2210 Emr White Paper Full Version

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July 2011

Planning our electric future:a White Paper for secure,affordable and lowcarbonelectricity


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Planning our electric uture: a White Paper or secure, aordable and low-carbon electricity

1

Contents

Ministerial Foreword 3

Executive Summary 5

Chapter 1: Objectives, policy response and vision o ElectricityMarket Reorm 15

Chapter 2: Decarbonisation 27

2.1 The Challenge 27

2.2 The Carbon Price Floor 33

2.3 Feed-in Tari 372.4 The Emissions Perormance Standard 49

Chapter 3: Securing Future Electricity Supply 59

3.1 The Challenge 59

3.2 Capacity Mechanism 61

Chapter 4: A New Institutional Framework 81

Chapter 5: Paving the Way or New Entrants 89

Chapter 6: Future Networks and System Flexibility 97

Chapter 7: Costs and Benets 111

Chapter 8: Managing the Transition 123

Chapter 9: Devolved Administrations and the European Union 129

9.1 Devolved Administrations 129

9.2 European Union 133

Annexes

A: List o respondents to December consultation 139

B: Further detail on the proposed design o the Feed-in Tari with 147Contract or Dierence

C: Consultation on possible models or a Capacity Mechanism 160

D: Renewables Obligation transition 213

Glossary 228


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Ministerial Foreword bythe Secretary o State

Electricity is a undamental part o our daily lives. Itlights our homes and streets, keeps our schools andhospitals running, and powers our businesses. Thatswhy it is so important that the electricity market workseectively.

Since the market was privatised in the 1980s thesystem has worked: delivering secure and aordableelectricity or the UK. But it cannot meet the challenges

o the uture.

Around a quarter o our existing capacity mainly coal and nuclear powerstations will close in the next decade. Keeping the lights on will mean raisinga record amount o investment. However, the current market arrangements willnot deliver investment at the scale and the pace that we need.

That investment must build an electricity system t or the uture. Traditionalossil uels leave us open to volatile prices, deepen our dependence onimported energy and emit too much carbon. Instead, we need huge investmentin renewables; a new generation o nuclear stations; and, in time, gas and coal

plant that can capture harmul emissions. This will diversiy supply and wean usaway rom imported ossil uels.

By reorming the market, we can ensure uture security o supply and build acleaner, more diverse, more sustainable electricity mix. This White Paper setsout how we will encourage this investment in the most cost-eective way.

This will mean making sure we create the right conditions to attract theinvestment needed to transorm our system, in particular by reducing risks andsetting a clear and stable ramework or investors.

It means establishing a system where, in time, low-carbon technologies can

compete against each other on a level playing eld to nd their place in theenergy mix.

And it means making the existing market airer:

to consumers, who want investment to take place in the most cost-eective way so they do not pay over the odds or their electricity;

to low-carbon generators, who currently have to compete in a market inwhich they are at a natural disadvantage; and

to new entrants, who struggle to sell their electricity in a market

dominated by six big rms.


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But this White Paper is about more than encouraging investment in newgenerating capacity. The Government understands that the most cost-eectiveway to secure our uture supplies is not just to build new power stations. Wehave put demand reduction and energy eciency at the heart o our policy

programme and we are committed to making the electricity system morefexible and responsive.

These reorms will yield the biggest transormation o the market sinceprivatisation, securing our uture electricity supplies and heralding the shittoward a low-carbon economy. They will put us at the oreront o low-carbontechnological development; ready to lead the world in the next energyrevolution. And they will deliver secure, aordable and low carbon energy orgenerations to come.

The Rt. Hon. Chris Huhne MP

Secretary o State or Energy and Climate Change


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EXECUTIVE SUMMARY

1. This White Paper sets out the Governments commitment to transormthe UKs electricity system to ensure that our uture electricity supply issecure, low-carbon and aordable.

2. The package o reorms outlined here will mean that by 2030 we will have:a fexible, smart and responsive electricity system, powered by a diverseand secure range o low-carbon sources o electricity, with a ull partplayed by demand management, storage and interconnection; competitionbetween low-carbon technologies that will help to keep costs down; anetwork that will be able to meet the increasing demand that will resultrom the electrication o our transport and heating systems; and we will

have made this transition at the least cost to the consumer.An unprecedented challenge

3. Electricity plays a part in almost every aspect o modern lie and is vitalto our economic and social wellbeing. Since privatisation in the 1980s,our competitive market and system o independent regulation has servedus well; delivering reliable and aordable electricity. It is crucial or theUKs international competitiveness and economic development that thiscontinues. However, we ace a number o unprecedented challenges in thecoming decades:

security o supply is threatened as existing plant closes: overthe next decade we will lose around a quarter (around 20 GW) oour existing generation capacity as old or more polluting plant close.Modelling suggests that de-rated1 capacity margins could all belowve per cent around the end o this decade, increasing the likelihoodo costly blackouts. In addition to this huge reduction in existingcapacity, the uture electricity system will also contain more intermittentgeneration (such as wind) and infexible generation (such as nuclear).This raises additional challenges in terms o meeting demand at alltimes, or example when the wind does not blow;

we must decarbonise electricity generation: it is vital that we takeaction now to transorm the UK permanently into a low-carbon economyand meet our 15 per cent renewable energy target by 2020 and our80 per cent carbon reduction target by 2050. To put us on this lattertrajectory, power sector emissions need to be largely decarbonisedby the 2030s. Without reorm, the electricity sector would have anemissions intensity in 2030 o over three times the level advised by theClimate Change Committee. Electricity Market Reorm will put in placethe institutional and market arrangements to deliver the scale o change

1 The de-rated capacity margin is the capacity margin adjusted to take account o the availability o plant, specic to

each type o generation technology. It refects the probable proportion o a source o electricity which is likely to be

technically available to generate (even though a company may choose not to utilise this capacity or commercial

reasons).


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in the power sector needed to meet the UKs carbon budgets, includingthe recently-adopted ourth carbon budget;

demand or electricity is likely to rise: despite the improvements inhousehold and non-domestic energy eciency which will be generatedthrough the introduction o the Green Deal and the roll-out o SmartMeters across the country, overall demand or electricity may double by2050 due to the electrication o the transport, heat and other carbon-intensive sectors; and

electricity prices are expected to rise: increases in wholesale costs,the carbon price and environmental policies are likely to lead to higherbills in the uture, even without actoring in the huge investment neededin new inrastructure. The Government is committed to reducing theimpact on consumers by making sure investment takes place in themost cost-eective way possible. The cumulative benets to theeconomy o Electricity Market Reorm are expected to be over 9 billionhigher than business as usual over the period 2010-302.

4. There is broad consensus that current market arrangements will notdeliver the scale o long-term investment needed, at the required pace, tomeet these challenges. Nor will they give consumers the best deal. Thisis in part because o the sheer scale o the investment required. Up to110 billion3 investment in electricity generation and transmission is likelyto be required by 2020, more than double the current rate o investment.

5. But it is also because the challenges o decarbonisation and security

o supply are best met today through a combination o measures. Thelow-carbon and renewable energy objectives we have set refect thisapproach, but current market arrangements do not. In particular:

the current market price or electricity is driven by ossil plant, such asunabated gas-red Combined Cycle Gas Turbine (CCGT), with muchlower xed costs relative to their operational costs in contrast to, orexample, nuclear or oshore wind. Investors in non-gas red generationare also disadvantaged by being exposed to more volatile and uncertainreturns when compared to gas;

new low-carbon generators oten have to overcome relatively highbarriers to market entry. High construction costs and market illiquiditymake it more dicult or low-carbon generation to compete with ossiluels and impede market access. Small and independent players arealso particularly aected by the risk o not being able to nd long-termbuyers or their electricity;

the social cost o carbon is not ully refected in the market price as thisdoes not take into account all o the damage caused by climate change.

2 Business as usual means all current policies, including the Renewables Obligation and the Carbon Price Floor.

3 Our analysis shows that around 75 billion could be needed in new electricity generation capacity, and Ogems

Project Discovery estimated that around an additional 35 billion o investment is needed or electricity

transmission and distribution.


