Draft Electricity Capacity (Amendment) Regulations 2016

Alan Whitehead Excerpts

Monday 27th June 2016 General Committees

[Dr Alan Whitehead (Southampton, Test) (Lab)]

As the Minister has set out, we are discussing a new auction to be put in front of the existing T-4 auctions, which will remain in place, in order to auction capacity four years in advance of the performance of that auction capacity. The purpose of T-4 auctions—I am sorry that the Minister did not mention this—is essentially to procure new capacity that can be on stream at the end of the T-4 period. That new capacity will get its underwriting so that it can be built in the three-year period before the last T-4 auction. That will incentivise building and production, and that is what the underwriting 15-year contracts will consist of. Those 15-year contracts would run alongside shorter term contracts intended to maintain capacity, but that is the central purpose of the original auctions.

An additional auction will now be in place before the T-4 auctions have run their term, but after they have started, in order to secure capacity on one-year contracts only—no 15-year contracts are available in this pre-auction. As the Minister said, that is simply to prevent, among other things, plants from being mothballed or closed down, so that they can continue to supply capacity even when we were hoping that the capacity from new plants would be coming on stream. This arrangement represents, at the very least, substantial mission creep on the original purpose for capacity auctions.

Not only is it mission creep, but it replaces a fairly well placed device, the contingency balancing reserve, which, even in the context of the original T-4 auctions, was in essence a guarantor that reserve capacity would be available outside the market, and largely bid for by, and separately placed with, plants that might otherwise have been mothballed or closed. As a result, in the period running up to the new plants becoming available, there will be sufficient capacity and reserve to ensure that the loss of load is not significant, so that we are within the limits and, indeed, have a fairly robust method of ensuring that the capacity margins are upheld in that period before the emergence of the new plants.

Something else the Minister did not mention when describing the draft regulations is what has actually happened with the original two T-4 auctions. To all intents and purposes, no new capacity has been procured under the auctions, with the exception of one plant, which does not look as if it will be built, because it bid into the system without having a clear way forward to add to the bidding and to invest in the plant. Overall, however, the vast majority of the contracts were the sort of one-year contracts that it is now envisaged will be the substance of the auction in front of the T-4 auctions.

Not only were they one-year contracts, but they were contracts that have gone to all sorts of producers—coal, gas and, surprisingly, nuclear. We have underwritten existing nuclear power plants to provide capacity, when it would be difficult to envisage how they could fail to provide capacity when required to do so. They would have to switch themselves off and close down for long periods in order not to provide capacity. So the first auctions have a rather perverse outcome, and the proposals essentially start to install those perverse outcomes into a continuing process for capacity auctions.

The first two auctions cleared at relatively low prices, as the Minister mentioned. She states that they were good value for customers, and one might view that outcome—clearing at £20.30 per kilowatt and £18 per kilowatt respectively—as good value, if one did not know what the original purpose of capacity auctions was. Arguably, that good value falls away if no new plants arise from the capacity auction and it is consumed entirely in short-term contracts, some of them for completely inappropriate forms of capacity going into the system.

The mission creep that we see in the regulations before us essentially means that their purpose, as the Minister suggested in her remarks, appears to be keeping plant open and preventing contractors from closing plant, rather than opening new plant. Furthermore, they are trying to bolster the idea—I do not disagree with it—that those who contract to provide power, particularly in a T-4 or 15-year auction but even in a one-year auction, ought to carry out that contract. Dangers have been suggested. A number of contractors have been considering the fact that the penalties for non-performance are considerably less than the potential savings from mothballing a plant; one has actually done the dirty deed. The extent to which the arrangements cause people to keep their plants open has begun to fray. I therefore support the proposals in the regulations to make penalties more appropriate to the power being provided, with high penalties for non-performance.

However, the central question is what analysis has been done of that mission creep to ensure a system that gives us energy security over the next period and reasonably good value for the consumer. By the way, I support the other consideration in the regulations: the question of organising demand-side auctions in a way that is more favourable to demand-side entrants who have had difficulty taking part in the general auction, and who have to some extent been superseded by would-be demand-side entrants that deal with things such as diesel plant. I support the sense of putting that into the system.

I would like to ask the Minister a couple of questions about how the benefit of the proposals has been arrived at. To find that out, we must once again look at an impact assessment, and I am pleased to see that on this occasion we actually have one. That is good. However, the impact assessment has been set against a rather strange counterfactual. If more plants close than predicted, prices will be pushed up, but the instrument might cause fewer plants to close and prices will therefore not go up to such an extent.

However, the impact assessment suggests that if fewer plants close the net welfare could, under some circumstances, be negative. In any event, as the document presents, the very fact that a new capacity auction has been announced causes operators to decide not to close or mothball plant. The counterfactual is therefore undermined by the idea itself, and that seems to be a strange way to conduct an analysis of what the cost is and should be. Indeed, all that the counterfactual arrangements do, in the end, is come out with the difference between a very high cost to consumers and a relatively high cost to consumers.

Can the Minister tell me how reliable she thinks the cost suggestions in the impact assessment are? The Committee ought to think carefully about the suggestion that the likely cost, for this auction alone, is between £2 billion and £3 billion. Over the past few weeks we have debated the gross and net costs of contributions to the European Union, but this is of a different order—it translates into a gross cost of between £28 and £38 on a household electricity bill. That would have an enormous impact on consumers and would dwarf many relatively minor impacts, such as the incentives for renewables to deploy.

