THE BALANCE BETWEEN ACHIEVING THE TARGETS
AND THE COST TO THE CONSUMER
By creating a separate category of Non-Eligible
Renewables which includes energy from waste and large hydro, the
Government has prevented windfall gains on approximately 5.6TWh
of renewable generation each year. The saving to the consumer
of this policy would be up to £168 million per annum. However,
the Government has failed to prevent windfall gains as follows:
(i) Approximately 2.2TWh of Eligible Renewables
currently operating without NFFO subsidy, at a cost to the consumer
of up to £66m per annum for windfall payments;
(ii) An additional 1.5TWh of output from
Eligible Renewables that are currently receiving support under
NFFO contracts. Those renewables will receive windfall payments
from the end of the NFFO contracts, until at least 2026, and the
cost of those windfall payments will be up to £45 million
per annum index linked; and
(iii) The Consultaton Document assumes that
an additional 7.0 TWh will each year be produced by Eligible Renewables
with NFFO 3, 4 and 5 contracts that are not yet operating, but
that are expected to be commissioned in future and which would
normally be expected to amortise capital costs over the lives
of the contracts. These projects will receive windfall payments
after the NFFO contracts terminate. This level of output would
imply additional windfall payments of up to £210 million
per annum from the end of the NFFO contracts until 2026.
Thus, the policy is likely to cost the consumer
around £321 million (indexed) per year in windfall payments
once NFFO contracts have terminated. There is also the potential
for this sum to increase as existing renewables on mainland Europe
will have the opportunity to obtain windfalls by selling Renewables
Obligation Certificates into the UK. The windfall payments discussed
in (ii) and (iii) above are ignored by the cost benefit analysis
in Annex A of the Consultation Document because this considers
only the costs in 2010.
By excluding certain types of renewables from
the obligation rather than addressing the problem of windfalls
directly, the policy as stated in the Consultation Document is
increasing the cost to the consumer by perhaps 12 per cent in
2010 and 60 per cent in later years.
The market price of Renewables Obligation Certificates
will be maintained at or above the buy out price for so long as
there are insufficient certificates to satisfy the Obligation.
The best interests of the consumer will be served if the market
has the maximum flexibility possible in its efforts to satisfy
the Obligation. Entrepreneurs will use this flexibility to deliver
lower cost technologies that eventually will lead to a surplus
of renewables capacity and thus drive down the market price of
certificates below the buy out price. Although the magnitude of
the effect is difficult to quantify, excluding some renewables
from the Obligation will unambiguously increase the market price
of certificates and, hence, increase the costs to consumers above
the economically efficient level. The consumer would be better
served by including the technology categories currently classed
as Non-Eligible Renewables within the Obligation but increasing
the level of the Obligation commensurately.
The minimum cost to the consumer commensurate
with the Government achieving its renewables target will be delivered
by adjusting the policy set out in the Consultation Document as
(a) Define Non-Eligible Renewables as all
existing renewables and any future renewables that benefit from
(b) Reduce the levels for the Obligation
set out in Table D of the Consultation Document to exclude those
Eligible renewables that are expected to be commissioned in the
future and that will benefit from NFFO contracts, and increase
the Obligation by an amount equivalent to the forecast growth
in large hydro and energy from waste excluding that element that
is expected to benefit from NFFO contracts.
These adjustments would ensure that no windfall
payments are made and provide the maximum flexibility in achieving
the Obligation. Hence they will minimise the cost to the consumer
of achieving the Obligation. It will also provide significantly
greater assurance that the Renewables Targets will be met.
It might be argued that by increasing the number
of technologies included in the Obligation as suggested above,
the cost to the consumer would be increased because of the need
to buy more Renewables Obligation Certificates. However, the Government's
aim is to meet the Renewables Targets at least cost to the consumer:
meeting the Obligation as set out in the Consultation Document
is simply the means to this end. As has been established in Annex
A, the forecast of growth in the output of energy from waste is
very optimistic. Thus, any additional cost to the consumer of
paying for more certificates is part of the necessary cost of
meeting the Targets. However, it is likely that even if energy
from waste projects were included, there would be a net reduction
in the level of the Obligation once NFFO contracted plant is removed.
