Changes to the renewables obligation

United Kingdom

On 15th July 2009, the Department of Energy and Climate Change (“DECC”) published, in addition to The UK Low Carbon Transition Plan and The Renewable Energy Strategy, a public consultation on financial incentives for renewable electricity. The consultation covers changes to the renewables obligation (the “RO”) and the implementation of the new feed-in tariffs. It does not cover renewable heat, potential subsidy mechanisms for a Severn Tidal Power Scheme or renewable transport, which will be the subjects of future consultation papers.

The deadline for responding to the consultation is 15th October 2009.

Key changes that would take effect on 1 April 2010

  • Extension to 2037 and 20-year participation limit: In order to ensure that the development of new projects is encouraged, the consultation confirmed that the RO would be extended until 2037 for new projects (being those accredited on or after 26 June 2008), but in order to ensure that new projects do not receive support for longer than necessary, a 20-year participation limit has been introduced. Projects receiving accreditation on or after 26 June 2008 and any additional capacity added to existing projects would be treated as “new projects”.
  • Removal of cap on obligation level without replacement: One of the original design features of the RO was the “scarcity signal”, meaning that the wider the gap between the actual level of renewable generation and the level of the renewables obligation, the higher ROC prices would be. This was intended to provide a stronger incentive to build renewable generation when levels of deployment were low. It is, however, now thought that this feature has had little practical effect in increasing deployment levels (which are affected principally by planning and grid constraints) and has resulted in “excessive” ROC prices. Therefore, DECC is not including fixed obligation levels in the extended RO, but is allowing headroom to determine the obligation level. It is also removing the current cap of 20 ROC/100MWh on the obligation level and not replacing it, reflecting the flexibility around the extent to which renewable electricity contributes to the UK’s 15% renewable energy target by 2020 (or perhaps the belief that there is no real danger of levels of renewable generation exceeding 30% of total generation).
  • Level of headroom: There has been a concern that setting the obligation level at just 8% above the expected level of ROCs in any obligation period is insufficient to avoid the possibility of the number of ROCs exceeding the obligation level - circumstances which could trigger a price crash. Predicting the number of ROCs a year ahead involves predicting total electricity use and the amount of renewable generation in different technology bands, which means there is considerable uncertainty involved in setting the obligation level. A mechanism would be introduced to increase the level of headroom to 10% by 2014 through a series of incremental increases. This is the level of headroom that a number of bodies, including the REA, originally argued for.
  • Generating stations outside the UK: Although the paper reiterates that the Government is aiming to meet the 15% target domestically as far as possible, it states that it is open to the participation in the RO of renewable projects outside the UK on a case-by-case basis and subject to certain conditions, including that the electricity is physically imported into and consumed in the UK. The examples given of potential projects are windfarms in seas adjacent to the UK and geothermal electricity imported from Iceland via a new interconnector. It will be interesting to see whether the draft order to be published in September sets out the detailed conditions of projects’ eligibility or whether a significant degree of discretion is retained for the Secretary of State to decide on any project’s eligibility.
  • Early review of banding for certain offshore wind farms
  • : In the April 2009 Budget, the Chancellor announced an early review of the banding for offshore wind, proposing that projects achieving certain milestones in the next couple of years would be “banded up”. This will be implemented in April 2010 provided that the banding review and the consultation confirm the evidence received to date. Wind farms would be eligible for 2 ROCs per MWh where: no firm contract for the delivery of wind turbines has been entered into before 22 April 2009a firm contract for the delivery of wind turbines is made no later than 31 March 2010a copy of that contract is sent to Ofgem, or otherwise made available for audit andat least one foundation for the installation of a wind turbine is completed to above the surface of the sea no later than 31 December 2011.

Wind farms would be eligible for 1.75 ROCs per MWh if they meet the same conditions a year later (except for the first condition, which must be met by 1 April 2010).

  • No limit to be introduced on use of tallow at this stage
  • : There have been concerns that demand for tallow created by the RO could lead to the supply of tallow for the oleo-chemical industry being restricted, potentially resulting in that industry using palm oil (which has sustainability concerns) instead. In spite of this, the use of tallow within the RO will not be limited at this stage. This decision reflects the possible closure of the only oleo-chemical producer currently using tallow in the UK and the pending clarification of the application of the Waste Incineration Directive to burning tallow. There may also have been a desire not to pre-empt the European Commission’s report on biomass sustainability which is due by the end of the year.

