arianna tozzi emr report

8/11/2019 Arianna Tozzi EMR Report

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6/12/2013

Internship Report | Arianna Tozzi | Student number: 42266984

ABSOLUTE

INVESTMENT

PARTNERS

ELECTRICITY MARKET REFORM IN THE UKPOLICY ASSESSMENT

Company Supervisor : Nick Koidl | Managing Director at Absolute Investment Partners

University Supervisor: Linda Kamp | Technical University of Delft | TBM Faculty


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Summary

1. Introduction ................................................................................................................................................... 4

2. Renewable Energy policy in the UK ............................................................................................................... 6

2.1 Feed-In-Tariff and Renewable Obligation Certificates ............................................................................ 72.2 Transition towards the Electricity Market Reform .................................................................................. 8

3. The Electricity Market Reform ....................................................................................................................... 9

3.1 Contract For Difference ........................................................................................................................... 9

3.1.1 Working principle ........................................................................................................................... 10

3.1.2 Eligibility criteria and Allocation method ....................................................................................... 11

First Come First Served ............................................................................................................................ 13

Unconstrained Allocation Rounds ........................................................................................................... 13

Constrained allocation rounds ................................................................................................................ 13

3.1.3 From the allocation of a contract to project construction and energy delivery ............................ 14

4. Research results ....................................................................................................................................... 15

4.1 Why is a reform needed and what are the main changing introduced with respect to the previous

mechanism .................................................................................................................................................. 15

4.2 Consultation process ............................................................................................................................. 16

4.3 Transition process.................................................................................................................................. 17

4.4 The Pay-When-Paid principle.............................................................................................................. 17

4.5 Eligibility and allocation methodology issue ......................................................................................... 17

4.6 Strike Price setting and Digression ........................................................................................................ 18

4.7 Power Purchase Agreement .................................................................................................................. 19

4.8 Subsidizing nuclear energy .................................................................................................................... 21

4.9 Exemption of Energy Intensive Industries (EIIs) from CfDs costs .......................................................... 22

1A- Compensation mirror: ....................................................................................................................... 23

1B-Reduced Exemption Level: ................................................................................................................. 23

2A- Wider eligibility: ................................................................................................................................ 23

2B- Compensation plus a taper for additional sectors: ........................................................................... 23

4.10 State Aid measures and the EMR in the EU prospective ..................................................................... 24

5.Conclusions ................................................................................................................................................... 26

Appendix .......................................................................................................................................................... 29

Feed in Tariff- Generation Tariff level from April 2013 .............................................................................. 29

Renewable Obligation banding level 2013/2017 ........................................................................................ 30

Draft Strike Price for available technologies ............................................................................................... 31

List of relevant Organizations and People interviewed for the report. ..................................................... 31


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Organizations: .......................................................................................................................................... 31

People: ..................................................................................................................................................... 32

Interviews .................................................................................................................................................... 33

Tim Warham - Senior policy Adviser at the Department of Energy and Climate change- 10-10-13 ...... 33

David Handley- Chief Economist at RES- 15-10-13 .................................................................................. 35

Keith MacLean- Director of Policy and Research at SSE and Board Member of European Wind Energy

Association- 29-10-13 ............................................................................................................................. 37

Srinivasan KavitaStrike price setting and digression specialist at the CCC- 5- 11-13 ......................... 39

Jenny Hill- Exemption of Energy Intensive Industries from low carbon levy specialist at the CCC- 15-11-

13 ............................................................................................................................................................. 42

Malcom Keay -Senior Research Fellow at Oxford Institute of Energy Studies ........................................ 43

Stewart Jamie- Deputy editor at ICIS and electricity market expert- 20-11-13 ...................................... 46Bibliography ..................................................................................................................................................... 49


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SummaryIn order to be competitive with common carbon derived energy sources, low carbon technologies still highly

need effective energy policies to be implemented at national level. The British government is actively trying to

reach this goal by implementing the Electricity Market Reform, a new low carbon policy scheme that will

substitute the current subsidy regime from mid 2014. The reform aims at boosting renewable energy

electricity generation, together with nuclear power and carbon capture and storage, by means of a new

supporting mechanism known and Feed-In Tariff with Contract For Difference (CfD). This scheme offers a 15

years fixed revenue for the above mentioned low carbon categories at a fixed level set by the government and

known as the strike price. In contrast with all the previous mechanisms, CfDs offer a subsidy payment that is

function of the relative difference between the spotted market reference price and the strike price.

This report will analyse in depth the proposed CfD mechanism in order to assess the effectiveness of the

scheme in bringing forward the future decarbonization goals in the British electricity system. In order to

answer this question, deep desk researches together with a series of interviews with relevant people actively

involved in the EMR have been organized. The desk research has been used as a preliminary study to identify

and understand the main changings introduced by the reform, the main controverted points of the reform and

the most relevant involved parts. A series of interviews has subsequently been arranged with the selected

stakeholders and governmental bodies. This process aimed at discussing more into details core and more

controverted topics of the EMR in order to deeply understand the opinions of all the involved parts. The

interviewed stakeholders are: Tim Warham, senior policy adviser at the Department of Energy and Climate

Change; David Handley, Chief Economist at Renewable Energy Solutions; Keith MacLean, Director of Policy and

Research at SSE; Srinivasan Kavita, Strike price setting and digression specialist at the Committee on ClimateChange; Jenny Hill, expert in Exemption of Energy Intensive Industries from low carbon levy at the CCC;

Malcom Keay , Senior Research Fellow at Oxford Institute of Energy Studies and Stewart Jamie, Deputy editor

at ICIS and electricity market expert. By tailoring the questions each time according to the area of expertise

and competence of the interviewee; a wider picture of the effect of the new policy has been drawn.

By examining the results of the desk research and of the field interviews, conclusions on the proposed CfD

have been drawn. With no doubts, there are few weaknesses in the proposed mechanism and in the way it has

been implemented. Firstly, the lack of a clear timetable with regards to the dates of publication of final strike

price level, together with an unclear final date on when the proposed EMR will effectively become active

created a climate of uncertainty among stakeholders. Uncertainty has also been encouraged by the lack ofspecific guidelines on the contract allocation method and by the uncertainty that every eligible projects will

get accredited for a CfD. On the other hand however, the reform has all the potential to efficiently drive the

required technological development and cost reduction among renewable technologies. This will be done by

encouraging early competition and by making use of an effective and wide spread consulting process with

regards to many of the major points of the contracts. Moreover, the certainty of long-term revenues offered

within the CfD framework and the ability to sell the electricity to the grid at a higher price with respect to the

previous mechanism, will help creating the right initial environment that is needed encourage projects at an

early stage of the reform. The Government should however speed up the decision making process and clarify

all the final details of the reform as soon as possible in order to dissipate the uncertainty climate surrounding

the above mentionedaspects of the reform.


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1. IntroductionIncreasing energy demand is posing a serious dilemma for those responsible for security of supply and

worldwide decarbonization targets. On one hand the increase in population and expected standard of living

is posing difficulties to the security of supply. On the other hand increasing carbon emissions resulting from

disproportionate energy consumption produced via fossil fuels is threatening the environment we are living

in and is posing challenging carbon reduction goals to industries. In order to be able to match these

opposing needs, the current fossil fuel use must be drastically reduced and gradually replaced by green-low

carbon power generation. To drive the required energy revolution, technological development together

with cost reduction for renewable technologies should be achieved through a substantial increase in

installed capacity. This process needs to be supported by the government by means of the implementation

of policies that aim at creating the right environment for low carbon generation.

