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United Kingdom

Market stops dead in sea of uncertainty -- British renewables obligation

Turmoil in the market for renewables obligation certificates (ROCs) -- the lynchpin of the UK's Renewables Obligation (RO) support mechanism -- has halted all trades and sent the value of ROCs tumbling to an all time low. The upset in ROC prices is one of the repercussions of energy giant TXU Europe's demise last year.

Market players fear that TXU bankruptcy administrator Ernst & Young will fail to honour TXU's commitment under the RO, either by purchasing ROCs or buying out of the obligation. If the administrator defaults, TXU's contribution to the pool of "buy-out" money will be missing and not available for recycling to other electricity retailers who have complied, or partially complied, with the mandate through ROCs purchases. These retailers planned their ROC investments based on receiving recycled funds and could find themselves in financial difficulty.

The bulk of TXU's retail business and some generating assets were bought by Powergen in October 2002, but the purchase did not include three supply licences with a renewables obligation attached to them. It is these licences that Ernst & Young may default on.

The RO requires electricity suppliers -- or retailers -- to present ROCs representing a specified proportion of their sales. In the first year of the RO, which ran from April 2002 to March 2003, the proportion was 3%.

Energy regulator Ofgem, which oversees compliance with the RO, is waiting to hear if Ernst & Young intends to comply with its obligation, either by buying ROCs for the period from April to October 2002, or by paying a penalty of £30/MWh to "buy out" of the obligation. If after the October 1 deadline for compliance Ernst & Young presents no ROCs and fails to pay the buy-out -- which seems the probable outcome -- Ofgem estimates the buy-out shortfall will be in the region of £23.1 million. ROCs brokers NatSource Tullett Europe calculate this could reduce ROC recycle values for the first year by around £4, leaving retailers who complied with the RO short-changed.

Meantime, Ofgem's threat of "enforcement action" involving a financial penalty is likely to cut no ice with Ernst & Young for whom Ofgem is not a favoured TXU creditor.

Shortfall

After Ofgem's warning in August of the likely shortfall, activity in the ROCs market has dropped off. NatSource says it brokered one pure certificate trade the day following the announcement, but since then there have been no trades and no firm bids in the stand-alone ROC market. Bundled transactions, in which ROCs are traded together with the power they are attached to and other generated attributes, are still being traded, says Natsource's Fiona Santokie. But "buyers were previously willing to shoulder more of the recycle value risk."

Prior to the downturn, Santokie continues, suppliers were willing to pay in the region of £48 for ROCs generated in the first RO period. Now they are only willing to bid on a percentage basis. This could involve paying 100% of the basic ROC price up front (£30.51 for 2003/4), plus a percentage of the recycle value to spread the risk of ROC recycling between the generator and the retailer.

Whatever its outcome, the TXU fiasco highlights that similar shocks could happen in any year, not just this year, says Santokie. This all adds to uncertainty over the future value of ROCs, and could make it even more difficult for renewable developers to finance their projects, as the finance community does not view the recycle value as a bankable commodity.

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