Counting the Costs of the UK’s Energy Policy | Page 2

ContextFollowing an extended period of policy development, businesses across the UK will soon feel the impact of the EMR, which is intended to keep the lights on and move the UK to a lower carbon economy.

EMR has been designed to encourage investment in low carbon electricity generation so that the Government can meet its targets on climate change and renewable energy. At the same time, the EMR acknowledges that conventional fossil-fuelled power stations will be needed to help fill the gaps from an increasing amount of intermittent renewables. To do so, it has created both CFD to attract investment into low carbon energy and a capacity mechanism that is designed to guarantee security of supply over the long-term. These policies both generate revenue for investors in power generation via a financial levy on energy suppliers, which is ultimately passed on to their customers.

In April 2015, the costs of two elements of EMR – CfDs and CM – will start to appear on the bills of large energy users. While the impact is likely to be only negligible at first, DECC estimates that policy costs are set to add up to 50% to electricity bills for major energy users by 2020.

Policy FocusWhile we have visited the CfD in a previous bulletin, we will briefly recap its purpose and also explain the meaning and function of CM – two policies which result in growing energy costs for businesses.

Contracts for DifferenceCfDs are designed to help reduce the UK’s carbon emissions and increase investors’ confidence in low carbon electricity generation. The idea behind CfDs is relatively simple; a price for the output of a particular investment is agreed for a period of time. The Low Carbon Contracts Company (LCCC) pays low carbon electricity generators the difference between that agreed price (the ‘strike price’) and the current wholesale market price for electricity (the ‘reference price’).

If the wholesale price for electricity is lower than the strike price, electricity generators receive a top-up payment, ultimately funded by electricity customers. If it is higher, the generators have to repay the difference. CfDs therefore protect investors in major low carbon energy projects against both fluctuating wholesale prices and the risk of the market price being too low by guaranteeing them a fixed revenue.

One key aspect of the EMR is the eventual transition from the Renewables Obligation (RO), the current main support mechanism for large-scale renewable electricity generation, to CfDs. The CfD operational

cost accounts for some of the cost increase from April of this year.

Capacity MechanismCM is designed as a national insurance against the lights going out, ensuring that existing plants stay open and new plants are built to provide for increased demand. The mechanism consists of an annual auction to secure the capacity to generate electricity four years later. One year prior, there is a follow-up auction to enable a ‘top-up’ of any capacity shortfall and allow Demand Side Response (DSR) participation by industry and major electricity users.

During the first auction, which took place in December 2014, DECC purchased49.26GW to ensure sufficient capacity to meet demand at peak in 2018. In the follow-up auction DECC will procure a further 2.5GW. This should ensure that the lights stay on, though costs will rise as a result.

What are the business cost implications?

From April this year, the operational cost for CM will be recovered by suppliers. For CfD contracts the full levy costs will be recovered which is the operational cost and the supplier obligation cost, or the CfD rate.

The operational cost element for CfD’s will be 0.004p/kWh (£0.40/MWh) and will be

applied for the 2015/16 year. The impact will be minimal at first, but costs will ramp up, with DECC claiming that large energy users’ bills could increase by £8/MWh by 2020. DECC has estimated that by 2020 this additional amount represents increased electricity charges of about 10%.

Why the increase? For CfDs, DECC has decided on a quarterly fixed unit cost to pass costs on to suppliers, with a reconciliation at the end of each quarter. Suppliers will also pay a fixed operational cost towards running the LCCC and will have to put down collateral for a reserve fund and an insolvency fund.

The full CM levy costs will not be introduced until October 2016, when demand-side-response participation begins. DECC will levy the costs of CM on suppliers according to their forecast market share of peak demand (between 4 -7 pm on winter weekdays from November to the end of February). These are known as Triad periods. Because the capacity is procured by means of an auction, it is difficult to predict the costs thanks to volatility of prices. However, we do have certainty of 95% of costs four years ahead of delivery and of total costs one year ahead of delivery, so there will be no surprises.

Costs and Benefits

of the UK’s Energy Policy

In sum, DECC envisage that CfDs will cost in the region of £8 to £10 per MWh by 2020 and CM costs will rise in the region of £3 to £4 per MWh by 2018/19. This makes a total additional cost of electricity for businesses between £11 and £14 per MWh.

