United Kingdom

United Kingdom

Behind the British energy review

In the unshaken belief that electricity markets, when properly structured, serve the people better than bureaucrats fixing purchase prices, the British government is determined to make its Renewables Obligation work as intended. Its package of measures for curing the ills of the RO may just be the right one. Intelligent industry feedback is now being sought. That will require objective vision and a thorough understanding of all the issues

Renewable energy emerges from the UK government's energy review as one of the major pillars of a national policy to combat climate change and strengthen security of energy supply. But as the wind industry digests the government's proposals to boost renewables, little agreement is being formed on how best to move wind power forward. The chances of industry presenting a coherent and detailed response to "The Energy Challenge -- Energy Review Report 2006" look slim.

Nonetheless, most regard the government's plans to reform the UK's main renewables support mechanism, the renewables obligation (RO), as positive. But a widespread fear is that the changes, which government has yet to discuss with stakeholders, could damage investor confidence and slow deployment of wind.

The RO requires electricity retailers to source a proportion of their electricity sales from renewable sources. The level of the obligation currently stands at 6.7% and will rise annually to 15.4% in 2015. Retailers meet their obligations by buying renewables obligation certificates (ROCs) or by paying a penalty to "buy out" of part or all of their obligation. The buy-out price rises each year in line with inflation.

Buy-out money is redistributed to holders of ROCs as an extra incentive to invest in renewables. Against the background of a chronic shortfall in the amount of renewable capacity available, retailers factor the expectation of buy-out money into the price they pay for ROCs. This has resulted in ROC prices this year of over £40 a megawatt hour, a sum consumers must shoulder on top of the wholesale purchase price for renewables power and the cost of climate change Levy Exemption Certificates. In total, consumers are paying about £100/MWh (EUR 149/MWh) for wind, up to double the price paid in other major markets in Europe and North America.

The RO reforms set out in the government's review document are intended to improve value for money for the electricity consumer, boost investor confidence beyond 2015 and bring on emerging technologies such as offshore wind and marine renewables. The thorny issue of value for money has long been a bone of contention (Windpower Monthly, October 2005). Much of the high price of wind power in Britain is blamed on the high financial risk associated with the buy-out recycling mechanism and the 2015 market horizon.

"There is intense political pressure on the RO, from many directions," says Gaynor Hartnell of the Renewable Energy Association. She points out that a 2005 report by the EU Commission showed the RO "to be the least effective, yet most expensive of member states' renewables policies." Hartnell also blames the high prices on delays in gaining site consent and grid access, problems unconnected with the RO. The delays would have slowed deployment even under the most generous regulated price support, she says. "But with the RO, customers pay regardless of the level of delivery. Under a feed-in tariff, no delivery means no cost."

Government's solutions

Despite the criticism, the UK government clearly has faith in the basic concept of the RO market structure. But to deal with its shortcomings, the government proposes raising the expected contribution of renewable energy to 20% of the national supply and replacing the series of fixed yearly obligation targets used to date with a mechanism which increases the level of the obligation by a small margin -- perhaps 1-2% -- above the amount of renewable energy actually produced. This "guaranteed headroom" is intended to minimise the current waste of customers' money in the present system, where the severe shortage of renewable capacity means that many retailers have to pay large sums into the buy-out fund for not being able to fulfil their obligations, sums which are passed on in electricity prices. In effect, consumers are paying for renewable energy which is never produced.

Reducing the waste is an important driver for the government's Department of Trade and Industry (DTI), which is having to make its existing pot of money go further since the Treasury refuses to throw any more funds at renewable energy. For this reason, from 2015 the buy-out price will no longer increase automatically in line with inflation. The review document states that its proposed package of measures -- including increasing the target to 20% -- will be "cost neutral" to the consumer and "not increase the impact of the RO on [electricity] bills." The government's document does not, however, provide any basis for making this claim or fully explain what it means.

The DTI also plans a further measure to increase investor confidence by introducing a mechanism to prevent ROC prices from crashing once the 20% target -- known in industry circles as the cliff edge -- is reached. Instead, it will ensure a gradual price reduction.

Tailoring support

One of the most controversial measures, however, is the proposal to band the RO so that more support can be afforded to less commercial technologies. Under this system, renewables that are not yet economic under the RO, such as offshore wind, wave, tidal, PV and some biomass, will receive more than one ROC per megawatt hour, while the more economic technologies, landfill gas, co-firing -- the burning of biomass alongside fossil fuels, and potentially onshore wind, will receive less than one ROC/MWh.

The DTI promises that the changes will only come in after a "reasonable" period of notice and will only apply to new projects; existing projects will be "grandfathered" -- continuing to receive the same number of ROCs after the changes come into force. Moreover, emerging technologies commissioned before banding is introduced will move up into the new band and receive the higher number of ROCs. All in all, the raft of reforms is set to further complicate an already complex mechanism.

