"A wonderful early Christmas present," was the UK wind industry's reaction to the government's planned quick fix to the Renewables Obligation (RO) to increase investor confidence in wind plant development. The British Wind Energy Association (BWEA) gave a warm welcome to the announcement of a 50% increase in the level of the obligation on electricity retailers. They are to increase the proportion of green power in their supply portfolios from 10% in 2010 to 15% by 2015.
The increased market certainty provided by the higher mandate will be vital in securing finance for large-scale wind projects, especially for projects offshore, says BWEA. The government announcement came at the start of last month after extensive lobbying from the industry for an increase in binding targets for renewables. A tweak to the national green power regulation had been widely expected after energy minister Stephen Timms and officials in the Department of Trade and Industry (DTI) had repeatedly acknowledged the industry's concerns and indicated that they would take action to reassure investors in advance of their planned review of the RO in 2005-06.
Marcus Rand from the BWEA says he is "delighted" the minister has listened to advice and acted so decisively. "It is the icing on the cake of a great year for wind," he says. "The ability to assess the value of renewable electricity for a further five years will increase industry confidence when making long term investment decisions," says Alan Moore of National Wind Power, chairman of the BWEA. "Perhaps more importantly, it is a clear sign that the government is serious about its aspiration of achieving 20% by 2020."
The RO requires electricity retailers -- known in the UK as suppliers -- to buy a percentage of their power from renewable sources. The level of the RO was 3% when introduced in 2002 and currently stands at 4.3%. Under its new proposals, the government will raise the level of the RO beyond the current target of 10.4% by 2010-11, to 15.4% by 2015-16.
Difficulty in raising finance in a market perceived to reach a cliff edge in 2010 has been seen by the industry as the main barrier to meeting UK renewables targets of 10% by 2010 and the government "aspiration" of 20% by 2020. After more than one year's operation, the RO has stimulated an unprecedented amount of potential development. Over 2200 MW of onshore and offshore wind projects already have planning consent -- equivalent to some 2.5% of UK electricity needs.
But so far, the long term power purchase agreements (PPAs) needed by developers to secure finance to build their projects have proved elusive. Suppliers have not been willing to shoulder the risk of the value of renewables obligation certificates (ROCs) crashing in the event of an oversupply of renewable energy come 2010. ROCs are the tradable credits issued to renewable plants for each megawatt hour of output. A supplier must demonstrate it has purchased or generated the required number of ROCs to meet its renewables obligation.
The attitude of suppliers towards ROCs is confirmed in a report, Investor Perspectives on Renewable Power, released by the Renewables Advisory Board, a group that advises government. "We are happy to write PPAs out to 2011, but won't go further," said one large utility, interviewed for the study by the report's authors, LEK Consulting. "There's no reason why we should assume the political risk of changes to the regime after 2011," the utility added. The study found that 66% of industry participants interviewed recommended increasing targets beyond 2010/11.
The five year extension was a difficult decision to take, says a government official, conceding that simply expecting consumers to pay for an increase in renewables beyond 2010 may not in the long term prove to be the most cost effective solution to getting green generation built. But the government realised that unless it acted, suppliers would be opting to pay to buy out of their obligations rather than signing PPAs for renewables, he says. The extension gives the breathing space needed for a more considered approach in the 2005-06 review of the RO. "Come the review, we will want to make sure the industry has the reassurance it needs, but not at any cost," he says.
The industry had discussed with government officials some innovative solutions to the problem, he says. "It is refreshing that people are not just whinging but coming up with very useful ideas." But he stressed that as yet, the government has not got any "favoured options" for a more permanent fix to the RO.
Whether extending the RO is enough to release the finance needed to build projects remains to be seen. It's still early days, says Peter Crone of small developer Farm Energy. He would have preferred an RO target of 20% by 2020. "That would really have provided a solid foundation for the market. This is a half-way house," he says. While the five year extension is helpful, other factors are adversely affecting the market for ROCs, he points out. Particularly unhelpful is the government's proposal to relax the rules to allow more co-firing of biomass in conventional power stations, because it will reduce ROC values.
