Select Committee on Environmental Audit Memoranda


Memorandum from Yorkshire Electricity Supply


  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.

  We propose:

    —  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 Market Activity

  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 plant—there 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 recycling.

  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 per annum.

  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 Distortion

  We believe some of these concerns can be addressed by:

    —  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 price.

  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 funding—funding already committee to and met through FFL;

    —  the level of buy-out would be targeted at new developments—those 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 plant;

    —  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 shot market;

    —  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 obligation—2005 onwards.

  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 price.

  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.


Eligible sources

  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 small hydro.

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%

by 2010)*
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 energy accordingly.

  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 early years.


  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 frame.

  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 supply companies.

January 2001

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