Considered in Grand Committee
My Lords, this statutory instrument amends regulations concerning the levies used to fund the operational costs budgets for the Low Carbon Contracts Company and Electricity Settlements Company. The LCCC administers the contracts for difference scheme on behalf of the Government under the Energy Act 2013. Under the same Act, it is anticipated that the LCCC will also administer the dispatchable power agreement and support the development of a new scheme for bioenergy with carbon capture and storage within the next three years. The ESC administers the capacity market scheme. Those schemes will incentivise the significant investment required in our electricity infrastructure, keep costs affordable for consumers and help to deliver our net-zero strategy, while keeping our energy supply secure.
The contracts for difference—CfDs—provide long-term price stabilisation to low-carbon generators, allowing investment to come forward at a lower cost of capital and therefore at a lower cost to consumers. The current CfD auction, which is the fourth to date, opened in December and we are seeking to secure more capacity than all the previous auctions combined. It will allow a broad range of renewable technologies to come forward, while delivering the best deal for bill payers. To date, only projects located in Great Britain have been awarded CfDs. However, BEIS and the Department for the Economy are considering whether to extend the current GB-only CfD scheme to Northern Ireland. Funds have therefore been included in the budgets to enable the LCCC to undertake some preparatory work in case a final decision is made to enable Northern Ireland to join the scheme.
I turn to the Electricity Settlements Company—ESC. The capacity market is tried and tested and is the most cost-effective way of ensuring that we have the electricity capacity that we need now and in the future. The capacity market provides incentives in the form of guaranteed payments to eligible capacity providers to be on the system and to deliver capacity when needed by increasing generation or by turning down their electricity demand in return for guaranteed payments.
The capacity auctions held to date have secured the capacity that we need to meet the forecast peak demand out to 2025-26. The next auctions, scheduled for early 2023, will secure most of the capacity we need out to 2026-27. In the CfD and capacity market schemes, participants bid for support via a competitive auction, which ensures the costs to consumers are minimised.
The LCCC and ESC’s effective administration of the CfD and capacity market schemes to date has demonstrated their ability to deliver such schemes at least cost to consumers. It is in part for this reason that the LCCC has been working with BEIS to develop new schemes for incentivising the deployment of more low-carbon technologies. For example, the LCCC has supported BEIS in the development of dispatchable power agreements, or DPAs, under the Energy Act 2013. These agreements, which are based on CfDs, have been designed to instil confidence among investors for power carbon capture and storage projects and incentivise the availability of low-carbon, non-weather dependent dispatchable generation capacity.
The DPA will drive the private sector investment required to bring forward at least one power carbon capture and storage project by the mid-2020s. The LCCC is expected to be the counterparty for DPAs, and funds have been included within the budgets to support this role. It is anticipated that the LCCC will also work with BEIS to develop incentives for bioenergy with carbon capture and storage. Although this has not yet been confirmed, contracts for such projects could potentially be entered into following a process established under the Energy Act 2013. Were BEIS to move forward with this option, the LCCC would need to undertake activity to prepare for acting as the counterparty during the next three years. Consequently, funds have been included within the budget for this purpose.
It is of course important that the LCCC and the ESC are sufficiently funded to perform their roles effectively, given their critical role in administering the schemes that I have just outlined. However, the Government are clear that both companies must deliver value for money and, with this in mind, we have closely scrutinised their operational cost budgets to ensure they reflect the operational requirements and objectives for the companies.
Both the LCCC and the ESC are themselves very mindful of the need to deliver value for money, as their guiding principle is to maintain investor confidence in the CfD and capacity market schemes while minimising costs to consumers. They have taken a number of actions to date to reduce costs, such as bringing expertise in-house rather than relying on more expensive outside consultants. It is because of actions such as this that CfD operational costs per contract are falling, despite the growing size of the CfD portfolio. There is a similar narrative for the ESC. The company currently manages 200.8 gigawatts of capacity agreements with 1,335 capacity providers under the capacity market. For the delivery year 2022-23, this equates to 52.9 gigawatts of capacity and 350 capacity providers, an increase of 78 capacity providers compared to the 2021-22 delivery year. Despite this increase, operational costs are expected to be lower in 2022-23 than in 2021-22.