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The carbon price is also volatile and hard to predict making long-terminvestment decisions more uncertain; and

the capacity and appetite o existing market participants to nance theunprecedented levels o investment needed is uncertain.

6. There are also likely to be insuciently strong signals to invest in the leveland type o capacity that we need in order to guarantee uture securityo supply. This is also due to the scale o investment needed and ailureswithin the existing market.

Our strategy

7. At the heart o our strategy is a ramework that will oer reliable contracts,administered through delivery arrangements that are trusted by investors,to achieve the diverse portolio o generation we need to meet our goals aseciently and cost-eectively as possible. Broadly this approach consistso our parts:

long-term contracts or both low-carbon energy and capacity;

institutional arrangements to support this contracting approach;

continued grandathering, supporting the principle o no retrospectivechange to low-carbon policy incentives, within a clear and rationalplanning cycle; and

ensuring a liquid market that allows existing energy companies and newentrants to compete on air terms.

Contracting or Low-Carbon Generation

8. At the heart o our strategy to deliver this transition is a new system olongterm contracts in the orm o Feed-in Taris with Contracts orDierence (FiT CD), providingclear,stable and predictable revenuestreams or investors in low-carbon electricity generation. This is acheaper, more robust mechanism than the alternative support optionsavailable and provides greater certainty that we will meet our carbonemissions targets. These new contracts could be delivered by a range opossible delivery organisations including private sector bodies.

9. In addition, there are two other complementary measures to decarboniseelectricity generation. These are:

the introduction o a Carbon Price Floor(CPF) to reduce uncertainty,put a air price on carbon and provide a stronger incentive to investin low-carbon generation now. This was announced in Budget 2011and represents an early and long-term signal to investors that theGovernment is serious about encouraging investment; and

an Emissions Perormance Standard (EPS) set as an annual limitequivalent to 450g CO

2/kWh at baseload to provide a clear regulatory

signal on the amount o carbon new ossil-uel power stations can emit.


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This will reinorce the requirement that no new coal-red power stationsare built without Carbon Capture and Storage (CCS).

10. The new contracting approach and wider reorms implement the coalitionagreement commitments to introduce an EPS and a new system oFeed-in Taris (FiT) and are consistent with the agreed position4 that newnuclear stations should receive no public support unless similar support isavailable to other low-carbon technologies.

11. Together, this package o measures will:

provide a more ecient and stable ramework or investors, ensuringthat the cost o capital required or new low-carbon generation capacityis lower. This varies by technology but the overall eect o the cost ocapital reductions rom Electricity Market Reorm will be a potentialsaving o 2.5 billion over the period to 20305;

encourage investment in proven low-carbon generation technologies,but also allow new technologies such as CCS to get o the ground andallow them to become cost-eective and compete without support. Thisis vital to our ability to adjust to dierent scenarios or ossil-uel prices;

boost competition within the market as it will provide the rameworkor independent generators and new investors to invest in low-carbongeneration. The ability o new entrants to come to the market will alsobe supported by action rom Ogem to improve liquidity;

lead to competition within and between dierent low-carbon generation

technologies or their appropriate role in the energy mix, as we moveto technology-specic auctions or contracts towards the end o thedecade, and technology-neutral auctions urther in the uture;

introduce an appropriate policy ramework in the electricity sector tocontribute towards delivery o the ourth carbon budget; and

achieve our aims at least cost to the consumer.

12. We also recognise that reducing demand or electricity will lower carbonemissions and is likely to be more cost-eective than building additionalgenerating capacity. As such, we will assess whether there are sucientsupport and incentives to make eciency improvements in electricityusage and consider whether there is a need or appropriate additionalmeasures.

13. Engaging with consumers on energy use will also be crucial. We havealready taken decisive action to reduce central Government emissions by13.8 per cent (exceeding our original target o a 10 per cent reduction)6.The introduction o the Green Deal7 will enable homes and businesses to

4 http://www.decc.gov.uk/en/content/cms/news/en_statement/en_statement.aspx

5 Further detail is set out in the Impact Assessment.

6 In the period between 14 May 2010 to 13 May 2011.

7 The Green Deal will predominately help to reduce costs and carbon emissions around home heating. For the

majority o homes this heating will be gas uelled.
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improve energy eciency with no upront cost. This will be complementedby a huge programme aimed at making sure every home in GreatBritain has smart electricity and gas meters, with businesses and publicsector users having smart or advanced energy metering suited to their

needs. This will enable consumers to monitor and manage their energyconsumption, and pave the way or a transormation in the way in whichenergy is supplied and used.

Contracting or Security o Supply

14. Historically the UK has beneted rom robust security o supply. Howeverthe unprecedented nature o the challenge means there is a risk ouncomortably low capacity margins towards the end o the decade. Weneed to take action now to address these issues and avoid problems inthe uture.

15. In addition, there are new opportunities rom innovative technologies thatwill take demand o the system at times o stress, store electricity andconnect our market to others in Europe. We need market arrangementsthat make the most o these opportunities.

16. Although we do not see security concerns until the latter hal o thedecade, we need to act now to address them. There are three primarychallenges under the banner o security o supply:

diversifcation o supply how to ensure we are not over-reliant onone source or technology and reduce our exposure to high and volatileossil uel prices;

operational security how to ensure that, moment to moment, supplymatches demand, given unoreseen changes in both; and

resource adequacy how to secure sucient reliable capacity tocover peak demand.

17. The measures outlined in this White Paper to contract or low-carbonelectricity generation will have the eect o making our electricity supplymore secureby encouraging a diverse range o new generation capacityand reducing our reliance on energy imports. New capacity will includerenewables, CCS on gas and coal and new nuclear stations. It is clear thatossil uels without CCS, especially gas, will also continue to have a keyrole to play in the coming years.

18. The System Operator, National Grid, is responsible or ensuringoperational security. It does so by making sure supply balances demandat any given moment. Ogem as the independent regulator iscurrently considering reorm o some o the current mechanisms thatensure balance. The Government is supportive o reorm and keen thatimprovements are made.

19. But these responses alone are unlikely to be enough. In order to ensure

resource adequacy, the Government will legislate or a new contractingramework or capacity: a new Capacity Mechanism. We are seekingurther views on the orm this mechanism should take.


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20. In this White Paper we have set out two options. The rst is a targetedmechanism in the orm o a Strategic Reserve, a development o the leadoption rom the December 2010 Electricity Market Reorm consultationdocument, designed to address stakeholder concerns. This comprises

centrally-procured capacity which is removed rom the energy market andonly utilised in certain extreme circumstances. The alternative would bea market-wide mechanism in which all providers willing to oer reliablecapacity are provided incentives to do so. Under both options, we plan toensure a air and equivalent treatment o demand side resources such asstorage and demand side response, alongside generation, with the aim osecuring best value investment across the power system.

21. The Government recognises that reducing demand is likely to be morecost-eective than building additional capacity. This will also requirebetter use o existing generation through the development o a more

fexible electricity network. Government and Ogem have made signicantprogress over the last ew years on improving networks. However thereare more signicant challenges ahead. This White Paper sets out a high-level strategy on networks and system fexibility, detailing work over thecoming months, in particular that being undertaken through the Smart GridForum. The Government will also develop its electricity systems policynext year, looking at the uture system and ocusing on challenges aroundbalancing and system fexibility. This will include clariying the role odemand side response, storage and interconnection, and the developmento a smarter grid.

A New Institutional Framework22. Putting in place an enduring, robust and credible institutional ramework is

critical to ensuring investor condence. The institutional arrangements oradministering FiT CDs and capacity-based contracts will need to provideclarity and certainty and be trusted by investors.

23. Government will continue to set policy, ensuring the objectives o securityo supply, decarbonising the electricity sector (in line with all carbonbudgets) and cost-eectiveness are met.

24. It is likely that an organisation or organisations at arms length rom

Government will administer the contracts. Other core unctions to deliverthe FiT and Capacity Mechanism include: translating the policy objectivesinto technical requirements, delivering the contracts, data reconciliation,managing payments, and monitoring compliance and enorcement.

