DECC pokes the bear again on capacity markets

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Maybe it’s getting a bit wearisome to keep on pointing this out and I know that I’m getting a bit like a bear that wakes up when prodded with a stick etc. But …yes it’s the capacity market again. The latest is a press announcement from DECC that ‘Britain’s energy security strategy [is] now fully in place.’ This refers, in case you didn’t know, to ‘the amount of electricity generation capacity the government will procure’ through the capacity market, which as long-toothed readers of this blog will know, will be done through a series of ‘capacity auctions’. These auctions will see Britain’s gas fired power stations, present and future, being invited to bid to receive large amounts of money to persuade them to continue to be available to produce power (i.e. not shut down). As the Secretary of State says in his breathless press release, this is so ‘the ticking time bomb of electricity supply risks’ can be averted.

And now we’ve got the figures and the likely cost to consumers. The Government is aiming, the report says without a trace of a smile, to procure ‘a total of 53.3 GW of electricity generating capacity.’ In case you aren’t up with this capacity game, that is, incidentally, TWICE the amount of new gas fired power capacity that DECC estimated in its 2012 Gas Strategy would be needed by 2030. It’s also about 20% more than the total amount of gas capacity the Department estimated would be likely to be installed by that date. So yes, you could say that this is quite a secure amount of gas fired power stations to procure, since it seems that every conceivable source of gas fired power between now and 2030 will get free money to persuade it to be there.

And of course, thanks in passing to the redoubtable Emily Gosden, writing in the Telegraph about the announcement, we know the cost to consumers of this bonanza for gas fired power stations – on average £13 a year on bills. DECC had initially put the figure out as £2 on their press release, but accepts that, well yes, that is net of some very heroic assumptions about what may turn up in advantages on price as a result of the policy, so it really should start at…£13.

Ah but this must all be OK, says DECC because (back to the press release again) the whole shebang has been OK’d by experts: ‘the analysis supporting the decisions made today has been impartially scrutinised and quality assured by the panel of technical experts for the enduring regime’. Well…up to a very small point. When you read the small print of the Panel report, it is made clear that, according to the terms of its establishment, the Panel:

‘has no remit to comment on EMR policy, Government’s objectives, or the deliverability of the EMR programme. The Panel’s Terms of Reference mean it cannot comment on affordability, value for money or achieving least cost for consumers. These matters are excluded from the Panel’s scope and therefore from this report.’

So not much to comment on at all really.

Which I suppose is just as well, because if the panel did have such a remit, it could not have failed to turn up the infamous 2011 impact assessment on the comparisons between a capacity market and a strategic reserve, the option for energy security which in the words of DECC at the time,

 ‘is a targeted capacity mechanism. The system operator tenders for capacity to be part of the strategic reserve. The capacity is then kept outside the market and only deployed at times of scarcity i.e. when there would be blackouts or brownouts in absence of the reserve being deployed.’

Far more sensible you might think, and it has the advantage of ‘being a smaller intervention in the market and of having a smaller impact on bills’ (DECC’s words in 2012, again). Just how much smaller is shown in comparative costings in the 2011 Comparative Impact Assessment, where the proposed capacity market is projected to come out at a cost per year of about what has now appeared.  The strategic reserve comes in at about ONE FIFTH of the cost. It was rejected as an option after a series of ‘qualitative’ analyses, which I know had at least one former DECC civil s
ervant scratching his head at the time when he reported (to me) ‘ all the time during this period it was clear to all of us that the strategic reserve was the right way to go. How we ended up with this, I really do not know’.

Well we have and it’s going to cost us. It strikes me as rather like announcing that you are going to concrete over the Somerset Levels to a height of six feet and then proclaim that ‘a flood prevention strategy is now fully in place’. It really is such a silly long term policy that I cannot believe it will last for the time it will take to procure all this 52.5gw of gas fired power stations. But you never know: stranger things have happened.

