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Business Analysis & Features

Huhne's green print for keeping lights on

Industry waits to see if Energy Secretary's bid to meet targets proves a bright idea or just a load of hot air

The electricity market reforms (EMR) unveiled with much fanfare by the Energy Secretary Chris Huhne yesterday are a tall order: designed to simultaneously keep Britain's lights on, keep consumers' bills down, and encourage investors to bankroll expensive low-carbon power generation.

In a White Paper billed as "the biggest reforms since privatisation", the Department of Energy and Climate Change (Decc) set out plans for long-term contracts-for-difference to insulate low-carbon power generators from market price fluctuations, with a view to attracting investment, creating a stable energy "mix", and meeting ambitious 2020 green targets.

Mr Huhne was explicit at the scale of the "Herculean task ahead", but warned of the potential for "costly blackouts" if nothing is done.

"The scale of investment needed to keep the lights on is more than twice the rate of the last decade," he said. "The current electricity market is not be able to meet that challenge."

There is no dispute that Britain's electricity sector needs attention. A quarter of its capacity will be turned off over the coming decade as obsolete power stations shut down and European regulations bite. Taken together with testing green targets requiring 30 per cent of electricity to come from renewables by 2020, Ofgem has estimated the UK needs £200bn-worth of investment. And with electricity demand set to double by 2050, any changes also need to be able to meet the long-term challenge.

That is where the EMR comes in. Historically, Britain's electricity market has been designed to deliver power at the lowest possible cost. But with the advent of climate change concerns, such a structure is no longer appropriate.

It is not only new technologies such as offshore wind farms that are too expensive for the private sector to fund out of purely commercial motives. Nuclear power stations and embryonic carbon capture and storage (CCS) technology face a similar challenge. And the problem is compounded by the reliance on revenues from unpredictable wholesale prices.

The EMR is the Government's attempt to unblock the impasse. It includes the carbon price floor implemented in the Budget, and the launch of a consultation into how to design a "capacity mechanism" to ensure sufficient investment in back-up capacity to fill in when, for example, the wind is not blowing. But the main component of the White Paper is the proposal is to replace the existing system for subsidising renewable energy generation – the Renewable Obligation (RO) – with a contract-for-difference mechanism that applies to all low-carbon developments, giving support to nuclear power and carbon capture and storage (CCS) technology for the first time. It is also designed to shield investors from uncertainty over the wholesale price.

The plan is for each low-carbon generating site – be it a wind farm or a nuclear power station – to agree a "strike" price at which it will sell its output. If the market price for power drops below the strike price, the difference will be made up by a central agency (as yet unspecified). If the market price is higher, then the money would flow the other way.

The changes have profound implications. Not only does the Government hope to invigorate private sector investment in costly low-carbon generation. It also aims to open the market to wider sources of capital than the "Big Six" energy suppliers.

"This is huge," Neil Cornelius, a director at Deloitte, said. "The scale of the change in the generation mix, and the scale of government involvement in enabling that to happen, is transformational."

But at this stage – ahead of legislation not due until the second half of next year – there are still significant unanswered questions. There is no detail, for example, about the agency that will administer the contract-for-difference top-ups, how the money in the central pot will be collected, or where it will come from. It is also not clear whether the contracts will be negotiated or auctioned, or how they will be set up. And there is uncertainty about how the system might evolve over time – not least because the contracts will be included in the Government's annual Budgets and Spending Reviews.

Then there is the thorny issue of cost. Decc said the EMR will cut the amount that household bills are expected to rise. But industry experts were less sanguine. "As a statement of intent, the White Paper is the right direction of travel," Dieter Helm, Professor of Energy Policy at Oxford University, said. "But it is quite wrong to lead people to believe this won't cost them a lot – it will."

The energy industry broadly welcomed the measures yesterday. But there were also echoed words of warning. "These measures come at a cost," said Mark Hanafin, the managing director of Centrica Energy, which, with partner EDF, is first in line to build new nuclear plants. "It is vital that all of us – government, regulators and the industry – are open with the public about the true impact of these changes."