What can businesses do to reduce these costs?First and foremost, make energy a boardroom issue. Global energy prices are some of the most volatile commodity markets in the world, so the current lowering of pressure on energy bills from the recent fall in global oil and gas prices must not be thought of as a lasting solution to one of your most important business costs.

Where CfDs are concerned, the

charge is based on overall consumption

and not on consumption based on a specific time. So the only way to

reduce the cost is to use less electricity or generate your

own on-site.

Once you have a strategic plan in place to manage your energy costs, you can consider the best response for your business to each of these new policy impacts:

CM, on the other hand, is time-

specific: demand-side response

through active load management at your

sites during peak times will help to reduce the cost.

WelcomeWelcome to the latest npower Business Solutions Energy Matters Briefing. Through these bi-monthly briefing documents we will keep you up to date with the latest changes to energy policy and regulation. Our goal is to explain clearly and simply what it means for your business, and what you can do about it.

From April 2015, the costs of the two main instruments of the Government’s Electricity Market Reform (EMR) – Contracts for Difference (CfDs) and Capacity Mechanism (CM) – will start to appear on the bills of Britain’s large energy users. This report focuses on the potential impacts of these costs, reporting on the findings of a survey of food and drink manufacturers. While we’ve chosen to focus on the impact of energy costs on the food and drink sector – which includes some of Britain’s most intensive energy users – these findings apply to large businesses across the UK.

Your viewIn March 2015, we conducted a survey of 100 decision-makers from food and drink manufacturing businesses across the UK to find out how they are responding to the imminent increase in bills due to UK energy policy, how prepared they are and indeed how aware they are of the expected changes.

Interestingly, three quarters (75%) of UK food and drink manufacturers said that rising energy costs are a factor in decisions to expand the business. By comparison, tax policies were important to 44% of businesses and skills shortages to 41%, suggesting that energy costs are very significant and rising in importance on the boardroom agenda.

Despite this, 38% of businesses say that they have not had enough warning about the bill increases in April, pointing to a perceived lack of engagement and transparency about the cost of energy policy by Government.

Of the businesses that were aware of the new EMR charges, it would appear that significant and potentially even drastic action has been taken to cope with rising energy costs:

• Over a quarter (26%) of food and drink manufacturers said they have either planned cuts to employees or freezes on recruitment

• 16% have considered moving production offshore

• 15% said that they plan to offset the increases in energy policy costs by passing the costs on to customers

On top of this, 65% of respondents feel that the Government is not providing enough financial compensation to business for the impact of funding UK energy policy through energy bills. If we add this to the finding that 38% of businesses polled feel that they have had too little warning or explanation of the impending new charges on their bills, the figures indicate a clear level of industry-wide dissatisfaction.

Despite this, we also learned food

and drink manufacturers already take strategic energy management very seriously, with 64% saying that they have already invested in some energy efficiency measures and 38% planning to go generate their own electricity or go completely off-grid. A further 30% said they had taken advantage of demand side response measures. Clearly, the prospect of compulsory additional EMR charges underlines the importance of reducing usage or supplementing it through off-grid generation.

The concerns of the food and drink manufacturing industry – which accounts for some of the UK’s heaviest energy users – will doubtless be reflected in many sectors. But it would also appear that rising energy costs might help increase recognition of energy management as a boardroom issue, and an effective tool in putting real pound notes on a business’ bottom line.

Large UK businesses collectively spend just over £15 billion a year on electricity

Counting the Costs of the UK’s Energy Policy | Page 4Page 3 | Counting the Costs of the UK’s Energy Policy

For example, say your business used

10 GWh in 2013, costing around

£850,000. If that business did nothing

to change the amount of energy it

consumed, by 2020 its energy bill

would be approximately £1.16 million

– requiring an equivalent increase in

sales to provide an extra £50,000 in

profit each year to offset the rising

overhead of increasing energy

costs. However, if that same business

reduced its energy consumption by

just half of npower Business Solutions’

20% rule, it would save £116,000

in 2020 alone. As such, effective

energy management can put money

on a business’ bottom line, and the

importance of energy efficiency and

DSR cannot be understated.

How can we help?As the impacts and complexity of energy policy and regulation grow, so do the opportunities – if you have the knowledge and expertise to grasp them.