The operational cost budgets for both companies were subject to consultation, which gave stakeholders the opportunity to scrutinise and test the key assumptions in the budgets and, more importantly, to ensure that they represent value for money. The response received to the consultation noted the significant increase of budget for the LCCC but was generally supportive of the Government’s rationale for the increase. BEIS is satisfied that the operational costs budgets for the LCCC and the ESC should remain as consulted upon. Subsequently, the budgets remain unchanged as a result of the consultation. The proposed operational costs budget for the LCCC in 2022-23 is £24,210,000, in 2023-24 it is £26,978,000 and in 2024-25 it is £29,051,000. For the ESC, the proposed operational cost budget is £6,954,000 in 2022-23, £7,382,000 in 2023-24 and £7,734,000 in 2024-25.
The amendments revise the levies currently in place to enable the companies to collect enough revenue to fund these budgets. Any levy collected that is not spent will be returned to suppliers at the end of the relevant financial year in accordance with the regulations.
Subject to the will of Parliament, the settlement cost levy for the ESC is due to come into force the day after the day on which these regulations are made and the operational costs levy for the LCCC by 1 April in each of the relevant financial years.
Finally, I assure the Committee that the Government are also mindful of the uncertainties involved in setting a budget for the next three years, such as any world events that we are witnessing now which could of course impact energy demand, and in policy decisions on new schemes that have not yet been taken. Consequently, BEIS will keep the companies’ budgets under careful review throughout the budget period to ensure, as always, that the costs to consumers are minimised.
I commend these draft regulations to the Committee.
My Lords, we on the Liberal Democrat Benches support these regulations so I will not take up too much of the Grand Committee’s time, but there are a number of questions which I hope the Minister will be able to address.
I fondly remember discussing these regulations—the previous, equivalent regulations—back on a cold afternoon last February. At that time, I asked the Minister why the review of the operation of the electricity market, which under Section 66 of the Energy Act 2013 is required after five years and so was due in 2018, had still not been completed and reported three years after it was due. The Minister said:
“We expect it to be laid in Parliament shortly.”—[Official Report, 23/2/21; col. 811.]
The Explanatory Memorandum accompanying these regulations says almost exactly the same the thing, stating that
“the findings for the review are expected to be laid in Parliament shortly.”
Can the Minister tell us what the Government’s definition of “shortly” is, and give us some reassurance that we will actually see the outcome of this review? Has it been completed? If it has, why has it not been laid yet? Had it been completed when we discussed it last year, when the Minister said it would be laid shortly? I hope that he can give us some reassurance on this matter. The reasons given were Covid and Brexit. Obviously, we understand that Covid was a big blow—although Brexit was due two years after we had voted to leave—but we really need some reassurance about when we will see the review.
I will make just a few other points. When we discussed forecasts last year, we were discussing only one year’s levy because of Covid uncertainties. The Government now say that they are confident that they can forecast electricity demand with sufficient accuracy to reinstate the multiyear format. I note that the Minister has explained how the Government expect to see demand falling, albeit modestly, over that period. I wonder whether he could say something about how the Government are factoring in all the complexities of the massive price spike, and what that might do to demand, alongside the new demands of electric vehicles and heat pumps, et cetera.
As has been noted, the operational costs are up 40% over the levy period, and that is on top of the 19% increase that we debated last year. I recognise that there has been an expansion in the CfDs that the organisation is responsible for overseeing, and we welcome it, but I hope that the relentless pressure down on costs which the Minister talked about really will be applied continuously. I wonder whether some further economies of scale can be achieved, because both these organisations, as I understand it, operate from the same address. Are there functions that could be merged to save more money?
