Budget 2016: Implications for the Power Sector

On 16 March 2016 the Chancellor George Osborne presented the Budget for 2016 which includes a number of announcements that affect the power sector.

The initial offshore wind strike price for the next Contracts for Difference (CfD) auctions at £105/MWh is lower than that secured by the two successful offshore wind projects in the first CfD allocation round (£114/MWh and £119/MWh). However, the eventual decrease of the strike price for offshore wind to £85/MWh will mean that those projects will have to accept strike prices similar to those secured by onshore wind projects in the first CfD allocation round (~£79-82/MWh). Whether the offshore wind industry will be able to meet the Government’s challenge to lower costs sufficiently to succeed with support at £85/MWh remains to be seen.

Further, the Government has shifted the focus for decarbonisation onto the demand-side. This was largely predicted and in line with the National Infrastructure Commission’s recommendations which suggested that energy storage, Demand Side Response and interconnectors reduce energy bills and help the UK meet its 2050 carbon targets.

Although the Government declared its support for research and development (R&D) in new and commercially untested technologies, the Budget did not include any statements on support for investment in technologies such as gas and tidal or about the future of carbon capture and storage (CCS). The Government has repeatedly stressed the need for improvements in baseload generation, particularly through the building of CCGT plants, yet it did not specifically commit itself in the Budget to supporting new investments in these technologies.

The Budget puts increased emphasis on markets and competition to drive down costs and a number of the CMA’s provisional remedies are being taken forward as Budget measures.

It is also interesting to see the support for small modular reactors in the context of recent comments about the delays in getting the necessary levels of support for Hinkley Point C. The Government remains committed to nuclear being part of the energy mix but, perhaps given the scale and speed of implementation of the current new nuclear programme, is seeking projects which may be smaller in size and quicker to bring forward.

Further details on the Budget proposals follow.

Key Changes and Announcements

Offshore Wind CfDs & Strike Prices

The Treasury, acting within the bounds of the Levy Control Framework, has set aside £730 million for CfD auctions by the end of this Parliament – destined for up to 4GW of offshore wind and other ‘less established’ renewables. In line with statements made by the Secretary of State for DECC Amber Rudd in her “Energy Reset” speech, the Government is seeking to lower strike prices offered to such CfD generators. The Chancellor said strike prices for offshore wind will initially be capped at £105/MWh (in 2011-12 prices), eventually decreasing to £85/MWh for projects expected to commission by 2026.

Promoting Smart Power

The Chancellor announced the Government’s continued backing for smart power systems and welcomed the findings of the National Infrastructure Commission’s study on “Smart Power” whose recommendations it will support and implement. This will be a combination of support and investment in energy storage and other smart technologies, coupled with a commitment to remove regulatory and policy barriers to help the UK become a “world leader” in this field. In particular, the Chancellor announced the Government will allocate at least £50 million for innovation in energy storage, Demand Side Response and other smart technologies over the next five years. There was an additional announcement that Ofgem intends to consult on opening up the £100 million Network Innovation Competition to “better enable innovation” by non-licensed companies from 2017 and a further consultation will be carried out to ensure there is legislative certainty to foster innovative products.

Further Interconnection

The Chancellor emphasized the need for increased interconnection with European countries and acknowledged the strong pipeline of projects such as IFA2, FAB Link, Viking, Greenlink and NSL. The Government estimates that these and other interconnectors will provide 9GW of additional capacity to the UK power market – a significant increase from the 4GW of capacity currently delivered by existing interconnectors.

Carbon Levies

As reported in our article dated 17 March 2016, the Climate Reduction Commitment (CRC) energy efficiency scheme is to be abolished with effect from the end of the 2018-19 compliance year. This measure will be fiscally offset by an increase in the main rates of the Climate Change Levy (CCL) from 1 April 2019 – which will be indexed in line with RPI from 1 April 2017 and 1 April 2018. To account for the increase in the main rates, the CCL discount for sectors with Climate Change Agreements will increase for electricity from 90% to 93% and for gas from 65% to 78% effective 1 April 2019. The Government has committed that it will not modify the existing eligibility criteria to qualify for Climate Change Agreements until at least 2023 although a target review will include a review of the buy-out price for periods 3 and 4 starting in 2016.

Consistent with previous announcements, the Government confirmed it will not make changes to the cap on Carbon Price Support (CPS) rates until 2019-2020. For the 2020-21 period, the Chancellor stated the intention for this cap to be maintained in real terms but increased in line with RPI. The Government is expected to set the long-term trend for CPS rates and the Carbon Price Floor in the Autumn Statement 2016.

Support for Nuclear Technologies

The Chancellor announced the launch of the first stage of a competition to identify a small modular nuclear reactor to be built in the UK and a roadmap to that effect will be published later in the year. Also announced was a £30 million fund for R&D in advanced nuclear manufacturing.

Focus on Increased Competition

Focus on CMA Recommendations

The Chancellor seeks to enhance the role of the CMA in the regulated sectors by increasing the scope of its Annual Concurrency Report.

The publication of the CMA’s provisional decision on their Energy Market Investigation was welcomed by the Government and the Chancellor committed to act quickly on the investigation’s final recommendations to ensure that “bill payers get a fair deal” from energy markets. Indeed, some of the Budget measures reflect the CMA’s provisional remedies.

Ofgem’s Role

The Chancellor stated the Government’s intention to split off E-Serve from Ofgem “to ensure Ofgem can focus on its core functions of economic regulation and promoting competition”, with additional consideration to be given on how economic regulators’ functions can be further streamlined.

The Government intends to amend the statutory duties of Ofgem (as suggested by the CMA in its provisional remedies) to ensure that wherever appropriate it considers competition levers first.

The Government intends to legislate to license industry code administrators and give Ofgem more power to deliver changes to industry codes, again as recommended by the CMA in its provisional remedies.

The Chancellor also announced that Ofgem and DECC will perform a review of energy supply licence conditions to “ensure they are as clear as possible, provide appropriate protections for consumers and do not act as a barrier to new companies entering the market, expanding or innovating”. Ofgem is already consulting on a move to principles based regulation and the CMA has indicated its support for this approach in its provisional remedies.