Electricity Market Reform simplified

Energy policy circles have been abuzz for months over proposed changes to the way renewable energy is to be supported, and the government’s overall plan to balance the supply and demand for energy in the years to come. The Department of Energy and Climate Change have recently released details of the draft ‘strike prices’ for the Contracts for Difference(CfD) scheme, marking an important step towards a radical change in the way renewable energy producers are aided by the government.

As a mathematician working in the field of energy policy, I’m keenly aware of the sheer number of complicated schemes, financial instruments and legislative hurdles electricity producers have to face. At the same time, the health of the UK’s energy generation and distribution system is vital to every member of the population, not just the select few who understand the intricacies of these new energy policy schemes.

I strongly believe that an intuitive understanding of how energy subsidy really works must be spread beyond the corridors of Westminster and Whitehall. A wider debate will result in more informed decisions from policymakers, who currently lack a strong mandate for helpful policies and accountability for poor ones.

In this blog post, I’m going to try to explain one half of the Electricity Market Reform bill, namely the Feed-in Tariff with Contracts for Difference (FiT with CfD) scheme. I’ll do this through diagrams and a maths-free description of the way the scheme works, and the consequences for customers like you and me.

Unfortunately, I can’t avoid making enormous oversimplifications, but it should provide a basic sketch, accessible to sustainability enthusiasts from all backgrounds.

Breaking even

Before we look at how the Feed-in Tariff with Contracts for Difference (FiT with CfD) scheme works, let’s think about what would happen without it (or some other equivalent subsidy scheme).

Renewable energy producers are for the most part private-sector, for-profit organisations. They need a financial incentive in order to invest in our energy sector; at the very least, they need to avoid making a loss in order to remain operating. I’ve drawn a very simple figure to represent the profits and losses they can expect to make over the next couple of decades.

The horizontal axis in the figure represents time; we begin on the left-hand side of the diagram, and time continues as you travel to the right, with the right hand side being around 20 years from now. At the moment, the cost of producing most types of renewable energy (the blue line) exceeds the price electricity producers would get for selling it on the open market (red line).  The red shaded area represents a financial loss for the producer of the electricity, whereas the green shaded area is the profit they can expect.

As time goes on, current projections are for the cost of production to fall, and electricity prices to rise. At some point, the cost of producing renewable energy and the money producers get for selling it will be equal. This is the so-called break-even point, and is where the red and blue lines meet.

The point of break-even is extremely important to policy makers. So long as electricity producers think they are going to make a loss, they have no financial incentive to expand the UK’s renewable energy generation capacity. Once the break-even point is passed the industry should grow, as potential investors see that the industry is profitable. In order to meet the steep legislative carbon-reduction targets of the UK, the government will want to reach this break-even point as quickly as possible, as it promises a growing renewable energy sector for the years to come.

So how do we get to the break-even point more quickly? Well, that’s a question of how much money we’re willing to spend, and the mechanism through which we support renewable electricity producers.

Contracts for difference

A contract for difference, or CfD, is a financial instrument that’s been around for many years. Until recently, CfDs were predominantly used in commodities and stock trading. However, the last few years have seen CfDs adopted as an instrument of energy policy, used by major renewable energy producing nations like the Netherlands and Denmark http://www.publications.parliament.uk/pa/cm201012/cmselect/cmenergy/742/74208.htm. The UK will soon be adopting a form of CfD scheme too, known officially as the Feed-in Tariff with Contracts for Difference (FiT with CfD) scheme. Let’s take a look at how it works.

In the FiT with CfD scheme, the government enters into contracts with electricity producers in an individual, case-by-case basis. They agree a ‘strike price’, at which electricity generated by the producer is to be valued for the duration of the contract. When revenues from selling electricity at market prices (red line) are below the strike price (brown line), the producer can ask the government to make up the difference (orange shaded area). This effectively takes the place of subsidy in more orthodox schemes, and brings forward the break-even point to where the blue line meets the brown line, making the industry profitable sooner and attracting new investors.

