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The Topic: Funding decarbonisation FUNDING DECARBONISATION THE TOPIC 10 | 16TH - 22ND SEPTEMBER 2016 | UTILITY WEEK A t the core of the government's efforts to decarbonise the power sector is the double-headed subsidy regime of the contracts for difference (CfD) scheme and the capacity market. Introduced as part of the government's Electricity Market Reform package, the first guarantees the price for generators, while the second pays them to provide capacity. Without the CfD scheme there would be insufficient incentive to encourage invest- ment in low-carbon generation – investors need an adequate return before they will part with their capital. Without the capacity market there would be insufficient incentive to maintain the spare capacity needed to fill in the gaps when the wind isn't blowing and the sun isn't shining. The mechanisms have, broadly speaking, been welcomed by the industry, although they are far from perfect. The government is working to reform the capacity market to try to prevent small-scale diesel dominating new capacity, as it did in the first two auctions. It is unclear how effective these changes will be. As things currently stand, it is pre- dicted that large-scale gas plants will be unlikely to beat small-scale diesel in the four-year ahead (T-4) auction this winter. The mechanism has also been criticised for subsidising existing plants, which would have carried on running anyway, and for put- ting demand-side response at a disadvan- tage. There have been calls for the auctions to be opened up to renewables and storage to enable them to compete with the alterna- tives, which in turn would lead to greater CfDs and the capacity market Should the current raft of subsidy regimes be tweaked until they deliver what they were supposed to deliver, or is a more fundamental rethink called for? Policy initiative: CfD for renewables – Decarbonise the energy mix Issue: Only one auction run so far; last year's cancelled. The issue is that a CfD arrangement gets more expensive as more renewables come online, cannibalising the CfD budget. Lots of investment uncertainty and stranded projects. Policy initiative: CfD for nuclear – Decarbonise the energy mix Issue: Just one project, Hinkley Point C. Expen- sive cost, no working examples of technology, EDF under financial pressure, £100s of millions in the hole already. Baseload generation require- "The one thing that British electricity policy is not is technologically neutral." • Dieter Helm, economist investment in these areas. The CfD scheme faces a different set of problems, a number of them related to the Levy Control Framework (LCF). The LCF sets annual limits on the amount that can be spent on low-carbon subsidies, but there is currently no mechanism in place to take account of changes in wholesale prices. Falling prices can significantly increase the cost of CfDs, blowing the LCF budget, despite having little effect on the ultimate price paid by British consumers. The LCF has only been set until 2020/21, leaving investors in the dark about what happens beyond then. The government has said there will be £730 million of annual funding available across the three auctions scheduled to take place during the current parliament, with £290 million up for grabs in the first. How- ever, it is unclear which technologies will be eligible to take part in each and how much funding will be available in the sec- ond and third auctions. There is also the issue of the effect on price signals in the wholesale power mar- ket. A report by Barclays Research found that the wholesale pricing mechanism is "effectively permanently broken as a signal to develop new generation capacity, under- mined by the introduction of significant levels of subsidised low/zero dispatch cost LEVY CONTROL FRAMEWORK CAPS 2014-21 Source: Phil Hewitt, director, EnAppSys ment disappearing as renewables get cheaper. Risk is that when Hinkley finally gets built in ten years' time, cheap battery storage and heat networks will have made the case for it difficult to justify and it will be an expensive and immovable lump in the market. In the meantime, a major investment uncertainty as the flagship project is suspended. Policy initiative: Carbon floor price – Decarbon- ise the energy mix by fixing the EU ETS price collapse with a unilaterally high UK price Issue: Combined with the capacity market, a policy that has been very successful at shutting ENERGY POLICY INITIATIVES 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 £ million 2014/15 2015/16 2016/17 2017/18 2018/19 2019/20 2020/21 Note: All figures in 2011/12 prices. Framework caps in nominal terms at the time of the relevant spending review or spending round. Source: Decc 3,300 4,300 4,900 5,600 6,450 7,000 7,600