U.K. Eyes Energy Reforms as Regulator Warns on Future Supply

By SELINA WILLIAMS
LONDON—The U.K.'s deregulated energy market, the most liberalized in Europe, should be reined in so the country can attract the billions of pounds in investment necessary to ensure an adequate power supply and meet tough climate-change targets, the country's energy regulator said Wednesday.
A new report from Ofgem, which regulates the gas and electricity market in England, Scotland and Wales, portends what could be a significant shift in U.K. energy policy. It said the country's energy-deregulation policy has delivered choice and price competition to consumers, but hasn't provided enough incentive for new investments. Utilities operating in the U.K. need to invest £200 billion ($320 billion) over the next 10 to 15 years to replace retiring nuclear and coal power plants with new and costly low-carbon generation, the regulator said.
Instead, companies are delaying investments or building cheaper gas plants, leaving the U.K. more dependent on gas imports and exposed to volatile international prices, Ofgem said. The global financial crisis and weak carbon prices have also compounded the problem and made it harder to get the funds to finance new projects.
To remedy that, Ofgem proposes five packages of solutions in its Project Discovery report. The suggested measures include a minimum carbon price, obligations on suppliers, a centralized renewables market, replacing the renewables obligation with tenders for renewable generation, and establishing a central energy buyer. The renewables obligation is a government mechanism that rewards companies for each unit of green electricity they generate.
Ofgem Chief Executive Alistair Buchanan said the evidence in the report shows that Britain has a window of opportunity to put in place far-reaching reforms to meet the security of supply challenges that the country faces in the coming decade.
"We do not advocate change lightly, but all the facts point to the need for reforms now to provide resilient supply security," Mr. Buchanan said. "Acting earlier will also help keep costs as low as possible for consumers and business."
Ofgem's most radical solution--the central energy buyer--would involve coordinating all future investment through a single entity. This central energy buyer would determine the amount and type of new generation needed and enter into long-term energy contracts for power.
If implemented, the central energy buyer option would represent a significant shakeup of the U.K. energy market. Ofgem said the government ultimately would determine what sort of entity would run the central energy buyer and whether the state would have a direct role.
U.K. Energy and Climate Change Secretary Ed Miliband said the government was confident the country would meet its security of supply needs in the years ahead, but agreed with Ofgem that changes were required.
"For the longer term, Britain will need a more interventionist energy policy," Mr. Miliband said. "The scale and upfront nature of the low-carbon investment needed is likely to require significant reform of our market arrangements to deliver security of supply in the most affordable way."
The U.K. broke up and privatized its electricity monopoly in the 1980s and 1990s and removed controls on prices. The nation's liberalized system has delivered benefits to consumers in the years since, but industry analysts are growing increasingly skeptical that the U.K. will be able to meet its target to cut emissions 34% by 2020 with the deregulated and liberalized systems it currently has in place.
It is still cheaper for U.K. power companies to supply customers with inexpensive energy generated by dirtier technologies such as coal- and gas-fired power plants than through low-carbon sources such as nuclear or wind energy.
The weak agreement at last year's Copenhagen climate summit was another setback for investors as it further weakened already slumping carbon prices--one of the key metrics for spending decisions on new nuclear-power and coal plants fitted with carbon capture and storage technology.
Although there's "considerable nervousness" in moving to a more interventionist approach, the stability and predictability it would provide could bring cheaper and easier access to project financing, said Andrew Wright, Ofgem's senior partner for markets.
"The ultimate balancing act on the finance side is this: Is the lower cost of capital that you get enough to offset the fact that regulators and governments aren't as efficient as markets? And that's what the government will have to decide," Mr. Wright said during a conference call.
U.K. utilities were divided on Ofgem's proposals.
"Changes to the market are needed if we are to meet the challenge facing the U.K. to provide clean, secure and affordable energy," said EDF Energy Chief Executive Vincent de Rivaz. EDF Energy, the U.K. arm of French state-controlled Electricité de France SA, is the largest operator of nuclear-power plants in the British Isles and plans massive investment in a new fleet of reactors.
Gas and power network operator National Grid PLC and the U.K. arm of German utility E.ON AG also welcomed Ofgem's proposals, while the U.K.'s largest gas and electricity supplier, Centrica PLC was more critical.
"Rather than a lurch to centralization, we need stability in the market with Government supporting the industry as it continues to deliver the key elements that underpin Britain's energy future," Mark Hanafin, managing director of Centrica's power generation and gas supply business, said in a statement.
David Porter, chief executive of industry lobby group the Association of Electricity Producers, expressed concern that reforms could create further delays to investment. "The last time we changed the electricity trading arrangements it took three or four years to complete," Mr. Porter said in a statement. "Changes of that kind actually add to the uncertainty facing investors, and Ofgem admits that even the most modest of its five proposals involves 'significant change'." —James Herron contributed to this article.
Write to Selina Williams at selina.williams@dowjones.com