The RO has cost consumers £1.7 billion so far and in its current form is forecast to cost £32 billion over its lifetime, says Ofgem. Since the legislation was introduced, rising wholesale prices for electricity and the European Emissions Trading Scheme (ETS) have improved the competitive position of renewables so that they need less of a subsidy, it argues. But under the structure of the RO, the price of Renewables Obligation Certificates (ROCs), which electricity retailers must buy to meet a specific requirement for green power purchases each year, remains the same.
Since renewables generators are in receipt of both ROC payments and higher power purchase prices, they are enjoying far more subsidy than they need, accuses Ofgem. In the first three years of the RO generators received a "deadweight subsidy" of £740 million, calculates the regulator. This figure assumes a wholesale price for electricity of £30/MWh. "At an average price of £45/MWh -- close to the current wholesale price -- all of the existing deployed technologies are economic without the need for any further support, suggesting that nearly all of the RO subsidy is in excess," states Ofgem.
Moreover, with the way that the RO operates, customers end up paying even if renewable energy generation does not get built, it says. Since the obligation began in 2002, the requirement for green power has consistently been set higher than generators can achieve, due largely to problems with securing building consents under the country's physical planning system. Generators unable to meet 100% of their obligation pay penalties, a renewables cost that they pass on to customers.
The over-subsidy coupled with the shortfall of renewables makes the RO an expensive way to reduce carbon emissions, says Ofgem. The cost of carbon abatement through the RO ranges from £184-£481 per tonne of carbon compared to £66/tC under the UK emission trading scheme and between £12/tC and £70/tC under the EU ETS.
The government's plans for RO reform to reduce costs and bring forward less commercial technologies would increase complexity and administration costs, Ofgem warns. In particular the proposal to introducing "bands" for the different renewables technologies to allow more support for offshore wind, marine renewables and biomass, could distort competition and, together with the overcompensation to generators, leave the government open to a legal challenge. It is time for a fundamental rethink of the RO from first principles, urges the regulator.
Ofgem suggests a system based on auctions of long-term contracts that offer renewable generators a fixed return and links the level of support to the wholesale electricity price. This means that the cost of renewables support to customers would fall as wholesale prices rise, driven up by the rising cost on fossil fuel generators of buying carbon emission permits under the EU ETS.
Prospective renewables generators would bid a fixed price into the auctions; the subsidy they would be paid would be the difference between their contract price and the wholesale price. Contracts would be firm and would include penalties for non delivery. Payments to generators would be funded by a levy on electricity retailers. In moving away from the current RO arrangements, the government should "grandfather" rights to existing projects under the RO.
The proposal is reminiscent of the former NFFO and Scottish Renewables Order (SRO) support systems which granted contracts to renewables in competitive tendering auctions. NFFO successfully drove down the price of UK renewable electricity but delivered relatively little capacity. But Ofgem says that stronger obligations to deliver would be placed on renewable generators to avoid the situation under NFFO where many contracted projects were never built. And, unlike NFFO, it would not require a central purchasing agency to buy renewable electricity, just a market administrator who would make payments to generators and levy retailers; this makes the concept more compatible with the aims of a competitive market.
According to its chief executive, Alistair Buchanan, Ofgem supports the government's aim of cutting carbon emissions and recognises that renewables can help achieve that aim. "But we think that a review of the scheme could provide more carbon reductions and promote renewable generation at a lower cost to customers who are already facing higher energy bills," he says. "We urge the government to consider our alternative to the RO and we would be willing to take part in the development of any proposals for options."
From market analysts Climate Change Capital, Tony White believes that Ofgem should have put forward its proposal for such far-reaching change in the lead up to the government's earlier RO review in 2005 or even its 2006 Energy Review. "I can understand the logic of their proposal, but you would have thought that they would have talked about this two years ago rather than now." White also questions how existing generators could be protected under such a dramatic move away from the RO. It is all very well for Ofgem to say that payments should be grandfathered, but how could that be done? he asks.
Ofgem's response to the government's consultation on the RO contrasts with that of the British Wind Energy Association, which is asking for more money to be made available (box). The BWEA says the RO has proved to be six times as effective as the NFFO, which delivered just 500 MW in 13 years. Nearly three times that amount has been commissioned during the five years of the RO, it says. Moreover, the competitive bidding process of a NFFO-type mechanism would remove investor confidence and drive projects to the windiest -- and sometimes most environmentally sensitive -- locations.
"The fact that delivery is still not enough and ROC prices are a little high is partly because Ofgem themselves have failed to prioritise issues of grid reinforcement and access which have slowed the ability of the industry to deliver," says the BWEA's Maria McCaffery. "Ofgem's proposal to revert to an old market model is a step backwards at a crucial time, when government and industry need to move forward together, to deliver in quantity under pressing time frames."