The politics of power

In the modern age, one of the clearest tests of the competency of any government is whether it can keep the lights on. No administration could survive a repeat of the infamous blackouts of the 1970s.

The new draft Energy Bill, introduced in the Queen’s Speech, is therefore of vital importance. It lays out the mechanisms that could shape the energy market for decades to come. In designing the bill, policymakers have tried to deliver on a complex set of objectives in an area subject to tight environmental, economic and political constraints.

Of the UK’s electricity generating capacity, 21 per cent is scheduled to go offline within the next decade. Meanwhile, the government believes, demand for electricity will rise: the Department for Energy and Climate Change (DECC) estimates that £110bn of investment will be needed in new power generation infrastructure by 2020. So security of supply is DECC’s top priority: minister of State Charles Hendry tells CSW that this “is the cliff edge that we face and if we don’t get investment we will, in the course of the early 2020s, find we haven’t got enough supply to meet demand. But it also gives us a unique opportunity to rebuild that infrastructure in a genuinely low carbon way.”

The government must meet its commitments to reduce carbon emissions under the Climate Change Act 2008. “This area of policy is quite innovative in that we have very clear, legally-binding, quantified goals,” says Ravi Gurumurthy, DECC’s head of strategy. The act calls for an 80 per cent reduction on 1990 emissions levels by 2050 and is monitored by the Committee on Climate Change (CCC), which recommends intermediate targets known as carbon budgets. Last year the government accepted its recommended target of a 50 per cent reduction by the mid-2020s.

The bills hitting domestic consumers are also high on the agenda. Rising fuel prices over recent years, combined with falling wages and employment, have driven more households into fuel poverty. “We have tried to achieve the decarbonisation of electricity, which is necessary to meet our Climate Change Act objectives, alongside energy security – and to do both of those at [the minimum] cost to the consumer,” says Gurumurthy.

In a report on the government’s plans published in June, the National Audit Office said they could save the average household £100 a year – but it’s a different picture for businesses, with the NAO warning that some medium-sized companies could face “crippling” increases of up to £302,000.

The pressures on policymakers
The deliberations of DECC’s civil servants have been played out against a backdrop of political disagreement over how swiftly emissions-reduction goals should be met, and by what means. There were divisions among the cabinet last year over the 50 per cent target, with chancellor George Osborne and business secretary Vince Cable reportedly anxious that overly stringent climate change goals might stifle economic growth, while then-energy secretary Chris Huhne argued in favour of sticking to the CCC’s plan.

There is also a growing divide within the Conservative Party over whether a move to low carbon energy generation will boost or hamper growth. In June two Tory Cabinet members, development secretary Andrew Mitchell and environment secretary Caroline Spelman, wrote to David Cameron to back a plea by foreign secretary William Hague for greater support for green industries to help boost the economy. But earlier this year, 100 Tory backbench MPs also wrote to the PM urging him to turn against on-shore wind farms.

Meanwhile, the corporate environment within the power generation industry has provided further difficulties for energy policymakers. The market is dominated by the ‘big six’ energy suppliers – British Gas, EDF Energy, E.ON, npower, Scottish Power and SSE – which not only control most generation capacity, but also sell almost all electricity to consumers.

The situation has led to concerns at DECC that, given most consumers’ reluctance to switch suppliers, the potential benefits of market competition are not being fully harnessed. There is also a lack of transparency in the electricity market: with the big six generating most electricity and selling it to their own retail arms, it’s difficult to determine the true wholesale price accurately. Meanwhile, the market has not delivered the level of investment that the government believes will be required to meet demand: “The big six have quite stretched balance sheets, and we need new entrants into the market to deliver that scale of investment,” says Gurumurthy.

Policymakers’ room for manoeuvre is also constrained by EU competition law. While public subsidy for renewable technologies is deemed acceptable, any subsidy given to nuclear power could be struck down by the European Commission as unfair state aid.

Even if DECC can boost levels of investment, it will encounter another hurdle: local resistance to the construction of big energy infrastructure. Few householders want a nuclear power station, wind farm or waste-to-energy plant nearby. Other technologies deemed less objectionable may not be able to close the power generation gap, however. “Wave and tidal may be very attractive technologies, but the scale of their potential to generate energy for the UK is much less than offshore wind, nuclear, or [gas with] carbon capture and storage,” argues Gurumurthy.

The problems of predictions
DECC’s strategy is based around the need to make up a shortfall in supply, but some energy market commentators believe that future need has been greatly exaggerated. “We produced a report in February showing that weak demand is taking the bite out of the capacity crunch,” says Brian Potskowski, an analyst at Bloomberg New Energy Finance. “Because of the recession and energy efficiency measures, you don’t need as much. We see weak demand continuing, and there is capacity coming on-line.”

Paul Steedman, a senior campaigner at Friends of the Earth, calls for the adoption of more efficiency measures to reduce energy demand: “There’s almost nothing about that in the Energy Bill. The idea that demand will double is fantasyland,” he says.

Gurumurthy responds that government has regulated to make lighting, appliances and boilers more fuel efficient, and brought in schemes such as free home insulation provided through energy suppliers. Nonetheless, he says, all of DECC’s predictions suggest there will be a shortfall in supply – no matter how much work is done to constrain demand. “You need both energy efficiency, and increased electricity supply in a big way,” he says. “All pathways involve a lot of electrification of heating, transport and industry. You have to replace fossil fuels with either bio-energy or electricity, and there is constraint on the supply of bio-energy. All of our pathways see an increase in electricity demand of between a third and two thirds, and some require a doubling of capacity.”

