnection as it effectively caps the market price.19 In addition. C5. C5. being more engaged in the decision about the minimum level of reliable supply they require based on the cost to them of differing levels of reliability. they both have the potential to robustly guard against abuse of market power in the electricity market as a helpful side effect. In this regard. such as a Reliability Market. C5. Should it occur. A Strategic Reserve would typically cap the prices at the despatch price.20 With regard to interconnection. generators may be incentivised to withhold capacity in order to drive up electricity prices further.24 A Capacity Market. one could imagine consumers. could be designed in a way that does not blunt price signals by capping market prices. potentially through suppliers.18 For a Capacity Market. the market price signals remains. if one of the generators has an outage. Since it is a market-wide approach. C5. the other generators that make up for this by producing more than required by their reliability contracts can keep the additional revenues from selling this output at higher prices.21 In a tight electricity market. providers of DSR could also participate.

a Strategic Reserve requires the central determination of at least two parameters (peak demand and forecast capacity). Again.28 Additionally. we assume a requirement on any Capacity Mechanism is that it provides the required capacity efficiently. C5. 206 . does not appear to hinder market entry by new generators. a Reliability Market would thus be likely to offer stronger protection against abuse of market power than a Strategic Reserve. To the extent that the strike prices are lower. the problem should be less severe because new entrants could compete in the Capacity Market (see criterion 5 below for more detail). This might be helpful to small suppliers. the percentage change in quantity demanded is less than the percentage change in price. and the market could then be subject to similar risks as experienced in the current market36. Similar arguments may be made for other types of Capacity Market. C5.31 With regard to new market entrants. whether in the tender for Strategic Reserve or in a Capacity Market. a Strategic Reserve.25 We might also be concerned about the potential for exploitation of market power in the procurement of capacity. particularly in the form of a Reliability Market. For example. Getting these forecasts wrong will tend to reduce supply-side efficiency. would be innovative and its design may offer unforeseen loopholes to allow participants to exploit the system. since only an incremental amount of capacity is being acquired. Still. C5. uses more energy than it expected) would be capped (at the reserve despatch price).26 A Strategic Reserve appears to be less susceptible to this kind of manipulation. a central determination of capacity could lead to an inelastic demand for capacity. a Capacity Market. On the retail side. sound design would reduce the risk. C5. the cash out penalty imposed on a supplier who is short (i. Criterion 5: Supports supply-side efficiency C5.e.  When demand is inelastic. depending on the incentive structure used. but this risk is likely to be higher than for a Strategic Reserve. if properly designed. C5. In principle. A Capacity Market will require either one or two parameters to be forecast (depending on the treatment of FiT CfD plants). the new entrant would be bidding into a different market (and a small one) since the reserve is not permitted to participate in the electricity market.Planning our electric future: a White Paper for secure. However. new entrants could enter the reserve mechanism if contracted sufficiently far in advance.27 A Capacity Market would need to be carefully designed to avoid being susceptible to exploitation. affordable and low-carbon electricity price than Strategic Reserve contracts without distorting market signals. 36 Inelastic demand is where the demand for a good or service in a market is relatively unresponsive to changes in the price of that good or service.30 As noted.29 Just as one of the goals of the New Electricity Trading Arrangements (NETA) was to provide the correct incentives to market participants to despatch their generators efficiently.  C5.

which it may or may not be possible to address with suitable design. reliability contracts – whether procured centrally. C5. We believe that the adaptations are possible (for example. To work in our market. again if contracted sufficiently far in advance to allow new build. One downside might be the generator’s risk of not being able to pay the required penalty when required (for example. close to real-time. then the option payment would simply be a transfer of money within that 207 .Planning our electric future: a White Paper for secure. C5. suppliers will face operating costs for trading in the new market. Criterion 6: Compatible with our market C5. Presumably. physical market with separation of generators and retailers. This may prevent small generators offering contracts for the full amount of their reliable capacity.35 The GB market has a number of distinguishing features which impact on a Capacity Mechanism – including that most energy is transacted in physical forward markets through bilateral contracts. For other forms of Capacity Market.36 In the case of a Reliability Market. Both of these market features present particular issues for a Capacity Market. over the counter (OTC) trading – namely.33 On the retail side. This could help smaller generators who were unable to cope with risks as well as larger players. promoting transparency. In addition. we could make use of existing day-ahead auctions) but this is not without design risk. If the two parties to a contract for capacity are one company. a lack of transparency and liquidity – will simply be replicated in any new Capacity Market (if it is run through a supplier obligation) and that this will be a barrier to entry for new. This could be mitigated by a liquid secondary market. affordable and low-carbon electricity C5. C5. their costs in the electricity market should be limited. if the contracts in a Capacity Market were procured by suppliers. e. or through obligations – were designed for systems with a single. and the payment for the capacity contract would result in a lower cost of capital.37 The fact that our market is strongly vertically integrated is also a challenge. these are real issues.34 There is concern that perceived problems of the current market owing to the prevalence of bilateral. C5. which reduces their risks. if the generator was offline) and the consequent counter-party risk faced by suppliers. contracts for capacity in a Capacity Market will be a more standard product than electricity (because there is not one market every half hour) and therefore could be offered on more liquid exchanges.g. they would need to be adapted. we would need to ensure that the incentive structure was compatible with the GB market. These new entrants would face less volatile revenues on which to base their investment decisions.32 A Capacity Market could in principle be helpful to new market participants. to cover periods of maintenance. Notwithstanding that presumption. then suppliers would face the additional costs of procurement. and that the market is dominated by vertically-integrated players. which would allow contract signatories to trade out of positions. independent suppliers. However.

Criterion 7: Consistent with decarbonisation and renewables targets C5. the impact of the choice of Capacity Mechanism on decarbonisation and renewables targets seems small.Planning our electric future: a White Paper for secure. In particular. Cost‑benefit analysis of Capacity Mechanism options C5. This is not surprising as both a targeted or a market-wide Capacity 37 See ‘Impact of vertical integration on availability signals’ in Section 3: ‘Capacity Market’.42 However. including low-carbon generation. and are discussed in more detail above in Section 3: ‘Capacity Market’.39 A Capacity Market offers incentives to any provider of reliable capacity. NPV recognises that society would prefer £1 today to £1 in the future – this is known as ‘time preference’. Again. though we recognise there are other forms a market-wide mechanism could take and these remain under consideration. 38 Net Present Value’ (NPV) is a way of accounting for the sum of a project’s future cash flows in today’s terms – showing the difference between a future stream of benefits and costs.43 Here. for comparative purposes we compare a Strategic Reserve with the Reliability Market form of Capacity Market. under ‘Interaction with Feed-in Tariff with Contract for Difference’.38 A Strategic Reserve should not be significantly affected by the presence of forward contracting and vertical integration. The precise issues that arise depend on the form of FiT CfD. C5. future cash flows are ‘discounted’ (using a discount rate) when calculating NPV. C5. Summary C5.41 The Strategic Reserve operates ‘outside’ the market and it is assumed that. the FiT CfD could introduce interactions with the proposed Capacity Mechanisms.44 Key conclusions from the cost-benefit analysis are: ●● the modelled differences in the Net Present Value (NPV)38 of a Strategic Reserve or a Reliability Market are relatively low in absolute terms compared to other Electricity Market Reform proposals. Views are welcomed on the best way to mitigate this. affordable and low-carbon electricity company. and it is not clear what the incentive would be. However. the Capacity Market could interact with low-carbon generation support.40 Interactions with other elements of the Electricity Market Reform package are an important consideration for Capacity Mechanism design. Criterion 8: Compatible with other elements of the Electricity Market Reform package C5. C5. there are potentially ways to address this – for example by requiring option payments to be returned to customers37. 208 . both the Capacity Market and the FiT CfD provide payments for some version of capacity. as participants in the reserve will likely be fossil-fired peaking plants. Therefore due to time preference. recipients of FiT CfD will not be directly affected. More detailed analysis is included in the Impact Assessment published alongside this annex. In particular.