Even though some renewable technologies, such as wind or solar, are now well developed and have

reached grid parity in some EU locations (Theenergycollective, 2013), subsidies are still needed due to the

characteristic high capital and low operational costs these technologies face. This is in contrast with fossilfuel generation which tends to have relatively low capital costs and high operational costs.(DECC, 2013a)

Since the current electricity market was shaped in an environment where fossil fuel plants predominantly

ruled the energy scene, the price of electricity is strictly correlated with the cost of fossil fuel plants. Low

carbon technology is considered as non-price setting and it is therefore more exposed to volatility in

electricity wholesale price resulting from fossil fuel price variation in the market. A government

intervention in the electricity market is therefore aimed at assuring a certain fixed level of income for low

carbon investments that would limit uncertainty of revenues.

Most of the European states have a governmental incentive scheme in place to help countries meeting

carbon reduction targets dictated by the European Union. This report will analyze in details energy policiesin the United Kingdom and will assess the effect low carbon subsidies are having on the national energy

sector. The particular interest in the British energy legislation is due to the imminent implementation for an

energy reform called the Electricity Market Reform (EMR) that will drastically change the existing low

carbon incentives system.

The main research question this assessment will answer is:

How effective will the EMR be in efficiently decarbonizing the British electricity sector?

In order to answer this question the following sub questions have been formulated:

Why was an electricity market reform needed and what are the main changings introduced with

respect to the previous supporting scheme?

What are the main strength and weaknesses of the proposed reform?

How will revenues for renewable energy investments change after the implementation of the

reform?

How does the EMR fit within the European Union legislation and how effective it is to efficiently

meet the 2020 decarbonization targets?

In order to answer these questions the opinions of various experts on the UK electricity market and

renewable energy policies have been collected by means of interviews conducted on the phone or inperson where interviewees answered specific questions each time tailored to their area of expertise. In

order to select the most relevant stakeholders, an initial detailed desk research has been performed mainly


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on the Internetvia government and energy supplier websites as well as energy related debate platform -

and by collecting informative leaflets, booklets, by studying the consultation process and drafts of the

reform published periodically by the government. This first initial theoretical background helped building a

deep knowledge on the previous and on the proposed future supporting scheme and to identify the main

differences, challenges and controverted issues surrounding the EMR. With this in mind, the involved

stakeholders have been identified via the initial desk research and by participating to a series of

conferences on the topic. The selected people have then been contacted via e-mail in order check their

availability to take part of this survey. Some of the contacted people were unfortunately too busy and

therefore have not been able to take part to the assessment. The response has however been really

encouraging and all the main topics of interest have successfully been covered with relevant experts. While

performing the assessment, the following people have been interviewed: Tim Warham, senior policy

adviser at the Department of Energy and Climate Change; David Handley, Chief Economist at Renewable

Energy Solutions; Keith MacLean, Director of Policy and Research at SSE; Srinivasan Kavita, Strike price

setting and digression specialist at the Committee on Climate Change, Jenny Hill, expert in Exemption of

Energy Intensive Industries from low carbon levy at the CCC, Malcom Keay -Senior Research Fellow atOxford Institute of Energy Studies and Stewart Jamie- Deputy editor at ICIS and electricity market expert.

The collected responses have subsequently been analyzed and divided into main topics of discussions in

order to give an organic and extensive overview on how the EMR is perceived by all the involved parts.

The following section of the report will give the reader a wide overview on the low carbon energy policy in

the UK and on how the current supporting scheme works. The third chapter will analyze more into details

the proposed Electricity Market Reform with a particular focus on the Contract for Difference supporting

scheme that will effectively substitute the current regime from mid 2014. The fourth and last section will

present the research outcome divided into ten different sub-sections. Each sub-section analyzes one

different aspect of the reform that has been considered as crucial and of particular interest to assure asuccessful implementation of the reform. In the conclusion section, each of the above-mentioned sub-

questions will be answered in order to finally assess whether the proposed EMR will create the right

environment to push forward the decarbonization process of the electricity sector in the UK.

2. Renewable Energy policy in the UKLooking at the European legislation, there is a common intent to increase low carbon production up to 20%

before 2020. (European Commission, 2009) Each member state can adopt the most consistent regulation to

achieve this goal on time. The specific UK carbon reduction target corresponds to meet at least 15% of thenational energy demand by means of green energy generation.(European Commission, 2009) In order to

achieve this target the UK government has set a series of legislations throughout the past decade that

boosted the percentage of electricity derived from renewable sources from 5.6 % in 2008 to 11.3 % in

2012.(DECC, 2013). Currently Great Britain adopts a combined supporting scheme for low carbon

generation, which makes use of a combined fixed Feed in Tariff (FiT) and Quota system for respectively

small and bigger size installations. Renewable developments up to 5MW could benefit from a fixed feed in

tariff mechanism whereas installation larger that 5MW can alternatively opt for one of the two options- FiT

or tradable Quotas. (Uk government, 2013) . In order for a generator to effectively receive one of those

subsidies; an application must be submitted to Ofgemto get an eligibility certificate in which the level of

support is also clearly specified.

In the following chapter a brief overview on the current supporting scheme will be given.


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2.1 Feed-In-Tariff and Renewable Obligation Certificates

In April 2010 the government launched the FiT scheme to encourage hauseholds and businesses to

generate their own low-carbon electricity. The FiT scheme is an obligation for certain licensed electricity

supplier to make pre-determined tariff payments to developers for generation and export of low carbon

electricity.(Ofgem, 2013) Therefore as a renewable energy generator you are assured the electricity

produced by your installation will receive a certain fixed income for a period of 20 years. The UK FiT system

is a fixed tariff; meaning that once the generation tariff has been determined according to your

application date, it will be guaranteed for a 20 years period and will only change in accordance to the Retail

Price Index (RPI) to reflect inflation. However, since most renewable energy technologies are expected to

get cheaper over time, a baseline digression for new applicants is used to ensure that resources are

efficiently allocated without overcompensating investments. The extent of digression is technology specific

and is periodically revised in order to better reflect current levels of development.

Effectively, the income received under this subsidy scheme is made of two different components:

Generation tariff

Export tariff

The generation tariff represents the main element of the FiT income and consists of a fixed payment per

kWh produced, irrespective whether you feed electricity into the grid or use it yourself. The actual level of

generation tariff depends on the renewable technology in use and on the size of the installation. Obviously,

the larger the installation and the more mature a technology is; the lower the generation tariff. The current

technology specific generation tariffs are available in Appendix. On top of this, generators will also get an

extra payment for the electricity they export to the grid, which corresponds to a bonus payment for every

kWh sold to the energy supplier. The export tariff has been implemented to provide an additional bonus for

energy efficient generators. There is a minimum floor price for this payment, which is set by the

government and currently corresponds to 4.64p/kWh. (DECC, 2013c) Each generator can either take this

floor price as export tariff or negotiate a more convenient one by signing a Power Purchase Agreement

with trusted rated suppliers. PPAs are effectively contracts signed by both energy generator and purchaser

in which the price at which the electricity will be sold for a fixed period of time is determined. On top of

this, the Levy Exemption Certificates (LEC) exempt renewable generators from the climate change levy

therefore adding an additional net profit. The overall cost of this scheme is borne by the electricitysuppliers that will then pass on the costs onto consumers.

Projects exceeding 5 MW can choose to either benefit of FiT or opt for the so-called Renewables

Obligation which effectively consists of tradable quota permit. The ROs are the main supporting

mechanism currently in use for large-scale green projects in the UK since 2002. The working principle of RO

is as follows: on one side an obligation is placed on electricity suppliers to source an increasing portion of

the supplied electricity from green sources. On the other hand, Renewable Obligation Certificates (ROCs)

are issued by Ofgem to eligible green energy electricity generators according to the technology they use.

