tim stone. 28th january

1 Presentation title - edit in the Master slide

α⇒n

HOW THE UK IS INNOVATING WITH ELECTRICITY MARKET REFORM

The basis for major new nuclear investment

January 2014

2 Electricity Market Reform Slide 2

Objectives and Agenda

Overview of session

• How the electricity market works in the UK

• EMR – our strategic approach and objectives, what we are trying to achieve

• EMR – relating to new nuclear, drawing on the key terms agreed with EDF


UK’s commitment to liberalised competitive markets

The UK has led the way in the introduction of competition into electricity markets

• Privatised gradually from 1990

• Significant generation investment in 1990s – in particular in CCGTs

• Reform of the wholesale market – “New Electricity Trading Arrangements” (2001)

• In 2005, NETA became BETTA incorporating the Scottish market

• Unbundling and EU Third Package


Size of the market


Financial and physical markets

Generators Transmission DistributionSuppliers

(retail)

Wholesale markets


Generation

Major players account for c.60% of market - E.On, EDF, RWE, SSE, SP, Centrica. Also small number of independents such as Drax, Independent Power etc.

Competitive market, not subject to price regulation.

Subject to environmental legislation to control Carbon emissions and the treatment of other by-products of Generation

Accounts for approx 50% of final electricity bill.

Generators Transmission Distribution Suppliers


Transmission

Winter peak demand c.60GW

England and Wales owned and operated by National Grid plc.

Scotland: system operated by National Grid but owned by Scottish Power and SSE.

Natural monopoly: Subject to Price Controls set by Ofgem, the regulator

Licence involves technical and contractual obligations to allow fair access by companies and effective operation of the system.

Transmission Generators Distribution Suppliers


Distribution

Over 300,000km of overhead line and c.500,000km of underground cable

Distribution is arranged into regions, but those are now owned by six main companies

Like transmission, Distribution is a natural monopoly: Subject to Price Controls.

Running it and maintaining it costs around 17% of each electricity bill.

There are also smaller, independent distributors with slightly modified licences – currently 6 IDNOs. Those operate distribution networks to small housing developments and industrial estates etc eg. Manchester’s Media City.

Distribution Generators Transmission Suppliers


Supply

Competitive market with over 40 licencees

26m domestic electricity customers, over half dual fuel.

Dominated by six (vertically integrated) companies: Npower (RWE), E.On, Centrica, SSE, SP and EDF

Some small ‘niche’ suppliers (in domestic market, mostly innovative or green suppliers)

Supplier obligations to comply with licence within the regulatory framework.

Rules to prevent anti-competitive action such as cross subsidy.

Suppliers Generators Transmission Distribution


How the system balances

Residual pool managed by System Operator through balancing mechanism

Generators

Suppliers

System Operator (National Grid)Balances generation and demand efficiently Regulated by Ofgem

Balancing mechanismMatches generation to demandEnsures delivery at times of system stressCosts recovered from generators through charges


Electricity Trading


Governance and operation of the systemGovernment Independent

Regulator: OfgemSystem Operator:

National GridELEXON

• Government establishes a transparent and stable legal framework,

• Decides which activities should be licensed

• Sets objectives of independent regulator

• Protect the interests of consumers through competition.

• Administers licensing regime to achieve policy objectives.

• Regulates monopoly companies which run the gas and electricity networks – sets price controls

• Has role in enforcing competition law in energy sector.

• Independence is a part of EU law

• Balances generation and demand efficiently Regulated by Ofgem

• Matches generation to demand on a second by second basis

• Ensures delivery at times of system stress (margin c. fifth of generating capacity)

• Costs recovered from generators through charges

• Effective and efficient implementation of the Balancing and Settlement Code.

• Rules and governance arrangements for electricity balancing and settlement in Great Britain.


Agenda

Overview of session

• How the electricity market works in the UK including




What we are trying to achieve

• Decarbonisation, security of supply and affordability to consumers

• Planned course of action to achieve 2020 targets, on path to 2050

• To meet these challenges an estimated additional 40 – 70GW of new low carbon capacity will be needed by 2030

• Energy is essential for economic growth – it’s th biggest infrastructure sector

• Current market arrangement and incumbent investors are unlikely to be able to deliver the required investments

• Transition to a competitive market


Electricity Market Reform

Long term price certainty (“strike price”), indexed to inflation Private law contracts with Government-owned counterparty 15-year contracts for renewables (except biomass conversion) CCS and nuclear projects also eligible

Contract for Difference (CfD)

New contracts for capacity First auction in 2014 for delivery in 2018/19 Open to supply-side and demand-side measures including storage.

