United Kingdom

United Kingdom

Why are ROC prices so high?

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It is the way in which Britain's Renewables Obligation Certificate (ROC) price is structured that makes renewables more expensive in Britain than in other markets. The intention of the Renewables Obligation (RO) was to create a market where competition controlled prices. But the introduction of an advanced "penalty and reward" system has knocked market forces out of action.

Recycling the penalty levied for not holding enough ROCs back into the market means that consumers pay the same amount for a small volume of renewable energy as they do for a large volume. The rules of supply and demand function, in that the less renewable energy coming on line, the higher the unit price, and the more renewable energy, the lower the unit price. But the recycling system means the total cost to society remains unchanged.

The system is liked by government, as it knows what the cost of the RO will be. It is liked by electricity retailers, who drive the market and have most to gain financially. It is also accepted by generators selling energy to retailers, since either way they remain in pocket. The losers are consumers, who pay a subsidy for renewables irrespective of the amount of green capacity online.

The ROC represents a megawatt hour of green electricity and is the major component of the price paid for renewables, which reached £0.09/kWh, or £90/MWh (EUR 133) in the August auction of green electricity originally contracted under the UK's now defunct Non Fossil Fuel Obligation. As ROC trades are usually commercially confidential, the auctions provide a good idea of the latest price paid for certificates. Electricity retailers must buy ROCs or pay a penalty per ROC to "buy out" of their obligation.

The government's intention with the penalty was for it to act as a cap on the cost of the RO to consumers. But ROCs are trading at around £46/MWh -- well above the buy-out price. This is because money from the buy-out fund is fed back to electricity suppliers who have met, or partially met, their obligation to buy green power. The "reward" becomes an integral part of ROC prices. Most electricity retailers both pay fines into and receive rewards from the buy-out fund, which last year was worth around £164 million (EUR 242 million). Without income from the buy-out fund, meeting the obligation in today's market would cost more than paying the fine.

Aside from the ROC value, the price of renewables is made up of the base market price for the energy of some £40/MWh -- which has risen significantly in response to high gas prices -- plus the value of wind power's exemption from the Climate Change Levy on conventional electricity.

Even though the buy-out price is not acting as a cap, it effectively sets the value of a ROC, in the process knockingout of action the market forces the RO is intended to create. As demand under the RO greatly exceeds supply, the price of ROCs turns out to be the annual cost of the RO divided by the actual volume of ROCs generated. If retailers fall 40% short of meeting their obligation, as in the first year of the RO, the price of certificates will go up above the buy-out price by about 66%.

Figures from electricity market regulator Ofgem show that in the year ending March 2005, the total RO on electricity retailers was 15,761,067 MWh. But the amount of ROCs available was less than 11 million -- a 31% shortfall. With a buy-out price last year of £31.39/MWh (EUR 46.3), the price of certificates rose 45%, resulting in a ROC value of £45-46.

Despite the high prices being reaped from sales of renewables electricity, plant owners are not likely to be the main beneficiaries. There is another factor contributing to the high wind price under the RO -- political uncertainty. Because the price ROCs will fetch in years to come is so uncertain, retailers inevitably discount ROC prices substantially within power purchase agreements (PPAs) with generators. Few offer terms more than ten years. On the presumption that ROC prices fall to zero as soon as the target is reached because there is no further demand for them (main story), the incentive for retailers to sign long term PPAs with generators also disappears.

The upshot is that the RO projects going ahead are mainly being built by generators that are subsidiaries of electricity retailers. Not only do the retailers need the ROCs, but they can also write their own renewable generators long term PPAs and they have strong balance sheets -- both of which attract cheaper financing.

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