Generators can then trade their ROCs in the market with other partieseither suppliers or other generators.

Ultimately, the ROCs purchased by the suppliers are presented back to Ofgem to demonstrate theircompliance with the Obligation. In case a supplier does not present enough ROCs with respect to the


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obligation issued, a penalty corresponding to the so called buy-out-price must be paid to Ofgemthat

collects and divides the return among those suppliers that presented enough ROCs.(DECC, 2012a)

The number of ROCs issued to each generator varies with the type of technology in use and the amount of

green electricity produced.(DECC, 2013d). The variation in number of ROCs received between technologies

reflects the difference between the level of development and costs of each technology: the moreROC/MWh received, the more costly a technology is, and the greater the level of support. Whereas the

level of supplier obligation increases with time to reflect the decarbonization target, the level of ROC/MWh

steadily decreases throughout the years to reflect cost reduction and learning processes among

stakeholders. The ROCs levels are revised every four years and published on the DECC webpage. The RO

banding for each technology for the period between 2013 and 2014 is available in the Appendix.

The RO supporting mechanism offers an additional payment on top of the wholesale market electricity

price, which corresponds to the market price for certificates. This payment is therefore not fixed- as in the

case of the FiT- but varies accordingly to the price of the ROC in the obligation market and strictly depends

on the negotiation between the supplier and the generator. For the government purposes, the value of aROC is calculated as a 10% increase in the buy-out-price which currently corresponds to 45/ROC.(DECC,

2013d) Each October the overall obligation level is published by the government and expressed as number

of ROCs/MWh (for the year 2013/2014 it was set as 0.206 ROCs/MWh). According to this value, each

supplier obligation is calculated by simply multiplying this value by the total electricity production. In order

to guarantee there will always be a market for the certificates, Ofgem uses a fixed 10% headroom between

obligation and certificates, the headroom works by providing a set margin between supplier and demand

for ROC. In this way generators are assured they will receive a suitable profit and the ROCs price itself is

adequately stabilized.

As in the case of FiT it is assumed that suppliers will pass the costs of the scheme onto consumers. It has

been estimated that the average price of RO scheme per households in 2012 has been of 30.(DECC,

2013d)

2.2 Transition towards the Electricity Market Reform

Generators have until the 31st

of March 2017 to choose between the RO and the new Contract for

Difference subsidy scheme. From the 1st

April 2017, generators will not be allowed to apply for the RO

scheme anymore and only the new CfD subsidy scheme will be available for large-scale generation. (DECC,

2013e) The government will however guarantee that for a period of 20 years till the 31st

of March 2037-

there will be a market for ROCs. The transition period after 2017 will probably be held in two phases: a first

phase that runs till 2027 and a second phase that will carry on till the last RO expires in 2037. (Ceeney,

2013) Regarding the period between 2017 and 2027; the government plans to simply adapt the current RO

system by fixing a higher headroom between supply and demand for certificates thus ensuring that

demand for ROCs will continue. This will continue until 2027 when there will only be few projects under RO

and therefore it will no longer be possible to guarantee a market for certificates. In this view the

government is planning to switch to a Premium-FiT system, which will fix the price for the remaining ROCs

for the following 10 years. The commitment of effectively grandfathering RO projects for the last 10 years

seems to convince investors and therefore there is confidence that the RO will efficiently operate

throughout the entire lifetime.(Keith MacLEan, 2013a) A public consultation is however going on with

regards to the RO transition and will be published shortly with the definite outline of the transition

method.(DECC, 2013e)


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3. The Electricity Market ReformThis chapter will explore the details and characteristics of the proposed Electricity Market Reform that will

be implemented in mid 2014 that will drive the UK electricity market to meet the 2020 decarbonization

target.

The challenges the government is encountering with regards to energy and climate change and that are

addressed in the EMR are threefold:

Maintain security of supply for future generations which is currently being challenged by a drastic

increase in electricity demand

Meet climate change target and lower carbon emission by changing the current energy mix

Minimize the costs of the transition for consumers

In order to meet these goals in time and to better direct the UK electricity sector towards the

decarbonization target, the UK government designed the Electricity Market Reform (EMR) in November

2012 with the aim of attracting investments and supporting employment in the low carbon sector. It isestimated that the reform will attract 110 billion investments and will create up to 250,000 new jobs in

the next decade. (DECC, 2012b) The reform is currently under consideration and is being revised by the

government to introduce final improvements and measures before it will effectively become a law in mid

2014.

The major market mechanisms that will become active with the reform are respectively:

Capacity market: payments for reliable capacity that is available when needed and that therefore

helps covering base load at all times.

Feed-in Tariffs with Contract for Difference (FiT-CfDs) : long term contracts that provides securerevenues for low carbon generation such as renewable energy, nuclear power and Carbon Capture

and Storage

These mechanisms will be supported by:

The Carbon Price Floor: a fixed tax for carbon emission.

The Emission Performance Standard: a regulatory measure which provides a maximum limit for

emissions from power stations

While it is the government role to design the policy and set the goals for the reform, the National Grid on

behalf of the EMR Delivery Body will administer the mechanism in its details by considering eligibility

criteria for generators and allocation rules. Finally, Ofgem will supervise that the delivery body carries out

duties efficiently and cost effectively.

3.1 Contract For Difference

This report will mainly focus on the FiT-CfDs supporting scheme that will be introduced within the EMR in

mid 2014. The other measures mentioned above will therefore not be directly considered in this review

since they do not constitute a major changing with respect to the previous regime and therefore do not

constitute a major concern for green energy stakeholders. With regards of the CfD regime, the following

sections will analyze in details the working principle of the CfD mechanism with respect to the payment

method for low carbon generation, eligibility criteria and allocation methodology for a contract.


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3.1.1 Working principle

As previously mentioned CfDs will substitute the current RO regime for big scale low carbon generation

including renewable, nuclear and CCS.CfDs effectively consist of a 15 years contract between low carbon

generators and the so-called CfD Counterparty and will offer renewable energy investments a feed in

premium with a variable premium. Meaning that renewable energy generators will get revenues by selling

electricity to the grid as usual and, on top of this, they will receive a top-up payment, which varies with

wholesale prices. The additional payment is calculated as the difference between a pre-agreed strike price

and a market reference price. The cash flow can go in two different directions depending on the mutual

difference between the strike and reference price. In case the strike price is higher than the reference price

the generator gets paid, otherwise the generator needs to pay the consumers back by the same amount.

Figure 1 CfD working principle(DECC, 2012b)

The strike price represents the estimated cost related to investing in a particular technology, it is adjustedon an annual basis and it is linked to the Consumer Price Index (CPI) in order to reflect inflation. The final

strike prices should be published in December 2013; at the moment only a draft is available which does not

include prices for nuclear nor CCS - see Appendix for the complete table.

