Major changes are taking place to the energy and natural resources sector: new incentives, industry reorganisation, changing frameworks and policies. As a consequence of this liberalisation, the laws regulating the industry are in a state of continual flux. This update informs you of the most recent changes, their origins and, most importantly, the effect they could have on your business.
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Renewables Obligation Reform: Banding
Following a widespread public consultation, the government's proposed reforms to the Renewables Obligation (RO) were published earlier this year in the draft Energy Bill. These reforms will 'band' the RO according to renewable technology type and aim to bring on those emerging technologies that have struggled to achieve commercial lift off since the RO was introduced in 2002.
This article examines the government's objectives in the banding reforms and sets out what the bands will look like. It also provides analysis of the likely short- and long-term effects of the reforms and discusses the crucial issue of the 'grandfathering' of operational or consented renewable projects in the context of the new banding arrangements."
The Renewables Obligation – the story so far
Since its introduction in 2002, the UK government's Renewables Obligation has provided the principal form of incentive and subsidy for renewable electricity generation in the UK.
During the last six years, the RO has been true to its main objective: the development of the most economic and efficient renewable technologies in the market. Hence, the steady growth and maturing of the onshore wind and landfill gas to energy sectors.
However, since 2005 and the government's commissioning of its Energy Review (published in July 2006), it has been clear to many (including government) that the RO in its current form is not capable of delivering the levels of growth demanded by the various legal targets for renewable electricity production.
The emerging renewables technologies, so key to achieving these targets, have not been able to compete with onshore wind. The government, aware of many problems holding back onshore wind development (including 'nimbyism', planning and grid constraints, and turbine supply), realised that other renewables technologies needed stronger support.
Added to this, the RO has been subject to widespread criticism, from both political and popular voices. The National Audit Office has publicly declared that it believes the RO is too expensive and receives a greater level of support than is necessary, a view recently endorsed by the House of Commons Public Accounts Committee. Despite opinion polls consistently pointing to high public approval for onshore wind, such criticism of the RO has had an impact.
In the clamour for a rethink, many renewables industry lobbyists have sought a continental style feed-in tariff for emerging renewables technologies. The government has resolutely resisted a wholesale introduction of feed-in tariffs to replace the RO, sending a strong signal to the investment community that the RO is here to stay. However, the Department for Business, Enterprise and Regulatory Reform (BERR) recognised that they could make RO more efficient and in July 2006 outlined its proposals for banding the RO in the Energy Review.
Legislative change
After a widespread public consultation ('Reform of the Renewables Obligation,' May 2007), the new banding system was confirmed on 10 January 2008 (the same date the draft Energy Bill was published) in the government's consultation response document.
Most of the RO provisions of this Bill comprise enabling provisions to replace the old enabling sections of the Electricity Act 1989 with new sections 32-32M. In the Bill, the Secretary of State has responsibility for implementing the new detail of the RO in a new RO Order, to come into force by 1 April 2009. Therefore, the RO provisions contained in the Bill do not materially alter the structure of the RO, save for the key reform of banding, introduced in Section 32D of the Bill.
What does Banding look like?
The banding system is intended to reflect the level of support needed to encourage investment in the various renewable technologies. The table below sets out the proposed banding regime:
| Band | Technologies | Level of support (Renewable Obligation Certificates [ROCs] per MWh) |
| Established 1 | Landfill gas | 0.25 |
| Established 2 | Sewage gas, co-firing of non-energy crop (regular) biomass | 0.5 |
| Reference | Onshore wind; hydro-electric; co-firing of energy crops; energy from waste (EfW) with combined heat and power (CHP); geopressure | 1.0 |
| Post-demonstration | Offshore wind; dedicated regular biomass | 1.5 |
| Emerging | Micro-generation; wave; tidal stream; solar photovoltaic; fuels created using advanced conversion technologies (anaerobic digestion; gasification and pyrolysis); dedicated biomass burning energy crops (with or without CHP); dedicated regular biomass with CHP; geothermal; tidal impoundment (e.g. tidal lagoons and barrages (<1GW)) | 2.0 |
The government's objectives
In its Impact Assessment document on the Energy Bill of 9 January 2008, BERR set out its three key objectives for banding:
Grandfathering
Banding is expected to come into effect from 1 April 2009, following the implementation of the Energy Bill and State Aid clearance.
In order to protect the revenue streams of existing projects, the banding reforms state the following:
Short-term effects
Already the renewables industry is seeing a sprint from certain technologies to get operational or at least RO accredited with planning permission by 1 April 2009. These are obviously projects that set to lose out through banding by being banded down. Landfill gas to energy is a classic example of this dash to keep at the 1 ROC/MWh rate.