25. The Government and the delivery organisation(s), working jointly, willperiodically evaluate, according to a planning cycle clearly laid out inadvance, their uture strategy in the light o possible changes in costs,technological developments and new challenges to the energy system.The rst o these assessments will be in 2016 and will also considerwhether the new contract structure or low carbon is delivering all the

benets, especially or consumers, and improvements over the existingRenewables Obligation, that we expect, and on this basis consider anyamendments to the uture approach that may be required. As now, any


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changes would be made in the light o our continued commitment tograndathering and no retrospective change.

26. There are several key criteria that will inorm the decision on whichorganisation(s) is best placed to take on this delivery role, includingappropriate levels o accountability, independence, credit-worthiness,skills and value or money.

27. A decision on the roles and responsibilities o Government and those othe delivery institution(s), as well as more detail on unctions, contractingand the planning cycle, will be set out around the turn o the year. We willcontinue to engage with stakeholders, as appropriate, in advance o thisdecision.

28. We envisage the EPS being administered outside o these arrangements.Subject to more detailed implementation planning, it is likely that the

environmental regulators in each part o the UK will be best placed toadminister the EPS.

Improving Market Liquidity

29. There are a number o barriers to entry and growth in electricity generationand supply markets. One o the most important is the low level o liquidityin the electricity wholesale market. Signicant improvements are essentialto promote a competitive market and long-term security o supply. TheGovernment also considers liquidity reorm to be critical in enablingElectricity Market Reorm to deliver eciently and cost-eectively.

30. Ogem has set out proposals aimed at improving overall liquidity andmeeting the needs o independent generators and suppliers. TheGovernment welcomes the direction o travel set by Ogem. Crediblereerence prices and routes to market are essential or low-carbongeneration. The Government is working closely with Ogem to ensure that,taken together, Electricity Market Reorm and the liquidity reorms deliverthe necessary improvements, including that there is enough liquidityto oer the means or independent generators o all sizes to competeeectively in the market.

31. To the extent that there are continued barriers to entry that are not

addressed through Ogems actions, the Government will work with allstakeholders to identiy appropriate solutions.

The economic case

32. The package o Electricity Market Reorm measures has been designedto be the most cost-eective means to meet our objectives. This isparticularly important as electricity prices and, to a lesser extent, billsare likely to rise relative to today with or without reorm due to increasesin wholesale costs, the carbon price and environmental policies. Thereis also substantial uncertainty about the outlook or ossil uel prices,particularly gas strengthening the case in the longer term or movingaway rom reliance on ossil uels with potentially volatile prices.


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33. In the short and medium term, the impact o Electricity Market Reorm onbills is likely to be marginal compared to a baseline o continuing with theexisting support arrangements or low-carbon generation. Average costsor households, businesses and energy intensive industries (EIIs) are likely

to vary (either increase or decrease) against this baseline by less than oneper cent over the initial period o reorm.

34. However, towards the end o the period, reorm is expected to have amore substantial impact in curbing rising bills. I we continued with currentpolicies, average annual household electricity bills could rise by around200 by 2030. With Electricity Market Reorm, this increase in bills couldbe limited to around 1608 a saving o 40 or around six per cent. Similargures or businesses and energy intensive industries are around sevenper cent and eight per cent respectively. Energy eciency measures canhelp reduce bills urther.

35. As part o the transition to a low-carbon economy, we must ensure thatenergy intensive industries remain competitive and that we send a clearmessage that the UK is open or business. There would be no advantage both or the UK economy and in terms o global emissions reductions insimply orcing UK businesses to relocate to other countries where carbonemissions continue unabated. As such, we commit to announcing in theautumn a package o measures to reduce the impact o government policyon electricity costs or energy intensive manuacturers whose internationalcompetitiveness is most aected by our energy and climate changepolicies and to support EIIs in becoming more energy and carbon ecient,

where it would be cost eective or them to do so. We will examineinternational best practice in determining how to do this. We will also workwith UK-based EIIs to ensure they benet rom rapidly increasing demandor materials in low-carbon supply chains.

Making it happen

36. Together, the policies outlined above will ensure secure low-carbon energysupplies, at least cost, and help deliver on the commitment to be thegreenest government ever. But to be successul we need to ensure theyare implemented eectively and eciently. That means making sure thatthere is a smooth transition rom existing policies, working closely and

collaboratively with the Devolved Administrations to develop and deliver acoherent and seamless package o reorm measures in each part o theUK, and ensuring that reorms are consistent with EU law.

Transitional measures

37. It is essential that the period o transition between the current and newmarket arrangements runs smoothly and allows investment to continue.As such, we support the principle o no retrospective change or low-carbon investments and have listened to industry views on the best way totransition to a new mechanism. Thereore:

to ensure ongoing Renewables Obligation (RO) stability, existingaccredited generation will continue to be supported under the RO;

8 Current policies include the Carbon Price Floor and the Renewables Obligation.


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once the FiT CD is introduced and until 31 March 2017, to providefexibility new renewable generation will have a one-o choice betweenthe RO and FiT CD;

the RO will close to new accreditations on 31 March 2017. No

generation will be able to accredit under the RO rom that date; and

we will grandather RO support or all technologies at the rate applicableon 31 March 2017.

38. To ensure the continuity o all low-carbon development, we will workactively with relevant parties to enable early investment decisions toprogress to timetable wherever possible, including those required ahead oull implementation o the FiT CD.

Devolved Administrations

39. The Government believes that by working closely with the DevolvedAdministrations, we will be able to deliver the level o new low-carbongeneration the UK needs. We will continue to work together to design anddeliver relevant elements o the policy package and ensure that reorm isconsistent with the devolution settlements and takes account o existingmarket arrangements.

European Union

40. We are working closely with the European Commission andother stakeholders to ensure our reorms are consistent with, andcomplementary to, the wider integration o the GB market with EU

electricity markets, o which we are ully supportive.

Next steps

41. We will publish a technical update by the end o the year. This will include:

the detailed design o the Capacity Mechanism; and

more details on the institutional arrangements needed to deliver thesepolicies.

42. In addition, we will:

undertake an assessment over the coming year to determine whether

DECC should take urther steps to improve the support and incentivesor the ecient use o electricity; and

develop an electricity systems policy next year, looking at the uturesystem ramework and ocusing on challenges around balancing andsystem fexibility. This will include clariying the role o demand sideresponse, storage and interconnection, and the development o asmarter grid.

43. The Government intends to legislate or the key elements o this packagethrough primary legislation in the second session, which starts in May2012. We intend that this legislation will reach the statute book by spring

2013 so that the rst low-carbon projects can be supported under itsprovisions in 2014. These dates are subject to Parliamentary time beingavailable and the will o Parliament.


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Chapter 1 Objectives,policy response and vision oElectricity Market Reorm

Summary

The Electricity Market Reorm package will secure long-term electricitysupply and decarbonise electricity generation, while minimising costs tothe consumer.

The Government announced in Budget 2011 that it would put in place

a Carbon Price Floor to reduce investor uncertainty, put a air priceon carbon and provide a stronger incentive to invest in low-carbongeneration.

We will introduce new long-term contracts Feed-in Tari with Contractor Dierence (FiT CD) to stabilise revenues and reduce risks to supportinvestment in all orms o low-carbon electricity generation.

An Emissions Perormance Standard set at 450g CO2/kWh will be

introduced to provide a clear regulatory signal that new coal plants mustlimit their emissions.

A Capacity Mechanism is needed to ensure uture security o electricitysupply. We are seeking urther views on the type o mechanism requiredand will report on this around the turn o the year.

This will be underpinned by a strategy or uture electricity networks andwork led by Ogem to improve market liquidity. The Government is alsoundertaking a series o measures to improve energy eciency, includingthe Green Deal.

Introduction

1.1 The electricity market needs wide-ranging reorm. The complexity othe market and the scale o our ambition means a number o policyresponses will be required in order to realise our goals. The detailedproposals are set out in later chapters o this White Paper. Together,these measures represent a coherent package designed to complementeach other and achieve the Governments vision or Electricity MarketReorm.

1.2 This section:

sets out the high-level objectives o Electricity Market Reorm;

outlines the scale o the investment challenge;


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reviews the package o policies as set out in the Electricity MarketReorm consultation document9;

provides a high-level summary o the responses to the consultation;

describes the interaction between the various elements o theGovernments preerred policy package;

describes a vision o the uture electricity system ater market reorm;and

discusses the wider context and how the Electricity Market Reormpolicy package complements the wider Government agenda.

