IEA Commends Free Market Approach to Energy Policy in UK, and Stresses Continuation of Effective Policy Modifications

(Paris) — 30 October 2002

Recent turmoil in the UK energy market does not detract from the remarkable achievements in the sector since the early 1990s, clearly demonstrating the many positive impacts that result from a free market approach to energy policy," said Robert Priddle, Executive Director of the International Energy Agency, today at the launch of "Energy Policies of IEA Countries - United Kingdom 2002 Review". "Gas and electricity prices have fallen in real terms for the consumer, the country has improved fuel diversity through the expansion of natural gas use, and carbon dioxide and air pollution have declined since the liberalisation process was begun."

"Moreover, the government has shown it is ready to respond promptly when faced with market imperfections or unanticipated developments," said Mr. Priddle, citing the introduction of the NETA trading rules as an example of effective government response. He also commended the strategic policy reviews that the country performs, such as the recent review by the Performance and Innovation Unit (PIU) which is to contribute to a policy White Paper later in the year. Such far-reaching strategic analyses valuably underpin the choice of the best path towards addressing the energy challenges that lie ahead, such as finding the right balance between environmental goals, continuing market reform and ensuring national energy security.

Electricity Market Reform
The UK's pioneering role in electricity market reform has allowed it to reap the benefits of free and open markets. Retail prices have dropped 30% in real terms since 1990 and the market is truly competitive, with 38 rival companies vying for business at the wholesale and retail levels. Over 100,000 customers now switch suppliers each week. Introduction of the NETA trading rules should further improve the market and has already achieved the goal of substantially reducing wholesale electricity prices.

Extending liberalisation to Scotland can and should be accomplished through the planned implementation of the British Electricity Trading and Transmission Arrangement (BETTA). The IEA review recommends that the government continue monitoring the size and diversity of the country's generating plants. This is particularly important in the light of changes in wholesale prices, which have come about as a result of NETA. Such price changes affect the financial viability of existing and new generating capacity of all kinds, including natural gas-fired combined cycle plants and nuclear facilities.

Reforms in the Natural Gas Sector
As in the electricity sector, liberalisation of the natural gas sector has been a success, from the introduction of the first competitive gas contract in 1991, up to and through the full market opening in 1998. Residential gas prices have fallen 30% in real terms since 1990, and consumers are exercising their right of choice, with over 67 000 of them switching supplier each week.

The availability of major gas resources in the UK section of the North Sea has contributed to the successful introduction of competition in the gas market. However, with the UK projected to become a net gas importer in 2005, optimal resource extraction is becoming increasingly important. The government will need to fine-tune the fiscal regime for upstream hydrocarbon activity in order to maximise the use of these remaining resources.

Capacity constraints in the UK transportation grid are a cause for concern. Recent capacity auctions have revealed bottlenecks at the entry point at St. Fergus, which reflect capacity constraints elsewhere on the national gas grid. Such constraints can both impede effective competition on the supply side and threaten the timely development of future gas production. The government and the regulator are encouraged to explore schemes which give Transco stronger incentives for new pipeline construction.

Climate Change
The UK is in an exceptionally favourable position among IEA Member countries in terms of climate change. Over the past decade, as a result of energy market reform and the rapid expansion of natural gas use, the UK has enjoyed both sustained economic growth and falling greenhouse gas emissions. As a result, the country is almost certain to achieve its 12.5% emission reduction target under the Kyoto Protocol. However, meeting the more stringent self-imposed national target of reducing CO2 emissions 20% below 1990 levels by the year 2010 will require additional effort.

The Climate Change Programme published in November 2000 includes a wide range of measures to reduce emissions. While the precepts behind these measures are sound, the review team felt that some modifications could improve their effectiveness. For example, the Climate Change Levy is based on the energy content of the fuel rather than the carbon content. In addition, the residential sector is exempted from this tax, denying this means to encourage less carbon-intensive fuels in this sector. The Levy could be modified to make it more effective in reducing emissions overall.

The emissions trading system established by the Climate Change Programme should provide valuable experience with a complex, but highly promising, means of reducing emissions. The system should, wherever possible, be developed in a manner consistent with similar initiatives in other countries, in order to facilitate trading at an international level. The review team also noted the complexity of the many measures designed to support renewable resources and suggested that some streamlining might lower costs without weakening the overall level of support to renewables.

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