Meantime, all these changes are to be subject to a DTI consultation in the autumn, with an energy white paper due out in March. Banding the RO will require primary legislation and approval from the European Commission under its rules for affording state aid to industry. The earliest the changes could be in place is 2009.

Industry fears

For Gordon Edge at the British Wind Energy Association (BWEA), the outcome of the review holds few surprises; most of the elements had been trailed previously by the DTI. But the aspect that is causing most concern to the association's members is the proposal to band technologies, he says.

The fear is that onshore wind will be among the first technologies to receive less than a full ROC per MWh of output and therefore receive less revenue. If so, the question is, when will it happen? Projects being developed now in the expectation of one ROC per MWh may not be built by the time banding comes into effect. Over 11 GW of capacity is currently making its way through the consenting process. It can take years to receive planning permission, particularly in Scotland where some 4.5 GW of large projects are waiting for decisions by the Scottish Executive. Consenting is not the only delaying factor; many Scottish projects are bogged down in the queue for grid connections or awaiting network reinforcements.

Offshore developers, on the other hand, are more bullish with the promise of extra support, says Edge. "They are pretty hopeful that it will make the economics add up." He warns, however, that the government's timetable does not allow a sensible build-up of offshore capacity. The projects in the Thames Estuary are in more advanced stages of development than most others in the government's second round of project licensing; they hope to proceed to construction in 2008-09. But developers will find it difficult to finance their projects until primary legislation is passed, he says. By that time, the component supply chain will have become increasingly starved and the other round two projects will have caught up. He fears there will be a "blood bath" in chasing what supply chain capacity remains. "The government needs to come forward with a measure to bridge the gap or to give some comfort to developers," he says. "We are engaging with government to see what can be done, but it is not an easy sell."

The case for additional help for early round two projects is also being put forcefully to the DTI by the Thames Estuary developers. "We have asked the government: do they want round two to get off to a flying start or do they want us to sit on our hands for a couple of years?" says one developer. "The response so far has been deafening in its silence." He adds that the energy review is pointing in the right direction but is not doing it fast enough for round two projects. "I would have liked the government to say that offshore wind will receive 1.4 or 1.5 ROCs per megawatt hour, but they have chosen to take it softly, softly so as not to upset anyone."

In addition to the uncertainty of not knowing what multiple of ROC is likely to be awarded to offshore wind, there is also the political risk from a change of government at the next election, he says. "Unless some interim support package is devised to help early round two projects, there is a real risk they will not reach financial close until 2009 at the earliest; nothing will then be built until 2011."

Other round two developers who do not expect to bring projects online before the expected introduction of the changes to the RO in 2009 are satisfied with the signals in the review document. The government is moving in the right direction, comments Sue Wheeler of energy group Centrica. "Banding and multiple ROCs are the way forward for offshore wind." The timescales for introducing the changes are not an issue for Centrica's three large projects totalling 1250 MW in the Greater Wash off the east coast. Although the promise of additional support is not signed and sealed, it will give round two developers confidence to take their projects forward, she says.

Good and bad onshore

Onshore developers are less sanguine. Falck Renewables Limited, a subsidiary of the Italian Falck Group, is exclusively interested in onshore wind. The energy review is a mixed bag, says the company's Charles Williams. "There are some good things and some bad things." Extending the RO to 20% is helpful. "People were becoming increasingly concerned about the 2015 cliff face. Guaranteed headroom removes this risk of price collapse." There are also encouraging measures to speed up consenting and grid connection, he says.

"On the other side, what concerns us most is the banding proposal. We have yet to see how that affects onshore projects, but we will be looking to make sure the ROC value does not diminish too much." Williams points out that the plan to freeze the buy out price from 2015 already means that ROC values will decrease in real terms over at least half the life of a wind farm.

The underlying problem with banding is that more support for less commercial technologies will be at the expense of onshore wind, says Andy Paine of Renewable Energy Systems (RES). "We have a discrete pot of money for renewables support and that is not going to change; government is looking at how best to distribute this. What we need to ensure is that we do not shoot onshore wind in the foot by assuming that it does not need as high a level of support as at present." He says that wind's cost base has risen dramatically. "Prices for turbines are 30% higher than six or seven years ago and we have got grid and infrastructure issues. It is about maintaining the risk reward balance; we need to ensure that the level of reward is commensurate with the risks we are taking."

Paine explains that RES is a portfolio developer with a spread of projects, from high risk sites in Scotland where wind speeds are attractive, but problems with grid connection could take years to resolve, to low risk, low wind speed sites. He warns that the less windy sites will remain undeveloped unless the government is careful about the level at which it sets the band price. "Banding is in danger of turning into a blunt instrument because it could put a brake on the most commercially developed technology."

Developer npower renewables has similar concerns. "At the end of the day, onshore wind is still a marginal technology from an economic perspective; it's not a licence to print money," says the company's Nic Rigby. "If onshore wind is banded down excessively, low wind speed sites and sites with high grid charges will not be built." As an offshore and onshore player, npower recognises the government's aims of value for money for the consumer and its determination to see offshore wind become established, but it is important it is not done in such a way as to damage investor confidence. "Provided the process is managed properly it will assist the industry and we will have more renewables going forward."