Objectives

1.3 The primary objectives o Electricity Market Reorm are to:

ensure the uture security o electricity supplies;

drive the decarbonisation o our electricity generation; and

minimise costs to the consumer.

1.4 The key to achieving these objectives will be to bring oward the levelo investment needed in new low-carbon generation capacity andinrastructure at the required pace.

Meeting the Investment Challenge

1.5 Given the scale o the investment challenge (with up to 110 billionneeded in electricity generation and transmission in this decade alone),it is important we attract the necessary investment in the most cost-eective way possible.

1.6 Without reorm, the existing market will not deliver the scale o long-term investment, at the pace that is needed, nor will it be able to ensurethat consumers get the best deal. I we are to meet our long-termcarbon and security o supply objectives, we need to reorm the marketnow, and make investment in low-carbon generation in the UK moreattractive.

1.7 We believe the package o measures set out in this White Paperwill help create long-term, stable and predictable electricity marketarrangements which are attractive to investors at home and overseas.This is particularly important as the existing Big Six energy companiesare unlikely to be able to nance all the investment at the scale andpace required.

1.8 Overcoming investment constraints will also require additional modelso nancing to encourage the participation o alternative sources ounding or generation and transmission projects. Given the importanceo debt to nance new energy projects and the constraints aced by

9 http://www.decc.gov.uk/en/content/cms/consultations/emr/emr.aspx
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banks, it is also important that providers o debt are able to renancetheir capital commitments in the public debt markets.

1.9 In recognition o these challenges and alongside the new marketramework, the Government is creating a Green Investment Bank (GIB).The GIB will oer a range o nancial solutions to accelerate privatesector investment in the UKs transition to a green economy. The GIBwill need to review the market need and potential impact o dierentinterventions.

1.10 I we are to be successul in meeting the investment challenge,investors also need to have condence in the planning system or majorinrastructure projects. This means giving developers greater certaintyon the policy ramework or decision-making on major inrastructureprojects. The Government has thereore put beore Parliament sixenergy National Policy Statements (NPSs) or approval, displayed inFigure 2.

Figure 2: National Policy Statements or energy inrastructure.

Overarching Energy NPS (EN-1)

Fossil Fuels

NPS (EN-2)

Renewables

NPS (EN-3)

Gas & Oil

Infrastructure

NPS (EN-4)

Electricity

Networks NPS

(EN-5)

Nuclear NPS

(EN-6)

1.11 The NPSs set out the need or new energy inrastructure, includingelectricity rom a mixed portolio o generation types, and (as set out inChapter 6) the expansion and reinorcement o the transmission systemto enable the connection o generation especially new renewable andother low-carbon generation into the National Grid.

1.12 The NPSs provide a clear ramework or decision-making by setting outthe strategic need or new inrastructure and how impacts associated

with proposals can be mitigated to an acceptable level.

The Electricity Market Reorm Consultation

1.13 In order to develop the measures necessary to tackle this investmentchallenge, the Government undertook a consultation exercise onElectricity Market Reorm in December 2010. This set out a range oproposals to catalyse the cost-eective investment the UK needs tomeet its carbon reduction and energy security goals. Responses to theconsultation were received rom a wide range o stakeholders.


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This White Paper serves as the ormal Government response10 anddiscussion o consultation responses can be ound in relevant sections.

1.14 A separate consultation exercise11 was conducted by HM Treasury onthe introduction o a Carbon Price Floor (CPF), at the same time asthat carried out on Electricity Market Reorm. The response to the HMTreasury consultation was published in March 201112.

1.15 The Electricity Market Reorm consultation sought views on:

whether respondents agreed with the Governments analysis thatreorm ocurrent market arrangements was required to deliver oursecurity o supply and decarbonisation objectives;

options to support investment in low-carbon generation through asystem oFeedin Taris (FiT), in particular whether consultees

agreed with theGovernments preerred option o a Feed-in Tariwith Contract or Dierence (FiT CD);

the introduction o an Emissions Perormance Standard (EPS) toplace a regulatory limit on the amount o CO

2produced by new ossil

uel power stations;

options to provide security o electricity supply through a CapacityMechanism, in particular whether consultees agreed with theGovernments preerred option o a targeted mechanism;

options orpackages o policies to reorm the electricity market,

in particular whether respondents agreed with theGovernmentspreerred package o a CPF, a FiT (either a FiT CD or PremiumFeed-in Tari (PFiT)), an EPS and a targeted Capacity Mechanism;and

issues surrounding implementation o reorm.

Consultation Responses

Current market arrangements

1.16 The Electricity Market Reorm consultation document described theexisting electricity market and explained why the Government did not

believe that the current market arrangements remained appropriate todeliver our objectives. There was broad consensus rom consultationrespondents that, without reorm, the existing electricity market wouldnot deliver the scale o long-term investment needed, at the requiredpace, nor would it give consumers the best deal.

10 All non-condential responses will be published shortly ater this White Paper. A ull list o non-condential

respondents can be ound in Annex A.11 http://www.hm-treasury.gov.uk/consult_carbon_price_support.htm

12 http://www.hm-treasury.gov.uk/d/carbon_price_foor_consultation_govt_response
http://www.hm-treasury.gov.uk/consult_carbon_price_support.htmhttp://www.hm-treasury.gov.uk/d/carbon_price_floor_consultation_govt_response.pdfhttp://www.hm-treasury.gov.uk/d/carbon_price_floor_consultation_govt_response.pdfhttp://www.hm-treasury.gov.uk/consult_carbon_price_support.htm


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Feed-In Taris

1.17 The parallel consultation by HM Treasury set out the Governmentsproposal to introduce a CPF. However, the Government also explainedthat this would not in itsel be enough to deliver sucient investment

in low-carbon inrastructure to meet our objectives and would not becost eective. The Electricity Market Reorm consultation described anumber o other policy responses to achieve our aims, including theGovernments preerred option o a FiT CD and the leading alternativeo a PFiT:

a PFiT: a static payment which generators receive in addition to theirrevenues rom selling electricity in the wholesale market; and

a FiT CD: a long-term contract set at a xed level under whichvariable payments are made to top-up the level o payment to the

generator to the agreed tari. The FiT payment would be made inaddition to the generators revenues rom selling electricity in themarket. The FiT CD is a two-way mechanism that has the potentialto see generators return money to consumers i electricity prices arehigher than the agreed tari.

1.18 Respondents to the consultation generally accepted that a FiT CDcould be introduced, and some believed that the FiT CD representedthe most eective mechanism to increase low-carbon electricitygeneration, but most requested more detail on how the FiT CD wouldwork in practice.

1.19 A number o the consultation responses expressed concern about thecomplexity associated with the FiT CD. The PFiT was preerred by anumber o renewable energy companies. This was in the main becauseo their similarity to the current Renewables Obligation (RO), which wasunderstood by investors, and was elt to be easier to implement.

1.20 A number o consultation responses sought more inormation on theimpact which the use o long-term contracts (and in particular the FiTCD) would have on the cost o capital or those building low-carbongeneration.

1.21 Many o the consultation responses observed that the FiT CD approachset out in the consultation may need to be tailored to dierent types otechnology.

Emissions Perormance Standard

1.22 The Electricity Market Reorm consultation proposed to set an annuallimit on the total amount o CO

2per unit o installed capacity that new

ossil uel power stations are allowed to emit and sought views onwhether that limit should be set at either:

a level equivalent to 600g CO2/kWh, consistent with demonstrating

post-combustion Carbon Capture and Storage (CCS) on a new,supercritical coal-red power station; or


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Packages

1.27 Four potential packages or reorm were put orward in the consultation.The consultation set out the Governments view that all our packageswere capable o delivering the Governments decarbonisation goals

and ensuring security o supply. However, the Governments preerredoption was or a CPF; an EPS; a FiT CD; and a targeted CapacityMechanism. This was because the Government believed that this wasthe most coherent and most cost-eective package. A urther package,which included a PFiT rather than a FiT CD, was also identied as acredible alternative.