More detail can be found in the accompanying Impact Assessment published alongside this White Paper. Figure C13: NPV for Feed-in Tariff with Contract for Difference scenario.000/ MWh39. 2005) 209 .47 Our analysis.000/MWh) -643 Reliability Market £m -837 C5. For more see ‘What is the optimal level of electricity supply security?’ (Oxera. while a Strategic Reserve sees slightly less investment in CCGTs. Oxera. this will by definition lead to a negative NPV in the modelling. publishes a range of estimates for VoLL between £5. By imposing a constraint that margins are increased to 10%. The net benefits are shown in Figure C13.45 We have carried out analysis of the electricity market to look at the impacts of these two potential Capacity Mechanisms – a Strategic Reserve despatched as last resort. suggests there is some net cost associated with either type of mechanism evaluated here. ●● modelling indicates a net cost associated with either Capacity Mechanism.000/MWh and £30. Any differences are likely to be due to the way that either mechanism is designed. in addition. ●● Analysis C5. This is simply because the model produces an “optimal” level of security of supply. £m (2009 real) Strategic Reserve £m NPV (VoLL = £10. affordable and low-carbon electricity Mechanism are at least theoretically capable of producing exactly the same outcome if designed efficiently.000/MWh.Planning our electric future: a White Paper for secure. an economics consultancy. This is sensitive to the assumptions made around the VoLL. If a higher estimate of VoLL is made then both mechanisms compared here have a positive NPV. Our model uses a VoLL of £10. carried out by Redpoint. Note that the argument for a Capacity Mechanism rests on the fact that this 39 Estimates of VoLL are very uncertain. market failures (discussed in Chapter 3 of this White Paper and in the Impact Assessment) are not included in the Redpoint model used for this analysis and would tend to increase the benefits of either of these potential Capacity Mechanisms. Our analysis includes FiT CfD providing low-carbon generation support. This means that with a Reliability Market we have higher capacity and generation costs. and a Reliability Market. given a specific value of VoLL. C5.46 A Reliability Market results in slightly more investment in new CCGTs which crowds out old coal. 20102030. coal stays on slightly longer. and there is some investment in cheaper OCGTs. but slightly lower carbon costs as the mix is slightly cleaner.

In addition. C5. £m (2009 real) Strategic Reserve £m NPV (VoLL = £30. If we use a VoLL of £30.000/MWh then both mechanisms have a net positive NPV as is shown in Figure C14. but the practical details of implementation will inevitably have an impact on the final costs and benefits.50 The costs and benefits of any Capacity Mechanism in practice will depend on the design of that mechanism. there is likely to be a cost to companies of participating in any Capacity Market. will require careful further thought to minimise distortions. including missing money. Figure C14: NPV for Feed-in Tariff with Contract for Difference scenario. which mean that the market will not deliver the optimal level of investment. at the top end of the range for VoLL.Planning our electric future: a White Paper for secure. These market failures are not incorporated into the model and to the extent that they lead to insufficient investment in new capacity. The institutional costs are however likely to be dependent on the design of the mechanism.48 The differences between the two are not particularly significant. 210 . C5. affordable and low-carbon electricity theoretically perfect market does not exist in practice (and that investors do not believe that it exists) because of the market and regulatory failures mentioned below and described in more detail in Chapter 3 of this White Paper and in the Impact Assessment40. Question 26: What are your views on the costs and benefits of a Capacity Mechanism to industry and consumers? 40 For our future modelling.51 The costs and benefits here do not include the estimated institutional costs for a Capacity Mechanism. However.000/MWh. we will examine whether it is possible to reflect the impact of market failures on capacity margins and energy unserved. The design of any mechanism is necessarily complex and as part of the implementation of the mechanism. this is sensitive to the assumptions around the average VoLL. as opposed to £10. they would tend to increase the benefits of either of the Capacity Mechanism options.000/MWh) 193 Reliability Market £m 50 C5.49 In addition. C5. there are a number of potential market failures. 2010-2030. These are assessed with other institutional costs in the Impact Assessment accompanying this White Paper. The modelling and associated cost/benefit figures are a best attempt to simulate the impacts of a Capacity Mechanism.

who would be best placed to carry out the review and how often should it be reviewed? Question 9: Into which market should Strategic Reserve be sold and why? Question 10: Do you have any comments on the functional arrangements proposed for managing a Strategic Reserve? Question 11: Given the design proposed here and your answers to the above questions. do you think a Strategic Reserve is a workable model of Capacity Mechanism for the GB market? Market‑wide Capacity Mechanism Question 12: How and by whom should capacity in a GB market be bought and why? Question 13: What contract durations would you recommend for a Capacity Market? Question 14: How long should the lead time for capacity procurement be? Should there be special arrangements for plants with long construction times? 211 .Planning our electric future: a White Paper for secure. affordable and low-carbon electricity Question 27: Which Capacity Mechanism should the Government choose for the GB market and why? C.6 Consultation Questions Targeted Capacity Mechanism Question 1: Does this table capture all of your major concerns with a targeted Capacity Mechanism? Do you think the mitigation approach described will be effective? Question 2: How long should the lead time for Strategic Reserve capacity procurement be and why? Question 3: Should the length and nature of contracts procured by the Strategic Reserve procurement function be constrained in any way? Question 4: Which criteria should providers of Strategic Reserve be required to meet? Question 5: How can a Strategic Reserve be designed to encourage the costeffective participation of DSR. Which of the proposed despatch models do you prefer and why? Question 7: How would the Strategic Reserve methodology and despatch price best be kept independent from short-term pressures? Question 8: Do you agree that a Strategic Reserve should be periodically reviewed? If so. storage and other forms of non-generation technologies and approaches? Question 6: Government prefers the form of economic despatch described here.

administrative determination of (i) the capacity that can be offered into the market by each generator. what level of physical back up (if any) should be required for reliability contracts and how should it be monitored? Question 20: Do you agree that a vertically integrated market potentially raises issues for the effectiveness of a Reliability Market? If so. and (iii) the penalties for non-availability? In outline.Planning our electric future: a White Paper for secure. and how should it be activated? Question 25: What is the most appropriate design of Capacity Market for GB and why? Capacity Mechanism Assessment Question 26: What are your views on the costs and benefits of a Capacity Mechanism to industry and consumers? Question 27: Which Capacity Mechanism should the Government choose for the GB market and why? 212 . (ii) the criteria for being available. how do you think the trigger should be established. affordable and low-carbon electricity Question 15: Should there be a secondary market for capacity? Should there be any restrictions on participants or products traded? Question 16: What are the advantages and disadvantages of making a central. how would you suggest making these determinations? Question 17: How should the reference market for reliability contracts be determined and what would be an appropriate reference market if it is set by the regulator? How could any adverse effects of choosing a particular option be mitigated? Question 18: For a Reliability Market. how should the strike price be determined? If using an indexed strike price. how should these issues be addressed? Question 21: What could we do to mitigate interactions between a Capacity Market (especially if a Reliability Market) and Feed-in Tariff with Contract for Difference without diluting the effectiveness of either? Question 22: How can a Capacity Market be designed to encourage the costeffective participation of DSR. which index should be used? Question 19: For a Reliability Market. storage and other non-generation technologies and approaches? Question 23: Do you have any comments on the functional arrangements proposed for managing a Capacity Market? Question 24: Do you think that a trigger should be set for the introduction of a Capacity Market? If so.

