Consideration of Market Mechanisms to Ensure an Independent Scotland Can Participate Efficiently in an Integrated Gb-Market, Addressing the Unique Requirements of Energy Generation, Transmission and Distribution in Scotland
- Continuation of the single GB electricity wholesale market, transmission and distribution arrangements post-independence will be the most rational outcome for consumers and investors
- Experience shows that single energy markets can withstand degrees of difference in energy policies adopted by the respective national governments
- Generation operating, or projects committed across the GB system at the point of independence, and supported by existing market mechanisms should be grandfathered - current commercial arrangements should be honoured, with the historic costs spread across all GB consumers as at present
- For new generation post-independence, the eligibility of Scottish generators for support under UK-wide market mechanisms should be agreed by an independent Scottish Government and its rGB counterpart as an early priority
- An independent Scottish Government will have trade-offs to consider within the single market structure between support for new Scottish generating capacity and greater interconnections with rGB and continental Europe, in the context of market signals which presently discourage new thermal capacity in Scotland
- An independent Scottish Government should evaluate the scope for (and effect on interconnections and system operability arising from) diverging approaches to network access, system capacity and investment, and transmission charging
- Clarity will be needed on the future of schemes designed to protect consumers from high energy infrastructure costs in parts of Scotland (such as the Hydro Benefit replacement scheme and cross subsidy arrangements for the Statutory Independent Undertakings in gas) and where these costs are allocated.
On 4 February 2014, the electricity markets of the North West region of Europe (covering 75% of the European power market and 15 Member States including GB) were coupled for the purposes of day ahead trading. "This move will significantly enhance the development of the single EU energy market by favouring price convergence, which fosters competition and therefore leads to a greater choice of services and tangible benefits for European electricity consumers." 
Electricity wholesale markets regulated by multiple jurisdictions operate in Europe. These have been implemented in recognition of the benefits to all parties of doing so, and are backed by a strong drive within Europe arising from EU Directives implementing moves toward a single, integrated electricity (and gas) market.
Within Great Britain, a single wholesale market has operated since the introduction of BETTA in 2005, when the New Electricity Trading Arrangements ( NETA) were extended to Scotland. By maintaining the established GB wholesale electricity market, and a single synchronous electricity system operating across GB, the larger economies of scale minimise the costs to all parties of any transition in the event of a vote for independence.
The advantages of a single market are wide ranging. The use of existing business infrastructure (for example, balancing and settlement services) maintains operability and reduces potential delays in implementation.
This Commission believes that it is sensible and cost-effective for consumers in Scotland and the rest of GB and for investors for the single GB wholesale electricity and gas markets to continue in a fully effective form, and that all parties should work hard to deliver such an outcome in the event of a vote for independence.
Operating under the current UK policy framework and the embodied renewable energy targets, energy supply companies have established a significant level of long-term supply contracts for renewable energy from Scotland. The Commission agrees with the proposal that generating capacity and contracts for all operating or committed projects at the point of independence should be grandfathered. This should apply reciprocally for both jurisdictions.
Scotland and rGB may choose to pursue differing policies within the retail market, where there is merit in doing so in terms of providing greater choice and improved services to consumers. Evidence from other jointly regulated markets in Europe demonstrates that different policy approaches can be applied in the retail sector for different jurisdictions, although the introduction of new mechanisms in one retail market that are not adopted by the counterpart retail market may lead to some additional costs and system issues for supply businesses which ultimately could be borne by the consumer. These are factors that can be assessed at the time of any policy change.
Industrial, technological and social policy are not core to the role of the Regulator and could be delivered through other agencies - although oversight of the balance between incentives and investment requirements would be beneficial. The incidence and priority of social interests in Scotland often differs from rUK - such as in social support, fuel poverty etc. where differing policy priorities could be accommodated.
