Lessons for Nigeria: Comments on “Such A Long Journey: Evaluating the UK’s Electricity Market Reforms”

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imageBy Olumide K. Obayemi, Viyon O. Ojo and Bolaji J. Idowu
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Nigeria may adopt certain features of the UK’s Electricity Market Reform (EMR), which is based on the twin system of Contracts for Difference (CfD) meant to support low-carbon electricity generation, and Capacity Market (CM): meant to address security of supply.

Also, the Nigerian electricity regime may also adopt the sealed bidding system and allocation of rounds. Nigeria must also set up a Low Carbon Contracts Company (Counterparty/Levy Collector) to liase between NERC and the Gencos and Discos.

The UK’s electricity regime CfD’s system provides model that can be emulated via the creation of a low-carbon generator is paid a top-up payment above the wholesale price (the reference price), up to a set strike price. The strike price is intended to be an amount equal to that needed to make low-carbon power projects commercially viable. The CfD takes the form of a private law bilateral contract between the CfD counterparty and each low-carbon generator.

Nigeria may also adopt the sealed bidding system: Under the regime, if all the qualifying applicants could have been granted a CfD without exceeding the budget pot for each group of technologies, then an auction would not have been necessary and all the projects would have received a CfD at the strike price set out in the delivery plan –the so-called “administrative strike price”.

Also, in the UK, for the auction, the Government adopted a “pay-as-clear” approach, whereby each project is paid the clearing price for its delivery year within the auction, capped at its administrative strike price. A sealed bid system was used to carry out the actual auction.

Nigeria can also adopt the Capacity Market (CM) model, whereby under the Capacity Market regime, capacity payments will be made to the providers of capacity, including both generation and non-generation forms of capacity such as demand-side response (DSR) and storage. This is a significant change to existing electricity market arrangements, which only reward generators for the electricity generated.

In 2011, the United Kingdom instituted a complex regulatory framework, i.e., the UK’s Electricity Market Reform (EMR), which, over the years has been punctuated with questions and concerns about the ability of the new regime to achieve its objectives:

• Energy security,
• affordability and
• a reduction in greenhouse gas emissions.

The UK’s EMR is, in turn, based on two (2) main pillars:

a. Contracts for Difference (CfD) meant to support low-carbon electricity generation, and
b. Capacity Market (CM): meant to address security of supply.

In 2014, these 2 aspects finally came into force, three years after the Government first set out its plans to reform the UK power market.

. Contracts for Difference (CfD)

The first CfD allocation round commenced in October 2014, and this new CfD regime is replacing the existing Renewables Obligation regime (a green certificate system), which will close to new capacity on 31 March 2017.

This operated based on the following:

• Top-up Payment
• Wholesale price
• Strike Price
• Low Carbon Contracts Company (Counterparty/Levy Collector)
• Two-Way Payment System

i. Based on Allocation of Rounds

For the vast majority of renewable energy projects, CfDs are being allocated to projects through annual allocation rounds. For some low-carbon technologies, where a competitive allocation process is not appropriate at this stage (e.g. nuclear and tidal lagoon projects), CfDs are allocated outside of an allocation round.

ii. Overview of the regime

Under a CfD, a low-carbon generator is paid a top-up payment above the wholesale price (the reference price), up to a set strike price. The strike price is intended to be an amount equal to that needed to make low-carbon power projects commercially viable. The CfD takes the form of a private law bilateral contract between the CfD counterparty and each low-carbon generator.

iii. The Low Carbon Contracts Company (Counterparty/Levy Collector)

A government owned limited liability company – the Low Carbon Contracts Company – has been established to act as the counterparty to CfDs, and to collect from suppliers a levy to fund CfD payments and administer payments under CfDs. A key feature of CfDs is that provision is made for a two-way payment mechanism, so if the wholesale price is higher than the strike price, the generator will be required to make a payment back to the CfD counterparty.

iv. Delivery Plan

Earlier on, in December 2013, the Government published a delivery plan, setting out the strike prices applicable to each renewable energy technology, for each delivery year up to 2018/19. The delivery year, as the name implies, corresponds to a project’s target commissioning date.

v. The first CfD allocation round (Established Technologies and Less-Established Technologies)

The first CfD allocation round commenced on 16 October 2014, triggering a two-week window for projects wishing to participate in the first allocation round to apply to the delivery body (National Grid). Applications were then assessed by National Grid to check if they met the eligibility requirements, such as the project having planning consent and an agreement with the owner of the relevant distribution or transmission system for connection to, and use of, that system. Once all the applications were received, National Grid valued all of the qualifying applications and compared them to the budget available. Earlier in October, the Government had published the final budget for the round: a total of £300m, representing the total spend per year for contracts assigned in the first allocation round. This overall budget was split into two separate pots: £65m for so-called “established technologies” and £235m for “less established technologies”. The budget for less established technologies was subsequently increased by a further £25m.

