Adapting energy markets to a low-carbon future by Professor Davi… · 15 20 25 30 35 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11

Adapting energy markets to a low-carbon future

David Newbery

12th ACCC Regulatory ConferenceBrisbane 28th July 2011

http://www.eprg.group.cam.ac. uk

D Newbery ACCC 2011 2Newbery IIB 1 2

Outline• The Challenge: climate change

• What is needed to deliver low-C electricity?– What is wrong with carbon trading as in ETS?

• Delivering low-C at reasonable cost– Contracts to lower cost of capital

– address carbon pricing

– care in designing renewables support

• UK’s Electricity Market Reformand Ofgem’s Low Carbon Network Fund

D Newbery ACCC 2011 3

http://www.withouthotair.com/

Height is emissions/head, areas give total emissions (MacKay, 2008)


0

1

2

3

4

5

6

0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5

cumulative post-1750 emissions (trillion tonnes car bon)

peak

CO

2-in

duce

d w

arm

ing

rela

tive

to 1

750

.

LowHigh

OilGas

Coalreserves

Unconventional oiland gas

Coal resource

Now

Medianprediction

most model predictions in this range

unlikely

If we want a 50% chance of lessthan 2C rise we can only emitanother 500 Gt C ever

After MR Allen et al. Nature 458, 1163-1166 (2009) doi:10.1038/nature08019

Peak CO2-warming vs cumulative emissions 1750–2500


Total cumulative emissions determines

global warming

• Delaying peak requires a faster subsequent decline

• peak should be before 2020

Source: ENEP Emissions Gap Report 2010


Policies to mitigate climate change

• GHG emissions are a global stock public bad– uncertain distant damage with uneven impacts

=> very hard to agree coordinated policies

– damage regardless of emissions location, persistent=> damage moderately independent of date of emission

– much irreversible over historical time scales

• Solution: uniform charge for GHG emissions,– rising at discount rate: Australia has right approach

– reset in light of new information


Failures of EU emissions trading

• Current ETS sets quota of total EU emissions– Weitzman argues for tax/charge not quota

• EU Renewables Directive increases RES=> increased RES does not reduce CO2

=> reduces price of EUA

=> prejudices other low-C generation like nuclear

• Risks undermining support for RES

Solved by fixing CO2 price instead of quota

or choosing a carbon tax!


EUA price October 2004-May 2011

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5

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15

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30

35

Oct-04

Apr-05

Oct-05

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Oct-09

Apr-10

Oct-10

Apr-11

Eur

o/t C

O2

OTC Index First PeriodSecond period Dec 2008Second period next DecCER 09CER 2010

start of ETS

Second period

Crashed as no banking

Crashed when use revealed

Depressed by RenewablesDirective and then recession

ETS is neither stable nor supports adequate carbon price


Start of ETS

Costs of errors setting prices or quantities

Reductions in emissions

Correct MC

MC

Best estimate of Marginal Cost of abatement

MB, Marginal benefit fromabatement

£/tC

efficiency lossfrom tax

efficiency lossfrom quota

t

Q* Q

t*

With tax would produce here at low cost

With quota would produce up to here at high cost


2020 projected CO2 price

0

10

20

30

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50

60

70

with 12.5% renewables with 20% renewables 2009 projections

Eur

os/to

nne

CO

2

2008 projections

2009 projections after Renewables Directive and recessionRenewables

depressesC-price

Source: Committee on Climate Change, 2008 and 2009

Renewables target undermines CO2 price


Making carbon prices credible

• Carbon taxes - can be readily changed

• Emissions trading + banking=> rising price floor– but vulnerable to shocks - credit crisis, Fukushima,..

=> Carbon Bank trades EUAs to stabilise price?

• need credible future C price over 20+ yrs– €25/EUA 2010 => €34 in 2020, €61 in 2040 ...

– Make it credible: write CfDon this path

– or write a contract for low-C generation

make low carbon investments financable


Start of ETS

2020 CCC’s ESI carbon targets are challenging

183 Mt

100 Mt = 55% 2006

Almost decarbonised- France shows it is possible


Rapid decarbonisation of electricity is possible -with nuclear powerCO2 emissions per kWh 1971-2000

0

100

200

300

400

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1970 1975 1980 1985 1990 1995 2000

gm/k

Wh

USA

Italy

UK

Europe

France


Background to EMR• Security of supply: reserve marginfalling fast

– 12 GW coal decommissioned by 2015 because of LCPD (20% of peak demand)

– 6.3 GW nuclear decommissioned by 2016

– extra flexible generation needed to handle wind

• Climate changechallenge: reach <100gm/kWh 2030 – Renewablesfalling short of targets

– Nuclearnot attractive at current CO2 price

• Cost rising:2020 targets might cost £200 bn= £760 per household/yr, current elec bill = £450/yr


Start of ETS

More capacity needed by 2015

SKM (2008) mid-scenarioprojection

20200

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

110,000

2020 middle

interconnector

other RES

other

biomass

offshorewind

onshorewind

gas

nuclear

new coal

old coal

demand


UK climate change policy• 2027 legaltarget: 50% C reduction from 1990

• Zero-C generation faces more risk than fossil– electricity price set by gas or coal

