Memorandum from TXU Europe
TXU Europe strongly supports the expansion of
renewables capacity in the UK and is committed to doing its part
to ensure that the recently announced Renewables Obligation (RO)
is a success. We have recently provided a detailed response to
the Government's Preliminary Consultation on the Renewables Obligation,
which I have attached for your information, and welcome the Environmental
Audit Committee's inquiry.
In relation to the specific questions raised
by the Committee we would like to make the following comments.
1. LEVELS OF
We believe that the Non Fossil Fuel Obligation
(NFFO) has been instrumental in facilitating the development of
renewables on a competitive basis resulting in increased capacity
at lower cost. However, the NFFO has not been as successful as
it could have been due to the planning difficulties experienced
by many schemes. To some extent this may have been exacerbated
through the mechanism of the NFFO which incentivised developers
to bid in lower cost projects based on optimal locations rather
than sites which were more likely to gain planning consents. The
change in emphasis of the proposed RO to the delivery of projects,
as opposed to the cost, may improve the planning success rate.
Without resolution of the current planning difficulties, which
we discuss below in more detail, we believe that the Governments
10 per cent renewable target will not be achieved.
We believe that the proposed methodology for
the obligation has the potential to deliver the Governments renewables
target, although some fine-tuning will be required in order to
create a fully effective and efficient system. Provided these
concerns are addressed we believe that a 3p/kWh buy-out price
is generally an acceptable cost to the consumer, although we do
have some concerns that energy intensive users may find the cost
unacceptable. We believe there are three key areas that need to
(a) the market impact of the proposals, both
as respects the market for green power and the market more generally,
the risks that may arise, and how these are likely to affect outcomes;
(b) the importance of avoiding undue competitive
advantage for any player; and
(c) current experience and likely developments
on the NFFO, and the impact these may have on the optimum profile
of the obligation.
Market impact and risk
The obligation is intended to work by giving
suppliers an incentive to pay up to the buy-out price for renewable
generation or ROCs. Indeed the amount paid could be more if the
Government retains the proposed recycling of penalties from non-compliant
to compliant suppliers (which we will call "repayment by
compliance") and there is a shortfall. It intended that the
incentive in the prompt (out-turn) market will provide "pull"
back into the construction market as suppliers move to cover their
positions in advance and/or merchant renewable operators build
against the demand in the out-turn market.
However, the efficiency of such a mechanism
in encouraging the construction of renewable capacity will depend
entirely on the amount of risk seen by market participants at
the time construction decisions are taken. While consumers can
be expected to pay the full cost of the renewables obligation
in the prompt market, at the time construction decisions are made,
that money needs to remunerate two things:
(a) the construction of renewable capacity;
(b) the risks, as seen at construction time,
that the high prices in the prompt market will not materialise.
The greater the level of risk, the less money
will be left to cover the cost of constructing renewable capacity
and/or the more attractive it will be to suppliers to leave their
positions uncovered and take their chances in the prompt market.
There are three significant risk areas, which
we believe need to be addressed if the system is to work as desired:
(i) The risk of over-success. If the Obligation
target is systematically met, the price of ROCs is likely to collapse.
In such circumstances, anybody taking the risk of investment in
renewable capacity would find their assets stranded. It is essential
that the target be set at a level which is not expected to be
fulfilled and that the Government is open in making clear that
there is an element of over-targeting in order to keep the system
taut. Measures like raising the buy-back price or choosing repayment
by compliance in order to make sure a particular target is met
are likely to be self-defeating because of the risk of over-delivery.
To put it another way, the pricing of renewable energy will be
inherently unstable - and therefore highly risky - if the target
is expected to be met or nearly met.
(ii) The risk of market flooding by imports.
Another factor that could crash the price on renewable generation,
and therefore strand the investments of those wishing to invest,
would be large scale imports of renewable power down interconnectors.
The interconnector with France has a capacity of 16TWh annually,
more than enough to make UK renewable investments loss-making
and the possibility of future interconnectors cannot be ruled
out. We have been told that there will be provisions aimed at
reducing this risk, but it is so fundamental to the economics
of any investment that clarity is essential. In particular, we
need to be sure whether the Common Position on the new Renewables
Directive (which we understand now includes large scale hydro)
will create European Green Certificates which will have to be
accepted for Obligation purposes.
(iii) The risk of change of policy as a result
of the impact on consumers. The main consumer pain is likely to
be felt by large industrial consumers. Because supply margins
in this sector are so small - practically zero - it is highly
unlikely that suppliers will want to take the risk of renewables
construction in order to supply the market, when a safer course
is to shed the load unless the customer is willing to pay the
cost of its green tickets in the prompt market.
The cost of this for large industry could be
comparable with the unrebated Climate Change Levy (CCL). Accordingly
the price impacts for large industry from the Obligation could
be so great that there might be strong, possibly even irresistible,
pressure for the scheme to be changed in a manner suppliers cannot
now predict. This risk factor, explored more fully in our response,
is likely to have a significant impact on the price suppliers
can offer for the construction of renewables. We believe that
it would be highly desirable for Government to solve the large
industrial customer problem now, so as to eliminate this risk
factor, and we would be very willing to help identify possible
It is worth re-iterating as a final point on
risk, that there are great benefits in addressing risk factors
at source so they can be substantially eliminated. This should
achieve the optimum "pull" from the market to encourage
construction of renewable generation. Increasing the buy-out price
beyond the appropriate level or measures such as repayment by
compliance are likely to have as their predominant effect increasing
the risk premium rather than increasing the funds available for
construction. This is because they increase the tension in the
system, which manifests itself in instability and risk. Such an
outcome could well lead to additional costs for customers but
not necessarily additional development of renewable generation.