1.28 Some respondents supported the Governments preerred package.The main reasons given were that this package was the most likely tobring orward investment across low-carbon generation as a whole,and that it had the potential to be the most cost-eective and thus most

aordable or consumers.

1.29 The alternative package including the PFiT was the preerred optionor other respondents. The main argument given was that it was themost similar to the existing RO and that this would provide the greatestcertainty to renewable generators and investors.

1.30 A number o stakeholders also argued that a one-size-ts-all approachwas not appropriate given varied characteristics o low-carbontechnologies. For instance, some advocated the adoption o both a FiTCD and PFiT; suggesting that it might be appropriate to have dierent

arrangements or dierent types o technologies.Implementation

1.31 The consultation also considered implementation issues, particularlythe institutional arrangements necessary to deliver the FiT CD and theCapacity Mechanism, and the transitional measures required to ensurethere is no hiatus in investment while Electricity Market Reorm is put inplace.

1.32 On the institutional arrangements or the delivery o FiTCD,respondents fagged the need or a credible and durable counterpartyto the contracts. Views diered on who could deliver this unction.Respondents also stressed that anybody with obligations under FiT CDshould be creditworthy to ensure payments can be met over the longterm. Several responses also highlighted the need or the institution tohave the appropriate expertise and skills to deal with these long-termmechanisms and the technologies involved.

1.33 In the case o a Capacity Mechanism, most respondents suggestedthat a central body should be responsible or delivery. Some suggestedthat the System Operators (SO) role could be extended to cover this,but a ew respondents thought that this should be independent oother commercial activities and political infuence. Some respondentssuggested that a central agency should be established to manage thecapacity contracts as this would allow or greater transparency.


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1.34 The Electricity Market Reorm consultation also set out proposals ora transitional ramework rom the current Renewables Obligation (RO)system to FiT CDs. Most respondents supported grandathering14existing investments under the RO. They also called or RO vintaging15

arrangements to be claried as early as possible. Given the sizeand scale o many projects under development, there was however,some concern that the 2017 cut-o date proposed or the RO may notallow a long enough lead in time or such projects, and a number ostakeholders supported a choice between the RO and FiT CD.

Our Proposals

1.35 The Government has careully considered the issues raised in theconsultation and this White Paper contains proposals or reorm othe electricity market which represent a coherent and complementarypackage designed to ensure the security o uture electricity supply and

the decarbonisation o electricity generation, at least cost. The policypackage includes:

as announced in Budget 2011, the introduction o a CPF starting in2013 to reduce uncertainty, put a air price on carbon and provide astronger incentive to invest in low-carbon generation;

we will introduce new longterm contracts (FiT CD) to stabiliserevenues and reduce risks to support investment in all orms olow-carbon electricity generation;

an EPS set as at annual limit equivalent to 450g CO2

/kWh atbaseload, to provide a clear regulatory signal on the amount ocarbon new ossil-uel power stations can emit; and

a Capacity Mechanism to guarantee uture security o electricitysupply as a quarter o ageing plant closes during this decade and theproportion o intermittent or less fexible low-carbon generation rises.We will conrm our decision on the type o mechanism around theturn o the year.

1.36 In addition, we are also undertaking urther work to:

develop by the turn o the year the detailed design o the CapacityMechanism and more details on the institutional arrangementsneeded to deliver these policies;

undertake an assessment over the coming year to determinewhether DECC should take urther steps to improve the support andincentives or the ecient use o electricity;

14 Grandathering is the policy intention to maintain a xed level o Renewables Obligation (RO) support or the ull

lietime o a generating stations eligibility or the RO, rom the point o accreditation. Further detail can be ound in

Annex D.

15 Vintaging the Renewables Obligation (RO) system means that it will no longer be open to accreditation or new

stations. The closure o the RO to new stations will create a closed pool o capacity which will decrease over time

as we approach the end date or the RO o 31 March 2037.


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develop an electricity systems policy next year, looking at the uturesystem ramework and ocusing on challenges around balancing andsystem fexibility. This will include clariying the role o demand sideresponse, storage and interconnection, as part o the development o

a smarter grid.

Coherence o the Policy Package

1.37 The Government recognises that it needs to provide the right marketramework or industry to be able to deliver the necessary investment.Together, these measures create appropriate incentives to supportinvestment, while ensuring that the costs to consumers are minimised.

1.38 The CPF, FiT CD and EPS will together all drive the decarbonisationo the UKs electricity system. The CPF and FiT CD are economicsignals which act in a complementary manner, while the EPS provides a

backstop regulatory signal.1.39 The CPF builds on the existing EU Emissions Trading System (EU

ETS) and provides a transparent and predictable carbon price whichwill make investment in low-carbon generation relatively more attractive,encouraging increasing amounts o investment as the carbon price risesand ensuring that the costs o carbon emissions are refected airly.

1.40 The FiT CD will provide low-carbon electricity generators withincreased condence in their revenues through agreement o a long-term contract. I the wholesale electricity price is below the price agreedin the contract, the generator will receive a top-up payment to make up

the dierence. I the wholesale price is above the contract price, thegenerator pays the surplus back. This means that, as the CPF graduallyincreases the wholesale electricity price, the support needed or low-carbon generators is reduced.

1.41 The interaction o the Capacity Mechanism with the FiT CD will dependon the type o mechanism chosen. A targeted Capacity Mechanismwould require payments to be made to secure only the amount ogeneration capacity required to make up the expected shortall inthe market. In this mechanism, there is little interaction with the FiTCD. There are a number o options or how a market-wide Capacity

Mechanism would operate. In designing a market-wide mechanismwe would consider as a key element any potential interaction with theFiT CD.

1.42 Box 1 describes a vision o the electricity system in 2030 in which wehave succeeded in attracting the necessary investment to the UK andreormed the market eectively.


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Box 1: The Electricity System Following Reorm (continued)

Commitment to the achievement o the UKs emissions reduction and

renewable energy targets has provided the basis or business and economic

development in these new sectors and the creation o green jobs. Our earlymove has given the UK a comparative advantage in the low-carbon sector

and we are a world leader, at the oreront o technological development in

this area. A large and highly skilled workorce has developed in response to

the growth in the sector.

Wider Policy Context

1.43 The policy proposals within this White Paper orm part o a much widerDECC agenda aimed at energy decarbonisation and security o supply.These include:

Decarbonisation a massive drive to improve energy eciency through the Green Deal,

the Energy Company Obligation, the roll-out o Smart Meters, theestablishment o a new Oce within DECC and a new commitmentto reduce central government greenhouse gas emissions by 25 percent by 2015;

the worlds rst Green Investment Bank (GIB) to address marketailures and help meet the low-carbon investment challenge;

1 billion or the creation o one o worlds rst commercial-scaleCCS demostration plants strengthening the UKs position as aworld leader in cleaner technology;

over 200 million to support new low-carbon innovation, including upto 60 million or oshore wind manuacturing inrastructure at ports,up to 30 million to support innovation in oshore wind componentmanuacture and up to 20 million or the development o marinetechnologies;

the Renewables Roadmap (published alongside this White Paper),which sets out our proposals or acilitating renewables deploymentto 2020, and the Microgeneration Strategy, which sets out the actionsto overcome a range o non-nancial barriers that could prevent themicrogeneration sector rom realising its ull potential;

Security o Supply

as part o the current Energy Bill, giving Ogem powers to sharpenthe commercial incentives on gas market participants to reducethe duration, likelihood, or severity o a gas emergency. Ogem isalso considering, under its Signicant Code Review, the case orenhanced supply obligations on gas market participants (which

could be implemented via legislation or licences). This should helpunderpin commercial demand or additional supply (or demand) sidefexibility such as additional long-term contracts and storage acilities;


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maximising the economic recovery o our remaining indigenousresources o oil and gas by launching a new oshore licensing roundin 2012 subject to the outcome o the Strategic EnvironmentalAssessment; and

working internationally with the EU and more widely to promotelow-carbon growth, improve interconnection, encourage necessarytransitional investment in oil and gas production, and promote morereliable transit o energy.