Rigby cautions against the bands being set too wide, which would fundamentally change the way the whole RO mechanism works. Changes to the technology bands should be clearly signalled well in advance with, preferably, three to five years' notice. Investors do not like change, he points out. "The fact that the rules have been changed to help offshore wind creates a nervousness that more changes may take place in the future."

As an investor, Tom Murley of HgCapital agrees. HgCapital owns wind projects in Wales and Ireland and under a joint venture with specialist developer Wind Direct, is to provide equity investment in a range of small projects on industrial sites in Britain. Murley's biggest concern is that the changes heralded in the review create an uncomfortable climate for investors. He explains that the current proposals come too soon after the RO was tweaked as a result of the 2005 RO review. "Another year on and we are looking at other changes. It does nothing to provide the regulatory stability that investors need." Some of the amendments will require primary legislation which can take 18-24 months on top of the consultation process. "That is getting uncomfortably close to the next general election. Then we could be looking to a new government and that may lead to yet more changes," he says. "It makes me wonder how often we'll have to go through this."

He is unconvinced that tinkering with the RO is the right way forward. "I have my doubts that the changes will have the desired effect of encouraging some of the less commercial renewable technologies, because I do not believe that problems with the RO are the reason why they are not advancing." The main issue with offshore wind is turbine availability, cost and liability. With the current global demand for onshore turbines, why would manufacturers want to sell to the riskier offshore market where erecting wind farms and providing warranties is more expensive, he asks.

As for other renewables, wave and tidal are still venture capital technologies, he says. "Until the technology is massively improved, there is nothing that the RO will do for them." And the issues that have dogged biomass are associated with its fuel-security of supply, transport and crop rotation, he says.

To keep the overall number of ROCs in the market unaltered, the DTI will have to balance the extra support to offshore by taking ROCs away from onshore wind, Murley argues. "They are talking about giving offshore wind 1.2 to 1.4 ROCs per MWh. If 50% of ROCs are expected to come from offshore wind, then onshore wind will have to be allocated just 0.75 to 0.8 ROCs per MWh, he says. "That is going to equate to a 10-15% drop in revenues."

Applause for government

But Centrica's Gearoid Lane applauds the proposals for boosting offshore wind, improving the economic efficiency of the RO, and reducing the risk of destabilisation of the mechanism due to constant under-delivery of renewables targets. He insists the measures have to be seen as a package. The lower level of ROCs for onshore wind is counterbalanced by the extension of the RO target to 2020 and the proposed guaranteed headroom -- both will improve stability of the market, bringing down the cost of finance. "And there is a fairly firm grandfathering proposal. It does not look to us like a bad package."

Also enthusiastic about the government's plan for the RO is Ian Temperton from Climate Change Capital. "It is one of the most thoughtful pieces of renewables policy that I have seen for a long time," he says. He believes that most industry players have come to accept that the RO cannot continue unchanged. "Something has got to be done to bring forward other technologies, particularly offshore wind. The DTI has done a good job; it makes the mechanism more stable and should not adversely affect wind developments." The proposals for guaranteed headroom and banding to be phased in should leave things "pretty solid" for developers.

Jeremy Wheatland from LEK Consulting agrees that most renewable developers are assuming that the RO will have to be changed. "They are discounting it in their investment appraisals," he says. The RO at present is a great mechanism for incentivising least cost solutions like onshore wind, he points out. But if those least cost solutions are not enough to meet the targets, it is not good at pulling through next stage technologies. In the longer term, the electricity generation capacity gap will become bigger from 2015/16 he says. "If you are looking at the requirement for large scale renewable generation to help fill that gap, you do need to bring in technologies other than onshore wind." The measures proposed by government will do just that while still creating an incentive for low cost, he says, but within a technology band.

For more efficiency

The government's proposed mechanism, however, is still not as efficient in terms of cost per unit of energy as a fixed premium on top of the wholesale electricity price, maintains Wheatland. In its report this year for the Carbon Trust, Policy Frameworks for Renewables, LEK Consulting proposes the most efficient mechanism would be a move away from the RO for bringing on offshore wind. The Renewable Development Premium would be guaranteed for the life of a project, but would be "stepped down" for new projects as the technology becomes more competitive and more capacity is brought online. The premium could deliver 8.8 GW of additional capacity by 2015 -- some 3 GW more than the current RO, and require less subsidy, claims the report.

"Banded ROCs and guaranteed headroom go some way to replicating that, but they retain some of the inefficiencies of the current RO regime," says Wheatland. There is still room for leakage as some of the subsidy will continue to go to suppliers rather than developers directly due to the uncertainty of future ROC values, he says. "But one of the biggest problems is that the mechanism is mightily complicated."

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