Electricity Market Reform Bill - More gas and not much else

The Government's Electricity Market Reform (EMR) (published on May 22nd) may be called a 'decarbonising' Bill, but it seems to be working out in practice as more of a natural 'gasifying' bill. Essentially (as discussed earlier on this blog) there will be no new nuclear power, there will (after 2017) be a slimmed down renewable energy programme and there will be a large increase in the proportion of our electricity coming from gas. This increase will have to come from imported gas, with consequential increased exposure to gas price (and, as a knock-on) electricity price volatility for the consumer.

This is not how it was intended. The original plan, at least in the eyes of the nuclear lobby who were in the driving seat of the original EMR vision, was that a plan for around 30 per cent electricity from nuclear power would be executed and largely in place by 2025, with, hopefully, much more to follow (onwards towards fast breeder reactors etc). Renewables were to be allowed only in so far as they came in at was assessed to be below the cost of nuclear power, and the way that some of the consultancy work seemed to be pointing suggested that after 2020 there wouldn't be much of a renewables programme at all. There would also be a few gas fired peaking power plant.

That this vision has not appeared in practice is down to two factors. The first is the perennial storyline with nuclear power is that the nuclear lobby push out a lot of public relations that the next reactor/project will be far cheaper than the rest and that without nuclear disaster will befall the nation (or world). To do them justice, they do actuallly seem to believe this (or at least that the ones after the 'first of a kind' will be very cheap), but their enthusiasm is undermined by the extremely consistent historical record that suggests that the cost trajectory of nuclear power is upwards rather than downwards. In practice, as with the evidence of cost overrun and delay of the European Pressurised Reactors (EPRs) at Okiluoto and Flammeville, the nuclear pr storyline has no basis in reality. It is just that the nuclear lobby manage to spice up their storyline every so often until such time as it is shown to be wanting.

The second factor is the expectations of the British Treasury. The nuclear lobby may have been pragmatically expecting that whatever the problems with the EPRs, the British Government would be so determined to ensure that the programme went ahead that it would be 'underwritten' by the state, that is given a blank cheque. The Treasury seems to have other ideas, and it actually seems to take its notions of 'competition' between energy sources seriously. Which means no nuclear power stations. The Treasury is insisting that the costs of offshore wind come down so that it is economic at a price of no more than £100 per MWh (10p/KWh). Given that nuclear requires a strike price of at least £150 per MWh, the Government can hardly start out handing these contracts to nuclear power at that price (£150 per MWh). The Government's EMR proposals seem to clearly point in the direction of this conclusion. Actually the price of £150 per MWh is probably on the low side. It is what I estimated in a previous blog, but it has been pointed out to me that I was using earlier, lower, cost estimates for nuclear the EPR than have emerged more recently. I made the point about Treasury expectations in a session on Scotland BBC Newsnight in which I helpfully suggested that the resources not being used to support nuclear should be transferred to renewables. I should have said 'renewables and energy efficiency' of course. Apologies to Andrew Warren from the Association for the Conservation of Energy for that slip. See http://www.bbc.co.uk/programmes/b007rhvm. On Radio 4’s Today programme (yesterday, about 7.10 am) I commented that selling investments in nuclear power is rather like selling Greek Government debt bonds. People need to expect a rather high promised return to buy them, like the very high electricity price that needs to be promised to nuclear power to get it going. Ed Davey has said that nuclear will not get a blank cheque. We can thank the Treasury for that one. Hear my interview on Radio 4 on http://news.bbc.co.uk/today/hi/today/newsid_9722000/9722691.stm

But the trouble with the Treasury's standard is that rather than transferring resources to green energy they are simply allowing natural gas generation to take over. In fact the renewables programme from 2017/18 onwards is planned to be a severely cost attentuated, truncated and confused reform of the current version. There is an auction system set to be introduced to truncate onshore wind first, the idea for which is adopted through a misunderstood version of the current Danish offshore wind procurement mechanism (which is not, by the way, working out very well at all). It is hopeless for onshore wind and will cut down delivery of projects by at least half, probably more (many Tory backbenchers will rejoice here). It also fails to fit in with the way The Crown Estate has been organising Round 3 offshore windfarms. The Scottish Government may be able to negotiate some small funds for tidal stream and wave schemes, but that remains to be seen.