Avoiding undue competitive advantage
A number of suppliers are competitively advantaged
by the current proposals due to their existing small scale hydro
capacity or the potential for favoured access to renewable capacity
supplied via interconnectors. This potential undue advantage is
intensified by certain aspects of the proposals such as the profile
of the obligation (which may allow for insufficient lead-time
associated with new capacity) and the suggested use of repayment
by compliance (which could have us making direct payments to certain
of our competitors even if we were investing more in UK renewables
than they were). We think that the logic of creating an effective
and efficient electricity market, and the policy and purpose of
the Utilities Act, both point towards doing what is possible to
eliminate undue advantage. In our response below, we give some
suggestions as to how this might best be done.
The NFFO and the phasing of the Obligation
Although the Obligation should help to remedy
some of the issues, which have arisen in the operation of the
NFFO, we think there are some transitional issues. In particular,
success rates for NFFO projects have fallen in recent years as
the planning climate has hardened. The RO at 3p/kWh may also intensify
the problem as developers may be tempted to let setbacks kill
off uncommitted projects if they feel they can make more profit
with the same capital or management time in the Obligation market.
The net effect of these interactions is to cast
some considerable doubt on the capacity predicted to arise from
NFFO 3-5 that forms the baseline for preparing the obligation
figures. In the light of that uncertainty, it will be difficult
to judge in a timely manner how much capacity needs to be acquired
under the RO and it may be difficult to set up the relevant RO
projects on a fast enough timescale. Accordingly, there seems
to be a risk that the market will remain excessively short during
this period, with a possible excess cost to consumers. There is
also a concern that these costs may fall differentially on suppliers,
especially favouring those with existing small hydro or links
to the Continent. Such differentials would be enlarged if repayment
by compliance were in force.
In relation to "acceptable costs"
we believe consumers, both industrial and domestic, and their
representatives are best placed to comment on the acceptability
or otherwise of the costs implicit in the Obligation.
3. THE IMPACT
We believe that the new electricity trading
arrangements will not significantly impact the amount of renewables
likely to be constructed in response to the renewables obligation.
This is for two reasons:
(a) a number of market players, including
TXU Europe, will be well placed to offer risk management products,
such as consolidation or aggregation, to renewable generators.
Indeed, we at TXU see this as a key way in which we can help facilitate
the development of renewables.
(b) in any event, under the obligation suppliers
will need to facilitate or undertake the construction of renewable
projects. They will have an incentive to secure the economic delivery
of projects and therefore to enable the power to be cost-effectively
taken by the system. Suppliers who do not develop or purchase
the appropriate energy risk management arrangements to take the
power would therefore find it much harder to achieve the targeted
compliance and would be exposed to buy-out charges.
4. THE LEVEL
We believe the RO will incentivise the development
of those renewable technologies that are already economic or nearing
commercially viability. This will be underpinned further by the
availability of funding through the Carbon Trust and the proposed
financial aid available to biomass and offshore wind technology.
However only time will tell where the current support will be
sufficient therefore we would advocate that Government regularly
reviews progress with the potential consideration of further support
We also support the provision of appropriate
Government funding to longer-term technologies. This should be
undertaken in partnership with academia and business.
5. THE LEVEL
As mentioned above, it is important that the
target remains sufficiently ahead of delivery in order to give
market participants confidence that the price of ROCs will not
collapse to near zero. (We think that would be the likely outcome
if the target were systematically met.) We believe that the Government's
10 per cent target for renewables by 2010 is challenging but could
potentially be met in the period 2010 to 2012. In order to avoid
stranding investments to be made over the next few years, it is
important that early signals are given that the obligation is
expected to be progressive, and that targets would be advanced
- at least for the years until 2015in the event that the
obligation is met.
It is important that the detail of post 2010 targets
is decided in sufficient time for suppliers to take the matter
forward. We would therefore advocate that the requirement for
future targets, based on socio-economic and environmental considerations,
should be reviewed and agreed by 2008 at the latest. Consideration
should also be given to future European Union renewables targets
and any post Kyoto commitments.
6. THE INTERACTION
We believe that the major planning difficulties
currently being experienced by renewable developers have not yet
been adequately addressed. The "lottery" element of
the renewables development process needs to be significantly reduced
by clearer and stronger guidance to councils that incentivises
them to resolve this issue. It is particularly frustrating for
project developers, who have spent considerable time and financial
resources in developing proposals with the involvement of local
stakeholders, to gain local planning consents only to find that
the project is called in for public enquiry.
Although we recognise that measures are being
taken to address planning difficulties (eg DETR's published Guidance
on Preparing Sustainable Development Frameworks), which have proved
the major barrier to the development of NFFO projects, we have
not yet seen any material evidence of success. The large amount
of wind and energy from waste capacity still outstanding when
compared to installed capacityand the low rates of success
in recent NFFO roundsare of particular concern:
It is also important to ensure that appropriate
planning procedures be adopted by Crown Estates in relation to
offshore wind projects.