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UK Electricity Market Reform and the Energy Transition: Emerging Lessons

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UK Electricity Market Reform and the Energy Transition: Emerging Lessons Michael Grubb Professor of International Energy and Climate Change Policy, UCL & Chair, UK Panel of Technical Experts, Electricity Market Reform and David Newbery Emeritus Professor & Director, EPRG, University of Cambridge * 1 About the Authors Michael Grubb is Professor of Energy and Climate Change at University College London (Institute of Sustainable Resources & Energy Institute). From 2011-2016, alongside academic roles, he worked half-time at the UK Office of Gas and Electricity Markets (the energy regulator, Ofgem), initially as Senior Advisor, Sustainable Energy Policy, and subsequently Senior Advisor, Improving Regulation. From Autumn 2016 he moved to Chair the UK government’s Panel of Technical Experts on Electricity Market Reform. He has combined research and applied roles for many years, bringing research insights into policymaking, and bringing practical experience to bear upon academic studies: before taking up his post at UCL he was part-time Senior Research Associate in Economics at Cambridge University, combined with (prior to joining Ofgem) Chief Economist at the Carbon Trust. Professor Grubb is author of eight books and, sixty journal research articles, and numerous other publications. His most recent book, Planetary Economics: energy, climate change and the Three Domains of Sustainable Development (Routledge 2014), brought together insights from 25 years of research and implementation of energy and climate policies. He was also founding Editor-in-Chief of the journal Climate Policy, and from 2008-11 served on the UK Climate Change Committee, established under the UK Climate Change Act to advise the government on future carbon budgets and to report to Parliament on their implementation. Professor David Newbery, CBE, FBA, is the Director of the Cambridge Energy Policy Research Group and Emeritus Professor of Applied Economics at the University of Cambridge. In 2013 he was President of the International Association of Energy Economists. He has managed research projects on utility privatisation and regulation, electricity restructuring and market design, transmission access pricing and has active research on market integration, transmission planning and finance, climate change policies, the design of energy policy and energy taxation Occasional economic advisor to Ofgem, former chairman of the Dutch Electricity Market Surveillance Committee, member of the Panel of Technical Experts offering quality assurance on the delivery of the UK’s Electricity Market Reform (2014-16). He is currently an independent member of the Single Electricity Market Committee of the island of Ireland and a panel member of Ofgem’s Network Innovation Competition. Professor Newbery is author of eight books, over one hundred and thirty research articles and numerous other publications. His book, Privatization, Restructuring and Regulation of Network Utilities, published by MIT press provides a definitive empirical cross-country study of de-regulation, liberalization and privatization in electricity, telecoms and gas to assess how structural reforms can enhance productivity. Both the authors are writing in their independent academic capacities, and drawing only on published materials. 2 Contents Summary ...................................................................................................................................................... 4 1. Introduction: ‘Model or Warning?’ ...................................................................................................... 6 2. UK Electricity in context ....................................................................................................................... 6 2.1 The evolution of the UK electricity supply industry – the origins ...................................................... 6 2.2 The electricity industry structure 1990-2001: the pool and the dash-for-gas ................................... 8 2.3 The electricity industry structure after 2001 .............................................................................. 10 2.4 Electricity demand and tthe retail market ....................................................................................... 11 3. The intellectual and political evolution of UK Electricity Market Reform .......................................... 13 4. A four legged beast? The EMR package ............................................................................................ 17 5. Results to date .................................................................................................................................... 22 5.1 CfD Allocation and Auctions ....................................................................................................... 22 5.2 Capacity Market ......................................................................................................................... 26 5.3 Carbon price floor and emissions performance standard ................................................................ 33 6. Popular caricature: “Return of the ‘Central Electricity Generating Board’?” ..................................... 36 7. Conclusions: the collapse of coal, lessons of contracting and future challenges ................................... 38 References .................................................................................................................................................. 41 Data appendix: Notes on construction of electricity bills .......................................................................... 43 Figure 1: UK electricity generation by fuel, 1970-2016 ............................................................................... 7 Figure 2: UK electricity consumption by end use ....................................................................................... 11 Figure 3 Real Industrial and domestic bills for standardized consumption level ....................................... 12 Figure 4 The four pillars of UK Electricity Market Reform .......................................................................... 18 Figure 5: Carbon price support, as seen by the UK Treasury in initial development of the EMR .............. 18 Figure 6: Structure of the Contracts-for-Difference ................................................................................... 20 Figure 7 Growth of renewable electricity generation in EU countries since 2005 .................................... 25 Figure 8 UK offshore wind cost reduction across allocation and auction rounds ..................................... 26 Figure 9: Results of main capacity (four-year ahead) auctions .................................................................. 29 Figure 10: New capacity in the Capacity market, bids and approved, 2014-2016 ..................................... 30 Figure 12 GB wholesale electricity price and the cost of generation, 2007-17 at 2011/12 prices ............. 34 Figure 11 Carbon Price Support and impact on coal generation, 2012-2017 (Q2) .................................... 35 Figure 13 UK quarterly electricity generation by fuel type, 1997-2017 ..................................................... 38 Box 1: Pricing and capacity payment in the Electricity Pool ........................................................................ 9 Box 2: The history of UK renewables policy before EMR .......................................................................... 16 Box 3 The (almost) ‘most expensive object on the planet?’ – the hinkley Point C nuclear contract ........ 23 Box 4 Transmission charging and ‘embedded benefits’ in the Capacity Mechanism ................................ 32 3 Summary Until 1990, the UK - like many other countries - had an electricity system that was centralised, state- owned, and dominated almost entirely by coal and nuclear power generation. The privatisation of the system that year and its creation of a competitive electricity market attracted global interest, helping to set a path which many have followed. Two decades later, however, the UK government embarked on a radical reform which some critics described as a return to central planning. The UK's Electricity Market Reform (EMR), enacted in 2013, has correspondingly been a topic of intense debate, and global interest in the motivations, components, and consequences. This report summarises the evolution of UK electricity policy since 1990 and explains the EMR in context: its origins, rationales, characteristics, and results to date. We explain why the EMR is a consequence of fundamental and growing problems with the form of liberalisation adopted, particularly after 2000, combined with the growing imperative to maintain system security and cut CO2 emissions, whilst delivering affordable electricity prices. The fifteen years after privatisation, coinciding with the era of low fossil fuel prices, had seen mostly falling electricity bills; from about 2004 they started to rise sharply, for multiple reasons including increasing fossil fuel prices, the need for new investment in both generation and transmission, and inefficient renewables policies. The four instruments of the EMR have indeed combined to revolutionise the sector; they have also both drawn on, and helped to spur, a period of unprecedented technological and structural change. Competitive auctions for both firm capacity and renewable energy have seen prices far lower than predicted, with the fixed-price auctions for renewable sources estimated to save
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