In addition, in the short term, investors have to take tough funding decisions based on forecasted project revenue from a regime that has yet to come into force as law. Whilst it is highly unlikely the government will change its course on banding, the proposals are only that at present. Many lenders are continuing to assess projects that hope to benefit from more than 1 ROC/MWh on the 1 ROC/MWh basis until the system becomes legally binding.
Long-term effects
In the long term, banding of the RO should lead to an increase in renewable electricity production across a broader range of renewables technologies.
Commentators and BERR both point to greater economies of scale for the more immature renewables technologies on the basis they will be more attractive to the investment community with their higher bands. Many agree this will be more measured than the likely impact of say, a feed-in tariff for renewables. However following intense cross party and industry pressure to move towards feed-in tariffs for micro-renewables, BERR has gone out to consultation (in the June 2008 consultation: 'The UK Renewable Energy Strategy') on a feed-in tariff for micro-renewables. Such a change may help the smaller scale less advanced technologies achieve the commercial 'lift off' that is needed.
Finally, along with the banding proposals, the government has sent out to the renewables and investment community a strong signal that the RO is here to stay (at least until 2027), thus allowing for project finance timetables to be planned with a level of confidence and predictability.
However, as a cautionary footnote BERR has commented that the government retains the right to review the bands in the event of unforeseen volatility in the ROC market, other unusual events or to ensure the EU 2020 target (20% of total energy to come from renewable sources) is met. This perhaps underlines the fact that the RO remains a 'managed' market subsidy, pegged to external political trends and targets.
UK Water Reform - a World Leader?
In our last energy and natural resources update in March 2008, we reported on the changes to the water supply licensing regime, which represented the conclusion of the first part of Ofwat's competition review. The focus of that review was on making water supply licenses more effective. The second part of the consultation published in June 2008 and entitled 'Ofwat's review of competition in the water and sewerage industries: Part II' proposes major changes to the industry to enhance competition in the water and sewerage sector. This article examines the key proposals of this latest review.
Introduction
Water and sewerage supply has been viewed for many years as a classic monopoly business. Water is not a homogenous product and combined with the high costs of transport, it was always considered that a true competitive market would never develop. Additional concerns about water contamination only heightened the view that competition was not appropriate. Water was, therefore, distinguished from the competitive gas and electricity markets. However, over the last few years, various measures to enhance competition have been implemented. These include the use of inset appointments to allow third parties to supply water in areas supplied by the local water utility, licensing of new suppliers to put treated water into the public distribution network and to sell water to eligible customers. However, the use of these options in practice has been limited and it is generally considered that none of these proposals have been successful.
Nevertheless, with the successful introduction of competition in other utility sectors, Ofwat has come under increasing pressure from government to review the opportunities to enhance competition in the water and sewerage sector.
Ofwat does recognise that there could be many benefits from truly competitive water markets. These include lower bills, environmental benefits, improved service responsiveness and reduced regulation. The purpose of the latest consultation paper is to highlight new proposals that could lead to more effective competition. The potential effect of these proposals is very significant.
The recommendations of Ofwat focus on four key areas: vertical separation, the retail services market, water resources and sewerage.
Vertical separation
Currently the water and sewerage and water only companies are vertically integrated businesses covering abstraction, treatment, distribution and supply. Ofwat is now proposing vertical separation of contestable markets to break down natural monopoly activities. This is a major change and Ofwat recognises that any such development will necessitate a number of intermediate steps.
The proposal is to take progressive steps to achieve this goal towards separated price controls before price limits are set for the period after 2015. Accounting separation will be the first step. Price control separation will require decisions on the allocation of the regulatory capital value between activities along the value chain. As part of this, Ofwat will consider how to allocate the regulatory capital value and returns in order to:
It acknowledges that separating the regulatory price controls for different activities has been used effectively to promote competition in other utility sectors. As regards stronger forms of vertical separation, such as structural separation, Ofwat will consider these in due course. However, it recommends that the legislative framework for competition should be made flexible enough to enable key industry structures to develop over time as its knowledge increases and the market develops.
Retail services market
Ofwat considers that the water and sewerage retail services is the most clearly contestable market and recommends proceeding to legal separation of the incumbent suppliers and retail businesses alongside a set of measures to free up and encourage competitive retail markets. It recommends:
Ofwat recommends a phased approach to enable more companies to choose their supplier. They recommend reducing the eligibility threshold first from 50 megalitres to 5 megalitres and in time to zero once the market and systems have developed, allowing households to choose. Retail licensees should be allowed to supply household customers only once market arrangements have been adequately tested on the business market, and necessary additional safeguards put in place.
