Cost of Energy Review
Dieter Helm
25th October 2017
Copyright 2017 Dieter Helm
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Contents
Preface and Acknowledgements ........................................................................................... i
Terms of Reference ........................................................................................................... iv
Abbreviations .................................................................................................................... vi
Key Findings and Recommendations ................................................................................. viii
Executive Summary ........................................................................................................... xi
1. Introduction ................................................................................................................ 1
PART I: THE BUILDING BLOCKS
2. The Objectives ............................................................................................................. 8
Objective (i): Decarbonisation, climate change and the Climate Change Act ................................. 9
Objective (ii): Energy security ........................................................................................................ 18
The other objectives ...................................................................................................................... 20
3. Constraints: Household and Industry Bills, the USO and the Ability to Pay ....................... 23
Price is only one dimension: the USO ............................................................................................ 26
Current household and industry costs ........................................................................................... 28
Alternative ways of allocating the fixed system costs across retail and wholesale customers..... 32
4. Current Policy Interventions and Forecasting ............................................................... 35
Forecasting and modelling to support the interventions .............................................................. 41
5. The Legacy Costs ....................................................................................................... 50
The pre-2000 legacy assets ............................................................................................................ 50
The post-2000 renewables and their legacy costs ......................................................................... 54
6. Technical Change ....................................................................................................... 60
Why the current structures emerged and why they are increasingly badly designed .................. 60
The generic technological seismic shifts ........................................................................................ 61
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PART II: THE ELECTRICITY COST CHAIN
7. Electricity Generation ................................................................................................. 80
The wholesale market .................................................................................................................... 81
Capacity markets ........................................................................................................................... 90
FiTs and low-carbon CfDs ............................................................................................................... 97
How to reduce the costs of renewables ...................................................................................... 110
Second-best solutions and a continuation of direct contracts for renewables ........................... 117
8. Networks ................................................................................................................ 122
What to do about the current periodic regulation ...................................................................... 124
Options now ................................................................................................................................. 134
Why the periodic reviews should be abandoned in the long run................................................ 135
The role of the NSO and RSOs ..................................................................................................... 137
Regulation and ownership in the NSO and RSO model ............................................................... 139
Transitional arrangements ........................................................................................................... 140
9. Electricity Supply ..................................................................................................... 143
The CMA approach ...................................................................................................................... 146
Recalculating the supply margins ................................................................................................ 156
A fair margin ................................................................................................................................ 157
10. Energy Taxes, Carbon Prices, Levies, and Regulations .................................................. 166
The case for tax simplification and harmonisation ...................................................................... 179
Direct regulation of emissions ..................................................................................................... 181
Other levies and costs: energy efficiency measures .................................................................... 182
Taxation and the industrial sector ............................................................................................... 186
PART III: THE WAY FORWARD
11. A Long-term Framework ........................................................................................... 190
Decarbonisation and the carbon price ........................................................................................ 190
The pricing of networks ............................................................................................................... 195
The institutional structures: the role of the NSO and RSOs ........................................................ 196
The role of Ofgem and government ............................................................................................ 198
Summarising the new model ....................................................................................................... 200
12. A Road Map: What to Do Now .................................................................................. 201
13. Conclusions and Summary of Recommendations ........................................................ 210
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Tables
Table 1: Current policies and interventions .......................................................................................... 36
Table 2: Policy development ................................................................................................................. 38
Table 3: Energy efficiency schemes ...................................................................................................... 41
Table 4: Historical plant capacity (GW) ................................................................................................. 51
Table 5: Existing coal plants .................................................................................................................. 52
Table 6: Nuclear plants due to retire by 2035 ...................................................................................... 53
Table 7: The CCCs estimates of LCF costs ............................................................................................ 56
Table 8: Capacity auction summary ...................................................................................................... 93
Table 9: The costs of capacity and auction results ............................................................................... 94
Table 10: Renewables support scheme timeline .................................................................................. 98
Table 11: CfD allocations ..................................................................................................................... 103
Table 12: Summary of auction results: allocation round 1 ................................................................. 104
Table 13: Summary of auction results: allocation round 2 ................................................................. 105
Table 14: Carbon values and sensitivities 20102100, 2016 /tCO2e ................................................ 112
Table 15: Carbon costs Canada ........................................................................................................ 112
Table 16: Ofgems calculation of the return on regulatory equity (RIIO eight-year) .......................... 129
Table 17: Post-privatisation mergers and acquisitions in transmission and distribution ................... 131
Table 18: Domestic supply market shares in Great Britain (%) .......................................................... 155
Table 19: Domestic supply EBIT margins in Great Britain .............................