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Chapter 2 Decarbonisation

2.1 THE CHALLENGE2.1.1 The Government believes that climate change is one o the gravest

threats we ace, and that urgent action at home and abroad is required.Decarbonisation o the economy in general and the generation oelectricity in particular is a key priority. Our analysis shows that changeis needed to meet our 2050 targets, in particular it indicates thatthe majority o decarbonisation o the power sector will need to becompleted by the 2030s. Decarbonising the power sector is essential oracilitating decarbonisation o other sectors in the economy.

2.1.2 The UK aces a huge investment challenge to meet our targets orelectricity decarbonisation, while ensuring security o supply, andkeeping electricity bills aordable. Ogem has estimated that we needat least 110 billion16 o new investment in electricity generation andtransmission in the period to 2020. To put this in context, in the lastdecade the market invested less than hal that amount. In a world oglobal competition or capital, this means both signicantly increasedinvestment by existing market participants and attracting investmentrom new sources o capital.

2.1.3 To meet our decarbonisation targets the majority o this new investment

must be in a diverse range o low-carbon generation such asrenewables, gas and coal Carbon Capture and Storage (CCS), andnuclear. Investing in diversity is key to preserving and enhancing theUKs security o supply.

The problem

2.1.4 The market has served us well. It has delivered enough capacityto keep the lights on, and to drive the UKs economy, while givingconsumers some o the lowest prices in Europe.

2.1.5 However, in order to meet the challenges o the coming decades it is

essential that the majority o new generation built is low carbon. Withoutincentives such as the current Renewables Obligation (RO), a numbero actors combine to make low-carbon investment slow to comeorward in the UK market and expensive to develop:

the EU Emissions Trading System (EU ETS) carbon pricehas not been certain or high enough to encourage sufcientinvestment in lowcarbon electricity generation in the UK.The Stern Review17 set out the case or addressing the negative

16 Our analysis shows that around 75 billion could be needed in new electricity generation capacity, and Ogems

Project Discovery estimated that around an additional 35 billion o investment is needed or electricity

transmission and distribution.

17 The Stern Review on The Economics o Climate Change, HM Treasury, 2006,

http://webarchive.nationalarchives.gov.uk/+/http:/www.hm-treasury.gov.uk/sternreview_index.htm
http://webarchive.nationalarchives.gov.uk/+/http:/www.hm-treasury.gov.uk/sternreview_index.htmhttp://webarchive.nationalarchives.gov.uk/+/http:/www.hm-treasury.gov.uk/sternreview_index.htm


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externalities associated with greenhouse gas emissions. It madeclear that it is desirable or polluters to ace the ull social costassociated with the environmental damage they cause. The reviewconcluded that a transparent and predictable carbon price is the most

cost-eective way to encourage emitters to invest in alternative low-carbon technologies and change consumer spending patterns; andthat acting sooner will also ensure a more equitable distribution o thecosts o climate change or uture generations;

the current market price or electricity is driven mainly by gasplant, such as Combined Cycle Gas Turbines (CCGTs), with muchlower xed costs relative to their operational costs and much lowercapital costs per MW o capacity in contrast to, or example, nuclearor oshore wind; and

new lowcarbon generators oten have to overcome relativelyhigh barriers to market entry. These include poor market liquidity,together with high regulatory burdens and o-take risk whichparticularly aects smaller players.18

Box 2: Why investment in low-carbon technologies diers romstandard investment choices

Gas-red power stations are a mature technology with low and predictablecapital expenditure. They are quick to build and their uel costs, which are alarge proportion o operating costs, are naturally hedged because the priceo electricity moves in line with the price o gas, since gas (or sometimescoal) is typically the price-setting (or marginal) plant. Their generation costswill tend to all in line with any all in revenues as electricity prices all,preserving protability.

Gas-red power stations are able to run fexibly and can thereore relativelyeasily respond to shiting demand. The costs o fexing a gas plant torespond to daily peaks in demand are relatively modest although morerequent stop/start and ast ramp-up operations do have a signicant impacton maintenance costs.

Each o the low-carbon technologies the Government is considering diers

materially rom this standard investment choice. In particular, low-carbongeneration typically has high construction (capital) costs and low operatingcosts, and as a result low-carbon plants are wholesale price takers. It isthereore dicult to make an investment case or them in a market wherewholesale electricity prices are predominantly set by the short-run marginalcosts18 o unabated gas and coal plant, even i the carbon price was highenough or their levelised costs to be similar.

2.1.6 We cannot aord to wait any longer to address the decarbonisationchallenge. Doing nothing will lead to consumers paying more in the

long term. We must act now because low-carbon inrastructure requires18 The incremental cost o providing an additional unit o electricity in the short term. Typically this only includes

variable costs (such as uel) that are needed to provide the additional electricity.


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Box 3: The Governments emissions and renewables targets

The Climate Change Act 2008 establishes a long-term ramework to tackleclimate change. The Act aims to encourage the transition to a low-carbon

economy in the UK through unilateral legally binding emissions reductionstargets. This means a reduction o at least 34 per cent in greenhouse gasemissions by 2020 and at least 80 per cent by 2050.

The rst three carbon budgets, covering 2008-12, 2013-17 and 2018-22were set in law in spring 2009 and require greenhouse gas emissions to bereduced by at least 34 per cent below the 1990 baseline by 2020.

The level o the Fourth Carbon Budget or the period 2023-2027 was set inlaw at 1950 mtCO

2at the end o June 2011. The level set equates to a 50 per

cent reduction in greenhouse gas emissions on 1990 levels or each yearover the Fourth Carbon Budget period.

The Renewable Energy Directive sets a target or the UK to achieve 15 percent o its energy consumption rom renewable energy sources by 2020. Atleast 10 per cent o energy used by transport is also required to come romrenewables by 2020.

2.1.15 Under current carbon accounting rules, the emissions reductions in thepower sector that we count against our carbon budgetsare calculatedbyreerence tothe EU ETS cap. The Government will review progresstowards the EU emissions goal in early 2014. I at that point ourdomestic commitments place us on a dierent emissions trajectorythan the ETS trajectory agreed by the EU, wepropose,(depending onadvice rom the Committee on Climate Change and the views o theDevolved Administrations),torevise our budget to align it with the actualEU trajectory. Nonetheless it is clear that signicant decarbonisation othe power sector is key to our longer-term climate change goals such asour 2050 target to reduce emissions by at least 80 per cent and actionin the 2020s will be key to putting us on this pathway.

2.1.16 The Fourth Carbon Budget will put us on a pathway to our 2050 target.Government is currently carrying out urther work looking at how we mightdeliver the necessary emissions reductions to meet the Fourth CarbonBudget and we plan to publish a report on this in the autumn. As shown inChapter 7, the Governments proposed Electricity Market Reorm policypackage could i necessary deliver the kind o ambition in the powersector proposed by the Committee on Climate Change (CCC). We willbe doing urther work on this, looking at easibility o dierent levelso emissions reductions in the power sector, over the coming monthsand beyond.

2.1.17 The Government is already committed to ensuring that the electricitysector delivers its share o the renewable energy target. In somescenarios this could mean approximately 30 per cent o our electricity


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being generated rom renewables by 2020. Much o this will be romwind power, onshore and oshore, though biomass could also playan important role. Looking beyond 2020, the Government believesthat renewables have a strong role to play as part o our broader low-

carbon portolio and that emerging technologies such as wave andtidal may begin to play an increasing role. We will need to have largelydecarbonised our electricity sector by the 2030s19.

2.1.18 The recent CCC advice to Government on renewable energy concludedthat there is scope or signicant penetration o renewable energyto 2030 and advised pursuing a portolio approach with each o thedierent low-carbon technologies playing a role.

2.1.19 Electricity Market Reorm sets the economic and regulatory rameworkor meeting this challenge. The market reorms are complemented byboth the Renewables Roadmap20 and the Microgeneration Strategy.21These documents set out positive action to tackle some o the obstacleswhich could otherwise slow the decarbonisation o electricity. As parto this work, the Government recognises the benet that decentralisedsupply and distributed generation can play, particularly in the contexto delivering solutions that maximise local opportunities and meetthe need and demands o local people and their communities. Itis expected that distributed generation using eligible low-carbontechnologies will be able to access the FiT CD on the same terms asother generation types.

