Motion to Consider
My Lords, today we are considering three instruments that amend legislation that came into force last summer to implement electricity market reform, with the powers to make this secondary legislation found in the Energy Act 2013. This reform, as noble Lords will be aware, is designed to encourage the necessary investment into secure low-carbon electricity generation through two mechanisms: contracts for difference, or CFDs, which provide long-term price stabilisation to low-carbon plant, allowing investment to come forward at a lower cost of capital and therefore at a lower cost to consumers, and the capacity market, which provides a regular retainer payment to reliable forms of capacity in return for such capacity being available when the system is tight, and ensuring that enough is in place to maintain security of supply.
As noble Lords may be aware, the results of the first CFD allocation round were announced last week, with 27 contracts being offered to applicants, which could deliver more than 2 gigawatts of new renewable energy capacity. The allocation by competition has driven down costs to consumers, with this capacity costing up to £110 million a year less than it would have in the absence of competition. The first capacity market auction also completed in December, with 49.3 gigawatts procured for delivery in 2018-19. The below-expected clearing price of £19.40 per kilowatt in that auction is also great news for consumers, with costs driven down by competition between participants. I thank noble Lords for supporting the market reforms to allow us to reach this significant point.
In order to build on these successes, the Government are looking to make some small amendments to the mechanisms. This is in order to ensure compliance with state aid requirements, the successful remaining implementation of the scheme and that the legislation properly reflects the original intent. As well as the changes that I will describe, I inform noble Lords that the Government are committed to ensuring that the reforms remain effective and continue to represent value for money for the consumer. To this end, we are carefully evaluating and monitoring the measures implemented and will continue to do so.
Before we commence the debate, I will briefly describe each amending instrument in turn. First, the Electricity Market Reform (General) (Amendment) Regulations amend the original instrument that came into force last summer. This very minor amendment enables the Gas and Electricity Markets Authority to enter into arrangements with a CFD counterparty or the Secretary of State to carry out roles relating to the measurement and sampling of fuel. This ensures that generators are paid only for energy that is both renewable and sustainable, and applies to both those CFD contracts that have been signed by the Secretary of State and any future CFD contracts allocated under the enduring regime. The necessary expertise to carry out this work is held by the authority, and this amendment allows that provision of support.
The Electricity Supplier Obligations (Amendment and Excluded Electricity) Regulations, build on the supplier obligation mechanism that is already established. The supplier obligation will be levied on all licensed electricity suppliers in Great Britain from 1 April 2015, to meet the costs of the support provided to low-carbon generators under the CFD. This instrument does four things: it introduces an exemption from the supplier obligation levy for eligible imported renewable electricity; it introduces an exemption from the supplier obligation and operational costs levies for electricity supplied to eligible electricity-intensive industries; it sets the rate for the operational costs levy for the CFD counterparty for the financial year beginning 1 April 2015; and it makes a number of minor and technical amendments to the original regulations. As a condition of state aid approval for the CFD, the European Commission required that the eligible renewable electricity imported from other EU member states and supplied to consumers in Great Britain be exempt from the cost of CFD payments.
These regulations set out the proposed implementation of this exemption. This includes the way in which suppliers should submit their evidence of eligible imports to the CFD counterparty, how the amount of exempt eligible electricity is determined and how electricity suppliers’ liabilities for CFD payments will then be adjusted.
The regulations also set out an exemption from the supplier obligation for a proportion of the electricity supplied to eligible electricity-intensive industries. They set out the application process for the exemption, the criteria that will be used to assess eligibility, the proportion of electricity that will receive the exemption and the way in which the exempt electricity will be identified.
Thirdly, these regulations also revise the operational costs levy that electricity suppliers must pay to the CFD counterparty to allow it to recover its operational costs. The new rate will apply from April 2015. It is expected that this amendment of the operational costs levy will take place annually, alongside the setting of the operational costs budget of the capacity market settlement body, as both bodies’ operational costs change.
