UK government's proposed Electricity Market Reform may put independent generators at a disadvantage

The UK parliament's Energy and Climate Change Committee has been scrutinizing the government's proposed Energy Bill. One of its conclusions is that independent generators may have difficulty in accessing the market and gain selling electricity to wholesalers.

The core part of the government's proposed Electricity Market Reform (EMR) is a feed-in tariff (FiT) with Contracts for Differences (CfDs), which is essentially a subsidy for all low-carbon generators. The problem for independent generators, however, is twofold. Firstly, there is the difficulty linked to the difference between CfDs and the current renewables support regime, the Renewables Obligation (RO), which forced suppliers to source energy from renewable generation in a physical sense. Under the RO, large, vertically integrated energy suppliers had an incentive to purchase power from independent generators. However, CfDs do not include any such incentive.

Secondly, there is the low level of liquidity in the market, which creates a barrier to entry for renewable generators. Selling in the market requires sufficient in-house trading capacity, but in addition to this, independent generators must also manage volume risks; namely, the risk that installed capacity generates less than expected. This is particularly a problem for intermittent generators. Therefore, until now, independent generators have tended to rely on power purchase agreements (PPAs), which are contracts to supply power to the buyer, usually at a discounted rate to reflect the reduced risk compared with selling in the market. 

The danger for independent suppliers is that the power asymmetry with large buyers will be exacerbated under CfDs. PPAs may be offered at a larger discount than before, meaning that generators would not actually earn the strike price promised under CfDs. The implication is a PPA market that fails to underpin renewable investment, which is clearly a serious problem for the government's low-carbon generation goals.

The route to market and low liquidity in the market are currently being reviewed by the Department of Energy and Climate Change (DECC).  Solutions being considered include mandating the "Big Six" vertically integrated companies to sell 25% of their generation output in the forward market; having an incentive built into CfDs to ensure low-carbon generation is purchased (such as a cost-reduction on the CfD in exchange for low-carbon power); having a buyer of last resort; and extending the RO regime beyond its closing date of 2017 for new entrants.

DECC is currently conducting a review of evidence on access to the market for renewable generators. A full energy bill is due in October/November 2012, with the approved legislation expected to reach the statute book in 2013.

Written by Yasmin Valji

Analyst, Datamonitor Energy & Utilities