An especially sad part of the reform package is the way that the 'contracts for differences' (CfD) scheme is being presented as saving money for the consumer. If you compare it to a German style 'fixed' feed in tariff (FIT), the model adopted for the small renewables (see earlier blog), it comes as as quite costly. The CfD mechanism is good, it is claimed, because it makes sure the renewable operators have to pay back money which is earned when wholesale electricity prices are higher than the 'strike' price premium payment (normally called the FIT rate). That is somewhat less than relevant since this phenomenon will be offset by the way that wholesale prices fall below the 'strike price'.

The Cfd system certainly gives a worse, not better, deal for the consumer than just giving an average price through a 'fixed' FIT. The consumer gets a worse deal because the system loses money in the bureaucracy, most of it which will go to the Big Six electricity companies who effectively run, and profit from, the electricity trading system. Renewable operators will be forced to trade on the electricity market and made to guess in advance when they are going to generate energy. Predictive mechanisms for wind power are good, and getting better, but it is senseless to make individual wind projects do this since they will lose money and the system will work much better if the System Operator, the National Grid, balance out fluctuating renewable energy supplies. This point has been made using economist's squiggles by David Newbery of Cambridge University.

In order to overcome the philosophical difficulty of deciding what exactly the wholesale price actually is (difficult since there there is no overall trading price), an invented reference price is used to calculate when operators should get subsidies, and when they should not. This injects uncertainty into the system about what projects will earn in advance, which puts up the cost of risk capital, which puts up the price of projects. The final kick of the CfD system is that it squeezes out anybody who is not a full trader on the electricity market, that is all but the very largest schemes and electricity suppliers. The independent generators will have to go to the electricity suppliers themselves to get contracts (power purchase agreements), and the electricity suppliers will take a big cut of the income. My own research done in the past suggests this may be around 20 per cent of the income stream.

The Cfd idea may have been driven by a notion that this obscures the existence of subsidies for nuclear power, ironic given that there is no nuclear power coming. However it is also justified by an ideology that renewables must be integrated into the electricity trading market arrangements. The fact that electricity trading is dominated by, and in free form peripheral to, the activity of the Big Six oligopoly, is not considered to be important. Neither is the fact that renewable energy would be much better off being outside this framework and that using a German-style FIT would provide genuine independent competition with the Big Six in ways which will reduce the costs of fossil fuel electricity.

To sum up, the new renewables regime which will operate after 2017 will reduce the flow of renewable schemes coming on line (compared to the current Renewables Obligation), and make the market even more dominated by the Big Six than it is now.

Energy efficiency, by the way, receives scant attention in this document. There are schemes for energy efficiency in the commercial sector that have been implemented in France, for example, but nothing effective is being offered to commerce or industry by Government policy in terms of sticks or carrots apart from 'voluntary' climate change agreements. The domestic energy efficiency programme has been cut back by around 50 per cent since 2009 according to the Association for Energy Conservation.

And as for solar power...well everybody who is interested in the story knows what has happened there (with the programme being slashed). You can be positive, I suppose, and say at least it is not as bad as the lunatic policy in the USA where solar power is taxed and oil given subsidies. But then we will just have to leave it to the Germans, Chinese etc...

Greenest government ever? Who said that?

Crazy American decision to impose 31 per cent tax on solar pv

Just as many countries in the world are giving incentives to expand the market for solar power, so the US Government has slapped a 31 per cent import duty on solar photovoltaic (pv) panels made in China. This must go down as almost the ultimate in the opposite of green politics - Narrow minded nationalism picking on a green technology with a facade of protecting part of the American solar industry. I say a part of the US solar industry because much of it is actively campaigning against this nationalist stupidity. See the campaign organised by the Coalition for Affordable Solar Energy at http://coalition4affordablesolar.org/.