Continuation of the Single Market, Transmission and Distribution Arrangements
A jointly regulated single wholesale market that operates across two jurisdictions is a realistic option. There are working examples across Europe of separate countries operating joint wholesale electricity and gas markets, overseen by separate regulatory bodies working in partnership. They also demonstrate that single energy markets can withstand degrees of difference in the energy policies adopted by the respective national Governments. This happens where it is mutually beneficial for the participating countries and their consumers, and is fully consistent with European energy policy and its drive towards a single, integrated energy market.
The power (transmission and distribution) network, meanwhile, is operated as a single synchronous electricity system that carries high voltage electricity from the generators on the transmission system (and increasingly collects distributed generation at the distribution level) to substations where the voltage is reduced ready for distribution. This network underpins the efficient, safe and reliable supply of electricity to consumers. It has also recently seen investment plans approved which will enable large scale investment in grid infrastructure and capacity across Scotland in order to help meet the UK's legally binding renewable energy targets.
While alternative structures could be developed, they would introduce additional costs and risks into the system with no resultant benefit delivered. In the event of negotiations between an independent Scotland and the Government of rUK not reaching an agreement, then ACER, an EU Institution, has a duty to intervene to make binding individual decisions on terms and conditions for access and operational security for cross border infrastructure, based on regulatory and economic analysis of the situation  .
New interconnector agreements and holding companies may need to be established for the ownership and operation of gas and electricity interconnectors between Scotland, England and Northern Ireland, and for users of the interconnectors to contract with the Scottish System Operator.
In the event of independence for Scotland, the continued operation of these arrangements will be subject to agreement between the respective governments. The need for, and scope of, a strategic energy partnership is addressed later in this report.
The Commission believes that there could be greater scope for Scotland and rGB to adopt different approaches within the energy retail markets, taking their markedly distinct geographies and circumstances - and thus customer needs and political priorities - into account.
Evidence from other jointly regulated markets in Europe suggests that such differences could be more easily accommodated in retail than wholesale markets, although there may be issues arising from the need to change existing systems which could give rise to complexity and some limited additional costs to supplier businesses.
This Report addresses the potential for retail market differences more fully in its consideration of fuel poverty and energy efficiency issues.
Operational and Committed Projects
The electricity sector is going through a period of transformation with new forms and scales of electricity generation, active demand response and new control methodologies. However, the sector remains characterised by assets with lifetimes that are typically measured in decades. These assets require significant levels of capital expenditure to establish, with project development and pre-construction periods covering a number of years.
In order to approve an investment decision, prospective developers require as much forward certainty as possible on the commercial viability of their project. For the vast majority of renewable energy generation projects, the cost of construction and the requirement for a reasonable return on capital mean that additional support and a positive regulatory framework remain vital elements if such investments are to move ahead with confidence.
A post-independent Scottish Government may wish to consider new mechanisms beyond EMR. However, Scotland should, initially at least, continue with the framework which EMR is putting into place. This means that the forms of market support currently available or being proposed for low carbon generation - whether through the Renewables Obligation ( RO), feed-in tariff for small-scale generators ( FIT) or forthcoming Contract for Difference mechanism - should remain available to generators in Scotland in the manner that is currently proposed.
Grandfathering existing investment is a fundamental principle of good governance; this applies not only to renewables, but across the energy sector and beyond. Failure to grandfather, and generally to legislate in a way that demonstrates that the state will retroactively undermine investment affects sovereign credit ratings.
The Commission shares the view expressed by the vast majority of witnesses that generation currently operating, or projects which are financially committed at the point of independence in either jurisdictions, and which either is or would be supported by the market mechanisms referred to above should be grandfathered. Current commercial arrangements should be honoured, with the historic costs spread across all GB consumers as at present.
These costs - to pay for new and sufficient renewable generation regardless of location - arise from an obligation placed on electricity suppliers by Governments across the UK, and are in respect of contracts and a market mechanism which have been in place for a number of years. The Commission believes that, unless the UK Government states unequivocally that the current arrangements will not be honoured - i.e. that it will take steps to materially change the eligibility of Scottish generation to help meet targets imposed on electricity suppliers in England, Wales and Northern Ireland - its assumption regarding grandfathering and the current sharing of costs will hold true.