This is also a concern of Jeremy Sainsbury of Fred Olsen Renewables. Now that the first couple of project finance arrangements have been concluded, banks are beginning to get used to the idea of financing projects under the RO, he says. The company's 50 MW project at Crystal Rig in the Scottish Borders broke new ground as the first wind farm to be project financed under the RO. The RO extension to 2015 can do nothing but help in financing projects, he says. But what is essential now, he stresses, is a minimum of interference in the RO regime. Above all, there should be no change the RO rules to create separate ROCs for offshore wind or biomass. "What we want is to get banks comfortable with the idea of a ROC becoming a stable component of the market place. We want a virginal, untouchable ROC."
The five year extension will be viewed by the banks as a positive development, and a sign of the government's commitment to renewables, says Dan Badger of investment bankers Babcock & Brown. But expectations should not be raised too far, he warns; it will still not be possible for shoestring developers to find finance for highly leveraged projects.
More imporantly, a difference may be seen at board level of the big six suppliers, he says, where senior management may be more easily persuaded that they should take a position on renewables, either as builders or buyers. According to Badger, suppliers are already showing more willingness to commit to power purchase contracts beyond ten years, but maybe not necessarily as a result of the five year extension. He says that in early 2003, Babcock & Brown sold its interests in the 60 turbine Robin Rigg offshore project to Powergen because no suppliers were willing to offer reasonable PPAs. "Things are looking much better now," he says. "If they had looked this good in January we might not have sold it."
Indeed, he five year RO extension will be of most help in financing offshore projects, according to Sainsbury. It also boosts confidence among companies involved in the larger second round of offshore development. With the high costs of large developments out at sea, offshore projects will be more at the mercy of future ROC prices.
The problem is not that bankers are unwilling to lend, claims Your Energy's Andy Holdcroft. Rather, it is the difficulty securing an off-take agreement -- or PPA. There are only five or six suppliers who the banks considered to be credit worthy enough to produce bankable PPAs. Of those, only two or three are actively offering PPAs, he says. "What people lose sight of is that suppliers do not have to buy ROCs," he says. "They can choose to pay to buy out of their obligation." He points out that some are already opting for this strategy. Others prefer to develop their own renewable capacity and rather than offer PPAs will buy up the project at a cheap price. Attitudes towards such "gaming" may change, says Holdcroft. As the size of the obligation increases, suppliers who have chosen to pay the buy out may not want to see a bigger chunk of their money recycled to their competitors, he says.
Timms admits there are formidable challenges ahead. Achieving the targets is far from straightforward, he says. But it is now the turn of the industry to respond. "We need to get those developments with consents and capital grants built as soon as possible if we are to meet our renewables targets and to sustain and create more jobs in the UK."
According to Ernst & Young's Jonathan Johns, the increase in the RO by 1% a year from 2010-2015 will remove regulatory uncertainty. It should also improve liquidity in the market for renewables obligation certificates (ROCs), he says. He expects more attractive prices to be offered by suppliers in long term PPAs as a result of the announcement. "In addition there should be increased participation by banks in this market who were previously unwilling to take regulatory risk." The longer time horizons should produce more innovative financing structures, involving specialist infrastructure funds, says Johns. "Very substantial capital sums in excess of £10 billion are needed over the next 15 years and this impetus was very timely if the UK is to take advantage of its wind resource."
Although many are not as positive as Johns, he says the extension to the RO restores the UK to the number one position for wind in Ernst & Young's country attractiveness index (Windpower Monthly, December 2003. The index measures 15 countries' renewable energy markets, providing scores for their renewables infrastructure and suitability for different technologies.
It increases the UK's score in the wind index to 73 from 69, placing it just ahead of Spain at 72. In the all-renewables index, the UK and Spain are level pegging in the lead at 70 points each. The extension to the RO is particularly significant for offshore wind and new technologies, such as wave, tidal and biomass, providing sufficient time horizon for these to be made more economic, says Johns.