On the subject of the expansion of CfDs, I wonder whether the Minister can tell us where we are on the CfD for hydrogen. I note that it is the number two request on the CBI’s call for measures from the Government in terms of growth—number one, incidentally, is to close the public investment gap in terms of retrofitting commercial and domestic buildings. Perhaps the Minister could tell us whether that CfD on hydrogen will be forthcoming soon.
In terms of costs on bills, the Explanatory Memorandum estimates that these will be 50p on domestic consumers’ bills and between £30 and £1,200 on business bills, depending on their electricity usage. Obviously, 50p may seem a small amount, but I am slightly confused because I believe that the Explanatory Memorandum for the last levy-setting regulations said that it would be increased by 40p. It seems odd that this is only 50p over the period. Clearly, although these are small amounts, they all add up. People are facing crippling bills at the moment, so it is important that we keep an eye on that and on how we can drive down costs.
Another point I want to ask the Minister about relates to page 5 of the Explanatory Memorandum—which was presumably prepared some time ago—which talks about inflation of 5% having been allowed and discusses omicron and so on. However, this was clearly before some of the price spikes happened, and obviously before the Russian invasion of Ukraine. The CBI and other commentators expect inflation to peak somewhere around 8% to 9%, and there is increasing feeling that that level of inflation may be sustained for a longer period than was initially anticipated. In his reply, can the Minister tell us whether these new inflationary pressures in the system have been taken into account? If they have not, as some of them are fairly new, can he tell us how things might be adjusted over the period of the levy?
Finally, if there is a surplus and the money is paid back to consumers, can the Minister tell us whether there is a way of ensuring that the electricity supply companies deliver that rebate back to consumers if they effectively have to pay the charges in the beginning?
My Lords, I thank the Minister for his explanation of the regulations before the House. They are essentially non-controversial and, on this lonely side of the House, we do not take issue with them. As we have heard, the regulations update the rates for the operational costs levy and settlement costs levy, which fund the operational costs of the LCCC and the Electricity Settlements Company, respectively. As these two private companies share staff and facilities, these levies are set together.
After a single year of unpredictably and reduced electricity demand during the pandemic, first, it is welcome that this process has been able to return to a three-year system, allowing stakeholders greater visibility of the estimated operational costs, as well as reducing the administrative burdens on the two companies and on us here. Given the situation, it was sensible to reduce the periodicity, and I am glad that we have returned to normal.
Both the LCCC’s contracts for difference and the Electricity Settlements Company’s capacity market are measures that encourage low-carbon electricity generation and ensure security of supply, which is a noble intention. As my colleagues in both Houses have argued whenever these issues have arisen, since these arrangements came into place in 2013, a levy system, which will be passed on to customers by the electricity firms, is possibly the most regressive way of making these arrangements. The figures involved are certainly not large, as the noble Lord, Lord Oates, said, especially when looking only at the impact on the yearly changes, as is the case with the explanatory notice, but with energy bills increasing substantially amid a wider cost-of-living crisis, it is certainly the case that every little bit helps. Has the Minister therefore given any consideration to other methods that could facilitate the costs of these arrangements not falling on the customer?
I would also like to ask some questions about the consultation that took place ahead of the laying of this regulation, both on questions coming from it and the consultation itself. The consultation ran for four weeks and received only one response, from Scottish Power. While the perspective of this large stakeholder was welcome, I am sure the Minister would agree that having a single response to any consultation is not ideal. It is no fault of Scottish Power, but there were gaps in the responses leaving questions mostly unanswered, and inherent biases from a single respondent were unavoidable. Perhaps when this is revisited in three years’ time, the Minister could consider a longer consultation for a broader spectrum of responses to be generated.
One aspect of Scottish Power’s response that I would like to pick up upon surrounds budget lines related to providing policy support to BEIS, which Scottish Power recommended be kept under review. In their response, the Government committed to returning funds allocated here to suppliers. As this is the case with any unused funds, will unallocated funds from this aspect be ring-fenced for return, and, more importantly —as the noble Lord, Lord Oates, has said—will steps be taken to ensure that this is passed on to customers, given that any adjustment to their bills will have already been enacted?