• Renewables support is expensive

• return depends on electricity price– set by gas and carbon price

– and scarcity of ROCs - rewards failure

need to de-risk zero C investment


UK price movements: 2007 to 2009 in €

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120

1-Ja

n-07

1-Apr-

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l-07

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-07

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-08

1-Ju

l-08

1-O

ct-0

8

1-Jan

-09

€/M

Wh

e

Electricity forward 2010 (€/MWh)

Gas cost forward (2010) + EUA

Coal cost forward (2010) + EUA

EUA price in €/tCO2

Correlation of coal+EUA on gas+EUA slightly higher at 96%


UK ROC, EUA, and electricity prices

£0

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it

ROC+RPD 1 yr centred MARPDROC

windfall profits

ROC price stable


EMR White Paper 12/7/11• To de-risk and incentivise low-C investment

=> Long-term contractsfor credibility

=> C-price floorto underwrite wholesale price– ensures nuclear is not “subsidized”

=> Capacity payments- targeted or general?

=> EPS450gm CO2/kWh to deter unabated coal

• “technical update” by end of year– details of capacity mechanism

– “more details” on contracting institution

Aim at law on statute book by spring 2013


Long-term contracts• Electricity price is driven by fossil prices

– exposes nuclear and renewables to market risk

• CO2 price unpredictable, not credible

• => long-term contract enforceable in courts

• but technologies differ and so should contracts=> simple FIT for on-shore wind

=> auctions for off-shore wind?

=> Complex contract for nuclear?

Contracting institution left for consultation


Carbon price floor• Needed because EUA price is volatile, too low

and lacks longer-run credibility– undermined by 20-20-20 Directive and recession

• to bring C-price up to appropriate level– reduce implicit subsidy to CO2 emissions

=> ensures wholesale electricity price adequate to support mature low-C investment

• => nuclear power will not then be subsidized

Introduced in Budget March 2011


UK’s Carbon Price Floor

Source: EEX and DECC Consultation

EUA price second period and CPS £(2009)/tonne

£0

£5

£10

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£25

£30

Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20

£(20

11)/

EU

A

second period forward priceCarbon Support Price

As at 1 Jun 2011

to £70/t by 2030

23

Projected levelised generation costs 2017 NOAK

0

20

40

60

80

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120

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180

Gas

CCGTNucle

ar P

WR

CCGT+CCSASC C

oal+FG

D

ASC Coa

l +FGD

+CCS

Coal IG

CCCoal

IGCC+

CCSOnsh

ore

wind

Offs

hore w

ind

Offs

hore

win

d R3

£.M

Wh

extra for DECCC02 centralcaseextra for 10%interest

CO2 costs£20/t

CO2 T&S

Decommiss-ioning

fuel costs

variable opex

Fixed Opex

Capital Cost7.5%

CCGT at £20/t CO2

CCGT wins,nuclear (nth

of a kind) viable

Off-shorewind mostexpensive

24


0

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Gas

CCGTNucle

ar P

WR

CCGT+CCSASC C

oal+

FGD

ASC Coa

l +FGD+CCS

Coal IG

CCCoal

IGCC+

CCSO

nshore

wind

Offs

hore w

indOffs

hore

win

d R3

£.M

Wh

extra for 10%interest

extra for DECCC02 centralcaseCO2 costs£20/t

CO2 T&S

Decommiss-ioning

fuel costs

variable opex

Fixed Opex

Capital Cost7.5%

N-th of a kindNuclear wins;CCS, on-shore wind close

25


0

20

40

60

80

100

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Gas

CCGTNucle

ar P

WR

CCGT+CCSASC C

oal+

FGD

ASC Coa

l +FGD+CCS

Coal IG

CCCoal

IGCC+

CCSO

nshore

wind

Offs

hore w

indOffs

hore

win

d R3

£.M

Wh

extra for 10%interest

extra for DECCC02 centralcaseCO2 costs£20/t

CO2 T&S

Decommiss-ioning

fuel costs

variable opex

Fixed Opex

Capital Cost7.5%

CCGT at £20/t CO2,

10% capital

Capital costs do not affect rankingif C price high


Levelisedcosts 2015, Australia

Source: EPRI (2010)

CO2 at $23/tonneCO2 at $45/tonne


Installed wind capacity

0

5,000

10,000

15,000

20,000

25,000

30,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

MW

Denmark Germany Spain UK

CCC’09 UK 2020 target is 27,000 MW

UK wind very modestnow at DE 2010 level

UK’s target looks feasible at German

roll-out rate


Variability and need for back-up

Source: Green and Vasilakos (2010)

On-shore wind capacity factors 9-11 Oct 2003

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

hr 19-

Oct-03

3 5 7 9 11 13 15 17 19 21 23hr 110-Oct-03

3 5 7 9 11 13 15 17 19 21 23 11-Oct-03

hr 1

3 5 7 9 11 13 15 17 19 21 23

hours ending

perc

enta

ge

65% fall-offin 10 hrs = 18 GW

85% fall = 23 GW


Capacity mechanisms

• Concern over backup needed for massive wind– could have 7+ days of low wind at winter peak

– demand side unlikely to help much here

• such events are hard to predict– so without a contract no-one would build just for that

• Do we need it now? Wait and design carefully?

