The UK Energy Bill: High Risk, High Reward, and Anything but Boring

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With the UK Government’s Energy Bill to be introduced to Parliament this week, GlobalData latest release looks into its potential effects on pricing and energy security.

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It is far too simplistic to simply add £7.6 billion on top of current bills to calculate the impact by 2020

The key measure of the UK’s new Energy Bill will be to introduce a government-owned entity that will buy electricity at an agreed “strike price” from low carbon generators and recover the costs from electricity customers via electricity suppliers. The government-owned entity will buy the electricity under a contracts-for-difference mechanism feed-in-tariff (CfD FiT) that will top-up revenues for low carbon generators if the wholesale electricity price is below the strike price and claw back revenue if wholesale prices rise above the strike price. The CfD FiT scheme will replace the Renewables Obligation (RO) although the two will run in parallel from 2014 until 2017.

The amount of spending to support low carbon generation, through both the RO and the CfD FiT scheme, will be capped under the Levy Control Framework (LCF).The government has already announced that the LCF budget will grow from £2 billion in 2012 to £7.6 billion in 2020 in real terms, or £9.8 billion, accounting for inflation.

In the business intelligence firm's latest insight, Jonathan Lane, Head of Consulting for Power and Utilities at GlobalData, questions the feasibility of calculating what impact the measures will have on consumer bills: “It is far too simplistic to simply add £7.6 billion on top of current bills in order to calculate the impact by 2020.”

Lane says four unknowns make this calculation misleading:

1.         What fossil fuel, particularly natural gas, prices will be in 2020;
2.         How much electricity the LCF will be able to buy;
3.         What impact energy efficiency measures such as the Green Deal and the Energy Company Obligation (ECO) will have on overall demand;
4.         The impact electrification policies such as the Renewable Heat Incentive (RHI) and support for electric vehicles will have on both electricity and gas demand.

Lane warns that the government and consumer groups should be careful about how they portray the impact on bills as they could go up, down, or stay the same:

“For low carbon generators the policy is largely very positive but significant risks remain. The government would ideally like competition to set the strike price. This approach has worked successfully in, for example, Brazil where the government has an annual auction amongst developers to meet anticipated electricity demand growth for three and five years hence.”

However, Brazil has targeted its auctions at mature technologies – onshore wind and CCGT – whereas the UK will be targeting generation technologies with more cost uncertainty, such as nuclear and offshore wind.

Lane continues: “The UK government is very keen to encourage nuclear new build for baseload, low carbon generation and is likely to look to reserve CfD’s for nuclear new build. Therefore, unless the government is willing to authorise large step changes in the LCF budget post-2020 to account for new nuclear plants opening, it may transpire that the entire budget cannot be used before 2020.”

The government aims to agree strike prices by the middle of 2013, and have contracts signed from 2014, so there is still time to address these challenges.

GlobalData would recommend the inclusion of price re-opener clauses in the contracts, like those seen in long-term, oil-indexed gas import contracts, in order to protect both parties from unforeseen developments that could result from the interaction of so many policy initiatives.”

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Kevin McHugh
GlobalData
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