Of course the American decision is being justified by alleged Chinese 'subsidies' to its solar industry. Well who doesn't subsidise their energy industries? Solar needs subsidies so that it can build up its markets anyhow. But even here all the US investigators could find was between 4 and 7 per cent subsidies for the Chinese production. Even if this should be punished, how on earth does this justify a 31 per cent import tax? See the US findings on the size of subsidies on http://www.energybusinesslaw.com/2012/03/articles/environmental/us-department-of-commerce-preliminarily-finds-chinese-solar-panel-manufacturers-received-subsidies-from-the-chinese-government/

Meanwhile billions of dollars a year are being given away to the oil companies in tax concessions and incentives for renewable energy are being denied by Congress. See http://www.politico.com/news/stories/0512/76489.html. Of course the only explanation for these grotesque contradictions, apart from the clout of the oil companies themselves, is sheer anti-Chinese  protectionist nationalism that is sweeping the USA. Capitalist competition is the religion of America - until, that is, somebody is doing things better than them! Of course many Americans are much more far-sighted than the narrow minded protectionism that has grabbed hold of US policy. Let us see if we can give full support to those fighting this stupid decision by the US authorities (like the Coalition for Affordable Solar Energy mentioned above). See some details of the US decision on:

http://www.renewableenergyworld.com/rea/news/article/2012/05/31-percent-anti-dumping-tariffs-announced-for-chinese-solar-panels

Electricity Market Reform in meltdown - let's have REAL feed-in tariffs for renewables not nuclear

Independent renewable companies, allied to Scottish and Southern Energy (SSE), have condemned the Government's proposed arrangements for renewables as unworkable. They have branded the Electricity Market Reform (EMR) as a system designed to cover up  subsidies for nuclear power. See http://www.guardian.co.uk/environment/2012/may/15/reform-electricity-market-unworkable?newsfeed=true

Independent generators have issued a call for a real system of feed-in tariffs for renewable energy, not nuclear power, and not the unworkable and opaque 'contracts for differences' system (allied to a plan to move into 'auctioning' of contracts). They favour the German style system of feed-in tariffs for renewable energy. It is refreshing to have major players in the renewable world openly demanding what we have been demanding for the last 18 months. See the letter in the Guardian (December 2010) which launched the campaign for 'real feed-in tariffs' (or at least this blog!) on 

http://www.guardian.co.uk/environment/2010/dec/27/wrong-policy-on-renewable-energy

As the 'real-feed-in tariff' coalition of renewables (as reported) realise, the 'contracts for differences' system was invented as a cover for subsidies to nuclear power, and to ensure that it was more or less impossible to determine what subsidies would be given to nuclear power. Ironically it now appears (see other entries in this blog) that even this system will not be enough for nuclear power either, because nuclear can only be built with what amounts to a 'blank cheque' from the taxpayer or electricity consumer signed, in effect, by the British Treasury. Nuclear power is uncompetitive with renewable energy, including offshore windfarms. 

The Government's Electricity Market Reform (EMR) proposals are in meltdown. 

Renewables do not need blank cheques from the Treasury, but what they do need are real feed-in tariffs. In fact it would be very easy to implement a feed-in tariff for large scale renewables in the UK. All you need do is upgrade the system used to fund small scale renewables that was outlined in the 2008 Energy Act and implemented by a statutory instrument in 2010. See the details on http://www.fitariffs.co.uk/library/regulation/08_Energy_Act.pdf

and http://www.decc.gov.uk/assets/decc/what%20we%20do/uk%20energy%20supply/energy%20mix/renewable%20energy/policy/fits/1_20100331172153_e_@@_fitlicencemodification.pdf

and also http://www.fitariffs.co.uk/library/regulation/uksi_20100678_en1.pdf

The ‘real’ feed-in tariff alternative is simple (as exists in the UK in the form of the small renewables feed-in tariff mainly serving solar pv). Feed-in tariff rates are set by the Government for different technologies and electricity suppliers must pay the renewable developers those rates for 20 years. The electricity suppliers claim back the money for doing this from the Office of Gas and Electricity Management (OFGEM). OFGEM then recoups this money via a 'levelised' levy on all electricity consumers.

