Electricity Market Reform holds little promise for smaller independent UK generators

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2 April 2013, Electricity

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Contracts for Differences (CfDs) are at the heart of the government's Energy Market Reform (EMR) package, which the government hopes will stabilize returns to low-carbon investors and reduce the cost of capital, thereby promoting the new investment patently required in the UK.

The first transitional stage of the EMR, which will run until March 31, 2017, will be the most unclear for investment in new renewable capacity, as renewable generation investment will be eligible under either the present Renewables Obligation (RO) scheme or the new CfDs, and investors will be forced to choose.

One of the main aims of the EMR is to drive investment in low-carbon generation capacity. Independent power producers (IPPs) are vital to contributing towards the required investment in low carbon generation capacity. To acquire project finance, IPPs need power purchase agreements (PPAs) with suppliers; however, the PPA market is waning and has reportedly become more difficult for IPPs, with increasingly higher discounts, shorter contract durations, and lower or even no floor price levels.

Further, increased competition, the promotion of energy efficiency, and a protracted economic downturn translate into suppliers experiencing uncertainty as to the volume of electricity - renewable or otherwise - that they want to purchase long term. The imbalance can be seen in less attractive contract conditions for IPPs, and in greater discounts. Discounts are currently reported to be in the range of 10-20% for power and Renewables Obligation Certificates (ROCs).

Added to this effect is the element of uncertainty and regulatory risk from the EMR itself. The effect of the transition period makes it difficult to know how many generators will opt into the CfD scheme and therefore what the ROC value will be for those remaining with the RO.

The success of the PPA market in the transition period will depend on how commercially attractive PPAs are for both generator and supplier, given their respective appetites for risk. Logically during a period of transition, risk appetites will be smaller, but the need for assistance in maintaining the number and quality of PPAs has been recognized by the government.

Consultation with the industry on the transition period is due to start, in which the government will consider alternatives to avoid an investment hiatus by addressing market liquidity, imposing a volume-based obligation on suppliers to have PPAs, or having a buyer of last resort for IPPs. Such suggestions have unsurprisingly had a mixed reception from suppliers and generators.

Datamonitor will shortly publish a brief providing further insight into the issues for IPPs during the transition phase.

www.datamonitorenergy.com / asken@datamonitor.com / @DatamonitorEN

Source: MarketLine

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