Memorandum from Yorkshire Electricity
In this paper we make proposals to improve the
effectiveness of the renewables obligation in targeting primarily
at the output of "new build" renewable generation plant.
the renewables obligation applies
mainly to the output of new build plant;
the output of NFFO 3, 4 and 5 plant
are excluded from the obligation; and
a revised profile is adopted based
on the output of new renewable plant.
As currently proposed the obligation will significantly
escalate the price paid by suppliers for the output of NFFO 3,
4, and 5 plant. There is already a support mechanism in place
via the fossil fuel levy for the development of this plant. We
believe it is not in the interests of customers to include this
within the renewables obligation neither does it assist in meeting
the 10 per cent target in 2010.
We believe DTI are significantly underestimating
the cost to customers. The current proposal does not strike the
right balance between the cost to customers and environmental
benefits. Our proposal will reduce the cost to customers whilst
not detracting from hitting the overall objectives.
The profile of the obligation should be significantly
reduced in the early years of the obligation to recognise the
lead times for commissioning new renewable generating plant.
Having adopted a market based approach Government
should allow the market to work by giving maximum flexibility
in the selling and buying of renewable energy by not restricting
any further the range of eligible technologies nor seeking to
impose regulations on the way such energy is sold to customers.
Yorkshire Electricity is the leading independent
supplier of electricity. We supply some 224TWh to the UK market,
have around two million domestic customers and are the leading
provider of demand side services (eg load shedding) in the UK
market. Unlike the vast majority of other electricity suppliers
we are a "pure" Supply business in that we have no generation
assets. We offer services that provide customers with alternatives
to buying electricity and running very expensive generating plant
times of peak demand.
We believe the proposals do not currently strike
the right balance between cost to customers and progress towards
the target. Under the current proposal customers will pay additional
monies for the output of NFFO 3, 4 and 5, yet this will not result
in any additional plant being built.
Impact of the Renewables Obligation on Current
The renewables obligation is pushing up all
eligible renewable energy prices not just those technologies in
need of additional support. It is also focussing too much attention
on prices from existing plant and the output from NFFO rather
than new build plant.
The prices for generation from existing capacity
of eligible is in some cases too expensive and is being used to
boost profits of generators. It cannot be assumed that excess
income will be invested in new renewables or to refurbish existing
plantthere is no mechanism for ensuring this. However,
we recognise that some existing plant (ex NFFO 1 and 2) may not
survive at current market prices and inclusion within the renewables
obligation will assist in keeping such plant operating.
Analysis of current activity raises the possibility
that the NFPA will end up with surplus funds over time. We would
welcome clarification of the government's intention in this regard.
We understand from discussion with DTI that in this circumstance
monies would be returned to suppliers.
There is a widespread view across various commentators
and the industry generally that the market will be short of ROC's
particularly in the early years of the obligation. To quote the
Chairman of the Renewables Energy Association "It is the
Government's expectation and intention that there will be an excess
of demand over supply, for the period of the obligation. This
is likely to be most pronounced during the early years of the
obligation. Therefore there is likely to be a significant amount
of buy-out monies collected." Indeed within the consultation
document we note that DTI are predicting a shortfall of some 2TWh
from NFFO in the regulatory impact assessment.
Cost to the Customer
We are currently being approached by generators
offering to sell eligible renewable energy from existing plant
with a 3p premium for the ROC and 0.1p premium for the buy-out
The output from NFFO 3, 4 and 5 is to be sold
via an annual auction process under the NFPA. It is highly likely
that the amount of renewable energy available will be short of
that required to hit the suppliers targets in total. Therefore
in a short market it is expected that the prices in the auction
will include at least the 3p premium, and probably more, when
the effects of the recycling mechanism are taken into account.
In the case of YEG we therefore anticipate the
cost to the customers of meeting the obligation to be £350
million over the period 2002-10 as we anticipate having to pay
a minimum of 3p/KWh premium on all eligible renewable energy.
For our two million customers this equates to £22 per customer
We believe the Table E in the Impact Assessment
therefore understates the cost to customers by assuming output
from NFFO 3, 4 and 5 will not attract the additional 3p premium,
by not allowing for an increase in prices paid as a result of
the recycling mechanism and not calculating the compliance costs
for Ofgem, suppliers and generators (NETA can provide an indicator
of the likely levels for these costs).