Of course what does not help is when the Government arbitrarily alters the feed-in tariff rates, as what happened with the solar power pv rate. Fortunately some of the arbitrariness of this decision was overruled by the Supreme Court. In order to build confidence the feed-in tariff scheme for large renewables should work through standard 20 year contracts being issued to developers of schemes above 5 MW in size guaranteeing pre-determined, fixed, prices paid for electricity generation over that period. These contracts can be issued  by the electricity suppliers themselves; indeed the suppliers should be mandated to issue them assuming they conform to regulation as administered by OFGEM. Of course these should be fixed price contracts - let us have none of this confusing, uncertain, and (at least for many independent renewable operators) unworkable 'contracts for difference' scheme proposed by the Government under EMR.

Another great benefit of having a real, German-style, system of feed in tariffs is that they are transparent. Since all contracts for a given technology are for the same price to be paid per MWh generated, OFGEM can issue reports so that people know what schemes will be paid for generating given quantities of energy. This is good governance - but the Government proposals represent distinctly poor governance. 

And then there were none......

EDF abandons nuclear plans in all but name

The last surviving British nuclear construction consortium, led by EDF, has all but thrown in the towel. EDF announced that is has 'postponed' ground preparation works at Hinkley C that were otherwise due to begin in August. EDF say they will now begin the work in 2013 instead. This is reported by Damian Carrington in The Guardian online at http://www.guardian.co.uk/environment/2012/may/14/hinkley-nuclear-power-station-delay?intcmp=122.

This casts doubt on the assumption that EDF had fully committed £100 million to this ground clearing work. What is absolutely certain is that EDF's supposed partners in the project, Centrica (with a 20 per cent stake in Hinkley C and its putative sister project at Sizewell C)  have all but pulled out from the venture themselves. Sam Laidlaw, the CEO of Centrica declared last week that: "The investment case for nuclear power has yet to be proven," See http://www.telegraph.co.uk/finance/newsbysector/energy/9261237/Centrica-shareholders-revolt-against-executive-pay.html. Construction costs for the EPR reactors at Flamanville and Okiluoto have risen to ever more horrifying heights making it ever more unlikely that British nuclear power plans could be fundable under the Government's 'contracts for difference' scheme under the 'Electricity Market Reform' package. 

If nuclear power is now more expensive than offshore windfarms, the last remaining argument for preferring nuclear (on grounds of cost) flies out of the window, at least as far as British public opinion is concerned. Contrary to what nuclear advocates argue, there is no danger at all of the' lights going out' without nuclear power. The Government's own security of supply report attests to that. There is plenty of generation capacity available. What we do need to do is to substitute for imports of natural gas, and that can be achieved much more quickly, cheaply and cleanly with renewable energy energy sources rather than nuclear power. There is no shortage of renewable energy projects waiting for funding.

The nuclear industry are, of course, fielding desperate arguments that their construction costs could be 'underwritten' by the Treasury. That means that the British taxpayer/electricity consumer would be handing unlimited subsidies to the nuclear industry, a blank cheque. But it does not seem that the Treasury likes this idea, and with good reason. Not only would it create a massive bottomless black hole in British budgetary finances, but  it would be an even more flagrant breach of the Coalition promises not to subsidise nuclear power. A nuclear blank cheque would not be available to renewable energy, who will, for sure, demand to be given much better incentives than they are being offered now.

A 'blank cheque' would also run the risk of flouting EU state aid rules, although here, it has to be said (as I have been reminded by Professor Steve Thomas) that nuclear power seems to be more exempt than renewable energy from this rule. The nuclear industry gets a stream of state aid already - in the 1990s the non-fossil fuel levy was used to finish construction of Sizewell B nuclear power station (after electricity was privatised). Nuclear power's decommissioning and nuclear waste costs are funded by the Treasury, and so on. By contrast there are very strict EU protocols on how renewable energy feed-in tariffs can be disbursed.