Finally, I come to the Electricity Capacity (Amendment) Regulations 2015, which amend the instrument that established the capacity market last August. This instrument amends the Electricity Capacity Regulations 2014 to enable electricity interconnectors to participate in the capacity market from 2015 onwards. It makes a number of minor and technical amendments and amends the Electricity Capacity (Supplier Payment etc.) Regulations 2014 to set the settlement costs levy that funds the budget of the capacity market settlement body from 1 April 2015. The main purpose of this final amending instrument is to allow electricity interconnectors to participate in the capacity market and to be eligible to receive one-year capacity agreements, if successful in a capacity auction, from 2015.
These amendments include a definition of a new category of capacity market unit, a requirement on the delivery body to provide more information on the capacity to be provided by individual interconnectors, and provision for a financial penalty to be imposed in the case of a new-build interconnector where the failure to reach a completion milestone can be ascertained only where the capacity agreement has already expired.
A further change mitigates the National Grid’s potential conflict of interest by allowing the Secretary of State to provide the derating factor for interconnectors. On this point, we have recently published further details on the derating methodology for interconnector CMUs in the capacity market which will be included in the capacity market rules.
We have also made a number of minor and technical amendments to the principal regulations, after consultation with external stakeholders. These include provisions to require a capacity provider to repay capacity payments if a capacity agreement is terminated on certain grounds. This instrument also amends the supplier payment regulations to revise the total amount of the settlement costs levy in order to fund the operational costs budget of the settlement body. The opportunity has also been taken to correct a minor drafting error in those regulations, removing the unnecessary duplication of a provision.
As a final point before we start the debate, I draw noble Lords’ attention to the Government’s intention to introduce further small amendments. They introduce an additional performance incentive scheme, designed to encourage developers to sign and deliver on their commitments under a CFD, and were laid before Parliament on 23 February. The amendments aim to deter speculative bidding in the CFD auction.
On the capacity market, we recently published a consultation on further minor amendments to the regulations and the rules, with a response intended to be published later this month. I look forward to the debates on these future changes in due course. I beg to move.
My Lords, I am grateful to the Minister for introducing these three statutory instruments. The first was correctly described as a minor and technical amendment to enable the certification of biomass. We are fully supportive of that instrument.
Moving on to the second and third instruments, I have some concerns about the policy that is being introduced to exempt heavy industrial emitters from the costs of the CFD. It is not really fair to describe this as a small amendment when it has quite a wide significance. We have sat in this Room and the Chamber debating the significance of the EMR over many months on the Energy Bill. It is a significant intervention into the markets. It introduces a level of intervention into those markets which will cause rather large sums of money to change hands between suppliers and the recipients of contracts for difference. Now we see that the distribution of that cost burden is being moved far more on to consumers and away from heavy industry, and I have a concern about that.
It was only last week that we sat in this Room and discussed fuel poverty, and the outrage that so many people currently suffer from poorly insulated homes and are unable to pay their bills. The inequality of the economy exacerbates their poverty, meaning that they are classed as fuel poor. Any Government ought now to introduce a test so that any policy change is thoroughly scrutinised for its impact on poorer communities. In fact, I see in the impact assessment that some attempt at acknowledging this is made. It says:
“As low income households typically spend a higher proportion of their income on electricity, lower income households are disproportionately affected by an electricity price increase”.
This move to insulate heavy industry and shift the burden will have an impact, which will grow over time as the potential sums of money being spent under the CFD mechanism grow. I seek reassurance from the Minister about what is to be done to compensate for the impact of this policy by improving the level of intervention we are making on fuel poverty. There ought now to be a rule that anything which puts the burden of decarbonisation disproportionately on to consumers must take into account the impact on fuel poverty. I note that there was obviously a consultation exercise and that papers say that 47 responses were received. How many of those were from consumer groups or those associated with the fuel poor? What did they think of this policy mechanism?
