The Energy Prices Bill (the “Bill”) was introduced as emergency legislation to Parliament on 12 October 2022 and represents or mandates the Government’s proposed response to the energy crisis currently impacting homes and businesses across the UK.

The Bill would enact several of the Government policies that were announced in September 2022 to reduce the cost of energy for consumers, such as the “Energy Bill Relief Scheme” and the “Energy Price Guarantee”, which will limit the cost of electricity and gas for domestic consumers. Separately, the Bill, if passed, would introduce the “Cost-Plus-Revenue Limit”, which will limit the revenue generated by certain low-carbon generators, who the Government asserts are currently benefitting from the higher price of gas setting the wholesale market power prices.

BACKGROUND

The UK’s wholesale electricity prices are currently set by the so-called “marginal generator”, namely the most expensive form of generation in the relevant pricing period. In many pricing periods this is gas fired power generation. The wholesale price of gas has risen significantly since the beginning of 2021 due to the recovery from the Covid-19 pandemic driving up demand, and price shocks from Russia’s invasion of Ukraine and subsequent reduction in supplies to Europe.

For many low-carbon generators, such as nuclear and renewable power projects, their revenues have increased dramatically as the market price is set by gas fired generation, but their production costs have not increased. The Bill aims to tackle the additional profits it is believed many of these generators are making from the high current wholesale market prices.

KEY PROPOSALS

Cost-Plus Revenue Limit

If passed into law, one of the key measures the Bill will introduce is the “Cost-Plus-Revenue Limit” (the “Revenue Limit”) across England and Wales. The policy aim is to “sever the link between the high global gas prices and the cost of low-carbon electricity”. There are similarities with the proposed EU-wide mandatory cap on market revenues for inframarginal generators[1] (the “EU Price Cap”).

The Bill grants the Secretary of State broad powers to cap the revenues received by electricity generators. Key details are still to be published by Government. As such, what we know to date is that:

• The Revenue Limit is due to take effect from 1 January 2023.
• The Revenue Limit will not apply where the project has a public contract that means it does not benefit from high electricity prices (i.e. the Contract for Difference).
• The Revenue Limit is intended to allow for generators to cover their costs and receive an appropriate revenue that reflects their operational output, investment commitment and risk profile.
• The Revenue Limit will apply to generators in England and Wales (although discussions are taking place with Scottish Government as to whether to extend it to Scotland).
• Generators will continue to receive any existing revenue support or subsidy payments they are entitled to above the wholesale market price, such as Renewables Obligation Certificates (“ROCs”).

However, what is not yet clear is:

• The level of the Revenue Limit (some press reports have suggested that in contrast to the European maximum cap of EUR 180/MWh, the Revenue Limit could be set closer to the level of pre-pandemic wholesale electricity prices, e.g. £50-£60/MWh).
• Whether the Revenue Limit will apply to the amount the generator receives from the wholesale market, or to the amount it receives overall due to its wider commercial arrangements. This is important because some generators have hedged their revenues with traders or entered into direct power purchase agreements with big electricity users so may not themselves benefit at all from higher wholesale prices or may benefit only in part where they share such revenues, e.g. Energy from Waste generators who may share revenues with local authorities under PFI contracts.
• Whether the Revenue Limit will be technology agnostic or whether it will factor in the higher input costs of some generators, and so be different for nuclear compared to biomass for example.

Some investors in the sector are reportedly less likely to invest in new renewable projects until there is more clarity and have indicated that they are anxious that the Revenue Limit could discourage future investment in the UK energy sector. While some have said that UK-EU trading in electricity and the functioning of the UK-EU interconnectors could also be affected, in practice the EU cap is being implemented with a fair amount of variation among EU Member States so it remains to be seen whether this will be an issue unique to the UK.

Contracts for the sale, purchase or trade of electricity may also be affected. Some generators are particularly troubled because, as indicated above, the generator may not get all or potentially any of the benefit of increases in market revenues, having agreed a fixed priced hedging arrangement with a consumer or trader for its electricity, either on a medium or a long term basis.

There is also a risk that if the Revenue Limit does apply to a project, then it will trigger change in law provisions under the relevant contract leading to a large number of potential disputes in the sector on how to allocate the shortfall in revenues.

Voluntary CfD

Alongside the Cost-Plus-Revenue Limit, the Government is also legislating for powers that would allow it to consider running a voluntary Contracts for Difference process for existing non-CfD generators to take place in 2023. A voluntary contract would grant generators longer-term revenue certainty and safeguard consumers from further price rises. There has been limited public detail available about the nature of these proposals, which would need to be developed further in order for investors and lenders to assess the potential impact of taking part in this process.

Energy price support measures

The Bill provides the Secretary of State with extensive powers to assist with the cost of energy, which cover the Energy Price Guarantee, the Energy Bill Relief Scheme and the Energy Bills Support Scheme, which support domestic and non-domestic consumers.  The Energy Price Guarantee, which aims to limit the cost of electricity and gas per unit for domestic consumers so that the average household would see annual energy bills of £2,500, may now (following the newly appointed Chancellor’s announcement on 17 October 2022) only last for six months, which is also the confirmed period of support for non-domestic customers.

The Bill would also require landlords and heat network operators to pass the energy cost savings they enjoy from the new support packages through to tenants and would enable the Government to deliver similar schemes in Northern Ireland.

The Bill would also amend the Domestic Gas and Electricity (Tariff Cap) Act 2018 so that the “sunset” on the price cap and related provisions are removed and replaced with a power for the Secretary of State to determine when the price cap is removed.  In addition, the Bill would amend Ofgem’s duties when setting the price cap such that Ofgem would be required to consider the “impact of the cap on public spending”.  It is not clear how Ofgem could make such an assessment, which is dependent on policy decisions, in particular whether to maintain the commitment to a £2,500 average annual household bill.

Government powers of intervention

The Bill would grant the Secretary of State broad powers in relation to meeting the costs of using and supplying energy, and taking steps to respond to the energy crisis that he or she “considers appropriate”. Furthermore, the Bill would grant the Secretary of State powers to modify the licences of energy companies and issue directions to licence holders (without formally requiring consultation).

While it is generally recognised that the current energy security and cost of energy crises present unprecedented challenges and may require emergency government action to deal with further market shocks, the Bill contains very wide powers. We would expect that the need for these powers, the breadth of the powers and checks and balances on any powers ultimately granted will all come under significant scrutiny through the Parliamentary process.

NEXT STEPS

The Bill is being fast-tracked through Parliament and is expected to be passed into law very quickly. Whilst the key details and precise mechanics of the Revenue Limit are not set out in the Bill, the Government will launch a consultation on these imminently. If the Bill is passed by Parliament, the Revenue Limit will commence at the start of 2023 and will endure until the market returns to normal or the relevant generator moves onto other market arrangements, such as a Contract for Difference.

Unsurprisingly, as with the similar interventions proposed at the European Union level and across other European states, the measures proposed by the Bill has rattled the sector. The energy sector urgently needs clarity on the scale and scope of these measures.  Alongside this, the Government will need to be mindful of warnings of further potential increases in the price of energy, the scale of the cost of energy crisis for many households, the need to ensure energy security in the short term at a time of potential natural gas shortages across Europe and the need to maintain the UK as an attractive and reliable destination for investment in clean energy projects over the coming years.

Kindly shared by CMS.

Authors:

Munir Hassan

Juliet Stradling

Dalia Majumder-Russell

Louise Dalton

Helen Raynsford

[1] The Council Regulation on an emergency intervention to address high energy prices, dated 6th October 2022