ROCs have been trading at prices considerably above the £30.5/MWh cost of buying out of the obligation -- a figure set by government ostensibly to cap the cost of the Renewables Obligation (RO) to consumers. The high prices are partly a result of redistributing money from the buy-out fund to electricity retailers who have met, or partially met, their legal obligation to buy green power. This is because buy-out fund proceeds received by retailers become an integral part of the price of each ROC.
The buy-out price effectively fixes the annual cost of the obligation. With demand set to exceed supply, the price of ROCs is the annual cost divided by the actual renewable energy generated. This means that if retailers fall 40% short of meeting the obligation to buy green power, as is the case in the first year of the RO, the price of the certificates will go up by about 66%. If there is a 25% shortfall, the price rises by 33% -- as has been demonstrated in recent months.
In practice, most electricity retailers pay fines and receive rewards from the buy-out fund which, in the first year of operation, was worth around £90 million. Two of the country's six major retailers took the lion's share of this money -- some 46% of the total.
The recycling acts as an incentive on retailers to fulfil their obligation: those who have had most success in meeting it will always have lower costs for wholesale purchases of electricity than those who have not done as well (figure). Indeed, the current structure of the RO, which controls the price of renewables, means that before the recycling of buy-out fund proceeds, meeting the obligation would be more expensive than paying a hefty fine (figure).
The other major factor contributing to the high price of wind under the RO, aside from the recycling of buy-out funds, is political uncertainty. As the RO is structured today, the price that ROCs will fetch in the years to come is so uncertain that certificate prices cannot be part of a long term power purchase agreement. On the presumption that ROC prices fall to zero as soon as the target year is reached, short term contracts -- down to five to seven years -- are all that retailers have been offering to independent developers. And short term contracts for capital intensive technologies mean high electricity costs. The upshot is that the RO projects going ahead are mainly being built by utilities.
The uncertainty over ROC prices has a further knock-on effect. Uncomfortable with the idea that ROC prices will fall off a cliff in 2015 (when the 15% target is due to have been reached), providers of project loans want a large chunk of a project's cost -- up to 35% -- put up as equity. To attract equity under those terms, high returns of 15-20% must be on offer.
Whether last month's extension of the RO from 10% in 2010 to 15% in 2015, will increase the length of typical contracts from five to seven years to ten to 12 years, remains to be seen. But the price-inflation effect of the recycling mechanism and the need for high returns to attract equity remain. So too do the risk factors which these days pervade the entire market for electricity sector financing.