I am of course not blind to the reason behind the proposal, which is to try to ensure that we do not see the flight of industrial manufacturing jobs from this country. That is because of the fact that they are facing increasing costs for a number of reasons, not least the financial crisis raising the cost of capital. It means that there is a potential that we will see more jobs lost in the heavy industrial sectors as we face the pressure of globalisation, coupled with the need to invest in our energy infrastructure. There needs to be a solution but I am not convinced that simply handing out exemptions and compensation payments for evermore is going to give us that answer. The answer has to be in providing incentives for heavy industry to invest in decarbonisation. One of the problems with energy policy, at the UK and EU levels, has been that we have focused so much on the power sector, almost to the exclusion of the industrial sectors. This has left them in a situation where they face increasing costs, as a result of carbon prices, but have no incentive to invest in decarbonisation. I am sure that those who can will invest in CFDs if they have on-site power generation, but if they do not and are simply receiving electricity or process emissions and have a heat load, few incentives are available to them. There is no equivalent to the RHI that allows them to invest in carbon capture and storage. We have been very slow to realise that carbon capture and storage is a technology needed as much by the industrial sector as the power sector.
What is the department doing to ensure that we move quickly to provide incentives for industrial players properly to invest in decarbonisation? Otherwise, I fear that we will always be in a game of catch-up, where policies are introduced but exemptions have to be made, introducing great levels of complexity, form filling and definitions, which means that energy policy in the UK gets ever more complex and full of red tape. We should really be thinking about how we structurally help industry to invest in the UK in a new industrial revolution based on decarbonised energy systems. That has to involve CCS for industry.
Those are my concerns with that SI. Moving to the capacity mechanism regulations, it will come as no surprise to the Minister that I have concerns about the capacity mechanism, which I have raised on numerous occasions. I am pleased, however, to see that this intervention will allow interconnectors to be eligible to bid in the capacity mechanism. That was raised by noble Lords during the passage of the Energy Bill. A Lords committee report on interconnectors recommended looking at them with a higher degree of interest.
It is lamentable that this has come as an afterthought and as a result of the EU stipulating as one of its state aid qualifications that we must do it. The department was asked to do it a long time ago, but said it was impossible or dragged its heels. Finally, it is being introduced, but rather later than it need have been and only really as a result of the EU making it a condition of state aid. The provision is overdue, but I am pleased to see it there.
There is a general question mark about the capacity mechanism. The more we give away three-year contracts for old coal, as we did in the capacity auction in December 2014, the more we squeeze out cleaner and more enduring solutions. By that I mean interconnectors—and gas investments where they can be profitably brought on stream. If we are to continue to make changes to the capacity mechanism—I was interested to hear the noble Baroness refer to further reforms to it—we need to look again at how it interacts with our low-carbon objectives. It cannot be sensible to be giving old coal money to stay open at the same time as we are charging everyone money to close and replace coal. Something must be built into the capacity mechanism to prevent us locking into high-carbon infrastructure. We need to reconsider the provision of three-year contracts for coal.
There is also a question about small-scale gas generation. The noble Baroness will be aware that in the auction in December, a range of smaller gas-generating plant qualified for 15-year contracts. Those small gas plants are scaled exactly to avoid any form of carbon price, avoid entry into the ETS and therefore avoid any payment of carbon pricing of their externalities—of pollution. At the moment, the number bidding in totals about a gigawatt, which is not an insignificant amount of capacity. Will we see more of that? Will the next capacity auction see yet more small-scale gas bidding without a carbon price? That is distorting competition. If they are not facing a carbon price but other gas generators are, that is a distortion. Yet again, the capacity mechanism is not dovetailing with the other objectives of the Government’s energy policy. We need to look again at that.
It will also come as no surprise that I think we need to look at whether an energy performance standard needs to be applied to stations qualifying that would help us control their CO2 . That concludes my comments on those three statutory instruments. I look forward to the response from the noble Baroness.
My Lords, I am extremely grateful for the contribution of the noble Baroness. Of course, she raises questions to which I need to respond but, as with all these things, if I do not respond today I will undertake to write to her.
The noble Baroness asked about the cost of EII exemption to consumers. To lay out the context, first and foremost we do not want to see our industry moving away from the UK because of what our policies will cost to other countries that do not take our commitment to reducing carbon emissions as seriously as we do. We have to make sure that we do not lose our heavy industry simply because we want it to be more compliant than industries in other nations. We want to make other nations follow what we are doing and ensure that they are helping to reduce carbon emissions on the same scale as us. I think that the noble Baroness understands that all of these things will have a cost implication if we are mindful to have a blanket look at trying to reduce our carbon emissions and work with member states to help them to reduce theirs.