Capacity Market

Long-term certainty of the cost of carbon Started April 2013 Price (in 2009 terms): £16/tCO2 in 2014 rising to c. £30/tCO2 by

2020

Carbon Price Floor

Regulatory cap restricting CO2 emissions from new power stations.

450g/kWh allows new CCGT but not new unabated coal-fired power

Emissions Performance

Standard


The complete market reform framework


CfD introduces a number of benefits for developers

Reduced wholesale electricity price exposure by providing a fixed strike price to developers, therefore stabilising project revenue

Robust and reliable private law contractual arrangement providing developers with a clear set of rights and obligations, and recourse to arbitration/expert determination processes to resolve disputes

Robust single counterparty owned by government and set up as a limited liability company

Early certainty and security of support levels in the project development process

Provision of an element of protection against those risks that are outside the developer’s control (e.g. change in law, force majeure, grid connection delay)

12345


Robust single contract counterpartyKey characteristics

• Single counterparty body (“CPB”) set up as a UK limited liability company owned by UK government

• Likely to have a settlement agent balancing payments between suppliers and generators

• SoS has significant control up front over design of contracts, agreeing strike prices and setting maximum costs.

• CPB will need to seek consent of SoS before agreeing to certain matters under the CfD

• However, SOS has no rights under the contract and cannot impose any settlement or decision on the generator

CPB will have the duty to raise a levy from UK suppliers to fund ongoing obligations under the CfD

Suppliers will be bound by a licence obligation to honour levy raising requests from the CPB

Penalties or ultimately revocation of their supply licence for failure

CPB levy powers will be set out in primary legislation

CPB will be set up as an insolvency remote vehicle.

Notwithstanding the limited probability of default (given the remote risk of CPB insolvency), we have sought to design a system that limits any potential losses to generators

The various lines of defence that protect the CPB from any unsecured losses upon a supplier default occurring are:

Supplier Collateral, Mutualisation, Supplier of Last Resort, Energy Supply Company Administration regime and potentially an insolvency reserve fund.

Control over the CPB

CfD levy CPB support mechanisms


Sustainable framework: Stability for investors and protection of the consumer

Levy Control Framework (“LCF”) is a budget which sets out the maximum support for low carbon generation on an annualised basis. This include obligations under CfDs. The LCF is sized to enable us to meet our 2020 renewables target.

Transparency provides clarity for investors about the likely availability of support for a project commissioning in a particular year.

It is likely that regular information on remaining CfD budget will be available once allocation is under way..

£4.30bn £4.90bn £5.60bn £6.45bn £7.00bn £7.60bn

2015/16 2016/17 2017/18 2018/19 2019/20 2020/21LCF trajectory (2011/12 prices)


Strike price indexation

2013/14

2014/15

2015/16

2016/17

2017/18

2018/19

2019/20

2020/21

2021/22

2022/23

2023/24

2024/25

2025/26

2026/27

2027/28

2028/29

2029/30

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

£150

£170

£190

£210

£230

£250

£270

£290

Offshore Wind Generator, Commissioning 2015/16, Base Year Strike Price £155/MW

CPIStrike Price - IndexedBase Year Strike Price

Strike Price£/MW

Indexed strike price

Base year strike price

The consumer price index (CPI) measures changes in the price level of a market basket of consumer goods and services purchased by households.

The CPI 12-month rate between July 2012 and July 2013 was 2.8%


Long-term vision is for low-carbon technologies to

compete on cost


Timetable

Electricity Market Reform

LegislationContract for

Difference, including payments and settlements

Capacity Market, including auction design

Final design System

goes live

before

end 2014

Energy Act 2013

Secondary legislation laid in Spring 2014

Publications

Consultation on EMR implementation

Final Delivery Plan


… and it’s happening

The first practical point is that this is the year that EMR really happens. We are on track for our delivery timescales. We have already published draft secondary legislation (in October). In December we finalised the strike prices for the CfDs and published 300+ pages of near-final contract. In the next few months we will be:

• putting our finalised secondary legislation into the House and seeing it take effect (by the end of July, when the House rises);

• at that point seeing the counterparty body go live;

• we are in the midst of the process to appoint a Chair to the CPB;

• we will be ready to sign investment contracts under the FIDeR programme around Easter;

• the first allocations of contracts under the enduring regime will happen in October or November; and

• the first capacity auction will take place in December


… and it’s happening

Second, and perhaps more interestingly, it’s not just a story about jam tomorrow. The investment is starting to happen now. In particular:

• EMR underpins the Hinkley deal, as you know. The fact that EDF are prepared to commit to a multi-billion pound project is a massively positive sign for the arrangements we’re setting up;

• similarly the very high level of interest in the FIDeR programme – including some very big projects in offshore wind and biomass – shows that we are at the point where EMR is starting to unlock investment in renewables; and

• while this isn’t something the Government would take a view on a number of analysts I’ve spoken to have commented on the activity around projects changing hands with interested developers taking projects off those who aren’t going to take them up – we’ve already seen Horizon and more recently Race Bank, and there are a number of others in the ether.