Longer term change: Revenue Stabilisation Mechanism

  • Background: There has been a concern that the RO subsidy has been excessive in a period when wholesale electricity prices have been high, with the result that the RO has been unnecessarily expensive. This, coupled with a desire to reduce the uncertainty of future income streams (and hence financing costs) for renewable generators, has led to the proposed introduction of a mechanism that would result in generators receiving more stable revenues. DECC’s proposed solution is a mechanism whereby renewable generators would neither receive the full benefit of extra revenue when wholesale electricity prices rise nor bear the full risk when wholesale electricity prices fall.
  • Contracts for Differences: The most likely way of implementing this would be through contracts for differences which would operate alongside the RO. This would involve the Government determining a reference price for wholesale renewable power, set at a level which, together with the revenue from the RO, would enable investors to cover their costs and return on investment. In years when the chosen wholesale price index exceeds the reference price, generators would pay back the difference to the relevant Government agency; and in years when the chosen wholesale price index is lower than the reference price, generators would receive the difference.
  • Compulsory from April 2013: It is implied that this mechanism would be compulsory for projects that start generating on or after 1 April 2013, with projects that start generating between the date of the consultation (15th July 2009) and the start of the scheme having a one-off option of joining it. Due to their potential exposure to fuel prices which drive wholesale electricity prices, the mechanism is unlikely to apply to co-firing generators. It also may not apply to biomass generators if a link is shown between biomass and fossil fuel prices.
  • Reference Price: Little is said in the consultation about how the Government would determine the reference price, but it seems likely that, as is the case with ROC banding, it would be fixed for a project’s lifetime. It is worth noting here that in the Renewable Energy Strategy consultation paper published in June 2008, it is stated, “the current RO was designed on the basis of wholesale prices fluctuating around a relatively stable level of £40/MWh”, which may give an indication of the Government’s thinking.
  • Wholesale Price Index: The consultation paper does recognise the difficulties of choosing a wholesale price index and the risk that it will not reflect the actual price received by many renewable generators. This would mean that renewable generators would need to take steps to hedge this risk.
  • RO vs FITs: Following yet another debate on the relative merits of feed-in tariffs and the RO in the Renewable Energy Strategy consultation, the Government decided to retain the RO as the principal renewable support mechanism for large-scale renewable generation. If a compulsory revenue stabilisation mechanism is introduced to the RO, however, whilst the structure of the RO will be maintained, the differences between the RO and the feed-in tariffs will be few - particularly following the introduction of banding in April. In spite of this, maintaining the structure of the RO is, in itself, important and will help to prevent investor uncertainty at a critical time.
  • Commercial considerations: When the revenue stabilisation mechanism becomes compulsory, generators and suppliers entering into power or ROC purchase agreements will need to consider whether any of the upside or downside of the mechanism should be allocated to the supplier. Generators and suppliers entering into long-term agreements now should consider whether the possibility of the generator opting in to the mechanism should be catered for and whether change of law/industry change clauses should be amended. Equity investors will need to consider carefully whether the benefit of reduced volatility is outweighed by the loss of the upside from wholesale market spikes.

A further consultation on key aspects of the scheme is expected in 2010.

Other Issues

A number of other issues are discussed in the consultation paper, including:

  • proposals to reduce the uncertainty arising from Ofgem’s recent change in policy on the revocation of ROCs after they have been presented by suppliers
  • whether there is a case for the co-firing cap to be changed
  • whether there is a case to revisit the banding for wave and tidal stream technologies
  • how to make the predictions required to calculate the level of the RO in each obligation period and
  • how to take into account transmission losses in cases where an offshore generator’s export meter is not located at the grid entry point.

Feed-in Tariffs and Transitional/Cross-cutting issues

The consultation paper also sets out the Government’s proposals with respect to the design of the feed-in tariffs for generators with installed capacities below 5MW. These are to take effect from 1 April 2010.

The paper also covers a number of issues arising as a result of the transition period and the interaction between the RO and the FITs.

Further information

To view the consultation paper, please click here

To read our previous Law-Now on the Renewable Energy Strategy, please click here