Table 1 Draft strike price for most important renewable energy technologies. Values in the table below refers to /MWh. (DECC,

2013f)

Technology 2014/2015 2015/2016 2016/2017 2017/2018 2018/2019

Solar PV 125 125 120 115 110

Onshore wind 100 100 100 95 95

Offshore wind 155 155 150 140 135

The reference price is the estimated value of the market price for electricity. In order to set revenues for

low carbon technologies at the right level, reference price calculations should match as much as possible an

achievable sale price of electricity for low carbon generation. In case reference price estimation is not

accurate, CfDs strike prices would need to be increased to reflect any risks in significant shortfalls. The

estimation of the reference price is calculated differently for base load and intermittent technologies. In

case of base load, such as nuclear or biomass, it is set as a season ahead price whereas for intermittent

technology such as most of renewable it is set as a hourly day ahead price. (DECC, 2012c)

By looking at the exact capacity covered by CfDs, it is still under discussion whether the 5MW threshold for

FiT will be maintained or if it will be increased. Regardless, this is a controversial topic that will be finally


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decided on a later stage this year. In the case the threshold will be increased up to 10 MW- as some

generators wishes (The Clean Energy Forum, 2013)- most of the projects will benefit from the old fixed FiT

and the reform will effectively fail to deliver the required cost reduction. It is therefore more likely that the

5MW level will not be changed. (Handley David, 2013a)

As mentioned before, CfDs effectively consist of contracts signed by two parts: low carbon generators andthe so called CfD Counterparty. Low carbon generators must meet certain eligibility criteria that will be

assessed by the Delivery Bodyand that will assure that the site under consideration will deliver a certain

capacity within a certain time and that it will be capable of bearing reverse payment costs. The other

subscriber of the contract is the so-called CfD Counterpartywhich is a government owned limited liability

company that administer payments scheme to and from generators. The government will therefore not be

a signatory of the contract or have any obligation under it. The payments to generators are made by the

Counterparty, which in turn receives funds from electricity suppliers by mean of the Supplier Obligation.

(DECC, 2013g) The intention is to impose equal obligations on UK suppliers in relation to their market

share; money raised by means of these obligations will be paid to the Counterparty and will then be used to

meet the contract terms with generators. In order to give confidence to low carbon investors, Supplier

Obligations must be designed in a way that ensures the Counterparty will be able to meet payments to

generators without negatively affect suppliers and consumers. In this view a number of mechanisms, also

known as backstops, will be implemented to ensure that generators will get payments in the event of

suppliersfinancial issues. As will be described later in this report, security of payments between generators

and counterparty is still a controversial topic that is raising fierce discussion among stakeholders and it

therefore need to be carefully addressed in future stages of the reform.

The figure presented below is a schematization of the involved parts and their interactions with regards of

the CfD mechanism.

Figure 2 Key institutional and legislative framework(DECC, 2012c)

3.1.2 Eligibility criteria and Allocation method

As previously stated, it will be the National Grid on behalf of the Delivery Body to administer eligibility

criteria and allocation methodology. In order to be eligible to get a contract the developer will need to

provide evidence that a number of eligibility criteria have been met before the Delivery Body allows a

project to enter a contract with the Counterparty. Besides the 5MW capacity threshold, the two more


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stringent requirements for meeting eligibility criteria for a CfD are: having planning permission approval

from the council for construction and having accepted the grid connection offer- meaning the grid quote

letter from the Distribution Network Operator must be signed and the initial deposit paid. Additionally,

since developers must pay the Counterparty back in case the strike price is lower than the market reference

price, minimum financial bankability requirements for the generators are required to assure its ability to

handle payments under any scenario.(DECC, 2013h) More details on the financial requirements will be

published later this year.

Once the eligibility criteria are met, the site must go through the allocation process to assure a valid

contract with the Counterparty. The total budget available for CfDs will be set within the Levy Control

Framework (LCF) and it will increase over time reaching 7.6 billion pounds in 2020. The LCF in fact fixes the

maximum cap that can be taken from consumers as a tax for energy regulation; it therefore protects

consumers from excessive levies. As noticeable from the table below there is no specific budget allocated

for each technology; this might in turn raise questions on whether or not renewables are ready to compete

with more mature technologies such as nuclear within the same budget. It might be appropriate implement

a minima to ensure that technologies at an early stage of development will effectively receive contracts and

will not be suffocated by the huge capacity of nuclear or offshore wind. This eventuality is under

consideration and subject to public consultation. The final decision is expected to be published along with

final strike price in December. (DECC, 2013h)

Table 2 Levy control Framework expressed in bn

2014/15 2015/16 2016/17 2017/18 2018/19 2019/20 2020/21

3.3 4.3 4.9 5.6 6.45 7 7.6

Effectively the allocation process will be held in three different stages:

First-Come-First-Served:

Unconstrained allocation rounds

Constrained allocation rounds

The reason why the government designed three different stages for the allocation process is to closely

follow and efficiently encourage low carbon generation in reaching its complete maturity. Each of the

phases in fact reflects different stage of the development and therefore different competition

requirements between technologies. In the first two phases, the strike prices for each technology will be

set administratively, meaning set by the government and published well in advance. This will allow a

moderate competition between technologies but with no alteration of the final revenues, which is

determined by a pre-agreed strike price. It is likely that in the initial phase a certain minimum number of

contracts will be allocated to more niche technologies in order to facilitate their development that would

in other ways be hindered by more mature technologies such as nuclear wind and solar, the

implementation of this mechanism is still under consideration. The Government has however stated its

clear intention to move to a more competitive price setting as soon as practicable to effectively integrate

low carbon technologies in the wide electricity market.(DECC, 2013h)

The picture below summarizes the characteristics of each of the three allocation phases. Each phase is

then described more in details in the following paragraph.


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Figure 3 Allocation methodology under CfDs (DECC, 2013h)

First Come First Served

As the name suggests, during this phase each contract will be allocated to eligible generators by looking at

the application order. Each developer will apply to get a contract in a specific delivery year as soon as the

site have met all the eligibility criteria. This will in turn encourage developers to move fast during the initial

phase of development. This first phase will continue till approximately 50% of the budget available for

every delivery year for CfDs will be allocated. The first year that will extinguish the 50% budget limit will

trigger the unconstrained allocation for every year. The Delivery Body will however inform DECC when the

budget is close to running out and it might be the case that the Department will release additional budget

and continue with the FCFS for an additional time. There are in fact concerns that the CfDs budget will only

last for a really short period and this might harm the entire development process.

Unconstrained Allocation Rounds

In order to bring the required cost reduction the government is willing to introduce competition between

technologies at an early stage of development by introducing allocation rounds. Once approximately 50%

of the LCF for a specific delivery year will be allocated, contracts will be awarded through round held at

fixed points in the year- supposedly in April and September. The government is reassuring stakeholders

that all the bids will successfully get a contract. Stakeholders are however not entirely convinced this will be

the case and are asking for more security regarding contracts allocation through rounds.

Constrained allocation roundsWhen also all the budget to satisfy bids will be allocated, then auctions will be held. The strike price for

each project will then be set more efficiently during each auction thus delivering the required cost

reduction. In this phase strike price will therefore stop being administratively set and each site will have

different revenues according to the agreed strike price during the auction. Auctions mechanism is still

unclear and it is currently subject to public consultation to be published soon. What should however be

implemented is an initial technology specific auction mechanism running between 2017 and 2020 followed

by a technologic neutral auction system that will finally drive technologies to be effectively incorporated in

the wholesale market.

The scheme below is a representation of how the various phases will come in succession and the relativeexpected timescale.


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Figure 4 transition to competitive price setting under CfDs (DECC, 2012b)

3.1.3 From the allocation of a contract to project construction and energy delivery

The signed contract will set out all the terms of the agreement between the involved parts. First indicative

contract terms has been published in August 2013 and the final terms are expected to come out in

December this year. Since the government is aware that there might be variations in market conditions

resulting from developments in technologies, changing in market patterns or integration with the European

electricity system, it will retain the power to revise standard CfDs terms to ensure they remain updated and

effective in delivering government objectives. (DECC, 2013e)

In order to avoid late delivery of capacity by generators, three different measures will be implemented in

the contract terms:

The Substantial Financial Milestone (SFM) is an economic commitment that needs to be met within

one year of the signature of the contract. Generators are obliged to provide to the CfD

Counterparty the evidence they have spent or committed a percentage of the overall site scost by

the milestone date.