Therefore. The proposals in this White Paper will enable us to establish a stable and transparent long-term financial framework for renewables. from 3. the Northern Ireland Renewables Obligation is subject to a 2033 end date. and we aim to prevent a hiatus in renewables investment while the new arrangements are being put in place. In responding to the Electricity Market Reform consultation document2. the RO would not be the most cost-effective mechanism to incentivise post-2020 deployment. and that the UK should have the fastest improving growth in renewables deployment across Europe. affordable and low-carbon electricity Annex D – Renewables Obligation transition Introduction D.gov. The proceeds from the buyout payments are recycled to suppliers in proportion to the number of ROCs they submit.2 D. We will deliver the growth required to achieve our ambitions by mobilising investment from the private sector. 213 . The Government supports the principle of no retrospective change for renewables investments.4 D. even if the scheme’s current 20371 end date were extended. It requires suppliers to submit an increasing number of Renewables Obligation Certificates (ROCs) in respect of each megawatt hour of electricity they supply.decc. this Annex sets out the transition arrangements for renewables. and through the consultation process have listened to industry views on the best way to transition to the Feed-in Tariff with Contract for Difference (FiT CfD). The Government recognises that there is a significant existing renewable electricity investor community. Having sought industry views on the best means to transition to a new scheme.aspx.Planning our electric future: a White Paper for secure. http://www.uk/en/content/cms/consultations/emr/emr. The RO has successfully supported the deployment of increasing amounts of renewable generation. like wave and tidal. and encouraged new renewable technologies to evolve. or pay a buyout price.1 GW in 2002 to 8 GW in 2009.1 The UK has some of the best natural renewable energy resources in Europe. The Renewables Obligation (RO) was introduced in 2002 to support the deployment of renewable electricity. With these D. The RO is administered by Ofgem which issues ROCs to accredited renewable electricity generators in respect of their eligible renewable output. However. many stakeholders agreed with our assessment of the importance of a clear and stable transition period.5 1 2 Currently. The Government is determined that the UK should become the location of choice for inward investment in renewables. the proposals in this White Paper set out the framework for supporting renewables in the long term.3 D.

●● RO support from 2017: – RO is closed to new generation. including utility companies.8 The RO currently operates as three separate mechanisms working together – the England and Wales RO. support will still be available under the RO.6 The arrangements for transition are based on the principles of transparency. D. During the transition period. – RO calculated by headroom until 2027. – some limited grace periods. independent generators. http://www. D. 4 214 . D.gov. longevity and certainty. and – provisions for offshore wind phasing. Whether. The proposals for RO Transition have been discussed by a Steering Group comprising policy advisors and technology experts from the UK Government and the Devolved Administrations.9 3 ‘Vintaging’ the Renewables Obligation (RO) system means that it will no longer be open to accreditation for new stations. – provisions will be made for additional capacity. – all technologies will be grandfathered in the vintaged RO in 2017.7 RO support to 2017: – a choice of scheme for new renewables generation projects. All of the jurisdictions are committed to support for renewables. We have also discussed the proposals with a wide range of industry stakeholders. affordable and low-carbon electricity vintaging3 arrangements we recognise the importance of maintaining industry confidence and stable conditions for investment decisions made on the basis of RO support. The arrangements are subject to statutory consultation requirements set out in section 32L of the Electricity Act 19894. The closure of the RO to new stations will create a closed pool of capacity which will decrease over time as we approach the end date for the RO of 31 March 2037. the Devolved Administrations join the new support scheme for low carbon is subject to separate discussion.uk/ukpga/1989/29/contents. This Annex sets out the arrangements for: ●● D. This Annex sets out in full how the RO will operate to 2037. then Fixed ROC to 2037.legislation. supply chain manufacturers and existing and potential investors. and the Northern Ireland RO (NIRO). and – Non-Fossil Fuel Obligation (NFFO) generation will be treated consistently with other RO generation. The proposals have been broadly welcomed. or the extent to which. the Scottish RO. The new market arrangements are intended to start in early 2014.Planning our electric future: a White Paper for secure. We will continue to work closely with the Devolved Administrations to ensure that the transition arrangements are simple and transparent across all three RO schemes. and Parliamentary and EU State Aid approval.

15 Figure D1: Timeline for the Renewables Obligation Transition 2013 2014 2015 2016 2017 2018 2019 … 2027 … 2037 RO in operation Choice of scheme RO closes to new generation Move to Fixed ROC RO Ends FiT CfDs Introduced 215 . ●● D.10 The current RO is designed to provide up to 20 years of support for large-scale renewable electricity projects. and will run until 2037. so any accreditations after 31 March 2017 would receive less than 20 years’ support. The RO will remain open until 31 March 2017. chosen to remain with the 31 March 2017 RO closure date because: ●● D. Grace Periods and Offshore Wind Phasing). it would be necessary to hold another banding review in 2017. From 1 April 2017. the point at which the length of support offered begins to reduce. After 31 March 2017. however. the RO will be closed to new entrants. and if the RO were open later than 2017.12 Government decision D. up to 31 March 2017 when the RO closes to new accreditations. This should mean that investments are not delayed during the transition period as there will be transparency around the support levels in the lead up to 2017. subject to the restrictions set out below. D. The intention is to start letting contracts under the FiT CfD in 2014.14 We have made other provisions to address specific concerns around transition timing (see the sections below on the Choice of Scheme. new renewables generators will have a choice of support mechanism. Some respondents to the consultation requested that the RO should remain open to new accreditations beyond 2017.11 D. affordable and low-carbon electricity Context D.Planning our electric future: a White Paper for secure. The RO and all accredited capacity within it will be ‘vintaged’. We have.13 the RO is subject to a 2037 end date. therefore generators would not know post-2017 tariffs until 2015-16 at the earliest. After introduction of the FiT CfD. projects receiving support under the RO will continue to do so (subject to the maximum 20 years support and 2037 end date for the RO). The FiT CfD mechanism for low carbon is intended to be introduced in 2014. The timeline for the renewables transition is shown in Figure D1.

Some stakeholders suggested that providing existing projects the same choice between the RO and the FiT CfD. the original accredited capacity will continue to be supported under the RO. As set out below. once the new scheme is introduced. allowing investment to continue. Currently.16 The RO will close to new accreditations on 31 March 2017. as part of the RO transition arrangements. generating stations that have a total installed capacity of 5 MW or less. and meet the relevant eligibility criteria. will not be eligible to opt for a FiT CfD if. affordable and low-carbon electricity Renewables Obligation support up to 2017 D. Therefore additional capacity of less than 5 MW that is added to an RO accredited generating station in the period from the introduction of the new scheme to 31 March 2017.17 D. D. at the time it is commissioned. are able to opt for accreditation under the RO or the small-scale Feed-in Tariff FiT. Similarly.e. Once accredited under the RO. RO accredited generators who add additional capacity up to 31 March 2017 will have a one-off choice of mechanism for the additional capacity (i. Once the new scheme is introduced. a generating station will not be permitted to move to the new scheme at a later date.19 The vast majority of stakeholders expressed a preference for a choice of mechanism before 2017. they would like a choice of scheme before the RO closes on 31 March 2017. as new projects would provide reassurance to investors. A limited number of stakeholders expressed the view that offering a choice would create additional uncertainty and complexity.Planning our electric future: a White Paper for secure. Our intention is that the new support scheme for low-carbon generation will be introduced in 2014. We are minded that any additional capacity which would be ineligible for the small-scale FiT will be eligible to opt for the FiT CfD on the same terms as all other eligible capacity.20 D. However.21 D. As suggested by most stakeholders. Requiring all renewables generation to accredit under the RO only until 31 March 2017 would have the benefit of simplicity. offering a choice of scheme would provide the opportunity to invest at an earlier stage. the RO or the FiT CfD). A number of stakeholders also asked whether a choice would be available to existing generators. new renewable generation will have a one-off choice of support mechanism up to 31 March 2017.22 Existing generation D.23 216 .18 Preferred option for new generation and existing generation New Generation D. for those who would only invest under a new scheme which gave more revenue certainty. D. it is eligible for the small-scale FiT. The consultation asked stakeholders whether. this will apply to additional capacity.