Water resources and treatment
Ofwat also wants to enhance competition in upstream markets. In particular, Ofwat would like to see a well functioning water market for abstraction rights develop. Water trading rights should reveal the economic value of water in different locations. This would encourage allocation of water to high value uses, help achieve sustainable abstraction, and enable more efficient decisions about where and how to develop the water supply system. Ofwat proposes to take forward studies to better understand the nature of upstream water markets and the implications for the choice of market model and access pricing arrangements. In particular, Ofwat is to consider how to make sure that future price review processes do not unnecessarily perpetuate market power in contestable upstream markets. Ofwat is to work with the Environment Agency on a project to develop an effective abstractions trading market. The work will address improving market information and reducing perceived market risk, including that arising from uncertainty about licences' longevity.
Sewerage, sewage and sludge treatment and disposal
Sewerage markets have different characteristics to water markets: for example, they appear to be about five times smaller than water markets and sewerage is substantially non-homogeneous. This raises potential, but not necessarily insurmountable difficulties for competition. Ofwat also noted that there is already a contestable market for the on-site treatment of waste produced at large business premises. However, Ofwat is proposing to undertake its own analysis to assess the potential for competition in sewerage and sludge treatment in disposal markets.
Inset appointments
In principle, inset appointees will be treated in the same way as other appointed water and sewerage companies, in relation to the recommendations, so that all customers have the opportunity to benefit from competition. Ofwat will consider the detailed implications of each proposal for inset appointees before taking decisions.
Next steps
Changes to legislation will be needed to deliver much of the reform programme set out in the consultation document. The time
frame for future developments is therefore unclear. The Ofwat consultation will also form part of Ofwat's contribution to
the government commissioned independent review of competition and innovation in water markets, which is being undertaken by
Professor Cave. Comments on the Ofwat consultation document are requested by 29th August with responses to the consultation
to be published in early autumn. The Cave Review started in spring 2008 and is likely to be published in spring 2009. Whatever
the period, it looks increasingly likely that major changes will be implemented to the water and sewerage industry, with the
UK again leading the world on utility reform.
Update on Changes to UK Nuclear Liability Regime
In our previous issue, we highlighted major changes currently proposed to the UK nuclear liability regime. These include:
For more details on the proposed changes, please click here.
This article provides you with an update on the latest developments relating to the insurance issues created by these proposed changes.
Availability of insurance
A key issue of the new proposals relates to the availability of insurance. We understand that the Department for Business, Enterprise and Regulatory Reform (BERR) commissioned PricewaterhouseCoopers to look at various funding options to cover the increased liabilities. They concluded that insurance was the only option in the short to medium term.
The challenge is that there is no commercial insurance available for some of the new risks at the current time. The three new heads of damage, which are not generally recognised under English law, are particularly problematic for insurers. These are:
It may therefore be necessary for BERR to provide insurance cover at a commercial rate at least in the short term. However, there are a number of important matters in relation to this insurance cover to be decided. These include exactly what it will cover, the methodology for any premium calculation and the time frame and exit strategy for BERR.
Public consultation
BERR are hoping to hold a public consultation on the new proposals in the autumn. The consultation document should include detailed wording and proposals on the way forward, which interested parties can comment on. We understand that this timing is in line with that of other countries implementing the amendments to the Paris and Brussels conventions into national law.
However, the issues above are not just UK issues and similar matters arise for all the countries seeking to implement these wide ranging changes to the Paris and Brussels conventions.
It is likely that a number of countries will end up providing some form of public sector insurance at least in the short term against these increased liabilities.
With the daily news stories surrounding nuclear new build in the UK and the letting of significant nuclear decommissioning contracts such as for Sellafield, the proposed changes to the nuclear liability regime will remain an important issue for all those involved in the nuclear industry.
Reforms to Increase UK Underground Gas Storage
This article sets out the forthcoming reforms to laws affecting underground gas storage in the UK. The government aims to increase UK storage capacity and the proposed, more supportive, regulatory regime is expected to give rise to some exciting opportunities in this sector.
Historic basis for UK storage deficit
The government is putting the regulatory structures in place for a huge increase in underground natural gas storage capacity in the UK. We anticipate wide reaching reforms as the Energy Bill, the Marine Bill and the Planning Bill progress through Parliament.
Historically, the UK has benefited from a secure supply from the North Sea gas fields, enjoying a flexibility of supply from the swing fields (from which production rates could be varied according to demand), but production is declining. The UK ceased to be a net exporter of gas in 2004 and is expected to import 60-80% of its requirements by 2020.
Of all the western European countries, we have the smallest gas storage capacity in both absolute and relative terms, storing only 5% of demand, as compared to Germany, Italy and France each of which store around 20%. Unless more storage capacity becomes available, the UK could suffer a gas shortfall from interruptions of pipeline supply due to political, economic or technical problems. Storage is desirable to cushion the effects of such problems, but also to deal with normal seasonal and daily changes in demand in order to keep the gas system balanced.