When the market price of electricity exceeds the strike price, the deal is reversed. Electricity producers must pay the government the difference, shown on the diagram as the dark green shaded area. This allows the government to recoup some of the money it spent on keeping the industry afloat earlier. Producing renewable electricity still remains profitable though, as shown by the light green shaded area.

What does this actually mean to you and me, the consumers of electricity? Well, whatever the government spends on supporting renewable energy will be added on to our tax bills, regardless of how much electricity we might individually use. On the other hand, we will reach our carbon-reduction targets quicker. It’s possible to balance the pros and cons of the scheme by changing the strike price, but it’s not an easy problem given the politics surrounding renewable energy.

As I’ve hinted before, things are much more complicated than the explanation I’ve given here, and while I’ve tried to describe the scheme as it is intended to work, we can’t be sure that it will behave as expected; we haven’t reached the break-even point yet, so there’s little evidence to go on!

What’s next for the Electricity Market Reform (EMR) bill? Well, it’s currently under review by the House of Lords and is expected to be given Royal Assent before 2014. EMR, for good or for ill, is coming soon.

This blog is written by Neeraj Oak, from the department of Complexity Sciences at the University of Bristol.
Neeraj Oak

Sustainable landscapes for the future

On the 18th of July, the Cabot Institute at the University of Bristol hosted a one day conference for academics, landscape designers, industrial partners and policy makers to discuss how to create sustainable urban landscapes for the future. The event was organised to promote the exchange of ideas and to combine expertise from all stages of the process to determine how to create spaces that would maximise biodiversity and environmental benefits whilst remaining somewhere that people love to use.

City Academy Meadow, Bristol

A common theme throughout the conference was whether green spaces in cities can be designed to accommodate the needs of both local wildlife and people. Professor Nigel Dunnett from the University of Sheffield was one of the principle designers of the Olympic Park landscape, where he created a stunning biodiverse pictorial meadow with a long flowering season. His presentation highlighted the importance of creating a landscape that wildlife will benefit from, but critically that people will use and love. Professor Dunnett argued that we take more joy from seeing a beautiful expanse of flowers than a lawn monoculture and that “beauty in biodiversity is about people in ecology”.  Landscape architect Kym Jones echoed this, describing landscapes that people don’t want to use as “socially unsustainable”, no matter how many environmentally-friendly boxes they tick.

Professor Dunnett’s urban meadows are controversial because he often uses non-native plant species in his design to increase the flowering period. Professor Jane Memmott of the University of Bristol Urban Pollinators research group presented data collected at nature reserves, farms and urban green spaces around Bristol that suggest most pollinators don’t really mind whether native or non-indigenous plant species are used, as long as they produce a lot of flowers. She reported that whilst pollinators are more numerous in nature reserves than urban sites, the cities retain a high level of species diversity that it is important to protect in the future. This called into question the BREEAM system of measuring sustainability in new developments, which does not usually allow non-native species to be incorporated into a design.

Professor Graham Stone

The debate about whether people would accept more biodiverse landscapes continued by questioning public opinion. Many established parks are attached to historical expectations of that place; typically well-manicured lawns and pruned trees. The group agreed that it was time to try and change the public’s  perception to accept a little wilderness in parks and gardens as a habitat for local wildlife. Urban meadows begin to look neglected after flowering, however Professor Graham Stone of the University of Edinburgh mentioned that it is important to let the plants produce their seeds to provide birds with an important food source in the autumn. Bristol City Council have been trialling annual meadows in central reservations around the approaches to the city, and reported that they had not had any complaints from local residents about plants looking untidy when dying back at the end of the season. With sustainable landscaping becoming more popular in UK schools and communities, it is hoped that the public perception towards ecologically friendly designs have already begun to change.