The problem is that the Government will try to save face and pretend that the nuclear power plan is on track rather than do the obviously progressive thing and concentrate on funding energy efficiency and renewable energy instead.

Nuclear power is more expensive than offshore wind

The Government are developing a 'strike price' system under which guaranteed prices would be paid for long periods to 'low carbon' electricity generation. But this process exposes the Government to the danger that nuclear power would be seen to be much more expensive than its previous public relations based calculations had suggested - more expensive than offshore wind, never mind onshore wind. This analysis below 'blows the gaffe' on the Government's strategy. Note: On 21st June I amended this analysis to take account of the fact that costs for a 1.6 GW EPR nuclear power station have risen to £7 billion

Under the analysis below nuclear new build will need a  strike price of over £180 MWh (18 p/KWh), making nuclear clearly more expensive  than offshore windfarms. – That is from a vantage point of an adviser to a credit ratings agency who people like EDF can ill-afford to ignore. This is as measured by what nuclear would need to be paid for developments to occur and also what offshore windfarms are being paid – that is unless nuclear gets a ‘blank cheque’ from us all through the back door – which offshore windfarms certainly don’t get! Onshore wind looks like a real breeze by comparison of course.

What strike price for nuclear?

This costing is based on what strike price (under the Government’s Electricity Market Reform [EMR]) an adviser for a credit rating agency may advise is necessary for EDF to achieve in its new nuclear build plans. This will be in order to avoid evidence that would support a downgrading of EDF’s credit rating. In short, a ‘strike price’ of over £180 per MWh would be required, a sum that is considerably in excess of what offshore windfarm owners are currently being paid for their output.

It needs to be emphasised that major utilities are trying to avoid new power plant investments under pressure from credit rating agencies, with nuclear power investments being especially poorly regarded by the agencies. Utilities can ill-afford to risk credit downgrading as this is likely to lead to declines in share prices and increases in borrowing costs.

The calculation for a price of new nuclear power assumes a European Pressurised Reactor (EPR) is being built similar to that being constructed at Okiluoto and Flamanville. Key elements of making the calculation are a) test discount rate (TDR), b) length of power purchase agreement (PPA) during which ‘strike price’ is payable, c) capacity factor (proportion of time that plant will be generating at the equivalent of full output) d) overnight capital costs (ie construction costs before interest charges are added for capital spent before generation starts) e) length of construction period. f) operating and fuel costs. Going through these in turn:

a)Test Discount Rate (TDR). It seems that in contrast with the case with TVO, the Finnish developer of the Okiluoto 3 plant, construction cost guarantees (ie commitments to pay for cost overruns) are unlikely to be forthcoming from AREVA who is building the Finnish plant on a ‘turnkey’ basis. AREVA is in a poor financial position and further backing from the French Government looks unlikely. There is no chance of banks  or institutional investors lending to a nuclear power construction project without such guarantees, and hence the only source of available capital will be EDF’s own equity.

Conventionally returns to equity are expected to be high, with 15 per cent being regarded as a minimum even for a confident investor. Often nuclear power plant costs are calculated at a 10 per TDR (eg by the Committee on Climate Change). However this is very inappropriate in this instance since the much cheaper source of bank lending will not be available. Moreover the European Pressurised Reactor (EPR) is a new design leaving open uncertainties compared to other investments, including renewable energy where there are fewer cost and production uncertainties and where bank lending is usually available, or at least the costs can be shared between different institutional investors. In this case it seems likely that EDF will have to bear all or, at the very least, the large majority, of the costs, risks and uncertainties that are involved. In France EDF has now been part privatised and also has to compete on a part-liberalised electricity market. It no longer has access to the Government backed low interest borrowing used to support its nuclear power stations in the past, and it can no longer rely on being a monopoly electricity supplier to pass on the high costs of nuclear construction. Hence there will be no new nuclear power stations in France.

b) Length of power purchase agreement. This is assumed to be 30 years. This is considerably longer than the longest PPAs given to renewable energy developments which are around 20 years. A shorter PPA period would increase costs.