An additional legal driver for more storage may soon be added as the EU Commission is considering a directive to require member states to maintain a "strategic stock" equating to a certain proportion of their gas requirements.
Offshore storage
There is much interest in developing new offshore storage using depleted hydrocarbon features, especially in the North Sea, with their proximity to gas transportation hubs and to points of high demand on the UK coast. The UK has only one such facility, Centrica's Rough Storage facility, with a capacity of 118 billion cubic feet. However, EnCore Oil and Star Energy are currently drilling to define the scope of the proposed Esmond – Forbes/ Esmond – Gordon project, which promises to have at least as much capacity as Rough. The Hewett Unit field, the controlling share of which was purchased by Italian energy group Eni last month, is another depleted gas field ripe for conversion to storage and is conveniently close to the Bacton terminal.
Onshore storage
In addition to this, many smaller onshore facilities are being proposed, although these would be used slightly differently to their big offshore counterparts, being more suitable for rapid injection and recovery to trade on gas price volatility or to respond to short-term system imbalance.
The Energy Bill
In its Energy White Paper, the government recognised the need to reform the current, rather dysfunctional regulation of gas storage in order to encourage essential and timely investment. These reforms are set out in the Energy Bill, which is approaching the end of its scrutiny by Parliament and is expected to become law in the autumn of this year.
As reported in our March update (Please click here to view), the Energy Bill proposes the implementation of UK sovereign rights over the storage space under the seabed of the UK's exclusive economic zone as designated in the UN Convention on the Law of the Sea 1982. This area extends from the territorial waters limit (12 nautical miles from shore) for 188 miles. The Bill provides for these rights to apply in designated Gas Importation and Storage Zones (GISZ), rather like the existing Renewable Energy Zones. The GISZs can be used for storage of both combustible gases such as methane and non-combustible gas, paving the way for future storage of carbon dioxide if the Carbon Capture and Storage demonstration projects prove successful.
Developers will need to agree a lease with the Crown Estate in order to establish gas storage facilities in the GISZs, even if the facility is a depleted hydrocarbon field operated under the Petroleum Act 1998 (which do not currently require leases). We understand the marine division of the Crown Estate is preparing a precedent GISZ lease.
The Bill also provides for a new licensing regime for gas storage. This should ease the administrative burden on storage developers and streamline the application procedure. Under the existing regime, developers would potentially need consents under several laws including:
The Bill amends FEPA to remove the requirement for consent for injection of gas into the seabed in the English areas of the territorial sea, although the Welsh Assembly Government, the Northern Ireland Government and the Scottish Government may still enforce this requirement in their areas.
The Marine Bill
The Marine Bill makes additional amendments to streamline the marine consenting process, including merging the Coast Protection Act with FEPA so a separate Coast Protection Act consent will no longer be needed.
The intention is that the Department for Business, Enterprise and Regulatory Reform (BERR) will administer a new Gas Usage and Storage Licence (GUSL), tailored to the gas storage industry, and the Energy Bill provides for regulations setting out the application requirements and process to be issued. BERR will continue to regulate any gas pipelines.
As the use of depleted hydrocarbon features (such as the Esmond or Hewett Unit fields) for gas storage could result in inadvertent production of hydrocarbons when the gas is recovered from the facility, there is scope for storage facilities to require a Petroleum Act production licence in addition to the new GUSL. However, this would undermine the aim of introducing the bespoke GUSL and BERR expects the threshold level of production to be set reasonably high so that most GUSL facilities will not need an additional production licence. Consultation on the level of the threshold is expected imminently.
The Planning Bill
Planning consent requirements will vary between storage projects, depending on their location. The Planning Bill proposes a new Infrastructure Planning Commission (IPC) to replace local planning authorities in handling applications for 'Nationally Significant Infrastructure Projects', which include underground gas storage facilities. However, the remit of the IPC (which primarily deals with land-based projects) extends only to territorial waters and, as currently drafted, would not include those offshore facilities beyond the 12nm territorial limit in GISZs. Developers of the facilities in GISZs would still require planning consent for any structures such as pipelines crossing territorial waters or landing in the UK, but this will be much simpler than before. Consent from the IPC will remove the need for many of the additional consents that would previously have been applied for separately under various laws such as the Pipelines Act 1962, the Gas Act 1965, the Harbours Act 1964 and the Transport and Works Act 1992.
The creation of the IPC is likely to have a significant impact on the onshore storage industry, as Ofgem estimates that two billion standard cubic metres of potential storage is currently caught in the existing (onshore) Town and Country Planning Act 1990 system. Once the IPC is established, it is likely that many of these projects will be approved quickly.
Enactment
These three key bills (Energy, Marine, Planning) may be further amended as they pass through Parliament, so we await their enactment with interest to see exactly how these reforms will work together to promote the UK underground gas storage industry.
