Use smart technology to cut peak demand rather than coal
4 March 2015
The Government’s electricity Capacity Market - designed to meet peaks in demand and help keep the lights on – could result in higher than necessary energy costs and emissions because its design has been skewed in favour of fossil fuel generating capacity rather than innovative new demand-side response technology, according to analysis by the Energy and Climate Change Committee.
- Report: Implementation of Electricity Market Reform
- Report: Implementation of Electricity Market Reform (PDF 661 KB)
- Inquiry: Implementation of Electricity Market Reform
- Energy and Climate Change Committee
Tim Yeo MP, Chair of the Energy & Climate Change Select Committee said:
"Every consumer in the country is currently subsidising spare electricity generating capacity that may only be used for a few hours each year. But smart technology has now made it possible to reduce unnecessary electricity demand at peak times, thereby reducing the number of polluting power stations that need to be switched on. This could mean we can reduce the total electricity generating capacity that has to be maintained in future, bringing down costs for consumers while enabling us to reduce consumption of fossil fuels.
Yet this promising new demand-side response technology has been disadvantaged in the auctions under the Government’s Capacity Market – meaning costs and emissions could be higher than necessary. Only a fraction of the £1 billion pounds that will be spent keeping the lights on through the Capacity Market will actually provide new capacity and just 0.4% will go on demand-side response – with most of the rest going to existing fossil fuel power stations, paying some of them to stand idle for much of the year. Nearly a fifth of the capacity contracts already awarded are going to highly polluting coal power stations."
The Department for Energy and Climate Change (DECC) has not provided a level playing field for so-called ‘demand-side response’ (DSR) providers in the Capacity Market. To avoid paying for carbon-intensive generation capacity that may not be needed in the future, the Committee says the Government should consider increasing the contract length of DSR capacity agreements.
The MPs also raise concerns about National Grid's potential conflict of interest in its role overseeing the Capacity Market as the main Delivery Body for the Government’s Electricity Market Reforms (EMR). Given its existing role as the System Operator and owner of the transmission network it has a commercial incentive to procure additional capacity when it recommends how much capacity the Secretary of State should procure. This conflict of interest must be urgently resolved.
Levy Control Framework
The report also argues that the way low-carbon energy investment is being implemented could be improved to deliver better value-for-money. It points out the proportion of the Levy Control Framework (LCF) – a mechanism which caps the amount Bill payers will pay for low-carbon energy investment – already allocated to early contracts for very expensive off-shore wind farms may preclude better value-for-money renewable energy projects winning contracts in later years. Uncertainty regarding the amount and accessibility of future LCF funds after 2021 may in due course deter energy investors. The Committee is therefore calling on the Government to publish annual rolling forward projections of the LCF so that developers are always able to look at least seven years ahead to make their investment decisions.
Committee Chair Tim Yeo MP added:
"The results of the first CfD auction for long term low-carbon contracts show that small companies or community energy projects are in danger of being shut out. The fact that the final strike prices were cheaper than the administrative price is a very positive result, but it casts further doubts over the value-for-money of the early contracts for renewables under the Levy Control Framework."
Small players and community energy projects, who may have more limited resources than larger counterparts, are potentially disadvantaged by the complexity of the process in awarding long-term contracts to supply low-carbon electricity. Small enterprises also face financial barriers in attempting to secure these Contracts for Difference (CfD). In particular, the timing of CfD allocation rounds–currently once a year–means that, after having invested large sums of money to meet prequalification criteria, unsuccessful applicants have to remain afloat for an entire year before being able to bid in the next auction for a chance to secure revenues for their projects.
DECC’s upcoming review on EMR should focus hard on the issues voiced by stakeholders and raised in the Committee’s report. In particular, it should focus on:
- The role of highly polluting coal and diesel fired power generation in the capacity market
- How to facilitate cheaper and cleaner demand-side solutions to keep the lights on
- How potential conflicts of interest with National Grid will be avoided or addressed
- How engagement with small players can be improved
Tim Yeo MP concluded:
"The Government deserves to be congratulated for meeting the challenging timetable of EMR implementation, but important concerns about coherence, value-for-money and market accessibility remain. As it stands, the Capacity Market and CfDs are in danger of pulling UK energy policy in opposite directions, rather than complementing each other."
Electricity Market Reform is enshrined in legislation in the Energy Act 2013.4 In order to bring forward the investment needed to meet the goals of EMR, the Act introduced two key mechanisms:
- Contracts-for-Difference (CfDs) provide long-term price stabilisation to low-carbon plant. The budget for these contracts falls within the Government's Levy Control Framework,5 and generators can compete for contracts in an annual auction
- The Capacity Market provides a regular retainer payment to reliable forms of capacity, in return for the capacity being available when the system is tight. Generation and demand-side providers can compete for capacity payments in an auction held four years ahead of the year in which capacity is expected to be delivered, followed by a second auction one year ahead, if more capacity is needed. The first delivery year is the winter of 2018-19 and the first Capacity Market auction took place in December 2014.
CfD expenditure is to be governed by the Levy Control Framework (LCF).The LCF places limits on the aggregate amount levied from consumers by energy suppliers to implement Government policy, so that DECC can achieve its fuel poverty, energy and climate change goals in a way that minimises the impact on consumers. In its current form the LCF will support electricity policies to 2020–21. The level of the cap on spending under the LCF in 2011–12 was £2 billion, and will rise to £7.6bn in 2020—21 (in 2011–12 prices).
National Grid took on responsibility as the main delivery body for Electricity Market Reform in August 2014. Its role includes:
- Carrying out analyses to inform Ministers' decisions, including the level of support for CfDs and how much capacity to procure in the Capacity Market auctions.
- Administering both CfDs and the Capacity Market, establishing whether projects meet eligibility criteria to receive CfDs and running auctions for both mechanisms.