any generators that feel at significant risk of missing the 31 March 2017 date will have the option of choosing support under the new FiT CfD mechanism in the first instance.Planning our electric future: a White Paper for secure. Full details of how grace periods will be exercised are still being considered. Generation for which a contract has been signed to receive support under the new FiT CfD mechanism will not be eligible to accredit under the RO. This was on the grounds of the significant timescale uncertainties and risks during construction. for generators who may have met certain preaccreditation requirements. However.25 Administering scheme choice to 2017 D. During the transition period. Existing generation will therefore continue to be supported under the RO and. or to pre-accredit for either scheme. We believe that this will have a limited impact on the calculation of the obligation and that any risks posed are managable. Some respondents requested more significant grace periods.31 Preferred option for grace periods D. the level of obligation under the RO will continue to be calculated annually on the same basis as at present. these are to protect generators who have taken an investment decision on the basis of support which they are then unable to access due to factors which they could not have foreseen. D. and do not intend to introduce additional requirements on generators to inform us in advance of their choice of scheme. Some stakeholders have suggested that the potential for a free transfer might reduce investors’ confidence rather than increase it.30 D.24 However.32 217 .28 Grace periods D. allowing an open choice for existing projects to transfer to the FiT CfD has the potential to destabilise the RO mechanism and would make it more difficult to set the obligation level each year. in particular for offshore wind. affordable and low-carbon electricity D. a number of respondents to the consultation expressed concern over what would happen if that deadline were missed due to factors beyond a developer’s control.26 D. existing generation will not be permitted to transfer to the new scheme. but we will keep this under review. Given that generators will have approximately six years of warning of the date of closure of the RO. for example until 2020. to ensure ongoing RO stability. In principle. We intend to take a light-touch approach to administration in the transitional period. We have offered ‘grace periods’ for generators under previous RO reforms. The RO closes to new generation on 31 March 2017.27 D. such as the introduction of banding in 2009.29 D. and we are offering a choice of scheme in the years before the RO is closed.

affordable and low-carbon electricity D.33 However. The Renewables Obligation (Amendment) Order 2011 (ROO 2011) allows generators of offshore wind stations to phase their RO support. we should either extend the RO until 2040.39 D.35 D. This would mean that developers faced with these risks that they cannot control or quantify. D. Generators are able to register up to five phases of turbines over a maximum period of five years. or have increased ROC rates over a shorter timescale for the later phases.38 D.34 D.36 D. However the ROO 2011 imposes a new requirement for them to register turbines in order to receive ROCs on the electricity generated by them. This will be limited to a delay in grid connection instigated by the transmission or distribution operator. in each case where the originally agreed completion date was before 31 March 2017. The end date of the RO will not be extended beyond 2037 for those generators benefiting from the grace period.37 Offshore wind phasing D. A number of stakeholders suggested in response to the consultation that phasing should be allowed to continue under the RO after 2017 and. or a delay in the planned installation of radar necessary to satisfy planning conditions for wind generation projects. Therefore we will offer strictly defined grace periods aimed at those generators whose business case has been based on support under the RO. are better able to make an investment decision and a choice of support scheme based on calculated risks. It is likely that a number of stations accredited under the RO will not have planned to finish registering all their phases prior to 2017. such as a delayed grid connection. We will put in place evidence requirements that operators will need to demonstrate they have met if these grace periods are to be exercised. and recognise that this possibility cannot be reliably quantified and will affect the risk profile of the project. but whose accreditation is delayed beyond 31 March 2017 by factors beyond their control. This should therefore help to avoid a delay in investments.Planning our electric future: a White Paper for secure. given that any phases registered after 2017 would receive less than 20 years of support (due to the end date of the RO in 2037). generating stations continue to accredit in the same way as at present. with the first phase being at least 20 per cent of the total accredited capacity of the generating station.40 Preferred option for offshore wind phasing D. Under phasing.41 218 . and we need to address how to treat those unregistered turbines. we accept that some projects may be at risk of missing the 31 March 2017 date due to factors beyond their control. with each phase being eligible for up to 20 years support subject to the end date of the RO.

The administration of a FiT CfD for wind generation will require registered and approved metering to give output readings. We appreciate the need for early understanding of the revenue under the new FiT CfD mechanism in order for these projects to progress. no new offshore wind phases will be permitted to register under the RO after 31 March 2017.43 D. We anticipate that these can be calculated on a pro-rata basis using the meters that are already required for wind farms. The lifetime of the RO will not be extended beyond the current 2037 end date. as outlined in Chapter 8 of this White Paper.46 219 . D. Therefore accredited generators will be able to register all the remaining unregistered turbines that constitute the consented capacity of the generating station under the RO on or before 31 March 2017. Consequently. The Government is considering measures to provide technologies with early certainty. Generators will instead be eligible to participate in the FiT CfD on the same terms as all other eligible technologies for any remaining turbines that will not be registered under the RO by 31 March 2017. We understand that some generators may wish for their entire station to remain in the RO rather than receive support split between two mechanisms.42 However. as outlined in this Annex. Generation for which a contract has been signed to receive support under the new FiT CfD mechanism will not be eligible for the RO.45 D.44 D. the RO will close to new accreditations and additional capacity from the 1 April 2017 and we want this to be consistent across all technologies.Planning our electric future: a White Paper for secure. The 20-year support period will begin from the point of registration. in order to continue to receive support under the RO mechanism for electricity generated by those turbines. affordable and low-carbon electricity D.

Register some of the turbines that make up the remaining 45 MW under the RO on 31 March 2017 and sign a FiT CfD for the turbines that are not registered. or • a combination of the two. Renewables Obligation support from 2017: The Vintaged Renewables Obligation ‘Vintaging’ the Renewables Obligation D. With these vintaging arrangements we recognise the importance of maintaining industry confidence and stable conditions for investment decisions made on the basis of RO support. ‘Vintaging’ the RO system means that it will no longer be open to accreditation for new stations or to support the additional capacity commissioned after 31 March 2017 at accredited stations. The closure of the RO to new stations will create a closed pool of capacity which will decrease over time as we approach the end date for the RO of 31 March 2037. at which time it registers its first phase of 20 MW.48 D.Planning our electric future: a White Paper for secure. The developer can choose either to: • register all the remaining turbines under the RO on 31 March 2017 and receive support for the entire station from the RO mechanism. or • sign a FiT CfD contract for the remaining 45 MW of the station. A second phase of 35 MW is registered in September 2016. concerns were raised about triggering provisions (such as ‘change in law’ clauses) in existing Power Purchase Agreements (PPAs) and in existing project financing arrangements. All projects accredited under the RO will receive their full 20 years of support (subject to the end dates set in the RO). On 31 March 2017 a number of turbines equating to 45 MW would remain unregistered. The 20 year clock for all the remaining turbines will begin on 31 March 2017 and the RO support for those turbines will end on 31 March 2037. affordable and low-carbon electricity Box D1: Example case study A 100 MW wind farm accredits under the Renewables Obligation (RO) in January 2016. Therefore. the entire RO system will be ‘vintaged’ from 1 April 2017.50 220 . The turbines already registered will remain in the RO and each phase will receive the full 20 years of support from the point at which the phase was registered.49 D. D. the desirability of avoiding triggering change in law clauses or other default provisions was one of our considerations when designing these vintaging arrangements. While it will depend on the particular circumstances and terms of each contract as to whether its provisions are triggered. In the course of the consultation.47 The RO will be closed to new accreditations and additional capacity from 1 April 2017.