Potskowski agrees that a long-term strategy is needed. “Government policy is preventive surgery for a problem that will lurk beyond the 2020s,” he says: DECC must act now to squeeze fossil fuels out of the power supply, or it will be impossible to meet the government’s future commitments on CO2 reductions. “By 2030 the power sector will need to be almost completely decarbonised,” he adds.

The policy tools
The principal mechanism contained within the Energy Bill for decarbonising power generation is the ‘contracts for difference’ (CFD) feed-in tariff. Huge investment is required for most large-scale, low-carbon generation: a new nuclear power station costs £8-10bn, and a large offshore wind farm up to £1bn. Institutional investors are reluctant to commit such sums up front because of the uncertainty that surrounds future fuel prices.

The current system obliges energy retailers to buy an increasing proportion of their electricity from renewable sources, while ensuring renewable generators receive a fixed-rate feed-in tariff. This subsidised rate is paid for by a levy on electricity bills. Nuclear generators receive no subsidy.

Under CFDs, the government will agree a fixed “strike price” for power produced by each kind of low-carbon generation, including nuclear, so that investors know what their returns will be. The wholesale electricity price for electricity will continue to fluctuate, but when it falls below the strike price the generators will receive a top-up subsidy paid for by a levy on customers’ bills. When it rises above the strike price, generators will be obliged to pay back the difference, which will then be passed on to customers in the form of reduced bills.

“We believe we have found a mechanism which will incentivise investment, bring forward the new plant which is necessary. It will be low carbon and it will be the most affordable method of doing it,” claims Hendry.

In addition, the Energy Bill outlines proposals for a “capacity market”. This is required because, while managers can switch some fossil fuel power stations on or off to meet changing levels of demand, renewables’ output is determined by environmental conditions. Under the reforms gas-fired stations would be paid a fixed rate to provide backup capacity, ensuring that the system can meet sudden peaks in demand.

The bill’s third main provision is the establishment of an emissions performance standard for all new power plants. The standard is set at 450g of CO2 per KwH (kilowatt hour). This would require a cut in the emissions of the most polluting fuels such as coal, but would have little effect on gas-fired plants.

DECC argues that the reforms do not favour one technology over another, instead providing support for all forms of low carbon generation and allowing them to compete with each other so that the lowest-cost solution will eventually emerge as the most favoured. That argument has not convinced green pressure groups, however: “You have a one-size-fits-all model mainly designed to subsidise nuclear, but which will not be suited to renewable technologies,” says Nick Molho, head of energy policy at World Wildlife Fund UK.

Steedman too argues that CFDs will be less favourable to renewables than the existing system. The reforms have “been built entirely around the needs of gas and new nuclear,” he says. While nuclear generators will negotiate a CFD with the government for each new power station, renewables suppliers will have to compete at auction for build projects – leaving them all with big bills for scoping and planning work. There is also a risk that a few huge nuclear projects might end up absorbing all the available top-up subsidies (see box).

At the end of June, the energy and climate change select committee conducted hearings as part of its pre-legislative scrutiny of the Energy Bill. Most of the big six energy company chiefs gave the bill their qualified approval. Vincent de Rivaz, chief executive of French energy giant EDF – which is set to make a final decision at the end of the year on whether to build a new nuclear plant at Hinkley point in Somerset – said: “It sets our industry in the right direction.”

However, energy sector bosses were concerned about the detail of the bill, particularly the sections setting out which organisation will manage CFD subsidies and make top-up payments. At present, a group of suppliers will guarantee CFDs, rather than the government itself. Industry bosses fear that may make their investment decisions riskier, with consequences for the rate at which they can secure finance.

Steve Thomas, professor of energy policy at the University of Greenwich, says: “Any contract will have to be underwritten by government and come back to the public purse for it to be viable.” But so far, the Treasury has declined to give that assurance. Energy select committee chairman Tim Yeo had to write to the Treasury on 22 June requesting a response to this and other questions, because no HMT representative was willing to attend the hearings.

Back at DECC, Hendry accepts that more certainty is needed in this area: “What we have to clarify for industry is who [the energy providers] would take action against in the event that a contract was changed,” he says. “This is work in progress. We will publish the final components when the bill is published in its final form in the autumn.”

Meanwhile, there are signs that the electricity industry is postponing investment decisions until more detail is known. Civil servants at DECC will need to work hard to fill in the gaps in the intervening time, or legislation designed to bring forward investment could end up slowing it instead.

What does this mean across Whitehall?
The Treasury sets the levy control framework for DECC, capping the amount that can be raised from consumers, and this will cover any top-up payments to generators made under CFDs. The amount needed to support CFDs will depend upon wholesale electricity prices, so the requirements are unknown – but if the framework limits are too low, a few big projects could swallow up all of the available money. Environmentalists fear that a handful of nuclear projects could swallow up nearly all of the subsidy, leaving little for renewables. HMT has also so far refused to guarantee the contracts (see text).

The National Infrastructure Directorate of the Planning Inspectorate, an executive agency of the Department for Communities and Local Government (DCLG), reviews applications for electricity generation projects over 50MWs in England and Wales – although the secretary of state at DECC takes the final decision. DECC’s energy policy work has already been reflected in the National Planning Policy Statements recently prepared by DCLG, and in the allocation of eight sites for potential new nuclear plants.

“The Department for Transport is very interested in our work on electricity market reform, because electric cars only work if you have low-cost, low-carbon electricity,” says DECC’s Gurumurthy. “They don’t want a sudden rush for electric vehicles in the 2020s on the back of high oil prices, and then us not to have built the generation capacity or grid or distribution network. The Department for Environment, Food and Rural Affairs are interested in capturing some of the side benefits for air pollution of our work, as we shift out of combustion-engined cars, coal and gas.”