c) Capacity factor. There is uncertainty about whether a new design, the EPR, which has no track record, could achieve higher than the average capacity factor for UK nuclear power stations which is 70 per cent. Even Sizewell B has a capacity factor of barely more than 80 per cent, and this power station is based largely on the much better known PWR reactor design paradigm. A credit rating judgement must be based on plausible risk estimates, and it is plausible that the capacity factor of an EPR could fall significantly below 80 per cent, especially in the first few years of operation.  Hence calculations are done for both a 70 per cent capacity factor and for an 80 per cent capacity factor.

d) Capital Costs. An overnight capital cost of £4375 million per GWe of generating capacity is assumed. This is based on a wideley reported cost revision published in the Times and used also as a basis for analysis for the Citigroup analyst Peter Atherton. See http://uk.reuters.com/article/2012/05/08/uk-nuclear-britain-edf-idUKBRE8470XC20120508 

e) Construction period. The longer the two EPR projects have continued, the longer have their estimated construction periods. Indeed this is not entirely unexpected if previous UK nuclear constructions are considered. This is very important for consideration of costs since the longer the construction period becomes, the higher are the interest charges during construction. The same construction period and proportional spread of construction costs in this period is assumed as was the case in Sizewell B. Sizewell B was given consent in 1987 and completed in 1995, although a small proportion of the costs were expended prior to 1987. This example is used because the author has data on the proportional spread of costs during the construction period. It should be noted that Sizewell B took around 8 years to construct (ie. before electricity generation started ) after planning consent  was granted. Yet it now seems that both Flamanville and Okiluoto will take longer to construct than this. Hence my estimate of interest during construction is likely to be an underestimate of these costs for these projects.

f) Operating and fuel costs. These are assumed to be 1.2 p/KWh, in line with US experience. However, it should be noted that this also may be an underestimate since this cost is associated with PWRs about which there is much more experience compared to the novel EPR design.

These costs are then converted into a cost per MWh using the standard formula:

Price = [C x 1.rⁿ x (1.r – 1)] divided by [P x (1.rⁿ  - 1)] where C is the capital cost (including interest during construction) r is the discount rate (%), n is the length of the PPA in years and P is the annual electricity production.

As a result, the ‘strike price’ necessary to induce a tolerant credit rating agency report would have to be at least £186 per MWh –assuming a 80 per cent capacity factor. If an 70 per cent capacity factor was assumed then this strike price would be £200 per MWh.

By contrast, costs for renewable energy schemes can be adduced from what is paid in the market. In the case of new UK offshore windfarms the operators are currently being paid 2 ROCs worth just over £42 per MWh each plus the (roughly year-average) available wholesale electricity price which will be around £50 per MWh, making a total of around £135 per MWh for offshore wind. Of course onshore wind receives much less than this (around £92 per MWh –an incentive that is being reduced from next year to about £87 per MWh). But regardless of this it can be seen that even in the case of comparison even with offshore wind, new nuclear as proposed by EDF comes out as being more expensive.

British policy outcome shows that nuclear is less cost-effective than renewables

See my letter published in the Financial Times on April 28th:

The FT is right to feature a debate about whether subsidies should go to nuclear power or renewable energy. However, the article is in danger of confusing two things: first, allowing nuclear new build to get the same sort of premium price contracts for supplying electricity as may be given to renewable developers; and second, the government agreeing to “underwrite the costs” of new nuclear build. Renewable developers do not get their construction cost overruns underwritten by government.

If the nuclear industry is asking for additional layers of subsidy compared to that given to renewable developers, the nuclear industry is tacitly admitting it is less cost-effective than renewables. The danger is that nuclear developers may be offered unlimited subsidies to cover any construction cost overruns and that this will be hidden in “commercially confidential” contracts given to them. This would amount to the government giving nuclear constructors a blank cheque on electricity consumers’ behalf. What we must demand now is that such moves be made public rather than, as in previous funding streams for nuclear power, hidden from us until it is too late to complain.

FT 28th April 2012

http://www.ft.com/cms/s/0/04d8b5a6-8e00-11e1-b9ae-00144feab49a.html