Anyone who follows the intricacies of the UK energy sector will have seen a lot written in recent months about the prospect of a 'nuclear windfall' resulting from the introduction of a carbon floor price through the government's proposed Electricity Market Reforms (EMR).
But it is not only nuclear operators which stand to benefit from the coalition's complex reforms; wind farm operators and other large renewables projects could also enjoy substantial 'wind windfalls' as a result of the changes - a scenario that promises to provide yet more ammunition to those critics of low carbon energy who argue that the sector is over-subsidised and could result in calls for a windfall tax on renewables as well as nuclear.
These windfalls appear to be an almost inevitable result of the government's decision to introduce a carbon tax that will effectively provide a floor price for carbon in the EU emissions trading scheme. In short, fossil fuel generators will be forced to pay this new levy, driving up the cost of electricity.
But zero emission generators, meaning wind as well as nuclear operators, will also benefit from the higher price of electricity while incurring none of the additional charges resulting from the tax - hence windfall profits, which according to some estimates could top £3bn for nuclear operators.
The intention of the floor tax is to provide low carbon investors with greater certainty that their projects will be more competitive in the long term than rival carbon intensive energy sources. As such, the changes are arguably justified as a means of driving investment in the clean energy infrastructure the UK desperately needs. But there appears to be near universal agreement that existing nuclear and renewables installations will enjoy sizeable windfall profits as a result of the floor tax - it is hard to envisage a more open and shut case for a windfall tax.
Some green campaigners are already making this case, arguing that in the event of a carbon floor price a windfall tax must be levelled on nuclear operators. Although, they remain strangely silent on whether or not a similar tax should be imposed on established wind farm operators.
The prospect of a windfall and the possibility of a windfall tax pose considerable challenges to the nuclear and wind energy industries. Given that both sectors presumably want to see a carbon floor tax introduced in order to help stimulate investment in new projects, should they also argue against a windfall tax for operating power plants? The temptation will be there to try to protect additional profits for generators, but there is a real danger that any campaign against a windfall tax will only embolden those critics of low carbon energy who already argue that it benefits from overly generous subsidies.
It also raises the more interesting question as to whether we need a carbon floor price at all.
I understand that in some political circles concerns are mounting that the government's proposed electricity market reforms are overly complex and guilty of considerable overlap. The prospect of nuclear and wind energy windfalls are just one of many unintended consequences that could result from the reforms which, while admirable in their ambition, could introduce additional layers of complexity to the UK's already labyrinthine energy market.
The reforms boil down to four main components: the carbon floor tax; a so-called contract for difference mechanism that will work like an advanced feed-in tariff promising low carbon generators a guaranteed price for the energy the produce; an emissions performance standard that will effectively ban the development of carbon intensive power plants; and a 'capacity mechanism' that will provide additional payments to energy firms that construct reserve power plants and invest in energy saving measures.
The 'capacity mechanism' is undeniably necessary as a means of incentivising developers to provide back up power for intermittent renewable energy sources, while the prospect of an emissions performance standard that will block the development of unabated coal power plants offers a useful safety net should other policy measures falter.
However, the contracts for difference and the carbon floor tax appear to be designed to provide the similar outcome of incentivising investment in low carbon energy. If one works why do you need the other? If the carbon floor price is set at a level that makes low carbon energy sources a better investment prospect than fossil fuels, why do you need contracts for difference that guarantee developers a price for the energy they generate?
If contracts for difference prompt investors to plough money into wind farms, marine energy parks and new nuclear plants, why do we need a carbon floor price, particularly when there is already a carbon price imposed through the EU emissions trading scheme?
It is extremely difficult to work out which mechanism is preferable. The carbon floor price results in windfall profits, but does allow the market to decide which mix of low carbon energy is preferable, presumably at the lowest possible cost. Meanwhile, contracts for difference allow governments to ensure that appropriate levels of support are provided to emerging technologies that might become more cost competitive over time, such as marine or solar energy.
But this means the government could negotiate contracts that are either too generous or stingy, resulting in unnecessarily high energy bills or an unbalanced energy mix. Like the good economist he is, Energy and Climate Change Secretary Chris Huhne has hinted at an auctioning system for contracts for difference, but this again could result in an unbalanced energy mix based around those technologies that are currently deemed cheapest, i.e. gas-fired power plants and possibly onshore wind and nuclear.
These challenges might explain why the government has hedged its bets and proposed two policy mechanisms designed to deliver basically the same results. But as awareness of nuclear and wind windfalls grows, expect increased pressure on the government to reform its electricity market reforms.
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