Billed as a “seismic shift” and the “biggest shake up in the power market since privatisation”, the UK’s coalition government is proposing a radical package of measures to encourage investment in new low carbon generation capacity, in particular renewables, nuclear power, and clean fossil energy with CCS.

The electricity market reform proposals – now in a consultation phase, with final recommendations to be published in a White Paper in late spring of 2011 – consist of “four interlocking policy instruments” that are designed to change the returns generators can expect from their power stations, and encourage new entrants into the market:

•Carbon price floor. This will give greater long term certainty about the additional costs of running polluting plant and incentivise investment in low carbon generation by providing a clearer long term price for carbon in the power sector. The actual number would be set in the 2011 national budget but Treasury scenarios include £20, £30 and £40 per t of CO2. The floor would be implemented through a modification of the existing climate change levy, from which fossil fuels used to generate power are currently exempt. Under the new proposals fossil fuels used by generators would be taxed on the basis of their carbon content, taking into account the floor price.

•Feed-in-tariff. Through a proposed ‘contract for difference’ based (ie variable) feed-in-tariff, the government will agree clear, long term contracts, resulting in a top up payment to low carbon generators if wholesale electricity prices are low but clawing back money for consumers if prices become higher than the cost of low carbon generation. An alternative, ‘premium’ based feed-in-tariff, with static payments, is another possibility, also set out in the consultation document.

•Capacity mechanism. This refers to additional payments for capacity, to encourage the construction of reserve plants or demand reduction measures (so-called ‘negawatts’) to ensure the lights stay on. The proposed capacity mechanism would ensure there remains an adequate safety cushion of capacity as the amount of intermittent and inflexible low carbon generation increases.

•Emissions performance standard. This is described as a ‘back-stop’ to limit how much carbon the most dirty power stations – coal – can emit. The emissions performance standard (EPS) would “reinforce the existing requirement that no new coal is built without carbon capture and storage.” Among the options mentioned are: an EPS set at 600g CO2/kWh; an EPS set at 450 g CO2/kWh with exemptions for plant involved in CCS demonstration.

Introducing the proposed reforms, Chris Huhne, Energy and Climate Change secretary, said “More than £110 billion of investment is needed in new power stations and grid upgrades over the next decade, that’s double the rate of the last ten years. Put simply, the current market is not fit to deliver this.” Amongst its failings are weak carbon signals, a bias towards low capital cost and low risk gas generation, a danger of low capacity reserve margins and inadequate incentives to invest.

The government estimates that a quarter of the UK’s existing generating capacity will need replacing by 2020, ie about 19 GW. While “some new gas-fired power stations will be needed to complement renewables and the first new nuclear power station,” about “30% of the country’s power must come from renewables by 2020” (compared with about 7% today). Modelling commissioned by the government suggests that the carbon intensity of the electricity sector can re reduced from today’s level of 500g CO2/kWh to 100gCO2/kWh or even less by 2030. Domestic consumers would pay about £160 more on average per year for power towards 2030 “but around £30 less than they would do with existing policy” (due to reduced exposure to volatile gas prices and to high cost CO2 emissions permits).

Nuclear new build project developers such as Horizon and EDF have welcomed the proposals, while Gordon Edge of RenewablesUK has expressed concern that they will mean the phasing out of the existing ROC (Renewables Obligation Certificates) scheme, which has “turned the UK into an offshore wind powerhouse.” The new measures are expected to be in place by 2013, but renewables investors will be able to continue to build under the ROC scheme until 2017.