Dr. Sarah Webster presented DEFRA’s hopes for sustainable urban developments. The 2010 Making Space for Nature report outlined new guidelines for reducing the huge pressures on wildlife, which state that new landscapes should enhance the UK’s ecological network by being bigger, better and more connected to existing habitats. DEFRA is currently trialling “biodiversity offsets”, where companies restore an equivalent area for every habitat that is unavoidably lost during a development. It is currently undecided whether or not these offsets will be mandatory if introduced, and it remains difficult to quantify the importance of a habitat in order to produce a new site of equal value to the environment. If this scheme goes ahead, careful planning could ensure that urban landscapes become more connected and form ecological networks within cities.

One of the major difficulties facing the landscape industry is how to measure the economic benefits of sustainability. Howard Wood presented his work with Lyon Parks Department in France, an ambitious project that saved hundreds of thousands of Euros over a year using ecologically-friendly design and maintenance. His team made their own compost from green plant waste and horse manure, killed weeds using hot water, used bio-control methods to remove pests, planted annual meadows to reduce mowing and maintenance of lawns, and used wood chippings as mulch to reduce weeds and improve soil water retention. The group decided that one of the key aims for the future is to improve the baseline knowledge of how much money different types of sustainable landscape cost to create or maintain, and whether they will cost councils and developers less in contrast to the traditional landscape designs.

The day ended with a request from the landscape industry partners for academics to make new sustainability research more easily accessible and understandable. Kym Jones mentioned that sustainability is now an integral part of landscape design, but landscape architects need to have the facts about its importance and value to be able to sell it to their clients. The overwhelming feeling was that green lawns alone are not enough; urban meadows promote biodiversity whilst producing beautiful displays of colour for people to enjoy. Professor Dunnett summed the day up best for me when he said, “we need to mix aesthetics and beauty with the science”. We are building places for people and local wildlife, and innovative new approaches

This blog is written by Sarah Jose, Biological Sciences, University of Bristol
Sarah Jose

Future Water 2013

Members of the UK water sector met at the end of June at the Royal Geographical Society in London for a one day national water policy conference, “Future Water 2013”, which aimed to address a number of water related policy issues surrounding building a more resilient water sector for the future.

The morning session started with a panel debate chaired by John Vidal (Environment Editor, The Guardian) and panel members Anne McIntosh MP (Chair of HoC EFRA Select Committee), Ian Barker (Head of Water, Land and Biodiversity, Environment Agency), Tony Smith (Chief Executive, Consumer Council for Water) and Alan Sutherland (Chief Executive, Water Commission for Scotland). The discussion aimed to explore how the water sector can remain resilient financially, technologically and environmentally in the future and how customers can benefit from new reforms.

Ian Barker highlighted the range of problems which the water sector faces in relation to the water supply and the environment. 2012 saw the UK face ~90 days in drought conditions, followed later by 72 days in flood.  The country experienced 11 major flood events and 200,000 properties were protected due to flood protection schemes across the country. This highlights the need for us to efficiently manage our surface water, whether there is too little or too much. One of the key questions is whether we are able to use past observations to predict the future? and therefore inform necessary reforms in the water industry, where we already have a legacy of 200 years of abuse of our water. The UK needs to be better prepared for shock events such as floods or droughts so that if we can’t predict them we can deal with them when they do occur. Ian Barker stated that a clear policy direction was needed to help the water industry to plan and these policy decisions need to be reinforced at government level through our regulatory bodies.

The other major issue raised in the debate was customer dissatisfaction with the water industry, prices continue to rise yet customers struggle to see what benefit they are getting from the extra money they have to pay out. Prices for South-West water customers have become unsustainably high, so much so that central government has had to step in to help customers who can’t afford their basic bills. Tony Smith highlighted that regulation should be more consumer focused so that water companies do not focus purely satisfying the regulator and not considering their customers. A similar problem was highlighted regarding bathing water, south-west England has the highest proportion of low-income households in England, yet has the longest length of coastline to keep clean. This cost is passed onto consumers who are already struggling to keep up with escalating costs.