It was also pointed out that the year-on-year budget rises are not insignificant, reaching approximately 40% over the four years from this financial year to the last of the three years this regulation covers. The Government rightly say that this is not unprecedented, given that at least in the case of the Electricity Settlement Company, the Explanatory Memorandum suggests that the body has only become more efficient, but I would be grateful if the Minister could elaborate a little on where the cost increases come from.
I look forward to the Minister’s responses to these questions.
I thank the noble Lords, Lord Lennie and Lord Oates, for their contributions to this brief debate. The noble Lord, Lord Oates, is of course quite right to raise the issue of the publication of the five-year review, especially since I told him last year that it was going to be ready shortly—I am sure there could be a big debate on what “shortly” means in the context of government. If I may fill in a little more detail for the noble Lord, I understand that updated advice on the matter is currently with my colleague Greg Hands, the Minister for Energy, Clean Growth and Climate Change. I think he intends to publish the review in due course—I hope, shortly.
The noble Lord also, rightly, asked for an explanation of why the review is so delayed. I can certainly say that it has of course been a government priority to deliver on our commitment to open the largest ever CfD allocation round—I am sure that is something he would agree on—and it has been announced that the rounds will be running annually from March 2023. A lot of work has gone into the preparation behind that. Schemes such as CfD are vital in developing domestic sources of renewable energy to reduce our exposure to volatile global fossil fuel markets, which are of course peaking at the moment, and to protect consumers in the longer term. Delivering on those priorities has had an unfortunate knock-on impact on the publication of the review, but we will endeavour to get it out as quickly as possible.
The noble Lord also asked for an update on the hydrogen business model. Of course, it is not part of this statutory instrument, but I would be very happy to write to him separately. I can certainly confirm that we are not intending to fund hydrogen under this particular mechanism or under the Energy Act 2013, so it falls outside the scope of today’s debate.
On the noble Lord’s questions on inflation, we have used a somewhat optimistic assessment of 5% inflation for each year of the proposed budgets. That was after careful consideration of the forecasts produced by the Office for Budget Responsibility. They probably looked very sensible when it put its advice together, but it suggested that, on balance, an assumption of 5% was appropriate.
On the question from the noble Lord, Lord Oates, on returning CfD generator paybacks to consumers, the contracts for difference scheme is working exactly as it was designed to. In the current power market that means returning some money to suppliers. Generators pay back to the LCCC when the wholesale price is above the strike price originally agreed. This ensures that consumers do not pay higher CfD support costs during periods of high electricity prices, as is currently the case. As electricity prices are so high at the moment, the LCCC has stopped collecting the supplier obligation levy from suppliers, and CfD generators have instead been paying back on CfDs since quarter 4 last year. To date, this has generated net repayments of around £205 million to the LCCC and, of that, the LCCC has paid back about £40 million to suppliers. The balance on account with the LCCC will meet future liabilities towards funding contracts for difference.
The contracts for difference scheme is working well and is vital to developing domestic sources of low-carbon electricity in Great Britain, which will help to reduce exposure to potentially volatile global fossil fuel markets and, we hope, to protect consumers in the longer term. How energy suppliers ensure they meet the different costs of government policies, including the contracts for difference scheme, is a commercial decision for each supplier and will be factored into their tariff prices. Competition between suppliers and the Ofgem price cap helps to ensure that, in their totality, consumers are offered a fair deal.
The noble Lord, Lord Lennie, raised some good points on how we fund the operations of the company. The costs of decarbonisation should be shared fairly among consumers. Levying costs to support the deployment of clean electricity in this way enables electricity consumers to pay towards the costs associated with increasing the proportion of renewable electricity supply from which they will ultimately benefit. The CfD scheme was designed to deliver value for money for consumers and it is doing so, with costs falling at every auction held to date. The CfD has now entered a new phase, in which renewable projects could reduce consumer bills as, at the moment, they are much cheaper than alternative forms of generation. It remains the case that the LCCC must be adequately funded if it is to perform its vital role to deliver the CfD effectively.