However, even if we take the net benefit, which assumes that wholesale prices will be lower as a result of the measure than if no measure was taken—an interesting supposition and perhaps not a safe way of calculating an impact—it is still suggested that the impact on consumers’ bills will be between £10 and £21. So at the very least the impact is enormous, even if the changes are considered in the best light.

I have one final question for the Minister. Even in the context of one-year contracts only, the impact assessment sets out an assumed clearing price for the auction, on which all the calculations are modelled, of £62. Would it be a good outcome for consumers to have a clearing price for one-year contracts that would have been high enough if it was a T-4 auction to gain some new long-term contracts, which was the original idea of capacity auctions? It looks like we might now be getting an auction at very high clearing prices, with no long-term contracts let and under circumstances in which the consumer pays a heavy bill. Will the Minister comment on how we have come to that?

We will not oppose the statutory instrument, but there needs to be close examination and an explanation of the central issue of how the modelling took place to reassure hon. Members and the public that there is value for money and that it is better than the alternatives.

Finally, not only are the counterfactuals as I have described them, but, interestingly, the counterfactual of continuing with the contingency balancing reserve, which I mentioned a while ago, is set against one-year prices, as opposed to what was originally set out in the Energy Bill as a full-blown strategic reserve, rather than a capacity auction. That seems to be a much better counterfactual on which to compare and contrast value.

The whole thing therefore reeks of mission creep not just as far as the measure is concerned, but as far as the analysis of the measure is concerned. That is a worrying development in policy. I am sure that the Minister will want to respond to that and consider it carefully in respect of her future arrangements for capacity auctions.

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[Andrea Leadsom]

I am grateful to hon. Members for their comments and questions. It will be a great pleasure to answer them all and hopefully my answers will please hon. Members.

The hon. Member for Southampton, Test asks whether there is mission creep. The capacity market is there as an insurance policy for energy security. It is true that it has the secondary goal of bringing on new investment in new, lower-carbon plant, but its core goal is as an insurance policy that ensures that the lights stay on. As he pointed out, a 15-year deal is not available in the supplementary capacity auction. The reason is that, because it is only for 2017-18, there is not time to build the plant and start dispatching electricity between now and the delivery date. However, the T-4 auctions are indeed designed not only to provide energy security, but to bring on new investment.

The hon. Gentleman says that that has not been successful, but that is not true. We have had a variety of new build plants, including more than 800 MW of small scale gas and the CCGT that he mentioned. It is crucial that we provide opportunities for new investment, which is why we have announced separately that we will buy more capacity and do so earlier. We will announce shortly what that means for the next T-4 auction.

The hon. Gentleman talked about the counterfactual of the supplementary capacity auction versus the £8 billion cost of early closure. To be clear to all Members, he is exactly right that our best estimate of what the supplementary auction will cost is £2 billion to £3 billion. It is very difficult to assess exactly what that means per consumer bill, but it will be in the region of £11 to £20. As he has acknowledged, the reason for having the auction is the drop in wholesale prices, which has meant that the economics for wholesale generators have been difficult. In fact, the average dual fuel bill is roughly £200 a year lower than it would have been. We cannot be clear about what the bill impact will be, because it is subject to a competitive auction, but our estimate is that it will be between £11 and £20, which is less than 10% of the reduction in wholesale costs for consumers. In net terms, it is a very good deal for consumers and provides energy security at a time of low wholesale prices.

[Dr Whitehead]

I would be grateful if the Minister confirmed that the estimate she has just given is post the estimates about the dampening effect of wholesale prices of this particular measure, and not the gross effect of what the measures might produce. That is to say, this is the figure after that presumed effect is deducted, and if that presumed effect was not deducted, the cost would be substantially higher to consumers.

[Andrea Leadsom]

I will have to write to the hon. Gentleman on that point. I am not sure I completely understand his concern. The impact assessment is clear that our best guess is that the bill impact will be in the region of £11 to £20. I have just been informed that that is net. I will write to him if he wants a fuller answer, but I hope that clarifies things.

The average dual fuel bill is £200 lower than a year ago as a result of lower wholesale prices, which make it more difficult for wholesale generators to cover their costs. Bringing forward the supplementary capacity auction will therefore ensure that there is security of supply. The best estimate is that that will cost £11 to £20 per bill, which is very good value for consumers.

The hon. Gentleman also questioned the £8 billion counterfactual. That £8 billion counterfactual assumes that we do not bring forward the supplementary capacity auction. There would therefore be nothing available for wholesale generators, and they would have to deal with the consequences of the poor economics of low wholesale prices. He asked about the contingency balancing reserve. Our estimates show that it would be more expensive than the supplementary capacity auction. That is why we are doing this. The SCA is more cost-effective and provides energy security. I hope that that answers his questions.

The hon. Member for Coatbridge, Chryston and Bellshill asked about interconnector links. I can tell him that they will go ahead. I confirm for all Members that my view is that energy policy will not be impacted at all by the public’s decision to leave the European Union, because we will continue to have our energy trilemma and our commitments to decarbonisation at the lowest possible price, to energy security and to interconnectors, which after all are all commercial decisions made between businesses. Our policy for more interconnectors will endure, provided that Ofgem finds on a case-by-case basis that they offer good value to consumers.