Should we Reform the Electricity Market?

Hi there, I’m Jervis Whitley. Today is Friday, 19th of July, and you’re listening to WindFront. The weekly roundup of the wind industry from Australia and around the world. Today, I’ll cover the weekly top three earners, and time to reform the electricity market.

For a number of years now, the UK government has been reviewing their electricity market review to reform it completely. Back in 2010, they started off with the lofty goals of securing energy supplies while increasing low carbon technologies and reducing the cost of electricity, which is really the triple threat, isn’t it? And the reforms have undergone a bunch of consultation, and in late 2012, it was introduced as a bill into the UK Parliament, which is likely that it will soon receive the royal tip of the crown. And the plan at the moment is to go into production in 2014. So these sweeping changes, introduced by the UK government, in response to, I guess, outcries of maybe alleged price fixing, in the UK gas markets, it’s left a lot of people questioning the integrity of these markets.

So in their energy reform, and the electricity market reform, what’s going to change? Well, surprisingly, they’ve already got quite a few options on the table. And I’ll go through some of them now. The 2 main ones, they’re going to set up some contracts for differences and a capacity market. Now, remember, the stated goals were to increase low carbon technologies, secure energy supplies, and reduce the cost of electricity.

So in terms of the electricity market, a contract for differences, it’s actually like a hedge contract, similar to the ones that we have right now. It’s a way to prevent market volatility. If I wanted to build a new wind farm right now, I’d need to demonstrate to the bank that I had sold a large portion of my operating capacity, both in megawatts and renewable certificate terms, with contracts showing a steady price signal going out some years. Now, banks aren’t interested in taking a punt on the volatility of the wholesale market, which is why this scheme works. The hedge means I enter into a contract with a retailer, and we strike a price for electricity at, say, I don’t know, $60 per megawatt hour. And if the price in the market is higher than that, as a generator, obviously I’d be earning more money, and I will return that money to the retailer. And if the price is lower than that $60, well, the retailer is getting a good deal, and they pay me the additional amount. So net effect throughout the entire year we’ll both be paying $60, which is our strike price. So that takes a lot of the volatility out of the market and makes it so that I’m able to get the capital to build the wind farm in the 1st place.

So the concepts of CfDs already exist right now, but what has been proposed, how is that any different? They are setting up an arm’s length, not for profit contract, the difference is entity, that is compelled to make these contracts, to purchase an amount of green energy set by the national grid. Now, the national grid is similar to the Australian Energy Market Operator in Australia. So each year they’ll run a few studies and they’ll determine how much energy is required to meet the targets for that year, and they will open these contracts up so that enterprising individuals can take them and use that to lower the cost of their capital and build these green energies. So the wind farm operators won’t need to deal with the retailers to fix their strike price. Instead, their contract is with this entity. And they’re entering this with a view that the contract for differences will replace a mandatory renewable obligation, which is similar to the one we have in Australia, where retailers are obliged to purchase a certain percentage of their electricity on behalf of customers from renewable sources and surrender the certificates to prove so. They have a similar scheme in the UK right now, and these contracts for differences are going to replace them.

Now, I will look at the capacity market now. It’s a mechanism to pay load or generation to provide relief during times of system stress, as identified by the system operator. Though the exact details haven’t been hashed out just yet, but it would look like a system security event. An annual auction is run and the winning bidders are obliged to be on call to provide the relief when they are called on by the system operator. So to be similar, we do have some, I guess, analogies here in Australia, for similar systems, for system security, various aspects of system security are auctioned off each year, and the winning bidders are obliged to respond according to the contract when called upon by AEMO.

So that’s a sort of brief tour of the electricity market reforms that are going on in the UK right now. They’re being rushed through very quickly and in fact, having these set up by 2014 is very ambitious, to say the least. So I had some interesting questions about these 2 schemes. The report claims that the contract for differences structured payments will be cheaper than renewable obligation scheme, because they provide greater price security and reduce the cost of capital. Now, I wouldn’t argue with the fact that having one of these contracts set up would reduce the cost of your capital. But the contract is normally between a generator and a retailer, because they’re both on the 2 physical sides of the equation, you know, the generator actually has plant running and actually sells energy into the market, and a retailer actually purchases energy from the market on behalf of real customers. But how would an independent body balance its contract for difference payments? Would it enter into its own contracts with the load somewhere or auction off its own obligations to another party? Maybe acting as a kind of an in-between clearing house sort of mechanism. I don’t know, what do you think? And secondly, do you think something like this would be welcome in Australia? Looking at our market, do we have the same goals, I guess, to integrate renewables to such an extent, that we need sweeping change to the electricity market? Or could we fulfil the goals that we are trying to aim for under the current arrangements?

Now, finally, I will just go through the weekly top three earners this week quickly. So this week was a blustering weekend. Macarthur just came in under $1 million, so it’s top again on our list. Hardly surprising, considering it’s the largest wind farm in Australia. Waubra and North Brown Hill, 2nd and 3rd, again. For comparison, they’re on about half a million dollars this week.

So that’s all from me this week. Just remember, if you wanted to leave a comment, the questions I was asking about how the contract for differences scheme might work, and would it really deliver the benefits that they’re asking for. I’m not sure, what do you think? Leave the comments if you like. And until I see you next week, keep buying those green electrons.