Shared Market Experiences
The collective experience of England and Wales, Northern Ireland and Scotland in the operation of the Renewables Obligation Orders ( RO), since their introduction in GB during 2002 and Northern Ireland a few years later, demonstrates that Scotland and the rest of the UK can agree and operate a single market mechanism which accommodates minor differences across jurisdictions.
Autonomy over the review and setting of technology support levels under the RO (Scotland) has required the Scottish Government to evaluate, and be accountable for, the need, justification and cost impacts on consumers through an EU State Aid approval process of its proposals to introduce higher levels of support in Scotland relative to the rest of the UK.
The RO has clearly been successful in delivering a significant level of renewable generation capacity, as the following table (focusing on Scotland) demonstrates  :
Figure 4.4: Cumulative installed capacity of sites generating electricity from renewable sources in Scotland (MW), 2000-2013p
(Includes a small amount of wave/tidal/solar)
Source: DECC, Energy Trends, March 2014
This steady growth has been achieved within the framework of a single energy market and has been able to accommodate minor differences in the energy policies and approaches of the respective countries involved.
Many commentators, when considering these issues, focus their attention on the levels of subsidy. This argument overlooks the incentive under the RO to exploit the most cost-effective sites - many of which, taking into account the quality of resource as well as other factors, are located in Scotland.
Generation in Scotland accounts for 28% of the subsidy value under the RO mechanism and provides a greater proportion (commonly between 30 - 40%) of the UK's total renewable generation output. These numbers underline the cost-effective contribution that Scottish generation is making towards the UK target, thus reinforcing the mutual benefits which underpin the current market arrangements.
A Scandinavian Example
The ability of an independent Scotland and rUK to operate a single market mechanism can also be considered in the light of wider European experience. The common Swedish and Norwegian certificate market for renewable electricity  provides an example of a shared market support mechanism for renewable electricity. The certificate scheme was introduced in Sweden in 2003 and became a common certificate scheme with its adoption by Norway from January 2012.
The operation of a joint support scheme is intended to provide improved market functioning e.g. higher liquidity, better price formation and also a bigger market more attractive for investors. This should bring increased cost-efficiency, access to larger production base and increased long-term predictability for investors through a politically stable system.
The key underlying factor in the success of the common certificate market is that the Swedish and Norwegian Governments (and Regulators) agreed at the outset that the market should not be bound to physically deliver equal levels of capacity in each country. The purpose of the scheme was to bring forward the most economically efficient renewable generation capacity to the joint market, to the benefit of all consumers.
The process has been described as politically challenging; it poses questions about burden sharing, system operability and governance, and the ability and role of the market in determining the location of new generation. But the participants clearly believe that the common ground and targets underpinning the arrangement are worthwhile, and provide the impetus necessary to deliver support for a joint system.
Support for New Capacity in Scotland
In establishing the operation of joint market arrangements, including support mechanisms, their design and application, there will be choices for an independent Scotland in how it chooses to create a robust system. Different elements combine to meet the structural needs of the system: the capacity of operating thermal plant, renewable and intermittent plant, the availability of storage, the effectiveness of demand side management ( DSM), system reliability, the capacity of transmission connections to rUK, and the development of new interconnectors to Europe. For example, transmission connection to rUK or new interconnection to Europe provides access to capacity, but also to export markets for renewable generation output.
Scotland currently exports around 25% of the electricity that it generates and this helps meet consumer demand in rUK.
Figure 4.3: Electricity generated, consumed and transferred (GWh), Scotland, 2000-2012
Source: DECC, Energy Trends, December 2013
With an increasing level of renewable generation, there will be a greater need for system balancing services to cover the variability of output. Interconnection provides economically efficient access to capacity in other markets, but is not as physically secure as capacity that can be controlled and dispatched as part of the single GB-market.
