In its July 2011 White Paper, the UK Government committed to a series of reforms (known collectively as Electricity Market Reform, or EMR) in order to, in the Government’s own words: ‘transform the UK’s electricity system to ensure that our future electricity supply is secure, low-carbon and affordable.’ EMR will deliver greener energy and reliable supplies, at the lowest possible cost. It will transform the UK electricity sector to enable low-carbon generation to compete with conventional fossil fuel generation.
The institutional framework
This diagram indicates how the key EMR mechanisms and institutions fit together to offer a secure, competitive and low-carbon electricity market.
Contracts for Difference (CFD) and Capacity Market (CM) are two of the four policy components to EMR. The other two are Emission Performance Standard and Carbon Floor Price.
Contracts for Difference ( CFD)
CFDs are designed to support investment in new low-carbon generation by fixing the price received for power generated in advance. It is a long-term contract between an electricity generator and LCCC (a body established by Government). The contract enables the generator to stabilise its revenue at a pre-agreed level (the strike price) for the duration of the contract. Under the CFD, payment can flow from the Counterparty to the generator, and vice versa.
Capacity Market (CM)
There is a risk to the security of electricity supplies in the future; around 20% of the existing generating capacity is expected to close over the next decade and more intermittent (wind) and less flexible (nuclear) generation is built to replace it.
The Government has introduced the Capacity Market intended to provide an insurance policy against the possibility of future blackouts – for example, during periods of low wind and high demand – to ensure that consumers continue to benefit from reliable electricity supplies at an affordable price.
The Capacity Market is designed to ensure sufficient reliable capacity is available by providing payments to encourage investment in new capacity or for existing capacity to remain open. EMRS administers the payment mechanism.