Cloudy times ahead for renewables

Renewable energy is a priority. The EU Renewable Energy Directive commits the UK to meeting 15% of its energy needs from renewable sources by 2020, compared with 3.8% in 2011. In order to achieve this target, renewable electricity supply from large scale generation will have to increase from around 10% today to around 30% (under the central renewables deployment scenario) by 2020. Further deployment of renewable electricity will have to come from smaller scale generation (<5MW), including micro generation over which there continue to be doubts. 

The Renewables Obligation (RO), introduced in 2002, has been the UK government’s main financial policy mechanism for incentivising the renewable electricity generation. It has also played an important part in securing reductions in carbon dioxide emissions, alongside other policy measures such as the Climate Change Act 2008. Since the introduction of the RO in 2002, there has been a significant increase in the UK’s renewable generation, reaching 9.7% in 2011.

Renewables Obligation Certificate

From the RO’s introduction in 2002 until 2008/09, all forms of technology received the same banding of 1 Renewables Obligation Certificate (ROC) per MWh of renewable electricity. New bands were then set for new stations in the four years from 2009/10 to 2012/13. The bands were introduced to remove overcompensation for lower cost technology and provide incentives for more expensive technology that had significant potential.

The present level of the RO is set as the number of ROCs, which is determined through estimating the level of generation in the obligation period up to 18 months in advance multiplied by a headroom percentage of 10%. Under current arrangements, the RO is set for the forthcoming financial year on this basis, with electricity suppliers bound to submit ROCs up to their obligation level. Ofgem issues renewable generators with ROCs, which are then purchased by energy suppliers at the buyout price or some agreed value.

When energy suppliers have submitted their ROCs for the year to meet their RO, they have to pay the buyout price on any shortfall. This money is then transferred into the buyout fund, which is distributed among energy suppliers and transferred to renewable generators according to their agreement with the energy suppliers. The value of a ROC to a generator is therefore equal to the buyout price, plus the recycle value. If ROCs generation is at the forecasted level, the recycling payments will be worth 10% of the buyout price for each ROC. The total value of a ROC is thus the avoided buyout price plus 10% recycling payment. This is the target value of ROCs when setting the RO.

If the level of ROCs submitted to Ofgem is below the predicted level of generation (i.e. more than 10% below the RO level), then the recycling fund will be bigger, and the value of each ROC higher; if it is higher than the predicted level of generation, the value of each ROC will be lower. Over several years, if there is no systematic bias to the error in forecasting ROCs generation, the ROC value should average out at the target value of the buyout price plus 10%.

Risks and uncertainties

There are two key risks to the ROC price in the current system. First, if ROCs generation is more than 10% higher than forecast and therefore exceeds the RO level, there may be a collapse in the value of ROCs due to supply of ROCs exceeding demand and likely undermining investor confidence in the system. Second, if ROCs generation is overestimated (for example, it was overestimated in 2010/11 and 2011/12), electricity suppliers and generators will be overcompensated as the recycle fund would be larger than intended (with the sharing of this surplus dependent on the terms of their contracts) at the expense of electricity consumers. These are essentially unanticipated excess profits.

These risks arise from several factors which make it difficult to predict the level of ROCs generation in advance, including uncertainty over:

  • wind speeds and rainfall levels affecting wind and hydro output;
  • relative coal and biomass prices affecting the level of co-firing;
  • enhanced-co-firing and biomass conversions renewable output;
  • when new renewables plant will begin operating and the form of ramp-up to full operation over time;
  • the conversion of very large coal plants to biomass – when they might occur – and given the ability to switch fuels how much biomass will be burnt once converted; and
  • decommissioning dates – given the RO is paid for 20 years, RO eligible generation will start to reduce from around 2022.

All these risks are liable to increase over time. Wind is set to become a larger proportion of the overall RO. Biomass conversions and enhanced co-firing are individual investment decisions giving rise to very large amounts of generation relative to that from individual investment decisions in other technology, where plant size tends to be much smaller. If and when plants choose to convert during a given year will make a significant difference to the setting of the RO, as will the level of biomass burn relative to coal burn when converted. Finally, levels of decommissioning – against decarbonisation commitments – will increase in the 2020s and 2030s and represent another difficult parameter to predict.

Further details of the UK government's assessment of impacts from the Energy Bill can be found in the Renewables Obligation Transition impact assessment from where the information in this article has been taken.

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