Despite the criticism, proposals released last month by the Department of Trade and Industry under its review of the RO fall far short of the measures needed to keep prices from spiralling while at the same time maintaining confidence in the mechanism beyond 2015. Moreover, the government's favoured fix of the RO for achieving both those requirements, which had been much discussed in renewables circles, is surprisingly absent from the latest proposals.
The watered down government thinking was revealed by the Department of Trade and Industry (DTI) as it starts the statutory consultation stage of its long-winded RO review. The Renewables Obligation requires electricity retailers to supply a rising percentage of their power from renewable energy sources, demonstrating their compliance with the RO by the acquisition of Renewables Obligation Certificates (ROCs). The level of the RO began at 3% in 2002, in the current year it stands at 5.5%, and it will rise to 15.4% in 2015-16.
But a major concern of the renewables industry is what will happen to the RO after 2015-16. The fear is that if the level stays at 15% after that date -- and if renewables capacity continues to rise to meet the 15% target -- the value of the certificates will fall to zero as the target is reached. Since wind generation projects in Britain are largely financed on the basis of ten to 15 year contracts with electricity retailers for the sale of power and ROCs, the vision of worthless future ROCs undermines the foundations of the market, according to some industry observers.
Investors and project developers cannot put money into new projects with confidence given the future uncertainty of ROC prices, they argue. Market players likely to fall fastest off the cliff edge will be higher cost technologies like offshore wind, yet government is banking on offshore wind to help deliver its renewable energy targets.
A majority in the renewables industry would like to see increases in the RO percentages out to 2020 or beyond. This would improve confidence in the ROC market and drive forward additional renewables developments, they say. Fixing RO levels in the long term was discussed by the DTI in its preliminary consultation earlier this year, but the department has now decided against taking any action to deal with the problem -- at least, not for the next few years. Indeed, the proposals outlined in its statutory consultation document last month reveal the government is confining its tinkering with the RO mechanism to a bare minimum.
In the current climate of criticism about the cost of the RO, the DTI has reason enough to reject the industry's call for raising RO levels further. Prices being paid for wind energy are running at around £0.09/kWh (EUR 0.13/kWh), compared with a range of about EUR 0.07-0.09/kWh on the European continent. Raising the level of the RO could cost the consumer an extra £500 million annually in later years, the DTI says. Raising it would also be premature given that the low level of renewables build means the RO targets are far from being met.
Even so, the DTI had been seriously considering a solution to the RO's failings -- until the renewable energy lobby objected to it in informal discussions with government officials. The DTI favoured setting the level of the obligation from year to year after 2015 so that it remains a fixed percentage, say 2%, above the volume of renewables generation achieved.
The DTI had hoped an annual increase to provide headroom would reduce the shortfall between installed capacity and the level of the RO and, importantly, bring prices down by removing a large element of the risk which is contributing to keeping them high. Fearing the cliff edge, providers of project loans want to see up to 35% of a project's cost as equity before they are prepared to lend the remainder. To attract equity under those terms, high returns to equity investors of 15-20% must be on offer, pushing up the cost of wind power.
From the British Wind Energy Association (BWEA), Gordon Edge sees attractions in the DTI proposal and its guaranteed headroom: developers could build with confidence and financiers would know almost exactly what ROC prices will be doing ahead of time, he says. But Edge has reservations too. The industry would need to be assured, he says, that the green power percentage would never be set lower than the previous year; this would ensure that even if there is a significant gap between generation and the 15% level of the obligation come 2015-16, the obligation would not be reduced, which would cause ROC values to fall precipitously.
Edge fears the mechanism could even be a victim of its own success. By guaranteeing the obligation is always above the amount of generation, renewables capacity will be completely unlocked from targets. This could lead to a rush to build with an increased burden on the consumer. "If you eliminate price risk from the market there is a danger that everyone will go bananas and the government, worried by the cost, could pull the plug," he says.
From the Renewable Power Association (RPA), Gaynor Hartnell thinks guaranteed headroom in the RO above the renewables generation built would be a "bad idea." The association worries it could lead to a fall in ROC prices come 2015-16. Like Edge, she fears the link between the green power electricity retailers must supply and the government's renewables targets would be broken.
"The ROC price effectively becomes a slowly decreasing feed-in tariff," according to the RPA. It is referring to the setting by government of a fixed tariff for wind, as in Germany.
Ian Temperton of Climate Change Capital disagrees. He thinks the DTI's idea was the best political compromise it could suggest within the constraints of the review. He believes the department was genuinely trying to improve confidence in the RO without extending targets further. "We should not expect the RO to increase to 20% by 2020; we are still falling behind the yearly RO target," he says. "I do not think renewables has the blank cheque it used to have. There is a lot of nervousness in government nowadays about setting targets that might not be delivered."
Although not over-enthusiastic about it, Temperton says the guaranteed headroom idea could "probably" work. "It's fair play to the DTI for being inventive and the industry should be more constructive in its dialogue than it has been," he says. "Our big concern is that this review does not address the issue of offshore wind."
Edge believes the DTI headroom proposal could still be on the table. Nuances in the consultation document suggest the decision is merely being deferred, he says. The government is widely expected to conduct a review of energy policy some time in the next few years, he points out. This may be the opportunity for revisiting the mechanics of the RO as well.
Meantime, lower cost renewables like onshore wind and landfill gas are enjoying a bonanza -- receiving prices for their power well above the cost of generating it. From consultants Garrad Hassan, Alex Tindal believes that wind generators already operating under the RO are entitled to enjoy their profits. "People making money now are the people who had the guts to develop wind farms in a very different climate with no support mechanisms in place," Tindal says.
He argues that ROC prices need to be attractive to encourage wind developers to put time and effort into building projects. "If building renewables was easy we would be ahead of the RO curve by now," he says. "The carrot needs to be quite big to get the capacity built to meet the country's targets." He adds that while prices paid for wind generated electricity have risen, so too have upfront costs of development and getting projects through the site permitting process, as well as the cost of the hardware.
Tindal also points out that the rise in prices being paid for renewables electricity is linked to the rise in electricity prices generally as a result of hikes in oil and gas prices. "Suddenly electricity is worth a lot more compared to a few years ago when it was worth next to nothing," he says.
Meantime, the DTI's statutory consultation document holds few surprises. All the government proposes is making some changes to the eligibility of power generated from waste, simplifying administrative arrangements -- including for smaller generators -- and reducing support after 2009 for low-cost technologies, in particular landfill gas. In the case of onshore wind, the DTI does not believe the technology is ready yet for support to be reduced, but asks for views on the best approach to tailoring support for future onshore wind projects.