a low wind year) then the Obligation will have been set too high. and consumers would overpay. or our estimated generation plus 10 per cent headroom. or a lower than expected load factor (e. Investors with projects in the pipeline say that this gives them certainty over the ROC income. affordable and low-carbon electricity Calculating the Obligation post 2017 D. they are split between options B or C.57 D.g. D.55 D.54 Through the consultation process. It also maintains some incentive for suppliers to continue to purchase intermittent generation. we have made it clear that option A is not acceptable. even in the late 2020s and early 2030s. rather than having to take a discount through a PPA with a supplier. there is concern that. Fixing the price of a ROC turns the RO into a Premium Feed-in Tariff (PFiT). It could result in consumers paying for 15. but renewables trade associations and other stakeholders have agreed that this option is not tenable. Should one or more of these suffer a prolonged outage. it does mean that we would continue to set the Obligation each year. or option B – move to a headroom only mechanism. and old projects will only receive RO support for 20 years with a large number dropping out from 2027. or option C – fix the price of a ROC. A few respondents to the consultation asked for option A. when we expect there to be lower levels of RO eligible generation since new projects will receive FiT CfD support.56 D.4 per cent by 20155. we set out three options for the continued calculation of the obligation: ●● D. through to 2037. Proponents of the ‘headroom only’ option argue that it is the least disruptive to current PPAs.3 per cent by 2015. we will continue to calculate the Obligation each year.4 per cent generation through the RO. which would impose an annual administrative cost.51 D. with Government buying these direct from generators. as we near 2037. rising to 15. and therefore provides the most certainty to existing investors. the Obligation would be set on an ever decreasing pool of generators. The Obligation is currently set as the greater of either a fixed target. However.58 5 The Northern Ireland Renewables Obligation rises to 6. and allows them to access the full value of the ROC. ●● ●● D.52 In closing the RO to new entrants from 2017. In the Electricity Market Reform consultation document.Planning our electric future: a White Paper for secure. 221 . However.53 option A – no change to current arrangements. More importantly. an issue which has been raised by several independent generators.

Finally. to give certainty for investors.63 D. and then switching to a fixed ROC for the final 10 years of RO support.61 In the light of comments arising from the consultation. some investors have stated the fear that we would amend the RO in the 2030s). D. We believe the hybrid approach provides the best possible balance between providing long-term certainty over ROC income whilst minimising the disruption to current PPA arrangements. D. However. if the ROC price spiked. at the long term value of a ROC which is the buyout price plus 10 per cent headroom (roughly £41 per ROC at current prices). when a large number of projects are dropping out. The finance community has also indicated that it would be an acceptable way to ensure the value of the ROC. It is unlikely that there will be many projects that currently have PPAs beyond 2027. Under our proposal. The Low Carbon Finance Group stated in response to the consultation that “switching from guaranteed headroom to a fixed price post 2027 would be acceptable.64 D. Renewable UK stated that they “are open to the possibility of a hybrid system”.62 D. as existing projects are protected and new RO projects built in the transition period can take into account the post 2027 pricing”.59 It also allows them to access the RO income stream on. rather than up to an 18 month lag. the Fixed ROC would be introduced in 2027. affordable and low-carbon electricity D. and the obligation on suppliers would continue to exist until that date. to limit over-payment by consumers and provide a certain stream of ROC income to generators. especially in the latter years of the mechanism. a quarterly basis.60 Preferred Option for calculating the Obligation post 2017 Headroom then Fixed Renewables Obligation Certificates from 2027 D. developers say that they are concerned that banks may seek to use this as an excuse to call in loans and refinance on higher terms. without worrying that the final few years could be volatile and potentially subject to regulatory risk (for example. we have decided on a hybrid option – keeping with headroom (potentially with the fixed target underpin) until 2027.Planning our electric future: a White Paper for secure. for example. We have raised this hybrid option with a range of stakeholders across the renewables industry and it has been welcomed. it also means that banks/investors know that they will receive the full value of the ROC all the way to 2037. which would allow them to force the refinancing of projects.65 222 . In their response to the consultation. Some respondents expressed concern about the availability of PPAs if there were a fixed ROC and no obligation on suppliers. We will set the value of the fixed ROC now. several generators have voiced concern that PPAs for their existing assets could be adversely impacted if we went down this route. claiming that suppliers could use ‘change of law’ clauses to terminate/ amend the terms. This in turn could also lead to banks citing ‘adverse impact’ clauses. As many RO investments reached financial close ahead of the credit crunch. without having to pay a premium.

71 D. Wholesale electricity prices are likely to rise with the introduction of the Carbon Price Floor. D. including upside. in addition to current policy. RO generators may be able to participate in a Capacity Market mechanism. or provide some recompense for the additional uncertainty caused by the unknown impact of the package on electricity prices. Further detail on the options for Capacity Mechanism design can be found in Annex C. The prevailing capacity margin in the market will also continue to impact on electricity prices. then overall electricity prices would be reduced. RO generators will benefit from exposure to any higher price due to this policy in the shorter term.66 When investing under the RO. because the price setting technologies on the system will have lower marginal costs and are less exposed to assumed rises in fossil fuel and carbon costs. would have little or no additional impact on electricity prices. The RO is a support scheme which ensures that generators receive a mixture of variable income (the wholesale electricity price) and income which is considered fixed (the ROC value). A number of factors affecting long-term electricity prices will remain constant regardless of the introduction of the package. The Government is consulting on options for the design of a Capacity Mechanism. In the longer term. Generators and investors are therefore expected to assume a level of price risk. the value of the ROC provides only part of the generator’s income stream. and if so. Some stakeholders requested that the Government take additional measures to either stabilise the electricity price for RO generation.72 D. affordable and low-carbon electricity Impact on the electricity price D. shows that prices will rise even without policies. and investment decisions under the RO are made on that basis. depending on how it was implemented.68 D. the Strategic Reserve. depending on their ability to despatch. Of these options. and will continue to be exposed to the electricity price.67 D. The modelled impact of the proposals on long-term UK electricity prices. If the Capacity Market option were to introduce more capacity than would otherwise have been built. such as the increasing market share of intermittent generation. generators will continue to sell their power.Planning our electric future: a White Paper for secure. A number of stakeholders have queried how the package will impact on long-term wholesale electricity prices and therefore on the exposure of renewable generators operating within the RO mechanism. They also receive a price for the electricity they sell. due to increasing wholesale energy and carbon costs.73 223 . would receive additional revenue through that source. Under the vintaged RO. prices fall in a decarbonised electricity system.70 D. relative to a higher carbon intensity electricity grid baseline.69 D. as modelled.