The Target Commissioning Window (TCW) is the period of time within which the generator is ableto commission without penalty. The duration of the TCW will be set by the government to reflect

the practical realities of developing each technology and will provide developers with an adequate

degree of flexibility. Generators that commission after the TCW will still benefit from the agreed

strike price but will have the term of the CfD reduced to reflect the length of the delay beyond the

TCW.

The Long Stop Date is the point beyond the end of the TCW after which a project that have failed to

meet its commissioning will see its CfD terminated by the Counterparty.

When finally a project is built, the plant will start generating and selling electricity to the market normally.

In addition, the developer will either receive or make payments to the Counterparty depending on therelative difference between strike and reference price.

There are certain circumstances under which changing in the contracts terms or even unexpected

termination are admitted. Since the reform is designed to give investors the comfort of a secure, long term

return of investment, they will also be covered against certain changes in law and regulation that will put

into risks contract terms and revenues for generators. Moreover, in the contract a cost-free capacity

adjustment will be included. The current proposal is to allow a 5% adjustment in capacity to be made at

each stage of the development. Besides this, capacity can also be adjusted because of force majeure causes

or geological conditions. (Neil Budd, 2013). Any additional reduction in capacity with respect to the claimed

one at the beginning of the contract will lead to a reduction in strike price of 0.5% for every 1% capacityreduction. It is also possible that the Counterparty terminates the contract in case the installed capacity is

reduced to 70% of the initial agreed value.


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4. Research resultsThis section will give a better insight on the CfD mechanism by effectively looking at specific topics that

have been considered to be of a main interest with regards to the reform. The opinion of various experts

was collected via direct interviews and will here be presented in an organic way. This will give the reader a

good overview on the main issues of the reform and on the effect that its implementation will have on the

domestic as well as on the European electricity market. Each of the following subsection will be focused on

one specific topic that has been considered as crucial for the successful development of the reform. All the

results will mainly refer to the opinions collected via the interviews. The complete transcript of the

interviews is available in Appendix.

4.1 Why is a reform needed and what are the main changing introduced

with respect to the previous mechanism

What the government is trying to achieve with the CfDs is to gradually integrate low carbon generation in

the electricity market by setting a top up payment that is function of the markets wholesale price. The

government is however setting a secure long-term revenue for generators corresponding to the strikeprice, which is giving confidence to stakeholders in terms of revenues. On top of this, DECC is also trying to

achieve substantial cost reduction for low carbon technologies in the most cost effective way by efficiently

allocating resources and by homogeneously balancing risks between generators and consumers by means

of the reverse payment in the case market price is above the strike price. (DECC, 2012c).

According to Tim Warham- Senior policy adviser at DECC - the former FiT-RO mechanism was not enough to

effectively bring the required transformation in the electricity sector and a reform was therefore needed to

efficiently address sustainability and security of supply issues. (Warham, 2013) According to him, the long

term FiT-RO scheme created a stagnant situation where entrepreneurs were offered too high and secure

revenues and were therefore not encouraged to bring down the cost of technology. However, if renewabletechnologies want to fairly compete with fossil fuels in the market sales, their cost need to be drastically

reduced and they need to be actively integrated in the electricity market and not be shielded from it. A

reform was therefore required to push development forward and to increase low carbon investments by

the amount required. (Warham, 2013)

Another important issue that needed to be addressed by the British government is related to the stop of

operation of many nuclear and coal plants in the coming 10-20 years from now. These plants currently

cover a big portion of the base-load and need to be substituted. This fact offers a great opportunity to

change the domestic energy mix by implementing a reform that encourages in a more efficient, less

expensive way low carbon energy production. (Srinivasan, 2013)The table below reassumes the key pointsof the FiT/RO and CfD mechanism.


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Table 3 Main characteristics of the FiT, RO and CfD system

4.2 Consultation process

As previously mentioned, the EMR is currently under consultation and will become active after the

parliament approval expected in mid 2014. At least 2 years will pass from the first CfD reform proposal in

2012 to its forecasted implementation. During this two years the Government tried to solve problems and

refine the CfD scheme by interactively initiate a conversation with the involved parts. Many public

consultations, conferences, information lectures and polls have been issued and published alongside with

variations of the reform. This process not only helped to increase awareness on the reform itself but also

encouraged a good learning process at all stages of the reform by encouraging communication between

parts. The enhanced communication is part of the governments goal to improve transparency of theadopted reform. However, although we acknowledge the governments effort to inc rease transparency of

the CfD schem, the intrinsic complexity of the reform could in turn discourage the entrance of new, small-

scale developers into the market due to their inability to effectively be able to sign a convenient contract.

(Srinivasan, 2013) In addition some people might argue that this transparent and interactive process

initiated by the government has considerably slowed down the implementation of the reform which has

now been under discussion for more than one and a half years.(Jamie, 2013a) Some stakeholders are in

fact not confident the government will be able to solve all the issues related with the reform before mid

2014 and therefore suggest the implementation of a plan B subsidy to become active till all issues related

to the reform will be solved.(The Clean Energy Forum, 2013) The government however denies this option is

being considered and is confident the reform will be delivered on time. (Warham, 2013)

FiT RO FiT-CfDs

Consists of a fixed payment

received by renewable generator

for the electricity produced for a

20 years period

Consists of a premium

payment on top of the

electricity sold to the

market. The premium is not

fixed but it is function of the

price at which tradable

certificates are sold to

suppliers

Long term contracts that provide a

secure income for renewable

energies, nuclear power and CCS.

Low carbon generators sell

electricity in the market and

receives a top up payment which

corresponds to the difference

between a pre determined strike

price and the forecasted market

reference price

Generation Tariff: /MWh

payment for all renewable

electricity produced. Varies for

every technology and it is

periodically revised to reflect cost

reduction.

ROC are issued to eligible

generators according to the

low carbon technology in

use. An obligation is set onto

suppliers to purchase a

certain amount of

certificates from generators.

Strike price: estimated cost related

to investing in a particular

technology. Linked to CPI

Reference price: expected price for

electricity. Calculated on a seasonal

or day ahead basis depending on

technology.

Export tariff: additional fixed

income for exporting renewable

electricity to the grid. Floor price

for export is set by the

government at 4.64p/kWh. By

Signing a PPAs generators can

negotiate a higher price with

suppliers

Suppliers that do not present

enough ROCs need to pay a

fine for each missing

certificate to ofgem. The

money collected is then

divided among lawful

suppliers.

CfDs are effectively bilateral

contract, thus cash flow can go in

two different directions depending

on the reciprocal difference

between strike and reference

price.

20 years duration 20 years duration 15 years duration


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4.3 Transition process

The government is committed to make the transition from RO to CfDs as gradual as possible. The timescale

with which the transition will take place and the commitment to grandfather projects financed under the

RO regime from 2027 to 2037, is giving investors the required security they need in order not to lose

confidence on the RO system.(Keith MacLean, 2013) Moreover, as will be described into more details in the

strike price section, the initial strike price will be set in a way that reflects returns under the RO regime in

order to create less distortions during the transition as possible. However, a substantial difference between

the two regimes is underlined by the 14 categories of strike prices and the 35 renewable obligation support

bands, meaning that competition will be introduced as soon as CfDs will become active. (Keith MacLEan,

2013a)

4.4 The Pay-When-Paid principle

Among the terms of the contract that regulate payments between the CfD Counterparty and generators, it

is stated that The payment obligation on the single CfD Counterparty will be conditional on it having

received payments from electricity supplies under the supplier obligation (DECC, 2012b) In order to reducerisks the CfD Counterparty may encounter in case of insolvency of suppliers, the Pay-When-Paid principle

has been introduced. In simple words it is a system that protects the Counterparty from supplier insolvency

by obliging the Counterparty itself to pay generators back only when money from suppliers obligation have

been received. (DECC, 2012c) This will in turn introduce a time-issue, since financial payments between

parts should be made in real time in order to prevent investors to perceive the risk of passing time

mismatches back onto generators. Exponents of the government reassure that it is extremely unlikely that

the Counterparty will go insolvent since many suppliers will be obliged to pay obligation to a single

Counterparty. (Warham, 2013) This issue is however still of mayor concern since there are no clear time

restrictions yet on when the payments between the parts should be issued.

