Whenever we ask customers what they want, cost certainty is always a key requirement. Since the government announced its intention back in late 2010 to bring about one of the biggest-ever shake ups of the UK energy sector via Electricity Market Reform, our policy team has been working hard to translate the proposed measures into hard numbers our customers can use to forecast future energy costs.
Last week, we held what is likely to be one of the last in a long series of Electricity Market Reform (EMR) events. Customers joined our policy experts and DECC for a face-to-face Roundtable meeting in London, followed by an online Webinar to accommodate a greater number of participants.
A quick recap
Just in case you’ve missed the detail – or even if you haven’t but still can’t make clear sense of it – here is a quick recap on what EMR entails.
Of the four key policies that make up EMR, two have already been enacted.
• The Emissions Performance Standard, which limits emissions on new power stations, comes into force this Autumn.
• The Carbon Price Floor, designed to set a minimum price for carbon emissions released by power generators, was introduced in April 2013, but annual increases in costs were frozen in the last Budget.
The remaining two are due to become law by 1 August 2014 – and it’s these that consumers are most concerned about when it comes to cost implications for bills.
• Contracts for Difference (CfD) is designed to support investment in low-carbon generation, with a technology-dependent ‘strike price’ guaranteed for 15 years (wholesale price + top-up subsidy). This launches in November and will ultimately replace the current Renewables Obligation subsidy, although the two schemes will run concurrently until 2017.
• The Capacity Mechanism (CM) is designed to ensure we have sufficient power available to meet our future needs, which is becoming more important as older, reliable plant closes and additional low-carbon plant is built, with a greater volume of our energy coming from intermittent sources. The CM will operate as an annual auction starting in October 2014, procuring the majority of capacity four years in advance, with a top-up auction one year ahead of delivery to enable demand-side response to participate.
The bottom line
The cost of Contracts for Difference will start appearing on bills from April 2015. According to DECC, CfD costs are forecast to start at around £0.5/MWh, increasing to approximately £8/MWh by 2020. Long-term visibility is an issue, as actual costs won’t be finalised until 90 days ahead of each quarter, with a rolling forecast provided for the following three quarters. There will also be some additional costs to cover the operational costs of the administrator (the Low Carbon Contracts Company) plus reserve and collateral funds.
Energy Intensives are expected to receive some level of CfD exemption, but this still needs to be agreed in line with the European Commission’s new State Aid Guidelines, so nothing is likely to be in place before 2015, with no retrospective application. However, for those not eligible for exemption, there will be an increase in costs to pick up the shortfall in contribution, with the Department for Business, Innovation and Skills forecasting this to be between £0.30 and £0.80 per MWh.
Capacity Mechanism costs are harder to forecast until the first auction takes place in October 2014, and will not hit bills until Autumn 2018. DECC’s own analysis suggests that the first auction could clear at £39/kW, with a maximum cap of £75/kW. So the cost for the 50.8GW purchase target for 2018/19 is expected to be around £2-billion – but could be almost £4-billion.
CM costs will be recovered from suppliers based on their forecasted share of winter weekday demand between 4-7pm from November to February. So if costs to consumers are applied only during the charging period, they could be as high as £150/MWh. But if smeared across total annual demand, we anticipate a price between £3-7/MWh by 2018/19. We will be able to provide more exact costs after the first auction, when 95% of costs will be known four years ahead of delivery, with the final 5% confirmed in the second auction one year ahead.
In total, the cost of CfD and the CM is going to be in the region of £11-17/MWh by 2020 (across total annual demand). To provide greater context, this year the government spend on low-carbon subsidies is £3.3-billion – next year, it will be capped at £4.3bn, increasing to £7.6bn by 2020 (in 2012 prices).
Opportunities to cut costs
On the plus side, EMR is not just about increasing costs. There are also opportunities to cut costs via demand-side response participation in the CM (the majority of which will take place in the year-ahead action in 2017), plus other initiatives such as the National Grid’s Demand Side Balancing Reserve scheme. We are also awaiting details shortly of the government’s £20-million Electricity Demand Reduction pilot.
It’s these opportunities I’ll be looking at in more detail in my blog next week, so do please join me again. For now, if you want to listen to a recording of our latest EMR webinar, you can access this here.
Wayne Mitchell is npower’s I&C markets director.
This is a sponsored article.