No Michelin stars for the fat dud

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The Financial Times ran a piece yesterday, regrettably behind a paywall, that featured the findings of Aurora Energy Research. As the FT quaintly put it, ‘the pot of money ministers have set aside to subsidise UK renewable power is likely to run out much more quickly than previously thought, according to research, placing green energy projects in jeopardy’.

Apparently, the hitherto solid looking pot may turn out to be more like a collapsing bag as uncertainties about just what the pot’s contents may buy burgeon. This is because the sums that will be expended on Contracts for Difference (CfD) will change as the price of energy changes, which the government might have exacerbated anyway by freezing the carbon price floor. DECC doesn’t seem to have taken much of this into account.

To which the correct response should be, I think ‘blimey, you don’t say’ or perhaps more colloquially something like ‘no s*** Sherlock’.

It is good that a research company has now told us that, as an instrument to facilitate and plan investment in renewables, the Levy Control Framework (LCF) is a fat dud, regardless of its efficacy as a method of stopping anyone spending more than a set amount of ‘levy money’ whether what you get for that spend is worth having or not. But a number of people (me included) have been making this point for a long time now. It is perhaps only now that Contracts for Difference are upon us, that the true fat dud-ness of the device can be uncovered.

The point is that the LCF was perhaps not such a fully fat dud when it first came out. After all, it controlled the amount of Renewable Obligation Certificates (ROCs) and feed in tariff (FiTs) payments that could be made. Since both were in fixed sum form you could fairly accurately find out what you might get for what, and importantly, how much you would have in any one year for new entrants based on what you had already committed as fixed amounts. ROCs trading allowed renewables operators additional money from their activities to invest outside the process.

But now, with the more ‘market efficient’ CfD you never quite know what the ‘cost’ of a CfD in any one year will be, since it depends on the relationship over that year between the agreed strike price and the varying ‘reference price’ it seeks to make up the difference between. If you deliberately depress the likely reference price having set a strike price in the first place by, for example, taking some of the increase in carbon floor price out of the equation, then inevitably existing providers will get more money from the ‘pot’ each year. There will then be less from the same pot each year for new entrants.

And worse, as you keep doing that year by year based on a pre-agreed static strike price against a varying reference price, then the margin for new entrants gets smaller and smaller each year.  So that the ability to plan anything new that needs a CfD at a certain time (and contracts specify ‘windows’ within which your CfDs must start, otherwise you lose them, except if you are a nuclear power station) eventually and inevitably, melts away entirely. And to be fair to DECC, who didn’t design the system in the first place, there is nothing you can do about it, once a fixed out turn figure has been set against an inherently variable cost base in the years running up to that agreed figure.

So in terms of planning for renewables to come on stream on the basis of a known underwriting, or as the FT puts it, the sum ‘set aside to subsidise UK renewable investment ‘ the LCF is a complete turkey and has been ever since CfD were invented. If, on the other hand, you don’t care whether much in the way of renewables gets built or that what is built is good value, and you just want to stop whatever it is at the point at which the money stops in 2020, then it looks a bit better.

Except, of course, that come the early 2020’s when new nuclear finally gets off the ground and decides to cash in the monumentally bloated CfD allocation achieved under the ‘investment instrument’ mechanism, the whole edifice will almost certainly come crashing down under the weight of its own contradictions. Which is why, I guess, no-one has attempted to sketch in what might be thought of as some necessary reassurance of what a levy control envelope might look like after 2020.

There, that didn’t need a research report to get straight now did it?

 

Interconnection: small perturbations in a flat line graph

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There has been a veritable flurry of activity on the interconnector front over the past couple of months. No interconnectors as such, or even the prospect of new interconnectors in the near future, but quite a deal of fluffing of feathers and (sort of) discreet nest building moves that suggest that maybe there might just be something in it all.