Objectives and Agenda

Overview of session

• How the electricity market works in the UK




New nuclear and CfDs

• The UK Government’s intention is that future Contracts for Difference (CfD) allocation for nuclear projects takes place through competitive project selection processes, wherever practical and effective.

• This is in line with the UK Government policy of increasing competition within and between low-carbon technologies, which over time will assist with meeting Government’s goals for least-cost decarbonisation of the power sector over the longer term, and should also facilitate more effective management of the Levy Control Framework.

• Bilateral negotiation remains an alternative for nuclear CfD allocation where competitive processes are not practical. In such circumstances, any final allocation decision would still be subject to strict value for money considerations and an assessment of overall budget constraints. It is open to Government to amend any budget allocation between technologies, which may be an important way to foster inter-technology competition and maximise value for money.


Bilateral negotiation – Hinkley Point C

• During the transition from the existing market to CfDs under Electricity Market Reform, the UK Government has been aware of the risk of an investment hiatus whilst the institutions and legal framework necessary to manage CfDs are established.

• To avoid an investment hiatus, the UK Government introduced a ‘final investment decision enabling’ (FIDe) process under which developers whose projects were at serious risk of significant delay or cancellation, to approach the UK Government with the aim of receiving an ‘Investment Contract’ which would be an early form of CfD.

• For nuclear, EDF Energy approached us about an Investment Contract for its new nuclear project at Hinkley Point C. Since March 2012 the UK Government has been in discussion with EDF about the terms of an Investment Contract suitable for Hinkley Point C. We have been clear that an investment contract must be value for money and affordable to energy bill payers.

• On 21 October 2013, the negotiations were sufficiently far advanced to announce that there had been agreement with EDF on the key commercial terms including Strike Price and duration of the proposed contract.

• This agreement remains subject to further negotiation on the investment contract itself, EU State aid clearance and the passing of the Energy Bill through the UK Parliament.


Hinkley Point C agreement

• A “Strike Price” of £89.50/MWh fully indexed to the Consumer Price Index.

• This price benefits from an upfront reduction of £3/MWh built in on the assumption that EdF will be able to share the first of a kind costs of the EPR reactors across the Hinkley Point C and Sizewell C sites. If EdF does not take a final investment decision on Sizewell C, the Strike Price for Hinkley will be £92.50/MWh. The development of Sizewell C will be subject to relevant consent and regulatory and other approval procedures at the appropriate time.

• A contract difference payment duration of 35 years, from the earlier of the point at which each reactor at Hinkley Point C becomes commercially operational and the last day of the target commissioning window for that reactor, subject to satisfaction of certain conditions.

• A range of gain share arrangements, adjustment, re-openers and protections to reflect the fact that over the 35 year duration the market, legal and political contexts are likely to change, and to prevent the developer either being overcompensated or undercompensated.

• We believe that an investment contract based on this agreement will be value for money, fair and affordable as well as consistent with EU State aid rules.


Links to policy detail

Publications relating to policy decisions about the CfD and draft strike prices; and the Capacity Markethttps://www.gov.uk/government/news/new-energy-infrastructure-investment-to-fuel-recovery

Publication of the draft delivery plan for consultationhttps://www.gov.uk/government/uploads/system/uploads/attachment_data/file/223650/emr_delivery_plan_consultation.pdf

Publication of CfD contract details and allocation processhttps://www.gov.uk/government/publications/electricity-market-reform-contracts-for-difference

Department of Energy and Climate Change3 Whitehall PlaceLondonSW1 2AWhttps://www.gov.uk/government/organisations/department-of-energy-climate-change

https://www.gov.uk/government/news/new-energy-infrastructure-investment-to-fuel-recovery

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/223650/emr_delivery_plan_consultation.pdf



https://www.gov.uk/government/publications/electricity-market-reform-contracts-for-difference

https://www.gov.uk/government/organisations/department-of-energy-climate-change

30 Presentation title - edit in the Master slide

α⇒n

Dr. Tim Stone CBE

[email protected]

tim stone. 28th january

Technology