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The Helm energy cost review

By Dave Elliott

In his wide-ranging review of energy costs for the UK government, Dieter Helm says ‘the cost of energy is too high, and higher than necessary to meet the Climate Change Act (CCA) target and the carbon budgets. Households and businesses have not fully benefited from the falling costs of gas and coal, the rapidly falling costs of renewables, or from the efficiency gains to network and supply costs which come from smart technologies. Prices should be falling, and they should go on falling into the medium and longer terms’.  And he sets out his ideas for enabling that to happen.                  

Helm claims that ‘Complexity is itself a major cause of rising costs, and tinkering with policies and regulations is unlikely to reduce costs’. Indeed, he says that ‘each successive intervention layers on new costs and unintended consequences. It should be a central aim of government to radically simplify the interventions, and to get government back out of many of its current detailed roles’.

To simplify things, he wants to combine support systems and taxes into a universal carbon price and a unified equivalent firm power auction process. He says under the previous Electricity Market Reforms, ‘investment decision-making has been effectively quasi-renationalised’ and so ‘the government, not the customer, has become the client’. And he wants to undo that.

Firstly, there will be some major tidying up to do. He notes that ‘the legacy costs from the Renewables Obligation Certificates (ROCs), the feed-in tariffs (FiTs) and low-carbon contracts for difference (CfDs) are a major contributor to rising final prices, and should be separated out, ring-fenced, and placed in a ‘legacy bank’.’ He puts the total legacy cost at well over £100bn by 2030, incurred mainly due to what he sees as an over-emphasis on high cost renewables, in part due to the impact of the EU Renewables Directive. We are already committed to paying this, but he says ‘once taken out of the market, the underlying prices should then be falling’.

As a follow-on, the existing FiTs and other low-carbon CfDs ‘should be gradually phased out, and merged into a unified equivalent firm power (EFP) capacity auction’, which would include the current capacity auctions for flexible/backup balancing power. The costs of intermittency ‘will then rest with those who cause them, and there will be a major incentive for the intermittent generators to contract with and invest in the demand side, storage and back-up plants.’

To oversee all this, the government ‘should establish an independent national system operator (NSO) and regional system operators (RSOs) in the public sector, with relevant duties to supply, and take on some of the obligations in the relevant licences from the regulated transmission and distribution companies’, with the role of Ofgem in network regulation ‘significantly diminished’.

It’s a radical set of proposals, urgent he says ‘not just because of the many failures of the current market, but also because of the pressing need to meet the new and exciting challenges ahead which will come with the digitalisation of the economy, electric transport, new storage, demand-side opportunities, and the development of decentralised energy systems. This new world stands on their head the current assumptions on which the industry is structured: the new world is likely to be more zero marginal cost and capacity-driven, rather than a marginal cost-driven wholesale energy market world’. He claims that we may move to ‘a purely zero marginal cost world’ in which ‘there is only capacity. The energy itself is free’ and he says ‘it is hard to underestimate the scale of the revolution this entails’. 

Well yes, there are many new opportunities, but the new situation also presents potential  problems, e.g. a race to the bottom in price terms, with no one looking to whole system balancing. Would his proposed new combined ‘equivalent firm capacity’ auction system avoid that? He claims it would: the EFP auctions process ‘directly confronts those [technologies] that cause intermittency costs with the costs they cause, just as a carbon price confronts those that emit carbon with the costs they cause’.

In his plan, the auctions would be on an equivalent basis – so the de-rated contribution of intermittent capacity is taken into account. He admits that this would have a significant impact on some renewables, but he claims it would be fairer economically: ‘When wind starts to dominate the system, and wind availability is thus strongly negatively correlated with supply shortage, it gets a de-rating below its average load factor. For example, the EFP may be around 16% for wind today, substantially below its average load factor of around 27%, but still much higher than zero, despite it being quite likely that wind output is very close to zero at certain times’. He adds ‘It is especially in the latter sense that the relevant EFP is distinctly not the power/capacity that is ‘almost firm’, but it is the capacity that is on average similarly helpful as firm (i.e. always on) capacity.’

Helm concludes ‘what would be revealed in EFP auctions is that different renewables have very different system costs. Solar would have lower intermittency costs than wind, and both would have higher costs than biomass. Solar would need to address the problem of night-time hours and longer and darker periods during winter, whereas wind would have to address much more varied supply intermittency in order to achieve higher returns from the EFP auctions. These renewables would then have a strong incentive to do deals with those that offer back-up, to engage with customers on demand-side management, and develop storage options and other innovative ways of managing the variances they create through the market or by direct investments. This increases their value in EFP auctions, as their de-rating factor improves. It is much more likely that an active energy management market would develop with these incentives from a firm power auction, rather than if it is left to the system operators to determine. It would be a major spur to the energy services businesses’.

The obvious objection is that an EFP auction would take no account of carbon. It would be least cost and Helm claims achieve the security of supply objectives, but possibly at the expense of failing to meet the carbon budgets. Helm says this can be dealt with given his proposal to internalize the cost of carbon in prices, or failing that, by adding extra criteria in the auction process. That last bit sounds a bit messy – going back to what we have. He also admits that the EFP system ‘would hit new and emerging technologies’, but says ‘the problem here is best seen as an R&D and innovation one, and for this R&D and innovation support mechanisms are required’. So once again we are going back to a more complicated multiple phase system. And that’s also his ‘second best’ fallback position overall if the EFP can’t be developed: direct contracts for specific projects – as happened with Hinkley.

Overall though, while Helm wants a technology neutral approach, he does note that, given the uncertainty about new nuclear, the government ‘should as a matter of urgency give guidance to the system operator as to what measures it should take to mitigate this large-scale system risk, and the extent to which extra capacity should be auctioned ‘just in case’ new nuclear is either late or not delivered. Failure to do so could result in sharp spikes in the wholesale market’. So a bit more corrective intervention there…

However, Helm would obviously prefer just his single EFP approach, and says that then, ‘as the costs of renewables continue to fall, it is only the carbon price that is needed to ensure a level playing field as renewables become the new conventionals’. Optimistic stuff! Would ‘one size fit all’? The RO and CfD were subdivided – will single EFP auctions suit all the various technologies? Would they yield enough balancing capacity of the right type? The current capacity market auction rounds arguably did not, and linking the backup/balancing capacity to individual generation projects doesn’t make much sense – it’s a (shared) system-level issue. And, finally, would enough low-cost renewable capacity be backed, e.g. will onshore wind be let back in? Plenty to chew on…quite apart from the carbon price idea.

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