Bridging Britain’s generation gap – an industry view

After more than a year of intense debate on what Britain should do to address its looming generation gap, the electricity industry is awaiting new proposals from the government. They are due to be published jointly by the Department of Energy and Climate Change and the Treasury on Wednesday – Budget day – in an ‘energy markets assessment’ document. In an exclusive interview, European Energy Review asks Sara Vaughan, director of regulation and energy policy at Eon UK, one of the country’s biggest electricity generators, what kind of policies would be helpful, given the company’s investment strategy – and the country’s needs.

Sara Vaughan, director of regulation and energy policy at Eon
Trawl through the 50-plus detailed responses to a consultation exercise that energy regulator Ofgem concluded last October and it soon becomes apparent that some of Britain’s electricity generators are worried that the government may tinker unnecessarily with a market that they believe is working fine and should be left to do its job. Others, including Ofgem, feel that action to promote investment is essential to fill a looming gap between projected demand and electricity generation capacity, as EER reported last week. (See “Britain’s electricity sector headed for a cliff edge”,)

The government has certainly not been short of suggestions. Just the proposals put forward by Ofgem cover a wide spectrum of possibilities. When they were published at the start of February – in the Project Discovery consultation document – much of the subsequent media coverage focused on the more radical ideas, such as to create a central energy buyer. In a country that has been the trailblazer for market liberalisation in Europe, that was so radical and so different that the sensationalist reporting was not surprising.

Now that the dust has settled, the big question facing the industry is: what does the government actually plan to do? The answer looks to be just a couple of days away. This Wednesday (Budget Day) the government is expected to come out with an assessment of the energy market, with new proposals to tackle the climate and energy challenges Britain faces.

‘Ofgem’s Project Discovery document is a consultation document and Ofgem is not the decision-maker,’ says Sara Vaughan, director of regulation and energy policy at Eon. ‘The decision-maker in this area, because it is quite clearly a policy question, is the government. We’re responding to the Project Discovery consultation, but the really interesting document will be the energy market assessment document that we expect to see at the time of the Budget [on 24 March].’

Long-term target

What would Eon like to see in that assessment? ‘What would help you with the investment decisions you need to make to address generation needs over the coming decade?’

‘Eon believes in competitive, liberalised markets,’ Vaughan replies. ‘That is our approach to markets across Europe. We believe that the market has delivered in the past and is continuing to deliver across much of Europe – though clearly there are different stages of liberalisation.’

However, she continues, the authorities in both Europe and the UK have already intervened in the markets by imposing new environmental policies: the EU’s Climate and Energy Package with its 20-20-20 targets (20% emissions reductions, 20% energy from renewables and 20% increase in energy efficiency by 2020), which has been translated in the UK to 15% of energy from renewables by 2020; and the British Climate Change Act of 2008 which determines that carbon emissions should be lowered by 80% by 2050. ‘These are making a big difference to the market,’ she says. ‘All of us have gone away and done our modelling and looked at their impact on the market.’

What Eon has concluded is that these targets have created new considerations for investors in electricity generation that will challenge the existing market framework. A key issue, says Vaughan, is that there should be an appropriate price of carbon. ‘We are a firm supporter of the EU Emissions Trading Scheme (ETS),’ she says. ‘We believe that is the right way to promote de-carbonisation of the economy. But there is an issue with the ETS in that it doesn’t have a long-term target in it – a long-term cap and signal for 2030 and beyond that would drive a more robust price within EU ETS. In a country like the UK which has decided to move quickly towards decarbonisation, through its own internal targets, it looks as though something further will be needed. That’s something we are hoping to see come out of the energy market assessment.’

However, she cautions, alongside an acceptance that existing market frameworks need to change to deliver the necessary investment, Eon UK also wants to see ‘the government’s continued commitment to dynamic markets’.

More investment

Britain’s immediate concern is to fill the gap that will be created after 2015 as many coal-fired plants have to close, because of the Large Combustion Plant Directive and the Industrial Emissions Directive, and as most of the country’s nuclear stations reach the end of their lives. The higher proportion of intermittent generation on the system – such as renewables, whose production varies according to the weather – means that utilities will need to make up the difference using other generation sources such as gas when output falls short, says Vaughan. Taking into account the need for this back-up capacity, the total amount of capacity on the system is likely to increase.

‘What we need to come forward in the market is low-carbon generation to help meet our decarbonisation targets,’ says Vaughan. ‘But what we also need is for plant already on the system and coming onto the system – which is predominantly gas-fired – to be economic to operate. So it’s partly about encouraging new-build but also partly about keeping existing plant on the system.’

What is not in doubt is that a lot more investment will be needed to maintain a healthy capacity margin on the system, to ensure adequate security of supply. ‘We’ve talked previously about capacity gaps,’ says Vaughan. ‘In our previous modelling of that we could see a gap emerging around 2013-14. In our modelling last year that has moved back to 2016-17 – because there is a recession-induced dampening of demand, and also because some new gas plant has come onto the system.’

Gas dependence

While there is a push going on for renewables, nuclear and carbon capture and storage (CCS), isn’t it a fact that the UK will need a lot more gas-fired generation? Vaughan: ‘When we are looking at what sort of capacity we will build, we take into account a number of factors. Clearly, one factor is whether we expect a demand gap. Commodity prices are another. What does it look like in terms of the gas price? What does it look like in terms of the coal price? What does the carbon price look like? What are the capital costs of the plant that we expect to build? What’s the regulatory regime applying to that plant? What is our own plant mix? Because you don’t want to put yourself too heavily into plant of one type. Let’s say you only built gas and gas prices then soared. Clearly you would find yourself exposed, as against having a good mix in your portfolio of coal, gas, renewables, and so on. For us, diversity is the answer and certainly gas is one of the sources of fuel that we would consider.’