4.5 Eligibility and allocation methodology issue

The methodology used to award a contract is a key element for the success of CfDs and constitutes a

controversial topic between government and stakeholders. As previously mentioned, allocation will be

issued in three different stages each one reflecting a different level of development in low carbon power

generation. Each stage is meant to push the development forward by encouraging competition between

technologies and integration in the market in order to finally reach complete development of green power.

What stakeholders argues with respect to this point is thatin contrast with the previous RO regime where

certificates are allocated to all eligible technologies with the CfD scheme there is no guarantee of a

contract.(Handley David, 2013a) On top of this, specific technology goals have not been set and smallerscale installations fear it is still too early to compete with more mature technologies such as nuclear and

offshore wind power generation. Additionally, investors argues that is it not true that it will be able to apply

for a contract at an early stage of the development as the government repeatedly assured. Getting

planning permission and accepting grid connection offer from the DNO requires a great amount of

investments that is however not counterbalanced by the certainty of a contract. (Handley David, 2013a).

What Stewart Jamie from ICISa company specialized at analyzing the electricity market in the UK- argues

is that, since all big offshore installations as well as nuclear power will get into planning only in the next 3

years, they will probably be out of the FCFS eligibility stage. This will therefore leave a lot of space to small

and medium solar and wind developers to effectively secure a contract within the initial FCFS stage. (Jamie,2013a). Although there will be an initial substantial request for securing a contract with the FCFS

mechanism; the expectation is that the LCF and the government will be able to manage this process in the


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smoothest way possible without creating delays. In addition, the government is committed to inform

stakeholders way in advance before the allocation rounds will start and this will supposedly give enough

time to adapt to the new regime. Mr Jamie however does not deny that some installations will not be able

to get a contract and will be forced to reapply the following year with resulting substantial delays in the

project delivery.

The government still needs to publish many details with regards to the allocation process such as the final

% of the LCF that will trigger to allocation rounds as well as specific auction details and possible technology

specific goals to be assigned to certain niche technologies. There is therefore still time for DECC to address

these issues carefully and to partially meet stakeholders needing.

4.6 Strike Price setting and Digression

The key factor that determines whether or not the CfD scheme will be able to efficiently support green

energy generation is determined by the strike price level and its consequent digression over time. It is not

surprising that this topic is at the center of attention in the discussions between government and

renewable energy stakeholders. It is therefore of a great interest to analyze more into details the method

used to calculate initial strike prices and their digression and to expose the main critiques coming from

stakeholders as well as from governmental Advisory bodies such as the Committee on Climate Change

(CCC).

In order to be consistent with the previous RO scheme, for the years 2014/15 and 2016/17 the strike prices

have been determined by the government using the so-called RO minus X formula. RO underlines the

intent to provide a supporting mechanism aligned to that received under the Renewable Obligation system

and the minus X underlines the assumption that the required rate of return for renewable projects under

the CfD scheme will be lower than the one under to RO, due to a predicted decrease in perceived risks.

From 2017 on, strike prices will be calculated by looking at the expectation of declining costs due to

learning curvesand will not have any link with the RO mechanism. (DECC, 2013i)

Although only an initial draft strike price is available at the moment-see Appendix- stakeholders have

complained that the initial level of support is too low and that it decreases too fast over time. What Dr

Keith MacLean Director of policy and Research at SSE- argues is that the EMR has introduced big

distortions in the electricity market and that these distortions mainly come from issues related to strike

prices. The first mistake made by the government has been the ambition to set the strike price in

conformity with the RO revenues for each technology. The decision of using the wholesale price under the

RO - a completely different supporting mechanism- as a reference for CfD revenues calculation, represents

a wrong first assumption. In addition, he argues that the fact that investors will perceive their green

investment as less risky and will therefore accept a lower rate of return is only an idealized assumption.

(Keith MacLEan, 2013b) These two factors resulted in a too low first draft strike price that is depressing the

low carbon sector. In addition, he underlines that the digression of strike prices is purely based on idealized

learning curves calculated on the base of estimated increase in installed capacity. The extent of this

increase in installed capacity is however only an idealized estimation and it is not based on available

figures. (Keith Mac Lean. 2013)

The CCC is on the same page of Mr MacLean. The CCC however does not consider the initial strike price as

totally inconsistent and focus more on the strike price digression as a sign of the governments failure. The

general opinion is that, in addition of an unclear pathway for renewable energy project after 2020, the

government proposes a rate of digression of strike prices that is faster than implied by evidence.(CCC,

2013) With regards to this point Mrs Srinivasan Kavita specialist at the CCC on strike price setting and


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digressionunderlines that, besides the problems pointed out by Mr MacLean it is also unclear how the

government calculated the digression curve. She argues that, in the documents available to the public, the

technique used to calculate the digression curves it is not clear. It is therefore very hard also for the CCC to

point which factors have been wrongly addressed or misinterpreted by the government. The CCC argues

that there are three different factors that should guide the strike price decision and these are:

Technology specific factors

Market conditions

Policy considerations

The issues pointed out by the involved parts with regards to strike prices are therefore twofold. Leveling

returns for projects under two different supporting mechanisms is complicated and has lead the

government to slightly wrong initial strike price value. This is because, although the reduced perceived risk

in renewable investment might be the reality, it is not possible to foresee that this effect will effectively

happen before the mechanism is proven in the field. Moreover, the digression mechanism should only

reflect the evidence of an achievable cost reduction under current market conditions and not under

idealized ones. There is in fact significant uncertainty on how projects costs will evolve as a result of

learning curves. There is however still time for DECC to consider these opinions and to address them when

publishing the final strike price in December this year.

4.7 Power Purchase Agreement

Profits for low carbon energy technologies do not only depend on the level of subsidy received; they are

also extremely dependent on the price at which each single project is able to sell the electricity produced to

the market. However, since the current electricity market has been developed in an environment where

large-scale fossil fuel plant made up the bulk of the generation capacity, renewable energys wholesale

electricity price is largely subject to the continuous variation of fossil fuel price. For this reason signing a

contract that defines a fixed-long term price at which renewable plants will be able to sell their electricity is

vital to achieve a good return in investments. Therefore, renewable generators often enter so called Power

Purchase Agreements (PPA) which effectively consist of legal contracts stipulated between the electricity

generator (the seller) and the power purchaser (the buyer) in which the terms for the sale of electricity

between the two parties are specified. This partially protects renewable generators income from the

volatility of wholesale price.

Due to the importance of signing a convenient long term PPA, it is of interest to analyze how these

agreements work and how their market will change as a result of the introduction of the EMR-CfD. In order

to present all the opinion on the issue, the opinion Neas Energy and David Handley will be presented. The

first is one of the biggest PPA providers in the UK and the latter is an expert of PPA market especially from

an independent generators point of view. He works at RES- one of the biggest renewable energy

independent developer - and he is actively involved in the debate surrounding the evolution of PPA

agreements under to EMR.