I note the point that the noble Lord raised on the number of responses we received to the consultation. Clearly one response is not ideal, but we have never received more than five responses to any of these increases in the past. Given other pressures on suppliers’ time at the moment, and the other competitive pressures that they are under, it is perhaps not surprising that only one responded to this year’s consultation, but I can inform the noble Lord that it was widely disseminated both on the department’s and on the LCCC’s website.
The noble Lord, Lord Lennie, also asked if merging the companies would result in cost savings. The ESC has no staff of its own, as the LCCC staff performs its functions. They are both based in the same premises and the costs are re-charged. I hope that, as a result, the noble Lord accepts that merging the companies is unlikely to result in significant cost savings.
As I set out in my opening speech, the companies and the Government have taken a number of steps to ensure that the proposed operational cost budgets allow the companies to perform the crucial roles that they carry out effectively, while representing value for money for consumers. I hope the Committee will accept that those twin aims will be achieved if these draft regulations are approved.
In response to points made by the noble Lord, Lord Oates, I will not pretend that the increase in the LCCC’s budget is not significant. It clearly is, but I believe that the increase is justifiable, based on the increasing workload that it will have. Let me set that out for the benefit of the Committee.
The increase in its budget reflects a number of factors, in particular the company’s important role in helping to meet our legally binding net-zero targets and the requirements of the Net Zero Strategy, while minimising costs for consumers. The CfD scheme has proven that it can deliver large-scale low-carbon generation while driving down costs. I know that the noble Lord, Lord Oates, will be familiar with this, but the cost of offshore wind, for example, has fallen by two-thirds between the CfD auction held in 2015 and the third auction—the most recent—held in 2019. The proposed budget will allow the LCCC to play its part in delivering further CfD auctions more regularly, which will help to bring forward more low-carbon electricity and push down the technology costs associated with that in doing so. That will of course bring us closer to meeting our net-zero target.
I can tell the noble Lord that funds have also been included within the budgets to enable the LCCC to support dispatchable power agreements, which will incentivise power carbon capture and storage projects, and a potential new scheme for bioenergy with carbon capture and storage projects. We believe that such projects could well help us to meet our net-zero goals and the requirements of the Net Zero Strategy.
It is also fair to point out that the company is facing a number of costs beyond its control over the budget period, chief of which is the increased uncertainty resulting from world events. This has pushed up many of its costs in a number of areas; for example, insurance premiums for the companies are expected to increase and, as the noble Lord pointed out, assumptions for inflation have also increased. It is important to consider that the budgets also include two contingencies, one focused on electricity demand and the other on legal disputes. I hope these may not be needed if a legal dispute does not arise or if demand is within forecast. If that is the case, the funds raised from the levy to cover these costs will be returned to electricity suppliers. I think that also answers the point made by the noble Lord, Lord Lennie.
Noble Lords have also touched on what this budget increase means for electricity consumers. This is a critical point and I agree with both of them that we must scrutinise every penny that goes on to consumer bills. However, I believe that in this case there has been sufficient scrutiny, with a lot of discussion between my department and the companies. Therefore, given the important role that both companies play in our electricity system, a bill impact which equates to less than 0.1% for the average consumer is proportionate and justifiable overall.
I reiterate one final point to the noble Lord, Lord Lennie. Any unspent levy funds will be returned to electricity suppliers at the end of the financial year, in accordance with the regulations. Indeed, this has been the pattern to date: for example, at the end of 2020-21, the LCCC returned £1.5 million to suppliers and the ESC returned £576,000.
With the explanations that I have provided, I hope the Committee will agree with this statutory instrument. I commend these draft regulations to the Committee.