The UK energy market is under unprecedented pressure, whatever the background noise of a Competition and Markets Authority investigation or the Labour led promise of price freezes, the here and now of the energy market is the fact that demand will soon outstrip supply if power plants continue to be decommissioned without replacements being ready to take their place.
This relatively simple sum is one that currently does not add up; as a result the government and Ofgem have launched new schemes to tackle the impending energy hole.
The UK is due to lose 20% of its generating capacity over the few years as ageing coal and nuclear plants are retired and no new comparable replacements are in place.
Indeed Ofgem reports that a further 5GW of generation plant will cease operating for good by 2016 with another 1GW being mothballed due to being uneconomic to operate.
As a result Ofgem has warned that the UK’s electricity capacity margin – the surplus of peak power output over demand – could fall as low as 2% by the winter of 2015-16 because of the accelerated closure of old fossil fuel power stations and their replacement with intermittent and smaller scale sources such as wind power.
Indeed National Grid has reported that we face a one in four chance of blackouts over the next 18 months.
In order to address this, two schemes have been developed.
The government developed scheme, subject to EU approval, proposes that energy generators will be paid to maintain back up electricity generation that is ready and able to come on-line to fulfil our demand needs and keep the lights on.
The aim is to encourage 53GW of power stations – enough to meet 80% of Britain’s peak demand – to fire up when needed.
The problem is that this scheme needs to be paid for and as usual it is the consumer that has to foot the bill. It is estimated that customers will have to pay on average £13 per year to fund this scheme.
Already levies make up a significant proportion of a customer’s energy bill, up to 10% for various renewable energy initiatives and other network subsidies.
Unlike those pre-existing levies however the proposed generation levy will be a competitive one, in that rather than a one price is paid by all approach, generators will bid for capacity payments in an specially devised auction with the lowest bidder(s) winning.
The idea being that the auction and award process will encourage development of new plants (as profitability is ‘guaranteed’ by the payments) as well as keeping those plants likely to be mothballed due to their current uneconomic position, being brought back into action.
As a result of the competitive nature of the auction, the government hope that cost to end user customers can be minimised.
In exchange for winning the auction, the generators will be required to commit to delivering energy when needed or be hit by appropriate penalties. The auctions are designed to run many years in advance of delivery in order to provide time to develop and deliver the generation solutions needed.
Introducing the measure Ed Davey, Secretary of State for Energy and Climate Change said:
“There was a real risk back in 2010 that an energy crunch would hit Britain in the middle of this decade and lead to damaging power cuts.
“But the excellent news is that with [this] announcement we have the final piece of the jigsaw of our detailed energy security plans and can now say with confidence that we have defused the ticking time bomb of electricity supply risks we inherited.”
Addressing fears that this could just be another subsidy and reward charter for the much-maligned Big 6 energy suppliers, Davey said:
“A lot of the capacity out there is not owned by the big six but by independent generators, on the generation side, there has always been more competition [than in retail].”
Davey plans for 50.4GW to be auctioned in December for capacity that needs to be in place and fulfilling demand by the winter of 2018. Thereby providing much needed long-term investment certainty for generators so as to incentivise them to keep the lights on.
Under the second scheme, Ofgem themselves have continued to develop their demand side measures to reduce pressure on the grid at times of peak demand. It is hoped that this will allow an additional 1.8GW buffer to be created on the electricity capacity margin to further mitigate the risk of black outs.
The policy, focussed on incentivising heavy power users to use alternative sources of generation during peak times is forecast, in conjunction with the government’s capacity mechanism, to reduce the risk of black outs over the next 18 months from one in four to one in 31.
Dermot Nolan, Chief Executive of Ofgem said:
“Though the outlook for capacity margins is broadly similar compared with last year’s report, the fact that National Grid can use the new tools to balance the grid has reduced the risk of disconnections.”
Of course these incentives needs to be paid for too and it is conservatively anticipated that the cost will equate to £1 a year on customers electricity bills.
The cost of energy might not be getting any cheaper, but at least we can rest a little easier that what we pay for has a better chance of being delivered over the coming years.