From the New Power archive: Levy Control Framework – a chance for budget discipline or a political fiction?

The Levy Control Framework (LCF) came under debate at this year’s British Institute for Energy Economics (BIEE) meeting. Former energy secretary Ed Davey told attendees that “having a budget is a good thing, and reassuring for investors”, but he insisted that “the government is misleading people about whether the LCF is overspent”. He said the headroom was “designed to compensate [for the increased spend] if energy prices come down”, and there was expected to be attrition because “some projects that gained Contracts [for Difference] were unlikely to go ahead”. In any case, he said, predictions did not show the budget being breached until the final years and it never showed spending breaching the headroom cap, and the government was being “totally disingenuous” to say that it was.
Other speakers also had views on the LCF. Jonathan Brearley – an architect of electricity market reform at the Department of Energy and Climate Change (Decc) and now a consultant – agreed that the LCF was one ­measure where change was needed. “It’s not fit for purpose,” he said.

The problem was that the budget was too vulnerable to changes in the gas price – as gas prices changed, it dramatically affected the spending on the measure. He was not the only speaker arguing that “it can’t be right that from year to year budget projections would vary so much”. As the gas price changes, the budget was alternately breached or held – and that meant decisions on spend swung from being “good” to “bad” and back again. He thought it needed a redesign, either smoothing annual price ­fluctuations or using aggregate spend (ie, energy price plus top-up), instead of being “driven by externalities”.
Ian Marchant, former chief executive of SSE, agreed and said although cost control was needed for renewables, the LCF was “completely flawed”. Bryony Worthington, Labour’s shadow energy minister in the Lords, called it a “fiction”, and a “political tool”, noting that it did not include, for example, capacity market payments.
Kirsty Hamilton, a consultant working with the Low Carbon Finance Group, suggested the discussions around the LCF and the stream of policy announcements from Decc had spooked investors. A recent survey of investors had found that uncertainty has risen across the EU, but in the UK it was “materially worse”. The most important question for investors “by far” was whether there would be another CfD allocation round.
Hamilton raised questions around LCF governance. What were the assumptions underpinning the Office of Budget Responsibility’s estimate of the overspend? And what were Decc’s policy announcements seeking to achieve? It was not clear to investors, she said, whether we were at an end of such announcements, or how the budget was being managed.
“What are our [Decc’s] objectives?” Hamilton asked, and that was the question raised by several speakers.
Brearley said his experience was that for investors a stable system was more important than any single measure, and they would understand if the budget was too high. But government had to make its goals clear – not a generation strategy, but a target, and “let projects fight it out” – and it had to set out the consequences of the goals and the limits to action (such as subsidy). Simon Virley, also previously with Decc and now at KPMG, agreed, saying that although government had attracted new sources of finance over the past half-decade, “global capital can leave as well as come. Government only has a few months to come up with a plan before capital starts heading for the exit”.
Brearley advised any incoming energy minister to act fast where changes had to be made – albeit ­providing clear strategy. He suggested one area where changes might be needed was the capacity market, which is set for its second auction this year. Brearley said he had two concerns. First, “Will that gas plant [Trafford, the only new large gas plant to win a capacity agreement in 2014] ever get away?” If it does, it would be a great result for Decc at a much lower price than predicted. Second, he raised concerns over  “lots of small generation” that had come away with contracts. It is economic – but if more and more of it crowds out new large gas plant and demand-side management, that will be bad for system economics overall, he said.
Was there optimism about the UK’s policy? The consensus over the Climate Change Act 2008 still held, but Worthington warned that the government “really wants a fight with the EU over carbon reduction targets”. But a UK approach that, in general, sought to allow the most cost-effective options for CO2 reductions to come forward, was seen as a clear benefit.


This article was first published in the October 2015 issue of New Power. Not a subscriber? Details here

Also in the October issue

Mike Weston of the Pensions Infrastructure Platform talks about where pensions are investing – and the unintended consequences of Contracts for Difference

David Williams of Eco2 on why renewables investors are leaving the UK behind

Tidal lagoon in Swansea Bay – how it works
Evolving investment strategies