bio-energy developers suggested that plant was not being built as lenders and equity providers were withholding investment due to a lack of grandfathering. Following consultation on banding and grandfathering in 2008. grandfathering was introduced for most technologies except those with a fuel cost or income. anaerobic digestion. Grandfathering is the policy intention to maintain a fixed level of RO support for the full lifetime of a generating station’s eligibility for the RO. from the point of accreditation.75 Grandfathering arrangements D. nor to provide any further compensation for increased price variability than that already included in ROC bands. along with the Combined Heat and Power (CHP) uplift and energy crops uplift remain not grandfathered. affordable and low-carbon electricity D. Grandfathering all technologies in the vintaged RO will provide industry greater revenue certainty.Planning our electric future: a White Paper for secure. this will bring the RO in line with the treatment of renewables supported under the new FiT CfD mechanism. the Government is not minded to introduce a mechanism to stabilise the electricity price for RO generation. The Banding Review setting ROC bands for 2013-17 (2014-17 for offshore wind) will take into account the impacts of the package when setting banding levels. and reduce the costly administration burden of ongoing banding reviews for a limited set of technologies. Our preferred option is for support for any technology that is not covered by our grandfathering policy on 31 March 2017. We are still considering whether any uplifts not covered by our grandfathering policy as at 31 March 2017 should be grandfathered in a similar way.77 D. However.79 D. Therefore.80 D. after reviewing the policy we decided to extend grandfathering to dedicated biomass. to be grandfathered at the RO support level applicable on that date. advanced conversion technologies such as gasification and pyrolysis. D. ensuring all renewable electricity will have long term fixed support.81 224 .78 Preferred option for grandfathering arrangements D. Consideration on whether to grandfather these technologies and uplifts will be taken as part of the current Banding Review. bioliquids and co-firing. In 2010.74 As the package will not significantly impact expected income streams over the lifetime of a project. This was because we recognised the need for flexibility to amend support levels should fuel prices change. and should not increase the difficulty of forecasting prices. This was not an explicit option in the consultation document.76 D. and energy from waste plant. however a number of industry representatives suggested grandfathering all technologies was the best way forward. which is due to publish a consultation in summer 2011. Moreover.

if additional capacity were able to continue to accredit under the RO after 2017. The administration of a FiT CfD will require approved and registered operational metering.83 D. providing support for additional capacity through the FiT CfD will allow the support to better reflect the appropriate level needed. We are minded that plants which are eligible for the current smallscale FiT will not be eligible for a FiT CfD. We anticipate that output readings can be calculated on a pro-rata basis for stations that are also accredited under the RO. We are also minded that any 225 D. It is therefore necessary to address how additional capacity will be supported in the context of the RO closing to new capacity from 1 April 2017. Outlined below is the preferred way forward for additional capacity that is greater than 5 MW.Planning our electric future: a White Paper for secure. additional capacity will not be able to accredit under the RO after 31 March 2017. it would not be able to access a full 20 years of support.90 Preferred option for additional capacity less than 5 MW D. Due to the end date of the RO in 2037. In addition.92 .88 D.89 Additional capacity less than 5 MW after 2017 D.91 D. Under current regulations. We are committed to supporting small-scale and community generation. are able to choose between the RO and the existing small-scale FiT. at the time at which the additional capacity is installed and therefore ensure value for money for the consumer.84 Preferred option for additional capacity D.86 D.82 Currently. The original capacity will continue to be supported under the RO. stations in the RO can add capacity and receive 20 years of support on that additional capacity (up to 2037). Separate provisions for additional capacity of less than 5 MW are detailed below. plants that are less than 5 MW and meet the relevant eligibility criteria. In line with the closure of the RO to new accreditations. Generators who add additional capacity that is greater than 5 MW will be eligible to participate in the FiT CfD on the same terms as all other eligible technologies.87 D. However. we do want to continue to provide support to stations that add new capacity after 31 March 2017 and will do so through the FiT CfD mechanism. given that we do not intend to carry out further RO banding reviews. The additional capacity would be awarded the ROC rate applicable to that technology at the time at which the additional capacity forms part of the generating station.85 D. affordable and low-carbon electricity Additional capacity greater than 5 MW added after 2017 D.

legislation allows generators to transfer to the RO if they exceed this maximum level. biomass. They will be eligible to participate in the new FiT CfD mechanism on the same terms as all other eligible technologies. We want to carry on supporting stations that cease to be eligible for the small-scale FiT.97 Preferred option for small-scale Feed-in Tariff D.96 D. affordable and low-carbon electricity renewable electricity developments which are ineligible for the current small-scale FiT will be eligible to access the FiT CfD on the same terms as all other eligible technologies.Planning our electric future: a White Paper for secure. Small and micro generators participating in the existing small-scale FiT scheme will cease to be eligible for support through the FiT scheme if they add so much additional capacity that the total installed capacity of their installation exceeds 5 MW. D.99 D. wave. Currently.g.94 D. between the introduction of the FiT CfD mechanism and 31 March 2017. we will offer generators that exceed the small-scale FiT maximum level a one-off choice between receiving support under the RO or participating in the FiT CfD mechanism.93 Any further amendments to the eligibility criteria for the current smallscale FiT would be considered through a separate consultation process relating to that scheme. In line with the approach we are taking for new generation. D. We anticipate that output readings can be calculated on a pro-rata basis for stations that are also accredited under the RO. The administration of a FiT CfD will require approved and registered metering. tidal. In Northern Ireland there is no small-scale FiT and all renewable electricity generation is supported under the NIRO. the RO will be closed to new generation. 226 . Incentivising smallscale generation is being considered as part of the Northern Ireland Executive’s ongoing work on the suitability of a FiT CfD for Northern Ireland. This would include investors wishing to deploy a technology at less than 5 MW capacity. We need to address how such projects will be supported in the future. not currently eligible for the small-scale FiT (e. Advanced Conversion Technologies). in the context of the introduction of the FiT CfD mechanism.100 From 1 April 2017. as this is the maximum level permitted under the FiT scheme.98 D.95 Small‑scale Feed‑in Tariff schemes exceeding 5 MW D. Therefore after this date any station that exceeds the maximum level permitted under the small-scale FiT scheme will not be able to receive support under the RO.

D. we intend to mirror how such projects are treated under the RO in the FiT CfD mechanism. Once the NFFO contract expires. during the lifetime of the NFFO contract. D. projects operating under the Non-Fossil Fuel Obligation (NFFO) scheme are. D. able to accredit under the RO. ROCs will be awarded to the Non-Fossil Purchasing Agency (NFPA) or NFPAnominated supplier.Planning our electric future: a White Paper for secure.e.102 Sites which have already been developed in line with the terms of their NFFO contract and accredited under the RO will continue to receive support under the RO mechanism. This is consistent with our approach to other existing investments receiving support under the RO. D.109 Finally.108 Similarly.e. Preferred option for interaction with Non-Fossil Fuel Obligation D. It is therefore necessary to address how projects under the NFFO scheme will be treated going forward. that cannot then be developed outside of the terms of the NFFO contract in order to claim Renewables Obligation Certificates. 227 . affordable and low-carbon electricity Interaction with the Non‑Fossil Fuel Obligation D.103 As currently.101 Currently. on or after 1 April 2017). D. ROCs will continue to revert directly to the generator. projects developed under the NFFO will be eligible to participate in the CfD on the same terms as all other eligible technologies. projects developed under the NFFO will be required to accredit under whichever scheme (either the RO or the FiT CfD) provides the best return for the NFPA. where eligible. D.104 A number of those responding to the consultation asked for clarification on how we will treat generation that is yet to be developed under the remaining NFFO Orders.107 We intend that projects sterilised6 from the RO (i. in the case of a generator breaching their NFFO contract) will similarly be sterilised from signing a CfD contract. generation built on a site after the relevant NFFO Order has expired will be treated in line with the provisions we have set out for other new generation.106 Regarding generation developed after the RO has closed to new generation (i. in situations where the NFFO contract has been terminated. D. 6 Where there exists an underdeveloped Non-Fossil Fuel Obligation (NFFO) contract relating to a specific site. with the generator receiving the ROC benefit once their NFFO contract expires.105 In the case of generation developed between the introduction of the FiT CfD and 31 March 2017.