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Figure 5 PPA under RO and CfD scheme(Neas Energy, 2013)

The picture above represents how PPAs will change in the transition from RO to CfDs. Under the RO a PPA

provider such as Neas Energy will offer a fixed price for electricity, which increases with RPI over time. The

revenues for generators will vary according to the market price for ROCs. On the other hand, under CfDs

PPA providers will pay the generator the electricity at a discounted reference price with respect to a

predicted market price. The generator will however reach a fixed income due to the top-up to the strike

price from the Counterparty. According to Neas Energy the majority of risks for the PPA providers will becancelled under the CfD market since there will be less risks related to ROC price volatility. For this reason

lower PPA fees should apply and generators will be able to increase their incomes. However, risks related

to the uncertainty in the prediction of the reference price on a day ahead basis will not lower risks related

to imbalance costs.(Neas Energy, 2013)

Particularly, projects that require long-term finance need to sign convenient long term PPAs in order to be

bankable and receive the required long-term finance. The majority of these projects are carried out by

independent generators, which are likely to develop 35-50% of renewable energy projects by 2020.

(Cornwall energy, 2013). It is therefore of a great importance to protect their interests by providing them

with viable PPAs. There are however only around 6 to 10 credit rated counterparties able to offer long termPPAs in the UK and therefore the resulting market is relatively illiquid and non competitive. As a result, long

term PPA often include up to 20% or more discount against wholesale prices. The non liquidity of the

market is due to severe restrictions posed on long terms PPA providers with regards to their ability to make

the agreed payment over the 20 years lifetime of a contract.(Handley David, 2013b)

When moving to the CfD market, problems might arise

in terms of revenues for independent generators.

Developers might in fact not be able to sell their

electricity at the reference price due to non-convenient

PPAs. In case this factor is not taken into account when

calculating the strike price, generators will never

receive an income corresponding to the strike price and

therefore revenues will be consistently lowered- as

shown in figure 6 .

According to Mr Handley, on behalf of independent

generators, there are three possible solutions to this

issue:

1.

Increasing the strike price in a way it fully reflects the missed revenues for independent generators.This measure will in turn increase costs to consumers.

Figure 6 Effects of a non viable PPA on projects under CfD

(Handley David, 2013)


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2. Let independent generators to be squeezed out of the market- thus putting into serious hazard

green energy targets.

3. Creating an alternative solution that allows generators to achieve required income.

The solution proposed by a group of independent generators was to establish the so-called Green Power

Auction Market (GPAM). Within the GPAM, the reference price for each site is set via auctions held every 6months. Independent generators argue that this solution will ensure that all developers will achieve the

pre-determined strike price without any additional costs to consumers. It will also introduce more liquidity

in the market thus helping balancing revenues between generators and PPA providers. (Handley David,

2013b) According to Mr Handley it is unlikely that the government will implement this solution. Anyway,

DECC is aware of the lack of liquidity among long-term PPA providers and is currently looking into

alternative propositions. The one that appear to be the most likely is the so-called PPA of last resort under

which it will be assured that each independent generator will secure a minimum viable PPA contract. It

effectively consists of an obligation on suppliers to offer a floor PPA to green projects in case they have not

been able to get one before the beginning of the contract. In David Handleys opinion, the success of this

option will mainly depend on the price set by the government for the floor price in terms of /MWh. For

independent generators the appropriate level would be fixing the PPA floor at 75-80% of the wholesale

price. In fact, in case of a higher value there will be no incentive for generators to try to arrange their own

PPA and in case of a lower value then revenues for investors under the PPA of last resort will be put into

serious hazard.

There is still a lot to discuss before the government will come to a solution with respect to the lack of

liquidity in long terms PPAs but it seems that the problem is already widely acknowledged by all the

involved parts which are well cooperating to find a solution. However, although the PPA of last resort is

regarded as an adequate solution to the problem, only when the PPA floor price will be set it will be

possible to properly judge whether independent generators will be able to efficiently make profits with

green investment or if they will have a hard time to remain competitive in the market. From a wider

prospective, the CfD scheme will increase generatorsrevenues due to more convenient PPAs. This could

therefore generally increase low carbon revenues thus encouraging investments.

4.8 Subsidizing nuclear energy

According to Stewart Jamie, the British government has longer ago committed to nuclear generation; way

before the Japanese and German anti-nuclear plan. Britain considers nuclear power as a reliable technology

to be used to cover base load capacity at all times when fossil fuel generation will be extinguished. (Stewart

Jamie, 2013) The EMR will increase low carbon production in the UK electricity sector by particularly

focusing on the generation side of the market. It therefore does not directly consider subsidizing big scale

low carbon storage measures such as fuel cells or batteries. By looking at the reform from the generation-

side prospective, nuclear production is therefore the perfect candidate to cover renewable energy

intermittency in electricity production. Renewable energy stakeholders are however particularly concerned

that big scale nuclear installation will become dominant and use most of the available budget allocated

within the LCF leaving no space for other technologies. An extreme view is the one offered by Mr Mac Lean,

that suggests that the whole EMR reform was implemented only to offer an excuse to subsidize nuclear

generation (Keith Mac Lean,2013). Although this seems a pretty extreme position, it is undeniable that the

British position with regards to the nuclear issue has surprised most of the people in the low carbon

business, especially at a European level. This will cause problems to the EMR- as will be shown in thefollowing sections- especially when considering the UK within the EU context. The EU is in fact currently


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trying to push all the member states towards the implementation of an homogeneous approach with

regards to low carbon policies that does not currently include nuclear generation.

The reason why low carbon energy policies are needed is mainly because green power generation is still at

an early stage of development and therefore need incentives to keep the price of electricity competitive

with respect to fossil fuels produced one. It is therefore a surprise when nuclear power- a well-establishednon 100% environmentally friendly technology is regarded- together with renewable generation- as a low

carbon technology to subsidize. The debate surrounding nuclear power is fierce at the moment especially

after the Fukushima disaster in Japan and the German step back with regards to nuclear generation. It is

however undeniable that electricity produced by means of nuclear fission of Uranium is a low carbon

technology. Moreover the implementation of third generation reactors, which can partially re-use

radioactive waste to produce additional energy while lowering considerably the lifetime of radioactive

waste, is a really interesting option not to underestimate.

4.9 Exemption of Energy Intensive Industries (EIIs) from CfDs costs

The government is actively raising suppliers cost of production by imposing them a payment with respects

to their carbon emission. This obligation is in turns affectively lowering their revenues. The increases in

costs will directly be passed into electricity consumers that will ultimately bear the costs of the scheme.

This fact is well acknowledged by low carbon policy makers that need to find a balance between two

opposing concepts. On one side the main aim of low carbon policies is to decrease carbon consumption by

discouraging fossil fuel utilization; on the other side there is the need to protect energy consumers and

particularly competitiveness of national energy industries that are among the major electricity users in the

country. Industries that make use of great amounts of electricity throughout their production chain are in

fact the ones that will be more negatively affected by little variations in the electricity price, as shown by

the table below. What the government wants to prevent when implementing low carbon strategies, is the

so-called carbon leakage phenomenon. This phenomenon effectively consists in the delocalization of

manufacturing industries towards countries where prices for carbon emissions are lower, thus

impoverishing national economies. In order to avoid this, the British government wants to implement,

alongside with the EMR, a measure that exempt from CfDs payments certain categories of national

industries which particularly contributes to the economic wealth (DECC, 2013j) .The idea is to only exempt

companies which are both electricity and trade intensive and that are in direct contact with oversea

markets.The alarm to the British government is caused by the already high price in electricity faced by

British consumers with respect to the rest of Europe. (Jamie, 2013b) Any additional cost will therefore put

into serious hazard international EIIs competitiveness

If the government is to exempt energy intensive industries from CfD payments, this will surely add big

distortions in the electricity market. However, what Jenny Hillan expert on the matter of energy intensive

industries regulation at the CCC - argues is that distortions are in this case inevitable due to the lack of a

homogeneous approach on decarbonization at a global level. (Jenny Hill, 2013)She adds that if we want to

point the finger at serious distortions introduced by low carbon policies, than we should think about direct

carbon emission taxation. This idea is also supported by Stewart Jamie on behalf of ICIS. The figures

provided by ICIS in fact show that 3.8% of the electricity bill British consumers pay is due to carbon floor

price. (Stewart Jamie,2013) A distortion that needs to be avoided at all costs is however the one resulting

from an intrinsic discouragement of energy saving measures or the penalization of companies that

effectively invests in energy efficiency measures.


