According to Britain's energy ministry, the Department of Energy and Climate Change (DECC), the reforms will allow the country to meet its environmental goals and improve energy security at lowest cost to consumers.
Energy regulator Ofgem estimates that £110 billion (EUR130 billion) must be invested in electricity-generating capacity and grid infrastructure over the next decade. With a quarter of existing coal and nuclear plants due to be retired by 2020 and the UK committed under EU rules to generating 20% of the energy it uses from green sources, 30% of electricity produced will have to come from renewable sources within a decade.
Industry groups broadly welcome three of the four major proposals: a carbon price floor making the economics of low-carbon technologies more attractive; an emissions performance standard limiting the amount of carbon that power stations can emit; and capacity payments rewarding generators for building flexible reserve plants to support variable renewable generation.
Controversial change
More contentious is a proposal to replace the existing Renewables Obligation (RO) incentive mechanism in England and Wales with a system of long-term contracts for low-carbon electricity, including nuclear power and carbon capture and storage alongside renewables. The new mechanism, with support levels set by auctions, bears a striking resemblance to its predecessor, the discredited Non-Fossil Fuel Obligation (NFFO).
The government is referring to these contracts as feed-in tariffs, the current buzzword for fixed electricity-purchase prices set by government.
DECC's favoured approach is a contract-for-difference model in which low-carbon generators negotiate contracts for the electricity output of their plants on the wholesale market and receive a top-up payment or pay money back when the contract price differs from the wholesale price. This is similar to the Netherlands' sliding premium-tariff structure.
If contracts for difference turn out to be unworkable in the UK, the government is minded to introduce a fixed production-incentive payment, given to generators in addition to the revenues from selling electricity on the wholesale market - similar to the system used in Spain.
The UK government argues that long-term contracts for difference will provide generators with greater revenue certainty than the RO, therefore lowering the cost of capital and bringing down the overall cost to customers.
James Cameron, vice-chairman of investment advisor Climate Change Capital, says this mechanism "could provide much-needed certainty for investors over the right time horizons".
Loss of confidence
But wind industry voice RenewableUK warns that changing the existing mechanism will hit investor confidence. Director of policy Gordon Edge says the RO mechanism has turned the UK into the world leader in offshore wind and brought forward 20GW of projects in development onshore. "We shouldn't be looking to solve a problem that doesn't exist, or take a leap in the dark which might undermine investment," he says.
The chief operating officer of independent renewables developer RES UK & Ireland, Gordon MacDougall, says the new mechanism will broaden support for other low-carbon technologies such as nuclear - to the detriment of renewables. MacDougall believes the package does not fit together. While he concedes that, under certain market circumstances, a system of contracts for difference could bring more competition and liquidity to the UK energy market, he doubts that the current plans will allow those circumstances to materialise.
His biggest concern about the new system is removing the obligation on electricity retailers to bring renewables into the UK energy mix. Having price as the only trigger is a step backwards, he says.
Arguing in defence of the RO mechanism, MacDougall says that the government has already introduced measures to reduce the cost of the RO, one of the main criticisms against it. These include technology bands with different prices applicable for each renewable source, limits on retailers' obligation - to avoid consumers paying for non-existent capacity - and a 20-year cap on support for projects.
The government's preference for auctions to set the price for the contracts is causing alarm in the industry. Many remember the stop-go nature of support under the NFFO, a system introduced in the 1990s by a previous Conservative government that resulted in low prices for renewables but little installed capacity, as wind farm bidders who had bid too low for the contract were then unable to proceed with financing.
Gaynor Hartnell, chief executive of the industry body Renewable Energy Association, warns against repeating the mistakes of the past. "Auctions would have to be frequent, with a timetable stretching out years in advance," she says. "A stop-start regime would be no good."
Priority to grid
Hartnell also cautions that, with the demise of the RO, the government may have to consider giving priority to renewables generation on the grid, as elsewhere in Europe. It is currently in the interests of grid operators, which are often energy retailers too, to facilitate renewables' access to the grid because they need to collect the RO certificates.
DECC hopes to introduce contracts for difference in 2013, although to minimise disruption for existing renewables projects it intends to allow generators to opt for the RO mechanism until 2017. To ensure investor confidence, support that is already committed under the RO would also be maintained. In effect, three support programmes would be running at the same time: the fossil-fuel NFFO, which is still supporting some projects, the renewables obligation and the new contracts-for-difference mechanism.
Hartnell stresses the importance of the transition arrangements for moving to the new contracts. If the government can devise prices that reflect what generators would expect to achieve under the RO, then a swift move would be desirable. "The advantage of having all generation covered by one policy, both administratively and legislatively, should encourage government to make the transition rather than keep the RO going to merely provide some semblance of continuity," he says.
The market reform proposals are open for consultation until March 10.
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