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Regime change? How to ensure successful electricity market reform

11 Feb 2011

We are in the midst of a debate about how best to incentivise investment in clean energy, and in particular renewable energy, in the UK. The nature of the electricity market reforms required to achieve this are critically important given the scale of investment needed in the UK energy system in the coming years and also its potential cost to the energy consumer, writes Ian Temperton, head of advisory at Climate Change Capital.

Getting this right could be one of the most important things the Coalition Government achieves, but an ambitious outcome is being thwarted by a lack of clarity over how Government intends to protect capital already invested under the current incentive regime – the Renewables Obligation (RO).

The effective execution of electricity market reform requires two straightforward steps: firstly that a wide range of options, including potentially quite radical ones, are considered with the best proposed and secondly, that sufficient space is created in which to have a full and frank debate about future arrangements without existing investors becoming overly protective of the status quo. It is the latter requirement where policy makers have consistently failed in recent years – the fear of change impacting on existing investments has tended to pollute the really vital debate on the future of the market. This consistent shortcoming has lead to the hodgepodge of measures which now make the RO look like the most complex premium feed-in tariff ever invented.

Space for effectively discussing electricity market reform can only be created by a system in which market participants feel able to engage in a dialogue with Government about future policy developments, without fear of any impact on current or historical investments. The current fears of an investment hiatus as we have the debate on the future of the RO is symptomatic of this issue, where insufficient attention is being put on creating confidence and certainty in the regime applicable to historical, current and near term investments.

Given the very nature of renewable and other clean energy investments, addressing this issue is vital. Such investments (wind for instance) have high investment costs compared to operating costs and this means that post-investment there is almost no-way for the asset owner to adapt their investment to new market circumstances and policies. As a result, the prospect of change for investments that are historic or are in progress today will always be deeply concerning for those owners, and their first reaction in any debate will always be to act to secure the terms of these investments rather than fully participate in the dialogue about how best to support future long-term investments. This is exactly the reaction we are observing now.

Unfortunately, our existing incentive regime is currently not set-up to provide the security that those already invested require. While the RO has “grandfathering” of its bands, it does not have grandfathering of its other rules and arrangements and hence investments made today and in the past are exposed to the changes in rules and parameters which might occur in the future. The recent debate on grandfathering of the bands for biomass highlighted to the market the degree to which robust grandfathering is actually at its core a policy commitment.

As the debate on the future of renewable energy incentives hots up and the closer we get to the Government publishing its electricity market reform proposals, we can help change this by doing two things: firstly, create the space for reform by taking steps to robustly grandfather all the rules which apply today and for the short-term future under the current arrangements.

Secondly, introduce the concept of change into the system. It is clear that whatever the next incarnation of future policy, this will not be our last review or our last change to the system, and hence if this (actually quite healthy) cycle of experience, learning, review and change can be formally embedded in the way we create policy, then investors will be able to securely undertake investment today and in the near term, while engaging in active, open and ongoing debate with government about the future of the market. The present arrangements do, and will continue, to cause one of these to choke the other.

I would disagree with those connoisseurs of the RO that might claim that something called the headroom mechanism achieves the aim of future certainty. However, there are means, without radical change to the RO system, to achieve this robust grandfathering and hence create a safe space for the debate about the very existence and radical overhaul of the system. Recognising that investment costs, policies, and the situation of the wider markets vary with time has been debated since almost the start of the operation of the RO. Perhaps it is time again to look to reflect the vintage of an investment in the system which supports the returns to that investment.

Ian Temperton is Head of Advisory and in 2003 wrote ‘Financing Wind Beyond 2010′ for the BWEA which highlighted the potential role of repeated and systematic grandfathering of the RO.

 

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