• Established Technologies

Established technologies are onshore wind (>5 MW), solar photovoltaic (>5 MW), energy from waste with CHP, hydro (>5 MW and <50 MW), landfill gas and sewage gas. • Less-Established Technologies Less established technologies are offshore wind, wave, tidal stream, advanced conversion technologies, anaerobic digestion, dedicated biomass with CHP, geothermal and Scottish Islands onshore wind. vi. The Auction System Under the regime, if all the qualifying applicants could have been granted a CfD without exceeding the budget pot for each group of technologies, then an auction would not have been necessary and all the projects would have received a CfD at the strike price set out in the delivery plan –the so-called “administrative strike price”. Unsurprisingly, it is to be surmised that more projects qualified for both pots in the budget than could be accommodated, because the allocation process proceeded to an auction. When we say “surmised”, this is because, compared to the Capacity Market regime discussed below, the CfD allocation process is less transparent –information about the projects that applied to participate, and the ones that passed the qualification stage, has not been made publicly available. For the auction, the Government adopted a “pay-as-clear” approach, whereby each project is paid the clearing price for its delivery year within the auction, capped at its administrative strike price. A sealed bid system was used to carry out the actual auction. According to the initial timetable, sealed bids were originally due in December 2014, but the sealed bids submission window was subsequently postponed until February 2015, to allow time to resolve appeals by projects that had been disqualified by the delivery body. vii. The CfDs being offered The results of the first CfD allocation round were announced on 26 February 2015. Twenty-seven projects were offered a CfD, worth over £315m. While this may not mean that the first allocation round has been a success, as we will have to wait another three or four years to determine how many of the projects are ultimately commissioned. However, some initial observations can be made based on the strike prices achieved and the projects that have accepted the offer of a CfD. viii. Offshore wind Two offshore wind farm projects were successful, in each case achieving a strike price of around £20 less than the administrative strike price. Nonetheless, according to the CfD register, both these projects have accepted the CfD offered. The results have generally been considered to be a win for both the Government and industry. Originally, it was feared that only one offshore wind project would be allocated a CfD, so two projects are seen as a success. In terms of the price, it has been calculated that the level of support is some 14 per cent cheaper than that under the RO regime, thus representing value for money for energy consumers. Some commentators have pointed out that, while representing a success for the offshore wind industry, the fact that the two projects make up about 54 per cent of the total capacity awarded CfDs proves that the regime is better suited to large-scale projects. ix. Advanced conversion technologies (ACT) Three ACT projects were successful, at strike prices comparative to those awarded to the offshore wind projects, which competed against each other for the same pot of money. Once again, the strike prices are roughly £20 less than the administrative strike price. The ACT projects represent just three per cent of the total capacity, in stark contrast to offshore wind. x. Energy from Waste with CHP Two Energy from Waste with CHP projects were offered CfDs, at a strike price of £80, representing 4.5 per cent of the total capacity. These are the only projects that achieved a strike price equal to the administrative strike price. The Energy from Waste with CHP projects competed with onshore wind and solar PV projects for the “established technologies” pot of money. x. Onshore wind Perhaps unsurprisingly, 15 onshore wind projects (amounting to about 35 per cent of the total capacity) were offered CfDs, at strike prices of £82.50 or slightly less. However, as discussed in more detail below, the future of the UK onshore wind industry currently faces great uncertainty, and the CfD auction result may be its last hurrah for some time. Onshore wind has attracted a degree of opposition from various communities and, as a result, the new Conservative Government has pledged to curb its growth. x. Solar PV Five solar PV projects were offered CfDs, making up just 3.5 per cent of the total capacity. The three projects, with a delivery year of 2016/17, achieved a strike price of £79.23, some £35 less than the administrative strike price. Significantly, the other two projects, with a delivery year of 2015/16, achieved a strike price of only £50, a massive £70 below the administrative strike price. At the time the results were announced, there was speculation that this strike price was much too low to allow the projects to go ahead. It seems that this has proved correct – the projects are not listed on the CfD register maintained by National Grid, indicating that the projects did not accept the offer of a CfD. The results have raised some questions about the future of large-scale solar PV projects in the UK. In October 2014, the Government