United Kingdom

United Kingdom

UK regulator draws up options for market reform

UK: With the current approach to the energy market clearly not working, Ofgem is proposing some alternative models that could help wind.

UK energy and climate change minister Ed Milliband
UK energy and climate change minister Ed Milliband

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A return to a more interventionist electricity market is on the cards, with the UK energy regulator Ofgem and government now admitting that the current free-market approach will not achieve the country's green goals - nor provide the certainty that investors in new generation need in today's difficult financial climate.

Ofgem has opened up the debate by putting forward five options for reform. They range from limited interventions to a dramatic move away from competitive markets - reminiscent of the command-and-control system for ordering generating capacity under the Central Electricity Generating Board, the state-owned company that controlled power generation in England and Wales before privatisation in the early 1990s.

The list of options results from a year-long consultation by Ofgem. The regulator's reassessment of the market is an admission that the existing rules, which it pushed through a decade ago, are not attracting new investment. Nor are they providing security of supply at a time when unprecedented proportions of variable renewables are required to meet ambitious UK targets, coupled with the closure of ageing fossil-fuel and nuclear stations. It estimates that £200 billion of investment in energy infrastructure is needed by 2020.

The market rules, known as the new electricity trading arrangements (Neta), were hugely unpopular with the renewables community when they came into effect in 2001. The market is based on a system of electricity trades or exchanges between retailers and generators. Any imbalance between supply and demand is resolved in the balancing mechanism. It requires generators to forecast the amount of electricity they will supply ahead of delivery and pay the market price for any shortfall. This penalises variable output such as wind, which cannot guarantee to generate at a given time.

Ed Miliband, the energy and climate change secretary, has been warning for some time that a more interventionist energy policy is needed to deliver the low-carbon investment the country needs. In an interview with The Times newspaper he said that the government was considering an overhaul of the Neta electricity market rules and a return to capacity payments so that generators would be paid for capacity made available, rather than just for the electricity they generate. This would give certainty to investors in renewable and nuclear energy, he said. "This is very different from the current system, where you get paid for the electricity you produce and are not given any guarantees in advance," Miliband said. "In future you could say: 'We need a certain amount of low-carbon capacity' and generators would say how much they can provide."

Centralised market

But capacity payments do not figure among Ofgem's five main options. Three of the options include a centralised renewables market where system operator National Grid would dispatch wind and other variable renewables. This would allow wind generators to sell their output without the imbalance price risk, and enable National Grid to balance the system more efficiently since it can take a holistic view of wind generation.

One option involves replacing the current Renewables Obligation (RO) support system with long-term tenders for capacity, a measure that bears similarities to the Non-Fossil Fuel Obligation (NFFO) system that was in place prior to the RO. Ofgem also looks at short-term capacity tenders for all types of generation. Contained in all of these packages are incentives to encourage electricity storage and demand-side measures such as smart metering. A minimum carbon price is proposed in three options and obligations on market players to deliver minimum levels of security of supply figure in two.

Representing the most radical departure from the existing competitive market is the fifth option: a central energy buyer. This could see a return to the pre-Neta centralised dispatch - or pool - system that was swept away to make way for the current trading rules. The central buyer would determine the amount and type of new generation needed and enter into long-term contracts for power. Many industry commentators, however, claim the central energy buyer option is a ploy by Ofgem to shock the industry into accepting more moderate reforms.

"The central buyer is the most frightening thing they can think of to get people to agree to something," says Gordon Edge, director of economics and markets at the British Wind Energy Association. He is also dismissive about the prospect of tenders. The spectre of NFFO still renders this option unpalatable to the industry. "If Ofgem were at all serious about wanting to build more renewables more quickly, they would not have put tenders on the table."

More interesting is the centralised renewables market option, he believes. "But we don't need to rush into this. We have a five-year horizon to think about (market change)." By 2015, only 10% of electricity will come from wind. "I don't see the current arrangements not being able to cope with that," says Edge.

Meantime, there is no shortage of potential conventional generation, with many gigawatts of combined-cycle gas turbines either building, consented or in the planning process. "To my mind it's the wrong kind of capacity; we need more fast response and open-cycle gas turbines to deal with wind variability," Edge says. "But it gives us a few years to work out a careful, measured approach to market reform."

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