Reducing the Cost to Customers and Avoiding Market
We believe some of these concerns can be addressed
focussing the renewables obligation
on new build plant ie not NFFO 3, 4 and 5;
amending the profile of the renewables
obligation to reflect this; and
reducing the level of the buy-out
The advantages of focussing the renewables obligation
in this way are:
the cost to customers over the eight
year period is significantly less if NFFO 3, 4 and 5 are excluded
from the obligation. In the case of YEG we estimate the cost of
meeting the obligation would fall by nearly 30 per cent to £260
million. Some of this difference will be met through NFFO fundingfunding
already committee to and met through FFL;
the level of buy-out would be targeted
at new developmentsthose in need of additional support;
makes the renewables obligation consistent
in its treatment of UK and European renewable energy by applying
the receipt of state aid requirement in the same manner (ie NFFO
3, 4 and 5 are receiving state aid via FFL so should not be eligible
for renewables obligation);
prevents the potential for gaming
in the NFPA auctions;
limits the opportunities for excess
profits for existing plant and potential surpluses for NFPA where
there is no mechanism for investing this income in new renewable
risk of non-delivery of NFFO rests
with the party most able to manage that risk ie the project developer.
As the proposals currently stand the risk of non-delivery would
fall on suppliers who would fact increased purchase costs in a
NFFO developers have the security
of their NFFO contracts backed by FFL support, the ability to
deliver the project is not affected by whether it is included
or not within the renewables obligation;
electricity produced with CCL exempt
status will still be contracted by suppliers seeking to offer
CCL exempt tariffs to business customers;
it focuses the industry on the medium
to longer-term measures required to deliver the targets; and
it reduces the market advantages
of existing vertically integrated companies by allowing time for
all suppliers to develop their own capacity or find appropriate
partners or develop other purchasing strategies by the time significant
volumes are required from the renewables obligation2005
We understand that concerns have been raised
that NFFO projects may in this scenario attempt to "jump
ship" by seeking to get reclassified as eligible renewables
rather than continue under NFFO. The terms of the NFFO contracts
would appear to prevent this but in any event given the reaction
to date from generators and the view being taken by representatives
from the project financing community it seems extremely unlikely
that this would take place.
Level of Buy-out Price
The level of the buy-out price in relation to
the output from new build plant is primarily a matter for government
and as an independent supplier we have limited information as
to whether this price is too high or low in relation to attracting
new investment in generating plant.
Overall, however, we consider the level of buy
out has been set to high for the following reasons:
this figure does not appear to be
based on any agreement of what is the acceptable cost to consumers
of delivering this obligation;
eligible renewable energy is likely
to be at least three times higher under the renewables obligation
than buying energy in the normal market;
it is significantly more expensive
than the prices obtained under NFFO 4 and 5 which indicates this
level of premium is not required to attract investment; and
the price is higher than prices set
in other countries operating a buy-out type mechanism (Netherlands
approximately 1.9p/KWh, Denmark approximately 2.1p/KWh).
We do not consider this additional cost is acceptable
or necessary in relation to existing plant or output from NFFO
3, 4 and 5 plant.
Index Linking of Buy-out Price
It is generally acknowledged that the cost of
output from renewable sources is falling over time. This is supported
by the falling prices obtained under the NFFO schemes. In most
cases, the costs of renewable electricity would be closely related
to the initial capital cost of the project, which would be fixed
at the time of construction. This would result in an increasing
profit potential for "in-service" renewable generators
each year. This could become a significant windfall over the lifetime
of the generating plant.
The cost of building new renewable generation
is likely to continue to fall as the technology becomes more mainstream.
Generation built in later years would benefit from the knowledge
gained in the production of earlier sites. These later developments
should have lower costs of production and also be more efficient
than current developments.
We therefore see little justification for an
automatic escalator linked to Retail Price Index for the buy-out
In addition, the government has flexibility
to vary the buy-out price should the buy-out price prove too expensive
to customers or not attract investment in new renewables plant.
As indicated above the output of NFFO 3, 4,
and 5 should not be eligible for the renewables obligation and
the profile amended accordingly.
We do not agree with the blanket exclusion of
energy from waste for the renewables obligation, Energy generated
from meat and bonemeal for example, is a genuine renewable source
similar in principle to that of energy crops which requires the
support of the renewables obligation. Similarly energy generated
from non-incineration processes should not be excluded.
