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Unplugged: net zero highs, but capacity market lows

Nigel Cornwall Nigel Cornwall Director
26th June 2019

Cornwall Insight’s founder and non-executive director Nigel Cornwall is now writing a monthly review of the latest energy market developments in our weekly Energy Spectrum publication. Here is the first one.
The landmark legislation of 24 June committing the government to a net zero greenhouse gas emissions target for 2050 has been moving at us with the subtlety of an oil tanker since the Committee on Climate Change issued its excellent advice to government and the devolved administrations in May. But translating the aspiration into a binding legal requirement so quickly is remarkable.

The brevity of the draft Statutory Instrument laid before Parliament to fix the target is in direct contrast to the profound implications of this very bold but necessary step. The effect of the one paragraph change is simply to overwrite the old 80% target provided for in the Climate Change Act 2008 with a new value of 100%.

While there was much hype in the media about this being the first legislated commitment by a major economy to nullify emissions, many jurisdictions have already embarked on a similar path, notably France and New Zealand.

It is a historic commitment nevertheless, and it should secure Theresa May a lasting legacy.

The cost of net zero

Not all parts of the government were on board in implementing the net zero target, it seems. Indeed, the chancellor placed a £1tn price-tag on the shift.

While I can’t say whether I agree with a comment in the Telegraph that called the Treasury’s analysis “innumerate nonsense”, it is clear that traditional cost benefit assessments are not fit for purpose looking 30 years ahead, a period almost certainly likely to be defined by escalating climate emergency.

The new targets will drive through fundamental change across the economy. But the pace of change and the benefits that will flow from this are dependent on the policies and programmes that now need to be implemented to deliver the target.

Vulnerability focus

There now needs to be a more considered debate on the costs of the new target and, as important, how these will be shared between bill payers and taxpayers. Costs of existing policies are already very significant and are conservatively expected to add more than 20% to the delivered cost of electricity over the next five years. As an industry we do not have a good record of setting expectations and thinking through distributional impacts on different types of consumer. It’s time to have that debate.

Against this background, Ofgem’s new Vulnerability Strategy, published 13 June, is overdue. At a glance, the document represents a strong statement that will trigger a number of further workstreams, but it appears to be weak on how to target social policy measures on the fuel poor.

This is out of kilter with some of the good work being carried out internationally, not least in Scotland. There, a dedicated commission has been established to advise government on a just transition. While it is not of course Ofgem’s role to promulgate policy, its decisions and actions have a direct bearing on affordability, especially as it embarks on the process of determining when to lift the price caps.

Judging by a 13 June answer given by interim Energy Minister Chris Skidmore to Labour’s Alan Whitehead, the government is confident of Ofgem’s ability to rise to the challenge but also of its performance more generally on supporting environmental and social policy. The minister laid to rest the notion that the government intended to do anything with its powers confirmed in 2013 under the Energy Act to issue a Strategy and Policy Statement (SPS) to the regulator.

Personally, I think this is the wrong outcome. The key issue here is not about Ofgem’s competence but whether the wider institutional framework where the regulator’s mandate is not aligned with policy development is fit for purpose. The current policy guidelines go back to 2011 and are out of date. What is needed is a much clearer statement of what the government expects of the sector and its regulator as we move into a very different smart, flexible world. 

Curiously an SPS has been set in place in the water sector and seems to work well there. So, what’s the difference?

Capacity Market auction’s record low

I am unsure what to make of the capacity market (CM) T-1 auction clearing at 77p/kW – the reward for capacity in the top-up auction for the coming winter is a record low; it’s the same as the average cost of a first-class stamp in Europe. Gross that up for a typical peaking generation unit of 20MW (which the mechanism is supposed to incentivise) gives rise to a far from whopping incentive payment of about £15,000.

Explaining this and other recent auction prices away by simply referencing over-supply would be dangerous. Given the CM also depresses energy prices and wholesale prices are increasingly being “cannibalised”, some capacity support mechanism is needed for new build but also for existing generation that is suffering serious revenue erosion. A number of neighbouring markets are also now developing mechanisms for capacity remuneration, and the European Commission is poised to insist on market-to-market support. 

But the current GB mechanism is clearly flawed and, even assuming the European Commission reaffirms State aid approval, this is not likely to help address these issues. Unfortunately, BEIS’s five-year review of EMR mechanisms doesn’t touch on any of this either.

Developers will be looking at the forthcoming T-3 auction for winter 2022-23 with trepidation.

If you have enjoyed reading Nigel’s views here and are not a subscriber to Energy Spectrum, contact us for a month’s trial to catch the next round. Also why not head over to newangliaenergy.co.uk for more on local and community energy and follow @newangliaenergy?