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It has been estimated that the EMR-CfDs will add on average 5.80/MWh to the electricity prices between

2016 and 2020. (DECC, 2013j)Partial exemption of EIIS from CfD levies means that the additional costs will

be divided between the remaining non-exempted consumers. As table 5 suggests, according to the extent

of exemption, between 30p and 80p/ MWh will be added to electricity bills for non-exempted consumers

according to the exemption option. Currently there are four exemption options being considered and

subject to public consultation. These are listed and explained into details below.

1A- Compensation mirror:

This is currently the governmentspreferred option. All eligible industries within this option will be

exempted from 80% of CfD costs. The eligible exempted sectors and sub sectors are listed in a

document published by the European Commission, which list categories that are considered to be

at risk of carbon leakage.

1B-Reduced Exemption Level:

In this options eligible sectors and sub-sectors are unvaried with respect to option 1A. The main

difference consists in the amount of the exemption, which decreases from 80% under option 1A

down to 67% under option 1B. In this scenario non-exempted consumers are more protected

whereas big industries are less.

2A- Wider eligibility scenario:

In this scenario eligible industries are increased with respect to the European Commission guideline

and might include also medium electricity intensive firms. The exemption level is targeted at 80 %

of the CfD costs as in option 1A. This option will inevitably have more impacts on non-exempted

consumers and will also increase the costs for the government.

2B- Compensation plus a taper for additional sectors:

In option 2B all eligible industries under option 2A are included but divided into 2 different bands.

The core band comprise all the sectors outlined by the European Commission guidelines (the ones

included in option 1A/B) that will receive a 80% exemption such as in case 1A. In addition to this,

medium scale electricity intensive industries that would have been included into 2A will receive a

50% exemption on CfD prices. This allows a differentiation between big and medium-scale

industries thus reducing the impact onto consumers with respect to option 2A.

Table 4 How costs of the CfD scheme will be perceived by consumers and EIIs in normal

conditions and under the four proposed exemption levels (DECC, 2013j)


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A public survey published earlier this year by n-power one of the big six energy suppliers in the UK-

showed that low carbon stakeholders would prefer the implementation of option 1B.(n-power,2013) This is

in contrast with the government preferred option 1A. The four exemption options described above are

currently subject to public consultation. The final decision with regards to this measure will be published in

a later stage when the public consultation results will be out.

What is clear is that a serious homogeneous approach at international level is needed if we are to

considerably reduce carbon consumption and protect national industries and consumers. The European

Union is actively moving in this direction by trying to implement various measures to push low carbon

policies in its member states to become slowly uniform thus discouraging the carbon leakage

phenomenon. For this homologation of policies issue, the exemption of energy intensive industries from

CfD levies will encounter some obstacles at a European level, as will be better explained in the next

chapter. The problem of carbon leakage is however a global issues and need to be addressed horizontally in

each country if we are to succeed in the decarbonization process.

4.10 State Aid measures and the EMR in the EU prospectiveState Aid is defined as any form of advantage conferred on a selective basis by national public authorities to

certain undertakings. State aid measures are generally prohibited within the European Union unless they

can be justified by reasons of general economic development. Within the EU, the European Commission

(EC) is the body in charge of assuring that all member states respect state aid prohibition or alternatively

that state aid complies with EU rules. (European Union, 2013).

Currently, it is at the center of discussion whether or not and to which extent the EMR should be

considered a state aid measure and therefore apply for clearance to the European Commission. At the

moment there is not enough awareness among stakeholders on the state aid issue and the debate is

isolated between economics experts, European Union Parliament members and the UK government. It is

however a critical issue in terms of the consequences this might have with regards to radical adjustments

that might be required to the reform and of severe delays that might be encountered during the clearance

process. For this reason a section of this report has been dedicated at explaining how state aid works and

which are the consequences this might have on the green energy reform.

The European Union claims that, to be regarded as state aid, a measure needs to have the following

features:

There has to be a direct intervention by the state through state resources

The intervention gives the recipient an advantage on a selective basis Competition has been or may be distorted

The intervention might affect trade between member states.

There are however circumstances in which a state aid measure is allowed in virtue of its importance into

achieving common European goals. These cases are covered within the so-called European Guidelines,

which currently include energy efficiency, renewable, and CHP as allowed state aid technologies. Member

states are however obliged to notify and seek approval from the Commission before implementing a state

aid measure and in any circumstances the EC has the right to approve, refuse, or impose changing to the

examined measure. It might take from several months up to several years to get EC clearance depending on

the case and on the extent of legal issues encountered. (European Union, 2013)


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According to Mr Malcolm Keayresearcher and expert on energy policies and European laws at the Oxford

institutes of energy studies- there are two main elements that suggest that the EMR should be regarded as

a state aid measure and these are respectively the substantial amount of renewable energies incentives

introduced by the EMR and the presence of nuclear energy regarded as green technology.

Although renewable energies are included within the commission guidelines, the level of support allowedwill probably be lowered when the revised Guidelines will be published by the end of the year. According to

Mr Keay, this might put into risk EMR acceptance at EU level. The reason is because the Committee

considers renewable technologies ready to start being slowly driven into the market by decreasing the level

of support received and by implementing a homogeneous policy approach within member states which is

more market orientated and less shield from it. This is therefore in contrast with the fixed-income provided

by FiT-CfDs. Although CfDs are more linked to the market price than pure FiT, since payment to generators

will stop once the market price have reached the strike price, the commission is likely not to totally support

the proposed reform especially considering that the previous RO scheme was in a certain sense more

market orientated and therefore more compliant with Europeans new directives. (Keay, 2013)

The second issue regards nuclear power generation. As previously mentioned, nuclear power is for the first

time in a European legislation regarded as a green energy technology and therefore subject to the same

subsidy scheme as for renewable technologies. As stated by Mr Warham on behalf of DECC, nuclear energy

is strongly supported by the UK government as it is considered a low carbon, affordable safe technology

capable of covering base and peak load at all the times(Warham, 2013). Although the EC is generally in

favor of nuclear generation, the debate at European level is encountering the fierce opposition of many

member states such as Germany and Austria(Keay, 2013). It is therefore still unknown whether nuclear

generation will be included in the new Commission Guidelines for State Aid in December 2013. In

In addition to the above-mentioned problems, also the proposed exemption of energy intensive industries

will need to seek commission clearance. In fact, although others EU member states might already have

exemption in place, such as in the case of Germany, it is the intention of the EC to start limiting this

exemption mechanism and to bring all the involved parts to pay for their carbon consumption.(Keay, 2013)

The UK government has not applied for state aid clearance yet but the commission is aware of the issue

and discussions have already started. It will however take some time before all the issues will be clarified

and it is therefore probable that the EMR will be approved by the UK parliament and become active before

clearance is received. Renewable and nuclear generators will therefore enter a contract with the CfD

Counterparty before the EU issue is cleared. According to Mr MacLean the contracts will not be legally

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