Ofgem's recommendation comes in its response to a government invitation for input on its planned changes to the RO. Although the RO was designed as a competitive mechanism to bring the most cost-effective renewable energy technologies to market, one of the main criticisms levelled against it in recent times is that the legislation only promotes the cheapest technologies such as onshore wind.
To make the RO fulfil a new purpose, the Department of Business, Enterprise and Regulatory Reform (BERR) now proposes splitting the mechanism into separate pricing bands for each technologies to award support to less mature renewables, such as offshore wind, biomass and marine technologies (wave and tidal). Ofgem argues, however, that such bands will change the fundamental nature of the RO. The government's attempt to select technologies, referred to in economic circles as "picking winners," could be expensive for consumers, says Ofgem, as it is difficult to predict how much extra subsidy technologies will need.
Ofgem makes it clear that it would prefer the government to tackle climate change more holistically and bring polluter-pays principles into play through broad legislation to reduce greenhouse gas emissions rather than interfere with electricity market forces by directly subsidising renewables. The EU emissions trading system (ETS) should be at the heart of the government's approach, it says. But it accepts that the UK's commitment to EU renewables targets demand that it raise the contribution of green power to electricity supplies.
The regulator's favoured support mechanism is long term contracts for difference. Prospective renewables generators would compete for power purchase contracts in renewable energy auctions, with the subsidy to the generator amounting to the difference between the contract price and the wholesale electricity price. The cost of the system would be recovered through a levy on electricity retailers based on their market share, which would be passed on to consumers in electricity bills.
The proposed system is similar to the now discredited former UK support mechanism, the non-fossil fuel obligation (NFFO). Ofgem maintains that unlike NFFO, in its proposal firm penalties for non-delivery of contracted power would force project developers to build and honour their contracts. If contracts for difference had been in place over the past two years, says Ofgem, it would have cost consumers 40-60% less to support the same volume of renewables generation.
Ofgem also looks at the option of purchase prices fixed by government for renewable energy feeding into the grid, in mainland Europe commonly known as renewable energy feed-in tariffs (REFITs). It notes that paying a fixed price is a simpler more flexible system than the RO and appears to be the most successful support system in Europe for achieving high levels of renewables growth. But, Ofgem warns, it is difficult to set the tariff at the right level and it does not provide an incentive to minimise costs to the consumer. Nonetheless, Ofgem recommends that BERR examines whether in a British context a REFIT could help meet the 2020 target.
Ofgem's third option is to make the RO work more efficiently. At present, retailers meet the obligation by buying renewables obligation certificates (ROCs) or paying a penalty to "buy out" of all or part of their obligation. The buy-out money collected is then recycled back to retailers in proportion to the volume of ROCs they produced at the end of the accounting period. This recycling of buy-out funds means that generators get more of a subsidy than just the buy-out price. This year retailers must include 7.9% of renewables power in their sales, a proportion that rises to 15.2% in 2015, though once again will not be able to meet that requirement and will face buy-out penalties as a result. The obligation to buy green power remains in place until 2027 and will reach 20% by 2020.
Ofgem proposes breaking the link between the buy-out penalty on retailers for not gathering sufficient ROCs, and the financial benefit received by them from buy-out funds for ROCs in-hand. In the 2005-06 accounting period, the buy-out cash totalled £126,704,565. Breaking this link, says Ofgem, would cap renewables prices at the buy-out price and reduce the subsidies paid for renewables. That would also reduce the cost per tonne of carbon saved. Buy-out funds could then be used to support less commercial renewables technologies or used for other purposes related to sustainable development.
Feed-in tariffs in name
Meantime, consistent political lobbying by supporters of feed-in tariffs has had its influence on government opposition parties. In the run up to the party-conference season, power purchase contracts at controlled or fixed prices are emerging as the mechanism of choice for future renewables support among all three parties in opposition to government: the Conservatives, Liberal Democrats and the Green Party. Although each party dubs its pet system a "feed-in tariff," not all the proposals resemble the much quoted REFIT operative in Germany. All parties reject the RO.
The Conservatives, the main opposition party to Labour, contend that the RO fails less commercial renewables. Their "Blueprint for a Green Economy" was produced by a Quality of Life Policy Group set up by party leader David Cameron and headed by former environment minister John Gummer and popular millionaire environmentalist Zac Goldsmith. They took 18 months to prepare a green agenda, which picks on a renewables policy resembling the much maligned NFFO, but with separate price bands for different low carbon technologies. The price bands are referred to as feed-in tariffs. Price setting, however, would be done by competitive auctions for contracts. Fast track planning procedures should reduce a fundamental weakness of the NFFO-type approach, the group says.
The Conservatives believe onshore wind is commercial, quoting internal rates of return hitting 25%, and say it should not compete in the banded auctions. Under their policy, the EU ETS and a revised UK carbon levy on consumption of electricity from non-renewables gives wind enough of an advantage by increasing the price of polluting forms of generation, they say.
The Conservatives' proposal has incensed the British Wind Energy Association (BWEA). It would cripple the UK wind industry overnight, the association warns. "This proposal would make a mockery of David Cameron's commitment to renewable energy," says BWEA's Chris Tomlinson. "Ending support for onshore wind would make schemes uneconomic and effectively choke off investment overnight."
The BWEA disputes that wind farm operators are making 25% profits. In reality the level is between 10-15%, it says, and is dependent on the RO, which the report would scrap. "The proposals on wind energy would be a devastating blow to meeting Britain's renewable targets; the Conservatives need to reconsider," says Tomlinson.
The Renewable Energy Association (REA) is more enthusiastic, saying the report shows an understanding of the need for lucid and strong long term regulation to attract investment. "We support bold proposals like a feed-in tariff for emergent and on-site renewables, but would retain the Renewables Obligation for wind power and other established technologies," says the REA's Philip Wolfe.
The RO also comes under fire from the Liberal Democrats who accuse it of delivering poor results with regard to driving down the cost of renewables and exposing investors to significant regulatory risk. They say they would introduce feed-in tariffs with different guaranteed minimum prices for different technologies depending on their level of maturity. Over time, feed-in tariffs would replace the RO, they say. Their proposed policy is almost identical to that of the UK's Green Party, which was the first political party to opt for a feed-in system.
As for the Labour government, the REA's Gaynor Hartnell says she has noted a greater willingness by government officials -- and by renewables industry members -- to discuss feed-in tariffs where once they would have been dismissed out of hand as overly bureaucratic command-and-control government. The mechanism may have a role in the UK for micro-generation and emerging technologies where current administrative costs are disproportionately high under the RO.
Any move down the road to a feed-in system for other renewables, however, would be unpopular in much of the renewables community, she says. "Our members want evolution, not revolution. Wholesale change would be too destabilising." Furthermore, unless the site permitting system is changed and more attention is paid to providing grid links for renewables, the industry would build no more under a feed-in tariff system as under the RO, she points out. "The thing is, we would not be paying as much for it."