Following this discussion, Sonia Phippard (DEFRA) introduced the new Water Bill which is currently going through Parliament. While all the details are yet to be agreed the Water Bill will tackle issues of resilience to future change, growth and investment in our water infrastructure and will introduce competition for business customers – meaning if they don’t like the service from their current supplier then they could opt for gaining their services from another company in a similar way to the energy sector. The bill will also outline market reforms which will aim to create retail and upstream competition as a driver for efficiency and quality of service provided by water companies, these reforms will be rolled out by 2017. Sonia Phippard suggested that it was important to encourage innovation in the sector and this could be achieved by encouraging new players into the water sector. For example, it could become possible for smaller water owners to sell excess water into the system. There will also be a formal review of the responsibility for water leaks to remove the many grey areas which currently exist; this will be added later as an amendment to the Water Bill. It was also highlighted that reforms relating to abstraction from rivers will not be included in the current bill, but will be covered by future reforms centring around sustainability which will probably be announced next year. Also water quality will be dealt with by the next round of EA River Basin Management Plans and so will not be specifically be covered by the Water Bill.

The current version of the Water Bill which is currently being introduced into parliament is available at: http://services.parliament.uk/bills/2013-14/water.html

The morning session also saw John Penrose MP introduce his ‘radical’ paper “We deserve better” which discusses the current dissatisfaction amongst consumers with utilities and proposes to introduce reforms which would allow consumers to vote with their feet and switch supplier if they were not satisfied. It would also give customers the opportunity to buy from a company which provide ‘green’ water, similar to the system currently operating in the energy sector. For an executive summary and the full paper see: http://www.johnpenrose.org/images/wedeservebetter.pdf

The afternoon session began with interactive workshop sessions, I attended the session on “The impact of extreme events on freshwater ecosystems”. This session aimed to discuss what is resilience in freshwater? Where do we need it and do we currently have the right tools, including science, policy and practise tools. The discussion highlighted that restoring sections of rivers which were previously engineered can help ecosystems to recover and make them therefore more resilient if extreme hydrological or pollution events were to occur. High flow events are of particular ecological concern as in many areas these events can cause the combined sewage systems to interact with the river through overflow events, which will impact on the ecological health of the river. Managing water quality and maintaining god ecological health is managed through River Basin Management plans, the second round of which is currently being produced. As a pre-cursor to the RBMP’s the EA have produced a Challenges and Choices document, more details can be found at: http://www.environment-agency.gov.uk/research/planning/33252.aspx

The afternoon session continued with a keynote address from Dr Vicky Pope (Head of Integration and Growth, Met Office) who outlined some of the environmental challenges and how the Met Office is working to tackle some of the current issues. Under the banner of climate change, northern Europe as already seen an increase in extreme rainfall. However, one of the biggest challenges is that we do not currently understand how north Atlantic weather patterns (El Nino, Atlantic multidecadal oscillation) will change under climate change and therefore how these will impact of UK weather. This remains one of the main scientific research questions. From a water sector perspective it is the climate variability rather than long-term change which is important and therefore the Met Office is working along with other project partners to provide better seasonal forecasts and predictions of climate variability as well as to provide better information regarding storms, drought and storm surges. The Met Office is starting to use their weather models in ‘climate change mode’ in order to begin to get improved local detail which is important for water management. This type of research has not been possible until recently due to lack of computational power, and even now this can only be one for small areas rather the whole country.

The day was rounded up with a discussion based around innovation and the need for improved water infrastructure if a more resilient sector is to be achieved. For example, currently the UK system relies on members of the public to report leakages rather than having monitoring systems in place which can detect failures and quickly alert the water company to the problem. It was quoted that all UK water companies combined only spent £18 million last year on research and development, despite huge profits. Currently there is no incentive for water companies to invest in research and development providing that they satisfy the regulator – market reforms may help in this respect. That said, some water companies are now beginning to invest in their local environment as it is becoming more cost-effective to reduce pollution at its source before it reaches the river rather than having to clean up the water after abstraction etc. This type of new thinking provides benefits for both the water industry and the environment, and any cost savings could hopefully therefore be passed down to the consumer.

