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The blueprint for British power

AS difficult births go, this was up with the worst.

Two-and-a-half years in gestation, at least a month in labour, with mother and father getting on abysmally. It was a wonder Energy Secretary Ed Davey could limp out of the negotiating rooms and into the House of Commons to announce the Energy Bill last week. But the mood in most of the energy industry is that it could have been a lot worse.

Rewind to the Renewable UK annual conference dinner at the Thistle Hotel in Glasgow a month ago, hours after new Tory Climate Change Minister John Hayes had declared "enough is enough" in relation to building more wind farms.

Hayes replaced Charles Hendry in September. Hendry was seen as too pro-wind for high command, increasingly favouring fossil fuel power. Liberal Democrat Davey gave a stinging rebuke to his new underling, but the yawning split in Coalition energy policy was painfully apparent. As delegates sipped drinks at the conference that night, no-one could see how this was going to translate into a blueprint for the future of electricity. Some feared the industry they had spent years building was in danger of permanently losing credibility with investors.

Instead, the long-awaited Electricity Market Reform (EMR) has finally arrived, and not just the wind crowd is pleased. Energy specialist Simon Hobden of law firm Pinsent Masons says: "It's a significant improvement on the [draft] package that came out in May. It comes across as much more thought through. It has broadly been received positively by the investor community."

It could not be more important. The EMR, enshrined in the Energy Bill, aims to set the course for energy policy to 2050, when the UK is legally bound to have cut carbon emissions by 80% from 1990 levels.

As the Government says at the start, the policy must achieve three things: keep the lights on, make electricity affordable to consumers and decarbonise the country. Keeping the lights on seems to need more traditional electricity, and Government policy is to focus on nuclear power as well as gas to cut overseas dependence on the latter and placate the nuclear lobby.

Making electricity affordable means a subsidy system that costs no more than absolutely necessary, and cutting our addiction to the stuff. Decarbonising requires building much more renewable capacity, overruling John Hayes, not to mention shifting to renewable heat systems and breaking the link between transport and petroleum.

When the economy is at its weakest in a very long time, and all developed countries are competing for a diminished pot of international capital to get the same job done, the Government has to make the UK look attractive to investors in all these different parts of energy generation at the same time. Calling the task Herculean is putting it mildly.

The general view now is that there is a limit to what could be said conclusively about the Bill. Important details are still missing, above all the prices that will be paid in the subsidy contract (the so-called strike prices in the contracts for difference, or CFDs). The Government will give a clearer idea of what incentives it is prepared to offer in its gas strategy published this week. At the same time, the energy demand reduction proposals are in the very early stages and there are many fine details in other areas that will make a big difference to the final picture.

But a few big changes are now in view. The subsidies that have gone to the renewables industry for the past few years will in future be shared with nuclear, even though the SNP Government has said no new nuclear stations will be built in Scotland. The renewables industry has surprisingly few complaints on this, however.

Niall Stuart, chief executive of Scottish Renewables, says: "The Government has said it wants 30% of electricity to come from renewables by 2020, which is what lies behind the £7.6 billion subsidy that it has announced [for the same year]. It's going to be the very end of the decade at the soonest before new nuclear will be operational, so it will get very little."

There are said to be doubts among small renewables generators over the Government's claims that the CFDs will make construction cheaper applying to them. Under the existing renewables obligation system, big electricity suppliers had no choice but to buy green power from them. Now there is no such requirement.

Small players without the electricity trading infrastructure of big rivals fear this will make it harder for them to compete fairly. They are waiting to see if the Government makes good on indications that it might intervene.

Another major change is that under the incoming rules, Scotland will lose the power to set its subsidy level. Stuart says the Scottish Government has used this power particularly well in the past.

"If the strike prices turn out not to be right, we will all be saying you need some Scottish variability," he says.

Hobden says there are also risks around setting strike prices that mis-predict the future of electricity prices. "The underlying assumption of the whole package is that power prices are going up because gas is becoming more scarce. But we have seen the gas price in the US collapse because of shale, and there are large chunks of shale potential in Europe," he says.

He adds that there are also big questions about whether the capacity markets initiative that aims to keep the lights on will actually incentivise investors to build new gas-powered stations. He suspects they would want supply contracts for 15 or 25 years. Instead, contracts will be auctioned one year at a time.

Another issue that could be controversial is that energy-intensive industries will be exempted from paying subsidies, so consumers and smaller firms will have to pay their share. So far, however, there has been consensus on the matter. Labour has taken no issue with Ed Davey's argument that "decarbonisation shouldn't mean deindustrialisation". Even Dan Barlow, head of policy at environmentalist group WWF Scotland, is "sympathetic" to this policy, though WWF thinks there might be better ways to achieve the same result.

The direction of travel will be clearer once the bunting is packed away and the remaining vital details come out in the coming months. First up, this week's gas strategy, widely trailed as a key part of George Osborne's price for doing a deal with his LibDem partners. All eyes will be watching to see what it says.

KEEPING THE LIGHTS ON

Wind power is not predictable in the same way as dirtier technologies such as coal-fired or gas-fired power because it is only available when the wind is blowing.

It is set to rise from 11% to 30% of the UK's electricity mix by 2020 at a time where numerous power stations are being retired, either because they have reached the end of their safe lifespan (for example, the Torness nuclear power station in East Lothian) or because new emissions penalties are making them uneconomic for the operators (like the Cockenzie coal-fired station, also in East Lothian).

In total, one-fifth of the existing power supply is due to be offline by 2020. Energy watchdog Ofgem recently forecast that replacing stable power sources with more intermittent sources could mean that 1.5 million households will temporarily be without power by 2015, with the risks liable to increase each year thereafter.

The Government is introducing a new system, called the capacity market, to address this – however, it will not be in time to prevent problems in 2015. The system will work by calculating peak demand four years ahead of time, starting in 2014, and then inviting traditional power generators to bid for supply contracts in an auction. The winners will get one-year deals to supply power at above-market prices, in exchange for which they will have to pay penalties if they don't do so.

This aims to guarantee enough predictable power to keep the lights on, and encourage companies to build new gas-fired plants. This "insurance policy" is expected to add £14 to the average bill.

CAN WE CUT DEMAND?

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