Box 4: The Renewables RoadmapThe Renewables Roadmap is published alongside the Electricity MarketReorm package. The Roadmap ocuses in particular on the eighttechnologies which evidence rom the market suggests now have either thegreatest potential to help the UK meet the 2020 renewable energy targetin a cost-eective and sustainable way, or oer the greatest potential orthe decades that ollow. It outlines specic actions to remove the barriersto renewables deployment. Alongside the Roadmap, the MicrogenerationStrategy sets out the actions that the Government is taking to tackle thenon-nancial barriers which could prevent the microgeneration sector rom

realising its ull potential.Taking these actions will not only help drive renewable deployment acrossthe UK but will also be key to reducing costs or consumers and enablingmature renewables to compete on a level playing eld against otherlow-carbon technologies in the longer term.

19 DECCs 2050 analysis (http://www.decc.gov.uk/en/content/cms/tackling/2050/2050.aspx ) shows that power sector

emissions need to be largely decarbonised by the 2030s. The Committee on Climate Change proposed that the

power sector should be close to zero-carbon by 2030.20 http://www.decc.gov.uk/en/content/cms/meeting_energy/renewable_ener/renewable_ener.aspx

21 http://www.decc.gov.uk/en/content/cms/meeting_energy/microgen/stragtegy/strategy.aspx.pd.
http://www.decc.gov.uk/en/content/cms/tackling/2050/2050.aspxhttp://www.decc.gov.uk/assets/decc/11/meeting-energy-demand/microgeneration/2015-microgeneration-strategy.pdfhttp://www.decc.gov.uk/assets/decc/11/meeting-energy-demand/microgeneration/2015-microgeneration-strategy.pdfhttp://www.decc.gov.uk/en/content/cms/tackling/2050/2050.aspx


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2.1.20 Energy eciency has an important role to play in reducing the amounto power we need and, as a result, reducing the amount o carbonemitted through electricity generation. Both demand side and supply sidemeasures will be necessary. The Government is keen to ensure that

electricity consumers contribute an appropriate share o the UKs overallimprovement in energy eciency. We will assess whether the existingpackage o eciency measures is providing adequate encouragementor eciency improvements in electricity usage and, in parallel, will studyinternational examples to determine whether there might be appropriateadditional measures we could introduce to the UK market.

2.1.21 In support o this greater ocus on energy eciency, the Government willestablish a new Oce within DECC to drive a step-change in nationalenergy eciency in the autumn. This new Oce will work with leadingindustry experts to identiy ways to drive urther carbon abatement acrossthe economy and to learn rom best practice in other countries.

2.1.22 The Government will also ensure that regulations around heat products,eciency standards and product liecycle standards are properlyaligned and that the UK engagement with the European Commissionocuses on ensuring that devices, as well as the way we use them,become more ecient.

2.1.23 The Government recognises that heating and cooling accounts or asignicant proportion o the UKs total energy consumption and nearlyhal o CO

2emissions. Decarbonising the supply o heat across all

sectors is thereore an essential component o reducing emissions by80 per cent. The Government is thereore considering what actions arerequired now and through the next decade in order to ensure the supplyo low-carbon, secure and aordable heating (and cooling) or homes,businesses and industry. This will complement work on ElectricityMarket Reorm, by helping to reduce overall electricity demand andsupport system balancing.

2.1.24 Alongside these steps to reduce costs through domestic action, wehave the potential to work with our European partners on renewablesdeployment. Such collaboration could provide an important mechanismto saeguard UK consumers in the event that the costs o domesticdeployment do not come down and alternative, cheaper opportunities

arise in other countries where the UK could trade using the fexibilitymechanisms set out in the Renewable Energy Directive. We plan totake powers to trade renewable energy to provide this saeguard.

2.1.25 But this should not be viewed as a one-way exercise trading alsopresents an opportunity or the UK. We have an abundant oshore windresource and should also explore the possibility o exporting energygenerated in UK waters to neighbouring Member States. As part othis we could see oshore wind projects connected to both the UK andmainland Europe, increasing our security o supply as part o an AllIslands Approach22. By exploiting our North Seas resources together

we could also provide new manuacturing and jobs in the UK.

22 The All Islands Approach will develop an approach to energy resources across the British Islands and Ireland, to

acilitate the cost-eective exploitation o the renewable energy resources available, increase integration o our

markets and improve security o supply.


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2.2 THE CARBON PRICE FLOOR

Summary

In Budget 2011, the Government announced the introduction o a CarbonPrice Floor (CPF) rom April 2013. This is designed to top up the EUEmissions Trading System (EU ETS) carbon price to a target level or theelectricity generation sector.

The CPF will be introduced by removing rom the Climate Change Levy(CCL) the current exemption or supplies o ossil uels which are usedto generate electricity in the UK. For generators who use oil to generateelectricity, the amount o uel duty they can reclaim will be varied.

The CPF is the necessary rst step in delivering a package o reorms orthe electricity market to support low-carbon investment, but alone it will

not drive the required investment. The CPF as announced in the Budget begins at around 15.70/tCO

2in

2013 and ollows a straight line to 30/tCO2

in 2020, rising to 70/tCO2

in 2030 (real 2009 prices).

Introduction

2.2.1 This section sets out why we consider the CPF to be a key measure todrive the necessary investment in low-carbon technology and explainshow it will work alongside the EU ETS and the wider Electricity MarketReorm package.

Context

The case or a Carbon Price Floor

2.2.2 The CPF is the rst step to reorming the electricity market to supportlow-carbon investment. It gives an early and credible long-term signal toinvestors that the Government is serious about encouraging investmentin low-carbon electricity generation.

2.2.3 Having certainty about the price o carbon is particularly importantgiven the long lead times between the decision to invest in low-carbon

generation and the plant generating electricity. High levels o uncertaintyover uture protability and rates o return could increase the cost ocapital or investors and deter investment altogether. I uncertainty is toogreat, investment will either not go ahead or capital could be divertedto less risky but more polluting orms o generation. I developers havecondence that the Government will support the carbon price overthe long term, this should make a signicant dierence to investmentdecisions or new low-carbon generation.


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2.2.4 The EU ETS, a cap and trade system covering the EU electricitygeneration sector and energy intensive industries23, has created amarket in carbon so that emissions across the EU can be abated atleast cost. Although the EU ETS has achieved certainty over EU net

emissions, along with a strong signal regarding the uture level o thedeclining cap, the level o this cap (and associated carbon price) is notconsistent with the pace and scale o decarbonisation that is needed orthe UK to meet its 2050 targets. Thus the carbon price signal resultingrom this cap has not been stable, certain or high enough to encouragesucient investment in low-carbon electricity generation in the UK.

2.2.5 To enable a secure low-carbon transition in the UK power sector andencourage investment, the Government believes that there is a strongrationale to provide greater certainty and support to the carbon priceaced by the sector. Thereore, the Government has moved to providing

a stronger carbon price to promote investment in low-carbon generationover the longer term, to allow investors to include it as part o theirinvestment appraisal.

Description o mechanism

2.2.6 Following consultation24, the Government announced in Budget 2011a price foor that targets 30/tCO

2in 2020 rising to 70/tCO

225 in 2030

(2009 real prices26). A price foor o 40/tCO2

in 2020 would have ledto a aster decarbonisation trajectory and higher level o low-carboninvestment. However, there would have been larger impacts on existinggenerators and on electricity bills, which could have undermined

competitiveness and would have increased uel costs unnecessarily. Onthe other hand, a price foor o 20/tCO

2in 2020 would not have sent a

strong enough signal to encourage investment. The 30/tCO2in 2020

CPF is shown in Figure 3.

23 The EU ETS will include aviation rom 2012 http://www.decc.gov.uk/en/content/cms/emissions/eu_ets/eu_ets.aspx .

24 http://www.hm-treasury.gov.uk/d/consult_carbon_price_support .htm

http://www.hm-treasury.gov.uk/d/carbon_price_foor_consultation_govt_response.pd.

25 The Governments current estimated carbon price consistent with global action to limit the increase in temperature

to 2C is 70/tCO2 in 2030. This estimate is subject to the progress o international negotiations and may berevised as the science o climate change develops.