We do not believe there should be any further
restriction on eligible technologies for example by excluding
Eligibility from Foreign Sources
As a supplier seeking to minimise the cost to
customers we believe it is important that the option of buying
from eligible sources in Europe is not unduly restricted. This
acts as a necessary safety valve on the prices being charged by
generators in this country.
We believe the restrictions proposed (supplied
in UK, accredited source and not receiving state aid) are appropriate
and taken together with the physical restrictions associated with
inter connectors should ensure that this does not undermine the
objective of the renewables obligation.
Inclusion of eligible energy from Europe also
has the following advantages:
allows our own market is seen as
open and competitive which will be an advantage if we wish to
develop renewables as an export industry;
expose our renewables industry to
a limited international competitive barometer at an early stage;
allowing importing and exporting
of ROC's should reduce the potential for volatility of ROC prices;
would reduce the impact of unexpected
events eg freak weather conditions across the UK, which could
impact production; and
gives access to generators to a wider
range of potential buyers of ROC's in Europe.
We believe the proposed profile is unduly weighted
towards the early years of the renewables obligation. Whilst we
recognise that the bulk of the proposed target may be delivered
from NFFO 3, 4 and 5 any shortfall will have a significant impact
on the ability of suppliers to meet the renewable obligation targets
particularly in the early years. As we indicated earlier suppliers
are not able to manage this risk and we believe it should be removed
from the renewables obligation.
It is likely that any new build will take at
least four years to be delivered an contributing towards meeting
the obligation. The targets in 2002, 2003 and 2004 should be set
low with escalation from 2005 to 2010.
Following these two proposals would result in
the following profile:
| ||Estimated sales by licensed suppliers*
||Estimated total electricity available*
||Renewables target (to meet 10%
|Contribution from NFFO 3, 4 and 5 and large hydro**
||Contribution from Renewables Obligation
||RO as % of sales
Evidence required to demonstrate compliance
There is considerable additional detail to be prepared. We
suggest that an industry expert group consisting of various representatives
of the different market participants should be set up to advise
Ofgem and DTI on the detail. Yorkshire Electricity would be keen
to assist in this regard.
Our initial view on the proposals within the consultation
document is that mechanism for compliance appears overly complex
and bureaucratic. This is likely to result in significant costs.
Consideration should be given to simplifying the mechanism and
reducing the costs. It is not obvious as to why Ofgem should have
to log every trade between a supplier and generator or between
suppliers, for example. Similarly, it is questionable as to the
value of accounting for every variation of every supplier's take
during the 14 month settlement reconciliation period within the
renewables obligation. It may be more cost effective to take the
figures at initial reconciliation for renewables obligation purposes
and apply a dead band of plus or minus x% within which the supplier
is deemed to have complied.
Proposals for Banking and Borrowing
We welcome proposals to allow borrowing and banking. Suppliers
are operating in a competitive market where 12 month supply contracts
are the norm particularly for large business customers. This can
result in significant switching by customers between different
suppliers. Consequently significant variations in the volume of
energy a supplier is required to buy can take place year on year.
Actual supply can vary by 10 per cent year on year and banking
and borrowing should reflect this. Banking and borrowing will
allow time for a supplier to adjust their purchases of renewables
Given the widespread belief the market in ROC's will be short
we consider the level of permissible banking to be excessive.
It increases the possibilities for market manipulation by some
suppliers by reducing the availability of ROC's to other suppliers.
System for recycling buy-out payments
The system for recycling buy-out payments to suppliers on
the basis of their holding of green certificates represents the
third "demand side driver" for renewable energy. The
renewables obligation and climate change are in themselves very
strong demand drivers and we do not consider a third demand side
driver is necessary. It is already the case that we cannot buy
enough energy to meet customer demand for CCL exempt tariffs.
What the recycling proposal does do is increase risk and
uncertainty for suppliers. This will inevitably result in prices
going above 3p/KWh and therefore increase the cost to customers.
As the consultation document acknowledges (p 24) "recycling
buy-out payments will have the effect of raising the value of
electricity from renewable sources if total supply should fall
short of the obligation targets". However, the Regulatory
Impact Assessment (p 40) assumes the market will be short (by
including additional costs for projects which fail to deliver
under NFFO) yet still assumes that the recycling mechanism "does
not increase the maximum potential cost to customers". This
is clearly contradictory.