It is recognised that the Savings Arrangements for NFFO 3, 4 and
5 Contracts remove the financial effect of having this plant in
the Obligation while the NFFO contracts remain in place, but these
arrangements do not reduce the cost to the consumer of maintaining
the level of the Obligation in the period between termination
of the NFFO contracts and 2026.
Table 1 below calculates the revised level of
the Obligation on two bases; first, that all new energy from waste
projects being built are supported by NFFO Contracts (scenario
1); second, that only one third of those energy from waste plants
commissioned after 2003 would have NFFO support (scenario 2).
Both scenarios demonstrate a significant reduction in the level
of the Obligation required to meet the same Renewables Targets.
Both scenarios produce a significant net reduction in the cost
to the consumer. The impact on cost to the consumer of scenario
2 is illustrated in the final column of Table 1.
There are two aspects to the policy that unnecessarily
increase costs to the consumer.
First, by failing to target successfully windfall
gains to existing projects and projects that will be supported
by NFFO, the cost to the consumer will be increased by £66
million (12 per cent) in 2010 rising as the NFFO Contracts expire
to £320 million (60 per cent) by 2018. Some of these costs
have not been included in the analysis of costs and benefits set
out in Annex A to the Consultation Document.
Second, limiting the scope of renewables that
can be used to satisfy the Obligation and, in particular, excluding
those which are most likely to achieve commercial viability will
increase the price at which Renewables Obligation Certificates
trade and increase costs to consumers. The function of the market
mechanism that is at the heart of the policy on the Obligation
is to reduce the price of certificates when the costs of renewables
fall. The buy out price should be a cap rather than a target.
This cannot happen effectively unless markets are allowed to operate
without undue regulatory interference.
Although the Consultation Paper states that
the average burden for consumers has been calculated to be modest
(3.7 per cent), it will fall disproportionately on large industrial
energy users who could face increases in bills of around 12 per
cent by 2010 and greater amounts thereafter.
The cost benefit analysis in the Consultation
Document assumes that renewable generators will be paid the buy
out price of £30/MWh and calculates the cost to the consumer
to be £595 million pa in 2010. As has been noted above, this
understates the cost of the policy in later years, and the cost
could easily rise to £850m pa (in real terms) by 2018.
The cost of the policy has been presented as
the cost of achieving the 10 per cent Renewables Target, but this
is not the correct cost/benefit analysis. If the Renewables Target
is to be achieved with the proposed policy, the additional output
will consist of three elements; construction of capacity without
any form of support; construction of capacity supported by NFFO/SRO
contracts; and construction of capacity supported only by the
benefits accruing through the Obligation. The policy is responsible
only for the additional capacity indicated in the third category
and it is to this additional capacity that the costs of the policy
should be compared. On this basis, the additional cost (ie: excluding
the market price of non-renewable generation) of additional output
is £42.50/MWh in 2010 and £60.71/MWh in 2018. In other
words, by 2018 achieving the additional output will cost the consumer
over twice as much per unit as is suggested by the level of the
buy out price. Looked at another way, one third of payments made
by consumers in 2010 and half of payments made by them in 2018
will produce no additional benefit.
The policy does not achieve the right balance
between achieving the targets and cost.
THE SCALE OF THE OBLIGATION REQUIRED TO ACHIEVE
A 10 PER CENT RENEWABLES TARGET IN 2010 USING AN ALTERNATIVE DEFINITION
OF ELIGIBLE RENEWABLES
||Obligation as set out in Table D of the Consultation Document
||Effect of removing existing renewables
||Effect of removing future renewables with NFFO Contracts
||Effect of adding energy from waste to the Obligation
||Scenario 2 |
||Without NFFO TWh
||With NFFO TWh||TWh
||Scenario 1 TWh
||Scenario 2 TWh||Scenario 1 TWh
||Scenario 2 TWh
||Net Change in Cost to the consumer £m (2000 prices)