So what’s missing?

It seems to be taken for granted by many in the UK that the country’s gas production is bound to decline rapidly, as Eon’s Sara Vaughan indicates in this interview. The Conservative Party’s energy proposal does not envisage boosting domestic gas production. Neither is the government’s energy market assessment, to be published on Wednesday, expected to address this issue directly - much to the annoyance of Peter Odell, famous energy economist and member of the editorial board of European Energy Review. In a recent essay he appealed to the UK government to “take control” of oil and gas production. ‘The government should follow the example of Norway and other countries by setting up a Hydrocarbons Authority which would initiate new private-public partnerships to engage in offshore oil and gas production’, argues Odell. To read his appeal for a new oil and gas policy, click here.

The trouble with gas is that Britain already uses a lot of it and there are concerns that the nation will become overdependent on imports, as indigenous production from the North Sea continues to decline. Almost half of Britain’s electricity generation comes from gas-fired power stations and gas is widely used to heat homes and in industry. On the other hand, the nation does have a tremendous amount of gas import capacity in terms of interconnectors and LNG regas terminals. Is the government perhaps under-emphasising the role that gas could play in the fuel mix because of what some have described as ‘paranoia’ about dependence?

‘A prudent government will always look at what the possible risks and scenarios are,’ says Vaughan. ‘We have been used to having our own resident sources of gas on the UK continental shelf. We have seen that depleting rapidly and we expect to be importing somewhere between 60% and 75% of gas by 2020. To date the market has responded to this prospect and has invested in LNG regasification terminals and interconnectors. But there are two aspects to it. One is around the molecules: is there actually sufficient gas out there that we can get to come into the country? The other is price. Even if the molecules are there, the government has concerns about the impact of that on consumers and industry.’

Nuclear renaissance

Eon UK is one of the companies involved in the nuclear renaissance in this country. How confident is it that its nuclear plans will proceed as planned?
‘We are working very hard to ensure that the framework is in place and that everything we need is there to enable us to do that,’ says Vaughan. ‘Our own target is to have 6 GW of nuclear on the system and the target date for that is around 2025. That is what we intend to achieve.’

I remind her that the history of nuclear power in this country has not been a terribly happy one – and that if the renaissance is to be successful, Eon, EdF, RWE, Centrica and the others will have to break that trend.

What Eon has concluded is that the targets have created new considerations for investors in electricity generation that will challenge the existing market framework

‘There is a recognition in government of some of the things that have made nuclear difficult in the past,’ she replies. ‘For example, taking a design that has been approved elsewhere, and requiring lots of special UK tweaks of it, so that you end up with something that doesn’t look like anything that’s operating anywhere else. It was a long process to get people happy, which meant there were delays and delays and delays. Learning from that experience, the government is going through its generic-design-assessment process, which hopefully will sort that out. There is a clear will behind it, from both the main parties now. Together with our partner, RWE, we are hopeful and optimistic.’

UK opposition puts forward energy policy proposals

While Britain’s energy industry waits for the Labour government to launch its energy market assessment proposals this coming Wednesday, it has just had an opportunity to gain an insight into how the opposition is thinking: the Conservative Party launched its energy policy proposals last Friday.

Given that the UK faces an election within weeks, the result of which is unpredictable, the Conservative proposals will be scrutinised carefully. Of particular interest will be areas of overlap with the government’s proposals – not least because many believe the next election, expected in May, will lead to a hung parliament.

Setting out his proposals in a document entitled ‘Rebuilding security – Conservative energy policy for an uncertain world’, Conservative leader David Cameron accuses ministers in the Labour government of having ‘consistently ducked the task of reform’. This, he says, has left Britain with an ‘out-of-date’ energy policy ‘designed almost 30 years ago for a world in which Britain had an excess of generating capacity; in which we enjoyed the benefits of growing North Sea oil and gas production; and in which neither pollution nor climate change were the concerns they are today’.

The document – which states that ‘a Conservative Government will keep faith with the market, but will, where necessary, intervene decisively to safeguard our energy security’ – lists ‘12 key actions we will take to re-build Britain’s energy security’:

1. Ensure that Britain has a clear, consistent and stable energy policy
2. Establish a capacity guarantee in the electricity market
3. Establish a security guarantee for gas supply
4. Reform the Climate Change Levy to provide a floor price for carbon
5. Operate a streamlined planning process for large infrastructure investments
6. Facilitate nuclear power
7. Accelerate the demonstration of carbon capture and storage
8. Promote renewable energy
9. Revolutionise supply and demand by building an energy internet
10. Reduce demand by offering every household a Green Deal on energy efficiency
11. Electrify transport to reduce dependence on oil
12. Create a Green Investment Bank

There are, perhaps not surprisingly, large areas of overlap with current and proposed Labour policy, despite Cameron’s accusations, though some such policies differ in their detail.

Looking specifically at the carbon-price proposal, the Conservatives intend to reform the Climate Change Levy (CCL) by turning it into a revenue-neutral, rebateable carbon levy ‘that would act as a floor price for carbon in the energy sector’.

The CCL would be removed from the downstream supply of electricity to consumers and would instead be payable upstream on the carbon content of electricity when it is generated. The levy would be set at a rate determined by the Treasury, but power generators would be able to offset the costs of purchasing ETS allowances against their liability for the reformed CCL. The floor is set as follows: if the ETS price is at or above the level of the rebateable levy, no net charge would be payable; if the ETS is below this level, then the difference would be paid through the levy to the Treasury.

The policy document is accompanied by a green paper setting out the detail of the proposals, which will be the subject of consultation in coming weeks.