e. affordable and low-carbon electricity Glossary Balancing Mechanism (BM) Operated by National Grid (the GB System Operator) to ensure the electricity system balances (i. Policy instrument designed to help ensure security of supply by providing a more secure capacity margin than that which would be determined by the market without intervention. There are several forms of Capacity Market. and providers willing to offer capacity (whether in the form of generation or non-generation technologies and approaches such as storage or demand side response) can sell that capacity. A single wholesale electricity market for GB with a single System Operator independent of generation and supply introduced in April 2005. Participants in the balancing mechanism can submit ‘offers’ (proposed trades to increase generation or decrease demand) and/or ‘bids’ (proposed trades to decrease generation or increase demand). supply equals demand) at any one time. Indicates the difference between the price quoted for an immediate sale (bid) and an immediate purchase (ask). depending on the nature of the ‘capacity’ and how it is bought and sold. The difference between peak demand and installed capacity. adjusted for probable availability at peak. A type of Capacity Mechanism in which the total volume of capacity required is estimated. Bid offer spreads Big Six Bilateral markets/ contracts BM Start Up British Electricity Trading and Transmission Arrangements (BETTA) market Buy-out price The rate licensed electricity suppliers need to pay if they do not present sufficient numbers of Renewables Obligation Certificates to meet their obligations under the Renewables Obligation scheme. Largest six electricity providers in GB. A direct contract between the power producer and user or broker agreed outside of a centralised power exchange. A reserve service contracted on the day by the System Operator to ensure plant with a start-up time of several hours is available in the Balancing Mechanism at peak. National Grid then purchases offers and bids to balance the system.Planning our electric future: a White Paper for secure. A call option is a contract that gives the buyer of the option the right (but not the obligation) to purchase an agreed quantity of a commodity from the seller at an agreed time for an agreed price. Call option Capacity margin Capacity Market Capacity Mechanism 228 .

A power station that generates electricity by means of a number of gas turbines whose exhaust is used to make steam to generate additional electricity via a steam turbine. such as baseload and peak load. thereby increasing the efficiency of the plant above open cycle gas turbines. The process used under British Electricity Trading and Transmission Arrangements designed to target the cost of energy balancing incurred by the System Operator to the parties who created those costs (i. announced in Budget 2011. clip size is normally defined in MWh of total volume. Carbon Price Floor (CPF) Cash out Churn Climate Change Levy (CCL) Clip size The size of a contract to be traded. This results in a more efficient use of both fossil and renewable fuels if there is a customer for the heat. and •  other services. A measure of the extent to which energy is traded and retraded in the market as market participants manage their risks. in deep underground structures such as depleted oil and gas reservoirs. offshore. Generation where both heat and power is produced. those parties who do not balance their inputs and outputs within the relevant balancing period). •  commerce. It is chargeable on the industrial and commercial supply of taxable commodities for lighting. •  public administration. CCS technology captures CO2 from fossil fuel power stations. is set centrally. and deep saline aquifers. One of a range of measures designed to help the UK meet its legally-binding commitment to reduce greenhouse gas emissions. •  agriculture.e. affordable and low-carbon electricity Capacity payments Carbon Capture and Storage (CCS) A type of Capacity Mechanism where the price paid for capacity. the clip size is generally in MW. heating and power by consumers in the following sectors of business: •  industry.Planning our electric future: a White Paper for secure. Carbon dioxide emitted per kWh of electricity generated. For shaped products. The CO2 is then transported via pipelines and stored safely. rather than the volume required. Combined Cycle Gas Turbine (CCGT) Combined Heat & Power (CHP) CO2/kWh 229 . A carbon price support mechanism to support investment in low-carbon generation. A higher churn rate is an indication of a more liquid market. For flat electricity products.

Changing behavioural patterns to reduce the amount of energy consumed. short-term reduction in electricity consumption either through shifting it to another period. The ECO will ensure that households unable to take advantage of Green Deal finance can still be supported and can improve the energy efficiency of their homes. or simple not using electricity at that time. A limit on the amount of CO2 that can be released into the atmosphere from a source (or sources) of electricity generation. UK’s independent environmental regulator. This is converted into allowances (one allowance equals 1 tonne of CO2) which are then distributed by EU member states to installations covered by the scheme. For example. The capacity margin adjusted to take account of the availability of plant. A Europe-wide cap and trade scheme that sets an overall cap on the total emissions allowed from all the installations covered by the System. using another type of generation. The amount of electricity demand each year that cannot be met due to insufficient supply. Vulnerable households on low incomes. affordable and low-carbon electricity Day Ahead Market Demand Management Demand Reduction Market for buying and selling electricity for delivery on the day after trading takes place. Demand side response (DSR) De-rated capacity margin Emissions Performance Standard (EPS) Energy Company Obligation (ECO) Energy Efficiency Energy Intensity Energy unserved Environment Agency European Union Emissions Trading System (EU ETS) 230 . An active. A change in the use of energy to reduce waste and lower energy use. for example through switching off lights when they are not needed. insulation in buildings reducing demand from heat. will be a key focus of the scheme.Planning our electric future: a White Paper for secure. as well as those in properties that are more difficult to treat. demand reduction and energy efficiency. Energy use management which includes demand side response. there will be full auctioning for the power sector in GB. Government proposal to create a new obligation on energy companies. From 2013. A measure of total primary energy use per unit of gross domestic product. or increasing the efficiency of appliances so they use less energy. from the end of 2012. specific to each type of generation technology. It reflects the expected proportion of a source of electricity which is likely to be technically available to generate (even though a company may choose not to utilise this capacity for commercial reasons). which draws on the strengths of the existing energy company obligations.

month. The authority that governs Ofgem. For example: •  1.000 Watt (W) = 1. e.000 UK households. Fixed Feed-in Tariff Forward Market Gas and Electricity Markets Authority (GEMA) Gigawatt (GW) A power measure (usually electricity) equivalent to 1. The Feed-in Tariff payment would be made in addition to the generator’s revenues from selling electricity in the market.000.000 kWh.000 megawatt (MW) = 1 gigawatt (GW) = 0.Planning our electric future: a White Paper for secure. affordable and low-carbon electricity Feed-in Tariff (FiT) Feed-in Tariff with Contract for Difference (FiT CfD) A type of support scheme that provides revenue support to certain generators. The FiT CfD can be a two-way mechanism that has the potential to see generators return money to consumers if electricity prices are higher than the agreed tariff.000.5 per cent of the UK energy demand.001 terawatt (TW) Green Deal Government programme providing support for the implementation of energy efficiency measures in households and businesses. Market for buying and selling electricity for delivery at a future date. usually between countries which allow electricity to be imported and exported in response to price signals. One GWh of electricity would meet the hourly energy needs of over 600.000.000. Physical linking of a network with electricity generation. EU Directive which consolidates seven existing European Directives relating to industrial installations with the aim of providing a single clear and coherent legislative instrument for controlling pollution from industrial operations. An independent institution which will provide financial solutions to accelerate and increase private sector investment in the UK’s transition to a green economy.000 kilowatt (kW) = 1. Support scheme where a fixed rate is paid per unit of electricity produced.000 kilowatts.000 UK households. around 1. An energy measure (usually electricity) equivalent to 1. One gigawatt of electricity from wind could meet the annual energy needs of over 600. such as low-carbon generators. A long-term contract set at a fixed level where variable payments are made to ensure the generator receives an agreed tariff (assuming they sell their electricity at the market price). season or year ahead. Green Investment Bank (GIB) Gigawatt-hour (GWh) Industrial Emissions Directive (IED) Interconnection 231 .g.000.