The four operational thermal power stations in Scotland (Hunterston B, Longannet, Peterhead and Torness), totalling around 5 GW of installed capacity, are expected to have shut down by the end of the next decade, although some may close sooner, depending on plant operability and market conditions.
The reform of the GB electricity market is currently seeking to create market price signals to invest in new low carbon, long-term capacity. With the closure of aging power plants as they reach the end of their operational life, and fossil fuelled power plants closing early as a result of limits on operating hours under the LCPD (Large Combustion Plant Directive) and IED (Industrial Emissions Directive), we are seeing significantly fewer power stations available within the UK to meet peak electricity demand, exacerbating security of supply concerns in the period beyond 2015  .
New thermal plant in Scotland could provide valuable services to the power network in terms of voltage and/or frequency support and additional ancillary services, all of which help maintain system operability. The capacity market (as currently proposed under EMR) will award contracts following a competitive bidding process in order to meet the required level of capacity for the lowest overall cost, but has no technical weighting for the geographical location of that capacity, and the associated system support that could be provided.
Where potential capacity projects are transmission constrained or subject to higher transmission charges, such as in Scotland, they will receive a lower ranking in the bidding process. The projects to increase transmission connection to rUK already underway, provide a strong link for export, but are likely to reduce the market signals for new thermal capacity in Scotland. This imbalance in costs, charges and incentives needs to be considered and resolved, as the current arrangements could leave Scotland with a potential structural deficit for thermal generation in the medium term, which would be to the detriment not only of Scotland, but to the operation of a single synchronous system across GB.
The Commission believes that design elements, which recognise the grid control and stability benefits for rGB as a whole related to large scale generation located in Scotland, should form an important part of the development of the capacity mechanism being taken forward at present.
The development and operation of a separate Scottish mechanism would remain a possibility if support tailored to specific approaches on generation, transmission and distribution network access in Scotland could not be delivered through the joint regulation of the single market.
Under the current GB transmission charging arrangements, the impact of Transmission Network Use of System (TNUoS) charges on the competitiveness of both renewable and conventional (thermal) power stations in Scotland has been raised as a barrier to new developments. These issues were the subject of the investigation launched in September 2010 by Ofgem under Project Transmit  , an open review of electricity charging and associated connection arrangements including the launch of a Significant Code Review ( SCR) in July 2011. Ofgem published its final policy decision on the Significant Code Review in May 2014  , and recently announced that the outcome of Project TransmiT will be subject to further delay  .
Transmission charges form a key part of the investment decisions and long-term plans to be taken by developers. The lack of clarity arising from the current review of those charges clearly acts as a barrier to those investment decisions. While the changes proposed by TransmiT would mean a slight reduction in the charges faced by Scottish generators, they would still be higher than elsewhere in the UK. This leads to questions about the extent to which an independent Scotland might wish to pursue further changes to this mechanism, and the issues that this would raise.
Working in a constructive partnership with rGB counterparts, it should be possible, within agreed limits which retain a single wholesale market with joint regulatory oversight, to explore different approaches to grid charging, access and investment.
Historically, the need for solutions that address specific Scottish circumstances has been recognised. One example is through a recent consultation on competitive allocation of CfDs for wind projects on the Scottish islands  .
In the event that an independent Scotland wished to pursue changes beyond this, it should evaluate the impacts that could result from 'Scotland only' approaches in these areas in order to appraise the level of economic, social or environmental benefit that would be delivered. Any such proposals would require regulatory approval from the Scottish NRA and close cooperation with the rGB TSO and regulator.
Hydro Benefits Replacement Scheme and Common Tariff Obligation 
The Hydro Benefit Replacement Scheme, Common Tariff Obligation and arrangements for the Statutory Independent Undertakings in gas, are covered in detail earlier in this report. Clarity will be needed on the future of such schemes (that are designed to protect consumers from high energy infrastructure costs in parts of Scotland) and where these costs are allocated.