• Is the US approach to a demand curve good?

Choice left for discussion - targeted or system wide; SO or contracting agency?


Flaws in wholesale market

• Bilateral, thin illiquid markets that stimulated extensive vertical integration

• current design rules out pool & VOLL LOLP– the old pool model now looks good

• SO could run a voluntary pool for new entrants and renewables?

• Market coupling mandated by 2014– could provide a better spot price


Regulation for low carbon

• Generation needs incentives and standards- EPS

• Networks are regulated– have revenue stream, regulator can set rules

• Challenge fund for innovation - the Low Carbon Network Fund– learn how to make distribution networks smarter

• Transmission charges to influence location– ensure renewables delivered efficiently


Low Carbon Network Fund

• Ofgem’s LCN Fund = £500m 2011-2015– for DNOs financed by customers

– £150m divided among all DNOs for projects

– £350m open competition, £64 m for first round

• Aim: to stimulate DNOs innovation– to facilitate move to low-carbon future

– DNOs thought to be passive, regulated utilities

– “oversize, bury and forget” rather than “optimize, monitor and control”


Ofgem concerned whether incentive regulation stimulates innovation

Rationale for LCNF

• RPI-X for efficiency, not innovation

• DNs low risk - failure not funded

• No market reward from innovation

Value of LCNF

• LCNF sufficient for several flagship scale trials

• leverage: trial results disseminated to all DNOs

• Competition mimics market reward for innovation


LCN Fund structure


Criteria

• Accelerates development of low-carbon future– has direct impact on operation of DN

• DNOs co-fund (>10%) for commitment– involves other partners and external funds

• Involves risk, generates new knowledge=> disseminate all findings

• demonstrates robust methodology, readiness, relevance and timeliness

• has potential to deliver customer benefits


LCNF results• First round: 11 bids (£180m) received , 4 chosen

– competitive bidding highly successful– innovative proposals with University analysis

• CE Electricin NE England (£27m + £27m other– flexible tariffs, advanced voltage control, storage

• UK Power Networksin London (£24m + £12m)– smart meters/tariffs, EVs, emulates 2020

• Western Powerin S Wales (£7.8m + £1.2m)– monitor 1000 substations, 100k customers in real time

• Central Networksin E Lincs (£2.8m+£0.7m)– dynamic voltage control to increase wind access


Assessment

• DNO’s proved very responsive– incentives and competition matter

• Wide range of partners involved– encourages learning, integrates with smart meter trials and

EV experiments– innovative ways of overcoming local inertia

• Universities involved in data analysis– ensures wide dissemination and independence

Network innovation needs regulatory encouragement


Conclusions• Central element is contracting

– need careful design and a commissioning body

– wind needs location specific FIT

• CPF underwrites CfDbut distorts trade– need to argue for EU carbon tax or equivalent

• EPS rules out unabated coal

• Capacity mechanism– needed for peak and wind back-up

– will depend on form of wholesale market

But EMR does not reform Market!


Supporting renewables• ROCs pay high price for generation

– but the support should be for delivering capacity not outputas that is where the learning lies

• At present wind pays higher annual costs in distant locations to reflect transmission costs– but Scotland is lobbying for a uniform charge

=> both greatly encourage v costly and distant wind farms

FITs could handle this if sensibly designed


Location choices under LMP and spot pricing for wind

With ROCs wind farm inefficiently locates at N

Pay wind for availability + spot price => efficient E


Acronyms-1CfD contract for difference

CCGT Combined Cycle Gas Turbine

CCS carbon capture and storage

CPF carbon price floor

CCC Committee on climate Change

DN(O) Distribution Network (Operator)

EMR Electricity Market Reform

EPS emissions performance standard

ETS EU emissions trading system

EUA EU Allowance for 1 tonne CO2FIT Feed-in tariff: fixes price for power


Acronyms-2

GHG Green house gas (such as Carbon Dioxide, CO2)

LMP Locational Marginal Price (nodal price as in the US)

LNC(F) Low Carbon Network (Fund)

LOLP Loss of Load Probability

RES Renewable electricity supply

ROC Renewable Obligation Certificate

SO System Operator

VOLL Value of Lost Load (now £9,999/MWh)


Estimated impact of EMR on averaged domestic retail gas and electricity prices (including VAT)

33% increase


Pessimisticor realistic?

MacKay (2008)


5 plans “that add up” for 70kWh/d/p electricitydiversity Nimby LibDem Green Economic?

http://www.withouthotair.com/


Levelisedcosts, 2030

CO2 at $45/tonne

Documents

Adapting energy markets to a low-carbon future by Professor Davi… · 15 20 25 30 35 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11