There are two sides to the cost equation; you will save money by using less energy, but you can also make money by generating energy yourself and making use of the various incentives on offer.

npower Business Solutions has an incredibly strong track record of success with some of the biggest brands operating in the UK. In fact, by applying our own products and services to our own nationwide multi-site business, we managed to reduce our carbon intensity by 41.6% between 2008 and 2013, representing a cost saving in the region of £750,000 every year.

For instance, we installed wind turbines and solar panels to take advantage of the natural resources available at particular sites. At one of our offices in the West Midlands, we saw electricity consumption fall by 40% by deploying solar panels, energy efficient lighting, new energy management techniques and improved cooling and heating systems.

A number of options, including electricity storage and voluntary demand reduction, can also offer a real financial opportunity for businesses. Through DSR initiatives, companies that reduce their consumption at peak demand times, adopting a four-hour notice period, can earn revenue for

switching off and relieving pressure on the National Grid. We also actively encourage manufacturers with onsite energy generation capabilities to use these assets to earn additional revenue and to offset their own energy bill costs.

Taking part in our SmartSTOR scheme is one advantageous way of doing this. This enables companies to switch between existing onsite generation, such as back-up generators, and using power from the Grid, and exporting excess energy to the Grid at peak times – thus deriving valuable extra income. The SmartSTOR service means that customers not only receive payments for the energy they pump back into the Grid, but also benefit from the flexibility of supply around costly Triad periods during the winter months.

Another approach on energy intensive sites is to use half-hourly automatic metering to identify when and where energy is being used and to detect the spikes in each location’s energy systems. This data can be fed into energy monitoring software which enables sites to recognise opportunities to minimise energy use, and adapt accordingly.

So, whilst policies are difficult to navigate, rising energy bills should not be a deterrent to growing your business or investing in the UK. If anything, they create an opportunity for businesses to get to grips with one of their major outgoings and start controlling its impact on the bottom line.

and £5 billion on gas. Based on npower Business Solutions’ track record of lowering their customers’ energy use, we calculate that they could collectively achieve annual savings of more than £4 billion (£3 billion through reduced electricity costs and £1 billion in lower gas bills) if they reduced their energy consumption by 20%.

The numbers are significant, even for businesses that can already expect to benefit from all exemptions and compensations. DECC estimated that, based on 2014 levels, the average intensive user’s bill would be £9,577,000, with policy costs adding an extra 11% despite exemptions and benefits.

Message from Wayne Mitchell, Head of npower Business Solutions, who is responsible for overseeing the development of energy products, services, and solutions for some of the Britain’s largest businesses. He said:

Hoping that global oil prices will take care of your energy cost problems is not a long-term solution.

Our research clearly proves that energy management should be one of the top priorities of every company board.

“The reality is that energy bills will start to increase from April, yet we continue to underestimate the impact on large businesses. Cut backs and carbon leakage are a

concern for UK plc; not only do we risk losing productive, viable businesses but the overall objective of reducing carbon emissions could be lost as well.

“Government and energy suppliers must do more to engage businesses about the impact of energy policy. We should be doing everything we can to help them mitigate the risk of rising prices, maintain their competitiveness, and even turn energy into a commercial opportunity where possible.

“In the face of general dissatisfaction with the forthcoming EMR charges, the good news is that a number of businesses appear to be increasingly serious about investing in effective energy management; 64% of businesses have already taken action. That still leaves 36% of businesses who – with the right approach – should be more than able to offset any additional charges stemming from EMR.”

Stephen Reeson, Head of Climate Change & Energy Policy at the Food and Drink Federation, said:

The view from your sector

“As this research shows, Britain’s food and drink industry is increasingly concerned about rising energy prices. Ultimately it is consumers who will feel the impact in their weekly shopping basket if companies are unable to keep absorbing these costs. But rising energy prices will also substantially impact our sector’s ability to fund low carbon technologies and grow exports in highly competitive global markets.

“Whilst we fully support the Government’s focus on greenhouse gas emissions reduction and energy supply security – which is vital to the operations of our sector – we cannot ignore rising energy prices.

“A strong focus on energy efficiency management and investment in our sector will deliver energy cost savings and

help counter risk. Under the FDF’s Climate Change Agreement, we reduced our energy consumption per tonne of product by over 20%, meaning energy bills were around £300million lower than they might have been otherwise. We expect further savings as we work towards our 2020 target of a further 18% improvement in energy efficiency.”