Part of the Department of Energy and Climate Change. in the market. The generating capacity available to the System Operator within a short interval of time to meet demand in case other generation is not available. Operating Reserve 232 .Planning our electric future: a White Paper for secure. This in turn informs investment decisions and can help facilitate new entry. Under market coupling. power flows from low to high price areas. Evidence of Climate Change Levy exempt electricity supply generated from qualifying renewable sources. affordable and low-carbon electricity Kilowatt-hour (kWh) Levy Exemption Certificates (LECs) Liquidity A unit of energy equivalent to 1 kW of power expended for one hour of time. An economic term to mean the cost of an additional unit or the extra cost in relation to the baseline. It links interconnected wholesale energy markets with an implicit auction that determines efficient cross-border flows according to price differentials between markets. Part of the Department of Energy and Climate Change. demand changes unexpectedly or there is another disruption to the supply. An approach used to allocate capacity on interconnectors. or the number of buyer and sellers willing to trade. A liquid market is one in which market participants have confidence in traded prices. intermittent generators such as onshore wind – will be unable to guarantee a buyer for their electricity impacting their ability to obtain finance. Risk that generators – particularly small. The independent regulator for the GB energy sector. Liquidity enables companies to quickly buy or sell a product without causing a significant change in its price and without incurring significant transaction costs. Liquidity refers to the proportion of energy trading. A measure of energy equal to 1000 kWh. Marginal cost Market coupling Megawatt Hour (MWh) Office of Carbon Capture and Storage (OCCS) Office of Nuclear Development (OND) Office for Renewable Energy Deployment (ORED) Ofgem Offtake risk Part of the Department of Energy and Climate Change. This approach for allocation of cross-border capacity is endorsed by the European Commission.

Currently expected to require approximately 29 per cent from renewable electricity. as part of the overall strategy for tackling climate change and to meet the UK and EU targets.g. In return for this hedge. The UK’s current scheme to incentivise investment in renewable generation. EU target requiring that at least 15 per cent of UK energy comes from renewable sources by 2020. usually per unit of electricity generated. The market price for electricity that is stipulated in a Feed-in Tariff with Contract for Difference (FiT CfD). enabling the holder to purchase energy at no more than the strike price or. to be compensated for the missing energy. Power Purchase Agreement (PPA) Premium Feed-in Tariff (PFiT) Project TransmiT Reference price Reliability Market Renewable Energy Strategy (RES) (UK’s) Renewable energy targets Renewables Obligation (RO) Renewables Obligation Certificate (ROC) 233 . if energy is simply not available. A type of Capacity Market (which is a type of Capacity Mechanism). a specific time of day) or to averaged load over a given period of time (e. A contract between a generator and a licensed electricity supplier for the sale of the output of the generator for the contract duration at a price that is defined in the contract. arrangements for use of the gas and electricity transmission networks. affordable and low-carbon electricity Peak load.g. the provider receives a payment (the option premium) which provides a reliable source of income. Government strategy aiming to increase the use of renewable energy in the UK. The reliability contract provides a hedge for the holder. The payments made under a FiT CfD are calculated as the difference between this price and the strike price. and associated connection. what is purchased from providers (which could be generators or suppliers of storage or demand side response) is a ‘reliability contract’. or the amount of power required to supply customers at times when need is greatest. a specific day or hour of the day). An obligation on licensed electricity suppliers to provide a set number of Renewables Obligation Certificates per MWh of electricity supplied in the UK or to pay a buy-out price. They can refer either to the load at a given moment (e. A green certificate issued by Ofgem to an accredited generator for eligible renewable electricity generated within the UK under the Renewables Obligation.Planning our electric future: a White Paper for secure. In a Reliability Market. A payment which generators receive in addition to their revenues from selling electricity in the wholesale market. peak demand These two terms are used interchangeably to denote the maximum power requirement of a system at a given time. Ofgem’s independent review of the charging. essentially a call option.

A form of Capacity Mechanism whereby an amount of reliable capacity is held outside the electricity market and only utilised in certain circumstances. Trading for delivery on the same day as the trade (within day). It outlines specific time-bound actions to remove the barriers to renewables deployment. A Banding Review is currently underway to determine the support levels that will be in effect from 1 April 2013 (1 April 2014 for offshore wind).Planning our electric future: a White Paper for secure. A Feed-in-Tariff system to incentivise households. Single Electricity Market (SEM) Small-scale Feed-in Tariff (FiT) Spinning reserve Spot Price Spot trading Strategic Reserve Strike Price for Capacity Mechanism 234 . The strike price represents the effective maximum price that the electricity buyer will have to pay for the volume agreed in the contract. Providers of STOR must be available for at least two hours within four hours notice. Price agreed by the parties under a reliability contract for a Reliability Market form of Capacity Mechanism. The Roadmap focuses in particular on the eight technologies which evidence from the market suggests now have either the greatest potential to help the UK meet the 2020 renewable energy target in a cost-effective and sustainable way. When the market price is higher than the strike price the provider of capacity pays the buyer the difference in price for the total volume of electricity agreed. The extra generating capacity that is available by increasing the power output of generators that are already generating electricity into the network. businesses and community groups to generate low-carbon electricity up to a maximum capacity cap of 5 MW. affordable and low-carbon electricity Renewables Obligation Banding Review The process whereby the band levels for technologies eligible for support under the Renewables Obligation are set. Scotland’s environmental regulator. The wholesale price for electricity that is traded for delivery on the same day. The Renewables Roadmap Scottish Environment Protection Agency (SEPA) Short-Term Operating Reserves (STOR) A service procured and used by the system operator for the provision of additional power from generation or demand reduction used to balance supply and demand over critical periods in the day. The electricity market for the island of Ireland. Document published alongside the Electricity Market Reform package. or offer great potential for the decades that follow.

within the constraints of the network. The System Operator (SO) is responsible for ensuring the electricity system remains balanced within each half hour period. the larger the penetration of wind generation on the system. Assuming that the generator can sell his electricity at the reference price. he is paid the strike price for each unit of electricity he generates. The UK target to reduce our carbon emissions by 80 per cent below 1990 levels by 2050. The SO must ensure that imbalances in supply and demand are addressed on a second by second basis. System Operator (SO) tCO2 Verticallyintegrated utilities Vintaging Wind cannibalisation 2050 targets 235 . the more revenues for wind generators could fall. where the same entity owns generation capacity and also supplies energy to the retail market. Tonne of CO2. Under such circumstances. customers of suppliers may consume more  or less energy than the supplier has purchased. The closure of the RO to new stations will create a closed pool of capacity which will decrease over time as we approach the end date for the RO of 31 March 2037. Term used to describe a future scenario in which the wholesale price for electricity is depressed by large numbers of wind farms simultaneously generating large volumes of zero marginal cost electricity. For example. The generator agrees to do the same when the strike price is lower than the reference price. Vintaging the Renewables Obligation (RO) system means that it will no longer be open to accreditation for new stations. the contracting authority agrees to pay the generator the difference between the reference price (see above) and the strike price when the strike price is higher.Planning our electric future: a White Paper for secure. For a two-way FiT CfD. Where one business owns two or more parts of the energy supply chain. affordable and low-carbon electricity Strike Price for Feed-in Tariff with Contract for Difference (FiT CfD) The price (per unit of electricity) agreed by both parties to a FiT CfD. Generators may generate more or less energy than they have sold.

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