confirmed that it would be closing the Renewables Obligation scheme to new solar PV generating stations above 5 MW in scale from 1 April 2015, two years earlier than originally anticipated. This means that, looking ahead, large-scale solar PV projects are reliant on the CfD regime for support and will need to compete with the other “established” technologies. x. Looking ahead The next CfD allocation round is scheduled for October 2015. The draft budget notice for the allocation round is scheduled to be published in July 2015. The Government has said that for established technologies, it intends to release £50m for allocation in the October 2015 allocation round for projects commissioning from 2016/17, but indicative spending on less established technologies has not yet been confirmed. No further information is available at this stage. Under the Government’s Levy Control Framework (LCF), designed to control spending on support schemes such as the CfD (even though the costs of these are passed down to consumers rather than being funded through general taxation), an overall budget has been set until 2020/21. This means that, in theory at least, there should be some visibility about the likely budget available for future CfD allocation rounds, but this is undermined by the fact that it is not clear how much of the overall budget will be used up by other existing schemes, the potential impact of changes to the wholesale electricity price, and any future changes in government policy direction. This means that, in the short term at least, investors have limited certainty that budgets will be made available for future allocation rounds. Given the lead time and development costs associated with getting projects “CfD ready”, one could argue that there is not sufficient certainty to incentivise developers to progress with their projects. In a March 2015 report on implementation of EMR, the Energy and Climate Change Select Committee recommended that the Department of Energy and Climate Change “should commit to publishing more frequent updates of the funds left in the current LCF envelope and clarify rapidly what the timetable and budget of future CfD allocation rounds will be”. Further uncertainty arises in relation to the period post-2020. Developers of lowcarbon projects have gained some comfort from the fact that the UK Government has various commitments to reduce carbon emissions and increase generation from renewables, both at a national and international level. However, the recent election and consequent change in Government, raises some questions about future changes in direction. An immediate result of the change in Government is the fact that the Conservative Party are implementing their manifesto to “halt the spread of onshore windfarms”. It has already been confirmed that the forthcoming Energy Bill will amend the planning regime so that planning consent decisions in relation to onshore wind will be taken away from the Secretary of State and given to local authorities instead. The Conservative Party manifesto also said that it will “end any new public subsidy” for onshore wind. On 18 June 2015, the UK Government announced that it would be closing the Renewables Obligation scheme to new projects from 1 April 2016. It is unclear at this stage to what extent CfD support will continue to be available to onshore wind. The Secretary of State has said that. “With regard to CfDs, we have the tools available to implement our manifesto commitments on onshore wind and I will set out how I will do so when announcing plans in relation to further CfD allocations”. It seems likely that CfD availability for onshore wind will be limited in some way at least. . Capacity Market (CM) The first Capacity Market auction commenced in December 2014. i. Overview of the regime Under the Capacity Market regime, capacity payments will be made to the providers of capacity, including both generation and non-generation forms of capacity such as demand-side response (DSR) and storage. This is a significant change to existing electricity market arrangements, which only reward generators for the electricity generated. The starting point under the new regime is that, on an annual basis, the Government estimates the total volume of capacity required 4.5 years ahead of the delivery year (running from 1 October to 30 September), and then the System Operator contracts for the required volume of capacity from providers through a central auction process. The first capacity auction was held in December 2014 for the 2018/19 delivery year. It was open to all types of eligible capacity. This type of auction, four years ahead of delivery, is called a T-4 auction. The first year ahead (T-1) auction will take place in late 2017, also for delivery in 2018/19. For each auction, a demand curve is constructed around a target capacity level and an estimate of the reasonable cost of new capacity (the net cost of new entry or Net CONE). The intersection of these points sets the price at which the System Operator will demand the amount of capacity required to meet the reliability standard. For the first auction, Net CONE was based on the estimated level at which new-build CCGT will bid into the Capacity Market, and was set at £49/KW. ii. Pre-qualification for the first auction All generation technologies, including existing plant, were eligible to participate