26 This means prices expressed in real terms ater removing the eect o infation.
http://www.decc.gov.uk/en/content/cms/emissions/eu_ets/eu_ets.aspxhttp://www.hm-treasury.gov.uk/d/consult_carbon_price_support_condoc.pdfhttp://www.hm-treasury.gov.uk/d/carbon_price_floor_consultation_govt_response.pdfhttp://www.hm-treasury.gov.uk/d/carbon_price_floor_consultation_govt_response.pdfhttp://www.hm-treasury.gov.uk/d/consult_carbon_price_support_condoc.pdfhttp://www.decc.gov.uk/en/content/cms/emissions/eu_ets/eu_ets.aspx


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Figure 3: Carbon Price Floor to 2020.

Carbon Price Floor

0

5

10

15

20

25

30

35

Carbon price supportCombined EU ETS and carbon price support

/tCO

2,

2009prices

2020201920182017201620152014201320122011

EU ETS carbon price

2.2.7 Over the period 2013-30, a price foor targeting 30/tCO2

will provide1.9 billion o net present value benets, achieving the right balanceo encouraging investment without undermining the competitiveness o

UK industry. It is expected to drive investment in low-carbon electricitygeneration equivalent to 7.5-9.3 GW o new capacity by 2030.

2.2.8 The carbon price support rates or 2013-14 announced in Budget 2011are equivalent to 4.94/tCO

2. These rates represent the dierence

between the Governments target carbon price (the foor) and theuture market price or carbon in the EU ETS in 2013. Future rates willbe announced at subsequent Budgets27 depending on the prevailingcarbon price. A sustained increase in the carbon price would reduce thetax rate necessary to meet the foor. These rates will be set two years inadvance to allow generators time to plan hedging strategies and avoid

damaging liquidity28.

2.2.9 From 1 April 2013, supplies o ossil uels used in most orms oelectricity generation will become liable either to the CCL or uel duty.Supplies will be charged at the relevant carbon price support rate,depending on the type o the ossil uel used. The rate is determined bythe average carbon content o each ossil uel.

27 For a detailed explanation o how rates are calculated,see http://www.hm-treasury.gov.uk/consult_carbon_price_support.htm

28 Further details on the interactions between Electricity Market Reorm and liquidity are set out in Chapter 5.
http://www.hm-treasury.gov.uk/d/carbon_price_floor_consultation_govt_response.pdfhttp://www.hm-treasury.gov.uk/d/carbon_price_floor_consultation_govt_response.pdf


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2.2.10 The CPF is not sucient on its own to encourage the investmentneeded. Thereore, it needs to be combined with a Feed-in Tari (FiT)mechanism to be able to meet the Governments decarbonisation andrenewables objectives. Forthe CPF to drive all o the decarbonisation

which is necessary, it would have to rise signicantly higher than thelevel delivered through EU ETS (i.e. to at least 50/tCO

2by 2020

20/tCO2higher than the current CPF target).

2.2.11 The Governments view is that the CPF will complement the Feed-inTari with Contract or Dierence (FiT CD), the Governments preerredmodel o a Feed-in Tari (urther detail can be ound in the next section).Under the FiT CD, long-term electricity prices (driven or example bygas prices or the carbon price) do not signicantly aect the overallreturns earned by low-carbon generators as they adjust automaticallyto dierences in electricity prices. Thereore while the FiT CD and CPF

together provide more certainty o revenues and make investment inlow-carbon technology more attractive, they also avoid generators makingexcess prots and thereore minimises consumer costs.

Devolved Administrations

2.2.12 The CPF is a UK-wide policy and will drive urther investment in low-carbon technologies. In that respect, the Government recognises thedierent structure o the Northern Ireland energy market, and will workclosely with the Northern Ireland Executive to monitor the interactionwith the island o Ireland Single Electricity Market, and NorthernIrelands commitment to a higher level o investment in renewable

electricity.

Next steps

2.2.13 The Government has already consulted on drat primary legislationon the CPF. The primary legislative powers to implement the CPFwere presented to Parliament in the 2011 Finance Bill last March29.Legislation relating to specic tax relies or Carbon Capture andStorage (CCS) and Combined Heat and Power (CHP) will be introducedin the 2012 Finance Bill, to be ollowed by secondary legislation laterin 2012.

29 http://services.parliament.uk/bills/2010-11/nanceno3.html
http://services.parliament.uk/bills/2010-11/financeno3.htmlhttp://services.parliament.uk/bills/2010-11/financeno3.html


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Box 5: Descriptions o Feed-in Tari mechanisms

A Feedin Tari with Contract or Dierence(FiTCD) is a long-termcontract between an electricity generator and a contract counterparty. The

contract enables the generator to stabilise its revenues at a pre-agreed level(the strike price) or the duration o the contract. Under the FiT CD, paymentscan fow rom the contract counterparty to the generator, and vice versa.

A two-way FiT CD provides or payments to be made to a generator whenthe market price or its electricity (the reerence price) is below the strikeprice set out in the contract. However, when the reerence price is above thestrike price, the generator pays back the dierence. That is, generators returnmoney to consumers i electricity prices are higher than the agreed tari.

Figure 4: The operation o a baseload Feed-in Tari with Contract or Dierence

20

0

20

40

60

80

100

120

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11

Electricityprice/MWh

Reference price (e.g. annual average electricity price) FT CfD top-up Monthly electricity price

Generator topped-up

to strike price

Generator

pays back

Strike

price

Figure 5: The operation o an intermittent Feed-in Tari with Contract or Dierence

-40

-20

0

20

40

60

80

100

120

Time

Strike price

Market Revenue

/MWh

FiT CfD payment

/MWhMonthly electricity

price

Generator

pays back

Generator topped-up

to strike price



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Box 5: Descriptions o Feed-inTari mechanisms (continued)

This is similar to the model o FiT used in the Netherlands or renewables(though they call it a sliding premium) and in Denmark or oshore wind. It

provides a similar level o revenue certainty to a Fixed FiT, but by setting thelevel o support according to the average price it preserves the ecienciescreated by the market price signal, i.e. generators will have an incentive tosell their output above the average price because they will keep any upside.

A Premium FiT (PFiT) is a static payment which generators receive inaddition to their revenues rom selling electricity in the wholesale market.

Figure 6: The operation o a Premium Feed-in Tari

0

20

40

60

80

100

120

140


Monthly electricity price Electricity price plus PFT

Fixed

premium

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11

2.3.4 The Electricity Market Reorm consultation document established ourcriteria against which decarbonisation mechanisms would be judged.These were cost-eectiveness, coherence with the rest o the reormpackage, durability and practicality. The FiT CD was identied as the

support mechanism or low-carbon generation which oered the bestbalance o results across the our key criteria, because it was:

potentially more cost-eective than the alternatives due to lowerscope or rents in high electricity price scenarios and reduced costo capital as a result o removing long-term electricity price exposureand providing long-term revenue certainty;

complementary to other elements o the reorm package, interactingparticularly eectively with the Carbon Price Floor (CPF);

a more resilient and fexible mechanism which will operate eectively

in a wider range o scenarios and can deal with unanticipated


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outcomes on carbon prices, ossil uel prices or technology costs;and

able to provide more certainty that carbon targets will be met thanPFiTs, because the impact of uncertain future wholesale prices isremoved in favour of predictable revenue.

2.3.5 Following the consultation, we carried out urther analysis to test someo the initial conclusions set out above; and ensure that there could be amanageable transition to the new ramework.

2.3.6 In particular, the Government undertook urther modelling tounderstand:

the impact FiT CDs would have on cost o capital or investors inlow-carbon generation in more detail;

whether we could develop a viable model or the FiT CD whichwould work in the UK market; and

how to manage the variability o the net costs o FiT CDs.

I these issues could not be addressed then Government indicated thata PFiT mechanism could be an eective all-back to drive investment inlow-carbon generation.

2.3.7 Support or low-carbon generators under Electricity Market Reorm islikely to all under the denition used by the ONS or indirect taxationand spending. Similar arrangements to those in place to manage theoverall impact o DECC levy-unded spending, including the existin

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