There is a further issue for suppliers in setting prices
in sales contracts given that they will not know the net price
they will pay for renewable energy until the overall market position
is known and the recycling payments made, Effectively this is
likely to lead to conservative assumptions and increased cost
to customers. In the longer term this may result in the development
of a forwards market or other financial instruments but this would
require a level of liquidity that is not yet evident. Given the
value of ROC's falls significantly if there is a surplus then
this is likely to remain the case for some time.
Whilst the support for these two types of projects is welcome
we are concerned that the amount of funding proposed is insufficient
and needs to be ongoing if new forms of renewable generating plant
is to continue to develop.
If one of the Government aims is to stimulate the development
of new technologies then it seems sensible to offer ongoing support
to these industries until they reach a price level at which they
become economically viable. This support should then be stopped
or moved to other renewable sources.
The paper gives until the end of 2001 for submission of applications,
with results announced within six months ie mid 2002. These projects
normally take a number of years to build. It could therefore be
some time before they start to make any contribution towards meeting
the Renewables Obligation.
In addition, to apply for the money, applicants must have
obtained all the relevant consents. As we understand it no new
offshore wind farm has yet made an application for Section 36/14
consent. Given that it appears to take a year to complete an environmental
assessment and six months to get it through the system. It therefore
seems unlikely that applicants will be in a position to obtain
the money in the timescales suggested. This further strengthens
the case for the profile of the obligation to be flatter in the
We believe a start date of October 2001 from the renewables
obligation is neither practical nor desirable and a new start
date of April 2002 should be adopted.
It will be extremely challenging for Ofgem to deliver a system
for accrediting suppliers, issuing ROC's, registering all ROC
trades, monitoring suppliers compliance, recycling payments between
suppliers and continuously reconcile this over the 14 month settlement
reconciliation process, all before by October 2001. Even if this
were achievable for Ofgem all suppliers and generators would also
have to have their systems implemented by this date.
NETA is scheduled to go live on 27 March 2001, restructuring
of the PESs is scheduled for 1 April 2001, new licences for Supply
and Distribution are scheduled to be implemented 1 April 2001,
new transmission access arrangements are scheduled for October
2001. Given the scale of these changes we do not believe it is
desirable to introduce the renewables obligation in this time
Deferring the start of the renewables obligation will not
detract from achieving the overall target in 2003 as this very
largely dependent on the delivery of NFFO 3, 4 and 5 projects
which are not influenced by the start of renewables obligation.
Having devised a market based approach to renewables it is
important that neither DTI nor Ofgem attempt to regulate how renewable
energy is sold. We are particularly concerned about suggestions
that energy sold to domestic customers under green tariffs will
somehow not be counted against the renewables obligation. If groups
of customers are willing and have the ability to pay a premium
for 100 per cent green energy this reduces the burden on other
customer groups notably disadvantaged customers who may be faced
with additional costs as a result of the renewables obligations.
The size of the renewables obligation, the level of the buy
out price and the recycling of buy out payments amongst competing
suppliers means the renewables obligation will have a very significant
impact on the competitive supply market as a whole. Within the
Draft Regulatory Impact Assessment there is no attempt to analyse
the impact of this obligation on competition in the electricity
supply markets generally. The obligation may force all suppliers
to either become vertically integrated or exit the market. In
terms of a non-vertically integrated company, like Yorkshire Electricity,
this represents a very significant risk to our business. For small
suppliers, they are unlikely to have the strength of balance sheet
to have the option of investing in renewable generation. If not
correctly structured and implemented the renewables obligation
could lead to a reduction in the level of supply competition,
which will not be in the customer's interest.
Margins in the competitive supply market are typically 1.5
per cent or less, the impact of paying a buy out price of 3p/KWh
would be to eliminate profit from electricity supply without full
cost pass through to customers. If a vertically integrated supplier
were able to recover significant monies via the buy-out mechanism
from its non-vertically integrated competitors then it would be
able to maintain prices whilst its competitors would not, effectively
driving them out of the market.
Such market distortion and risk which is based on the business
decisions made prior to the renewables obligation can be avoided
by focussing the renewables target on new build capacity as both
suppliers would be in similar positions in meeting this requirement.
The renewables obligation should not discriminate between competing