The policy should benefit the consumer ultimately. Let us look at what the exemption does for heavy industry, and what its net cost is across the population. On balance, we think that this is the right approach. The noble Baroness was right to say that this was heavily discussed during the passage of the Energy Act. We need to put it in the context that it will be an increase of 0.3%, which is about £1.80 on bills in 2020. In overall terms, if we are to ensure that we do not lose heavy industry, keep competitiveness as part of the bigger equation, and ensure that consumers benefit and do not lose out, these steps have to be taken. I am as mindful of fuel poverty as the noble Baroness, and I know that both of us work closely to ensure that rising energy costs have the least impact on those who can least afford to bear those increases.
Ultimately we have to look at the market as a place of competition. During discussions on the Energy Act, the noble Baroness asked why coal was allowed to be part of the auction. It is because of energy security and the cost implications to the consumer. If we are genuinely serious about ensuring that the marketplace is open and offers best value, we have to take on board that, for at least the short to medium-term, coal will play a role. But the more we get the renewable sector to grow, strengthen and bring its prices down, the less dependent we will be on coal. We see it as eventually coming out of the marketplace. The noble Baroness is aware that we have been very supportive, through the measures taken in the Energy Act to ensure that the renewables sector has had the opportunity to work on a much more even keel alongside the more traditional fossil fuels. So I do not buy the argument that coal should not be there. It has to be there for the ultimate reason that I have always laid out: we cannot allow a focus not to be technology neutral. It has to offer the long-term benefit to the consumer in the end. That is the crucial point.
The noble Baroness spoke about carbon capture and storage, and we continue to support its development. We see it as very much part of the debate going forward. She is aware that £1 billion has been set aside to support it. I was desperately trying to remember the two projects that we are supporting following the competition that took place. Unfortunately, inspiration did not come forward and I cannot rack my brain to remember the names, apart from Peterhead. Again, I undertake to write to the noble Baroness on where we are with those two projects.
Overall, I think the noble Baroness accepts that these are difficult choices, but we have to make them on the basis that we constantly review what we are doing to make sure that the end-user—the consumer—ultimately gets the best value. If there are issues that she feels that I have not cleared up, I will read Hansard very carefully to ensure that I can give her a much more detailed response if she feels that I have not satisfied her thus far.
What I am trying to get across is that we absolutely agree that we do not want to see the flight of industrial players in our economy. However, we cannot simply keep loading the responsibility for decarbonisation on to consumers and not put in place a positive policy for the decarbonisation of industry. The two CCS projects are Peterhead and White Rose, but they are power projects. I am talking about heavy industry: steel, cement, chemicals and oil refining. How will those enter into the CCS market? We need to get an incentive in to help them to do that and we need the EU to support us.
Overall, my fear is that the net effect of these instruments might be that we exempt green electricity from overseas, which will be able to come in without bearing any of the costs that we have in this country. We may see that UK plc simply bears the cost but does not see the investment that we need in our industries. I hope that we will continue this dialogue. This whole raft of policies and how they interrelate has to be kept under a close eye.
I agree with the noble Baroness that we have to keep a close eye on this. We constantly look at whether those policies have the positive impact that we expect them to have. I always have to restate the importance of balancing that with the fact that we need to make sure that we do not lose our industries to places that are less ambitious about the reduction of carbon emissions.
We need to work closely with business. We are working all the time to make sure that we are not disincentivising it from trying to make sure that it can reduce emissions. Ultimately, this is about what the public are prepared to pay. We have to be mindful of this balancing act of making sure that it is not a burden on the consumer, while making sure that we do not lose manufacturing and that we keep our manufacturing base strongly here, which generates jobs and allows the economy to grow. It is very much a balancing act, but I agree with the noble Baroness that this should be kept under review, and that we should constantly look at how we can ensure that the renewable sector plays a bigger role as we work towards a much more low-carbon economy.