There was the departmental paper ‘More Interconnection: Improving Energy Security and Lowering Bills’ in December. Before that, The Guardian reported in October that the Icelandic President was getting very excited about a possible 1000km interconnector following the signing of a statement of intent between the UK and Iceland. Such an interconnector could supply perhaps 1.5% of the UK’s electricity needs by the early 2020s. There was a proviso on his excitement however: that the UK would guarantee the cost of £4.3bn for the line to be laid and connected.

Then this month, in a less than generally noticed footnote to his letter to Ofgem about gas prices, Ed Davey asked Ofgem to ‘indicate what benefits there might be for competition and for consumers from further steps towards completion of a Single European Energy Market of which interconnection could play an important part’.

I’ve long thought that interconnectors (for electricity that is) are a real no-brainer as far as our future energy security is concerned. Britain is almost an energy island as well as being an, er, actual island; we can only source about 5% of our supply via interconnection.  Even at this measly level (Germany, for example, is able to source 14% of its supply through interconnection) interconnection makes an enormous difference to our putative supply margins (as I set out some time ago at the height of the ‘lights are about to go out’ scare of last year).

Ofgem doesn’t count interconnection as part of our national supply margin because, well, interconnection could go two ways, although analysis of the Brit-Ned interconnector last year showed that 99% of the time flow was into the UK. If it did count it, the regulator cheerfully records, the doomy-sounding 5% margin in 2015 would look like a far healthier 10% gap. So imagine what a relatively easily achievable doubling of interconnection would look like. You might even not have to build quite so many new gas fired – or even nuclear – powered plants in the future.

So why the snail-like progress because of course you couldn’t even start to argue that an Iceland interconnector might go two ways – what would a country that can hardly move for hydro power and a population the size of Cardiff want with ever importing electricity? The clue, I think, is in the Icelandic President’s reported ‘ask’ of the UK government: that the project is somehow underwritten in order to go out to tender. Tricky, because in recent years the assumption has always been that interconnectors should essentially be ‘merchant undertakings’  at no risk to consumers. Furthermore it was assumed that the money to pay off the investment should come from what the December DECC strategy paper calls ‘price arbitrage opportunities’. Another way to put it is that interconnectors should make their living out of speculation as to price differentials between the UK and Europe. But with moves towards a more integrated and liberalised European energy market the likelihood of these differentials decreases. Perversely therefore, greater connectivity on a merchant basis and a level energy playing field means a lower likelihood of additional interconnection being achieved. The full bullet point in the DECC strategy paper incidentally, reads: ‘questions as to whether price arbitrage opportunities adequately capture the benefits of interconnection including security of supply’.

So the little flurry of late is therefore pretty interesting. Because, as can be seen in the language of Ed Davey to Ofgem and in the way the case for  interconnection is put in the strategy paper, it is apparent that feelers are being put out towards a different way of doing things. Stupid question I know but could it be that ‘arbitrage opportunities’ really do not reflect the value of interconnection to UK security of supply, and that, subject perhaps to EU competition regs (see ED’s coded reference in his letter to Ofgem above), a real case might be made to underwrite such projects from the public purse?  That probably wouldn’t be difficult, since the EU has recently designated no fewer than three UK-continent interconnection proposals as ‘European projects of common interest’. This designation is not a million miles from what the UK Government has tried to put to the EU Competition Commissioners about another project not likely to come on stream until well after a number of interconnectors could be up and running, namely Hinkley C power station. That project will have tax breaks and an underwritten power price behind it but a problematic route to travel with EU Competition Commissioners.  Interconnection, on the other hand, currently has no assistance of any sort riding on it but does have a loudly banging and waving open door from the EU.

As I’ve said, it’s a clear no-brainer and wildly in the national – and EU – strategic interest to pursue. It just needs a little prejudice-swallowing to get going quite rapidly. And sort of well done to DECC for beginning to raise the possibility of such a turn around, albeit in deep code. It would be good just to get underwriting in the public interest out in the open and get on with it, though, wouldn’t it?