in the auction, unless they already receive support through other means (e.g. the Renewables Obligation or CfD). DSR and storage projects were also eligible. A pre-qualification stage took place ahead of the auction to confirm the eligibility and bidding status of all potential capacity intending to bid. The application window for pre-qualification for the first T-4 auction ran from 4 August to 29 August 2014. Participation in the pre-qualification process was mandatory for all eligible licensed generators that were eligible, even if those generators did not intend to bid. The results of the pre-qualification process for the first T-4 auction were announced by National Grid on 3 October 2014. iii. The first auction As mentioned above, the first T-4 auction took place in December 2014. Auctions are run on a “pay-as-clear” basis, which means that all successful auction participants (including existing plant) will be paid the same price per unit of capacity, and the price is set by the most expensive successful bidder. Each auction is run in multiple rounds on the basis of a “descending clock” format, which means that providers confirm they will offer capacity at a particular price, and then further rounds are held at a lower price, until the auction discovers the minimum price at which there is sufficient capacity. To mitigate the risk of existing plant seeking to force up the capacity price, at the pre-qualification stage all participants were required to register whether they wish to participate in the auction as “price makers” (i.e. price setters) or “price takers”. Existing generators default to being a price taker unless they are a plant that will undergo refurbishment. Price takers are only able to bid up to a relatively low threshold set to allow the majority of existing plant to participate in the auction as price takers. The price taker threshold is determined as one of the auction parameters ahead of each auction. The price taker threshold for the first T-4 action was set at £25/KW/year, being approximately 50 per cent of Net CONE. The results of the first action were announced on 2 January 2015, confirming that 49.26 GW of capacity was procured, at a clearing price of £19.40/KW. A total of 64,969.341 MW entered the auction, of which 75.82 per cent received capacity agreements for delivery in 2018/19. National Grid’s analysis of the auction results is useful to consider, not just from the point of view of the generators that have been awarded a capacity agreement as a result of the auction, but also the generators that missed out. Figure 2 shows the breakdown of the so-called Capacity Market Units (CMUs), which were successful, by category. The vast majority of the successful generators are existing plants, and in terms of technology, the majority are CCGT plants. At the time the results were announced, the Government hailed the first auction a success, as capacity agreements had been procured at a clearing price cheaper than anticipated. But questions have been raised about what has actually been achieved, given that one of the aims of the Capacity Market was to procure new capacity. A total of 15,710.403 MW exited the auction above the clearing price. New-build generating CMUs make up the largest group of capacity that exited the auction. This is not a good result for investors in new-build CCGT projects. The Government had previously formally committed to supporting new gas-fired generation, which it sees as an essential component of the UK’s energy mix, at least in the medium term. The Energy and Climate Change Select Committee recommended in its March 2015 report “that the Government clarifies its ambitions for the future of coal-fired power stations in the Capacity Market and its expectations for both new plant and DSR in the second four-year-ahead Capacity Market auction in 2015.” iv. Looking ahead The next T-4 auction will commence on 8 December 2015, for the delivery year beginning on 1 October 2019. Unlike in the 2014 auction, interconnectors will be able to participate in this auction. In January 2016, the first-ever Transitional Arrangements Auction will take place, designed to facilitate the participation of DSR in the enduring Capacity Market. Successful participants in the Transitional Arrangements will see their agreements commence from 1 October 2016. The pre-qualification windows for both auctions will open on 20 July 2015. Very recently, it became evident that the Nigerian Electricity Regulatory Commission (NERC) and operators in the electricity power sector, including the distribution companies, generators and the Transmission Company of Nigeria (TCN) have adopted a new model for tariff adjustment considerations in the future. Further, NERC and the operators of the power sector are expected to present the final model to the Presidency to secure government’s s buy-in before it becomes operational. The Multi Year Tariff Order (MYTO) methodology provides that minor review be carried out to incorporate changes in inflation rate, foreign exchange rate, gas pricing and generation capacity. In effect, as Nigeria continues to reform its Energy Sector, there are ample precedents and guidance from the UK’s Electricity Market Reform (EMR) and gradual progress being achived. Obayemi, Ojo and Idowu are from Lagos State University.

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