The Future Water conference was a day packed with information and discussion which covered a whole range of issues facing the water sector, from financial to environmental pressures. It became clear very quickly that a co-ordinated effort is necessary if we are to create a water sector which can be resilient to climate change and the increased demands we are putting on our water and at the same time provide a service which is affordable and sustainable across the whole country. The challenge has most definitely been set……

This blog has been written by Dr Charlotte Lloyd, Geographical Sciences, University of Bristol.

Dr Charlotte Lloyd

Brinkmanship, flood insurance and science

The “Statement of Principles” on flood insurance agreed by the UK Government and the Association of British Insurers as a temporary measure in the year 2000 is due to expire on 31st July 2013. At the heart of this document is an undertaking by insurers to continue to provide cover for domestic property and small business customers as long the Government continues to manage the risk adequately.

Specifically the agreement says that cover will be provided for properties built before 2009 either if the risk is low or there is a commitment by the Environment Agency to reduce it to low within 5 years. ‘Low’ risk is arbitrarily defined as a property having a less than 1.3% annual chance of flooding, of which there are believed to be ~200,000 in England and Wales. In other words properties need to be protected against the 1 in 75 year event.

Premiums can still vary with risk and the Statement makes no explicit provision for affordability, but the agreement does allow owners of some at risk properties to continue to obtain cover (and hence for buyers of these properties to obtain mortgages). An implicit assumption is that for properties built after 2009 the planning system has been operating effectively and has only allowed development in low risk zones.

Negotiations over a replacement were clearly going to the wire but today a Memorandum of Understanding was agreed between the ABI and the Government. This involves the setting up of a flood insurance pool known as ‘Flood Re’ for the ~200,000 ‘high risk’ properties. Premiums for the ‘high risk’ properties will be set based on council tax band. Flood Re will charge member firms an annual charge of £180 million which equates to a levy of £10.50 on annual household premiums.

This represents the estimated level of cross-subsidy that already exists between lower and high flood risk premiums. The scheme will be up and running by summer 2015 and in the meantime, ABI members will continue to meet their commitments to existing customers under the old Statement of Principles agreement.

Clearly the questions most commentators have fixated on are “who pays?” and “how much?”. However, as a flood scientist a far more interesting question is “how will we know?” and this applies as much to the existing Statement as to any new agreement. To put this another way: are we confident that we can determine to reasonable accuracy which properties are ‘at risk’? You might think this is typical academic hand wringing, but actually answering this question is, in my view, critical to running an effective flood insurance business.

For any given site the 1.3% annual chance flood will not have been observed and the Environment Agency and insurers use computer models that simulate flooding to calculate what such events look like. To use these you need to know how big the 1.3% annual probability flow is and to have a detailed 3D map of the terrain. The model then uses more or less complex variations on Newtonian physics to determine how this volume of water moves over the land surface.

At particular places such models can be great, but all predictions have error and because of uncertainties in both data and models this is certainly the case with flooding. How big can these errors be? Well, in a recent study we found the plausible range for the current 1% annual probability flow for the River Avon in Warwickshire to be between 310 and 425 m3s-1: enough to make a significant difference to the area predicted as inundated. Ok, this isn’t the 1.3% level exactly, but you get the idea. Models also get worse as you zoom out because to be computationally tractable at regional to national scales they have to simplify the representation of terrain and flow which introduces errors.

Irrespective of what the ABI and the Government do in the future, this situation doesn’t change. The question of how good national scale flood risk assessments need to be to confidently manage risk and set insurance premiums is still unanswered.

This blog is taken from WillisWire and written by Cabot Institute Director Professor Paul Bates, University of Bristol and Willis Research Network (WRN) Senior Academic. Edits by Tim Fewtrell, Chief Hydrologist at the WRN

Professor Paul Bates, Cabot Institute Director