Greater certainty – and cost – for a renewable future
Last week, the Department for Energy and Climate Change surprised everyone by announcing the draft strike prices it’s planning to pay for renewable generation under the government’s Contracts for Difference (CfD) scheme. The industry was expecting the figures to be released later this month, but the timing was perhaps more opportune, as it coincided with the government’s announcement to invest £100-billion to modernise the UK’s wider infrastructure.
Now, with greater certainty regarding return on investment, the government is hoping we’ll see more development in renewable technologies. The UK’s target is 15% of our energy from renewable sources by 2020. We are currently hitting around 11%. But DECC modeling predicts that CfD will ensure new capacity in generation such as wind, large solar and hydro is built to deliver the extra we need.
However, the introduction of CfD will make energy more expensive. Of course, when you require investment in new technologies, it’s going to cost more initially. That’s why some of the strike prices offered start off higher, then reduce – for example, offshore wind projects will qualify for £155/MWh of support in 2014/15, falling steadily over the next five years to £135/MWh in 2018/19. But in terms of how this translates into additional cost per megawatt hour, that’s still hard to predict for a number of reasons.
Our Electricity Market Reform (EMR) team has already forecast that CfD will add between £5 and £10 per MWh by 2020. The availability of draft strike prices enables more rigorous analysis to be done, but until more detail – final policy decisions, reference prices and how the Supplier Obligation is structured – is available, it’s difficult to forecast a more accurate figure.
Larger business customers in particular are certainly keen to have greater certainty. At our recent EMR Round Table discussion – where some of the UK’s leading retail, telecoms and industrial manufacturers met with policy makers from DECC and the Department for Business, Innovation and Skills – we heard very clear feedback on the need to pin down not only costs but also the way in which costs will be charged.
For example, what’s still not clear about CfD is the way in which the costs will be recouped – the government currently appears to favour a variable rate, whereby the cost will rise or fall according to how much they pay out in strike prices for each period. But having encountered hugely variable Feed in Tariff charges, where prices varied significantly against forecasts, businesses are understandably keen to secure greater budgetary certainty for energy costs. “We have lots of variable costs already, so adding to them would just make my job more difficult and most of us are looked at to provide price certainty as the main function of our roles,” said one participant. “Businesses don’t like taking risks so price certainty is key,” said another. A final decision on CfD charging methodology is due later this year.
Securing future capacity
Alongside the Contracts for Difference draft strike prices, DECC also confirmed details for another key component of the government’s Electricity Market Reform – the Capacity Mechanism. The announcement coincided with Ofgem releasing a report suggesting electricity margins are set to tighten to as little as 2% by 2015-2016, so perhaps another case of good timing.
The Capacity Mechanism will work by holding an annual auction for generators to secure an adequate supply margin of reliable capacity up to four years in advance. It’s like an insurance policy to ensure the lights don’t go off. The first Capacity Market auction is now confirmed for next year to secure supply from winter 2018. The sticking point, however, is how the mechanism will actually work. Currently, the Capacity Mechanism discriminates in favour of new generation plant over existing by offering newcomers a much longer contract length. However, offering less attractive terms to existing generators means that older plant could close sooner, creating a need for new, more expensive plant to be built – and this could ultimately increase the cost to consumers.
The Capacity Mechanism is also open to consumers who can commit to demand reduction, rather like how our SmartSTOR product works now. This means if you commit to switching to on-site generation or simply shutting down when asked to do so, you could receive payment for the capacity you then free up. DECC’s latest announcement also confirms that organisations which pursue permanent reductions in electricity demand could participate, subject to a feasibility pilot. So we will be watching the outcome of this closely as, understandably, many of our customers will be interested in additional incentives for investing in greater energy efficiency.
In terms of funding the Capacity Mechanism, on the one hand it’s set to reduce wholesale market costs, by smoothing out the peaks that occur in the market when capacity is tight. But on the other, the cost of securing capacity via a Capacity Market is likely to add costs, meaning that consumers could end up paying as much as £15 extra per megawatt hour by 2018.
Customers participating in our recent Round Table on Energy Market Reform were also sceptical that such a scheme will really be effective in terms of generating new capacity. As one participant said: “If businesses aim to reduce costs associated with the Capacity Mechanism with demand reduction, this actually reduces the need for a Capacity Mechanism in the first place.”
You can read more about customer concerns – and DECC’s response – in our EMR Round Table report (click here to download). You may also like to read my recent blog EMR: More Certainty, Less Confusion for a broader overview. And do keep an eye out for future blogs, as I will bring you news of new developments – and the likely implications for business consumers – as further EMR announcements are made.