Memorandum submitted by RES |
1. RES (Renewable Energy Systems) is a privately-owned
British renewable energy project developer, active across Europe,
North America and Asia-Pacific. We have been in the renewables
sector for over 25 years and have built more than 5GW of wind
energy capacity worldwide. We seek to retain as many of the projects
we develop as possible. In the UK we retain around 50% of the
projects we develop. We therefore have strong interests in the
long term viability of projects and the market for renewables
2. The RES Group works in a range of technologies:
onshore and offshore wind: solar PV and solar thermal; biomass
power and on-site biomass heating; and ground source energy; and
offers strategic advice to businesses on carbon reduction.
3. Despite the current economic situation, we
continue to expand, with staff numbers rising sevenfold since
2002. We now employ over 300 in the UK and Ireland and almost
900 worldwide. With a broad portfolio of renewable technologies,
RES is a good example of a successful British company in the international
renewables sector, supporting UK industry and skills growth.
4. We welcome the opportunity to provide written
evidence to the Committee's forthcoming inquiry and will respond
to each of the questions posed in turn.
5. We consider that the Government's preferred
proposals as set out in the Electricity Market Reform (ERM) consultation
in December 2010 are unworkable and undermine the position of
renewable electricity generators and developers. Our key concerns
- (a) The removal of the obligation on suppliers
to source renewable electricity removes one of the key drivers
for increased deployment. It is likely that the contracting terms
renewable generators will be able to negotiate will deteriorate
if the obligation is removed.
- (b) The Contract for Difference (CfD) does
not benefit wind generators as they would remain exposed to short
term price risk. Wind generators are likely to realise substantially
less than the contract 'strike price', yet this lower level of
realisable revenues would be largely hidden.
- (c) The proposal to use auctions to set support
levels is unworkable and would increase development risk significantly.
6. We believe that the Government's alternative
proposal for a premium type feed in tariff for all low carbon
generation could, however, be made to work. Under such a scheme
it would be vital that suppliers were incentivised to source renewable
generation. Under current premium FIT proposals suppliers would
not have any incentive to source low carbon generation. This is
likely to lead to deterioration in Power Purchase Agreement (PPA)
terms and negatively impact low carbon generators' position within
7. RES has developed an alternative feed in tariff
mechanism which we believe addresses the government's objectives
for reform and, crucially, does not undermine renewable generators'
position in the market. The alternative proposal, and a paper
outlining our concerns with the EMR proposals, is included as
an annex to this submission. We have circulated these papers widely
within the industry.
What should the main objective of the Electricity
Market Reform project be?
8. Meeting the carbon and renewables targets
should be the primary objective of the EMR. A second but important
objective of the EMR should be to ensure that these commitments
can be met at least cost whilst maintaining secure supplies.
Do capacity mechanisms offer a realistic way of
achieving energy security, low-carbon investment and fair prices?
9. A capacity mechanism is one way of achieving
10. Recent developments in Germany have shown,
however, that the market alone can deliver secure supplies without
dedicated capacity payments. In Germany there is 26,000MW of
wind capacity installed, 17,000MW of solar, of a total system
capacity of around 150,000MW. In 2009 there were 140 negative
price periods in the market. Negative prices occurred when generation
was greater than demand, usually during time of high wind and
solar output. By 2010 there were no negative price periods. The
reduction was largely due to nuclear plant being operated much
more flexibly than had previously been anticipated. Nuclear stations
are now turned down in periods of high renewable output. This
demonstrates that the market can react rapidly to new market conditions
and deliver robust and low cost solutions. Plants operating more
flexibly could reduce the amount of highly flexible peaking plants
required to complement variable generation at much lower cost
than a capacity mechanism.
What is the most appropriate kind of capacity
mechanisms for the UK?
11. Initially a capacity mechanism is likely
to be needed to support the continued operation of existing fossil
fuelled plants rather than the investment of new capacity. The
mechanism should enable such an outcome.
12. In the longer term, if a capacity mechanism
is pursued it must be able to deliver a long term signal, upon
which investment decisions can be made, if necessary.
Should the system of Feed-in Tariffs be focused
on particular technologies or maintain a wider technology-based
13. Low carbon technologies are at very different
stages of maturity. It is therefore not appropriate to have a
single level of support. The level of support should be set so
as to get the most low carbon generation at minimum cost.
14. If a system of FITs is introduced it is vital
that incentives remain on suppliers to source low carbon or renewable
generation. One of the key drivers in renewables deployment to
date has been the obligation on suppliers to source renewable
output. As a result renewable generators have been able to secure
PPAs with supplier relatively easily. There is a very real risk
that if suppliers were no longer incentivised to contract with
renewable generators, that the terms of PPAs would deteriorate,
threatening projects' finances.
Will it be feasible to deliver EMR in one go,
or will regulations and implementation be spread over time?
15. We believe that EMR should be delivered over
a number of years. This would enable sufficient visibility of
the changes to occur. The current EMR, combined with Ofgem's proposals
on improving liquidity, have not been sufficiently thought through,
and nobody appears to have a full understanding of how the changes
will interact. This exacerbates the risks facing investors and
will lead to a investment hiatus until the regulations have come
into effect and shown to work.
16. Additionally, the scale of the changes proposed
risk undermining existing investments by opening up their contracts
under change of law provisions
17. Spreading the reforms over a number of years
will also allow policy makers to establish whether the market
can deliver the requirements of the industry, or whether reform
is necessary. For example it is not clear that the market can't
deliver the flexible and responsive generation and demand required
to complement variable generation.
Will market reform increase political risk for
investors or create certainty?
18. Market reform is likely to substantially
increase political and investment risk.
19. Replacing the Renewables Obligation with
another support mechanism such as a FIT would substantially increase
political risk associated with renewable investments in the UK.
The RO is working, there are mechanisms in place to ensure that
the level of support awarded to new projects is kept in line with
their needs, and there is very little uncertainty over the long
term value of support. The RO already operates in a way which
is very similar to some premium FITs and achieves the same outcome
as a premium FIT. There is therefore little benefit to be gained,
but substantial damage to investor confidence to be incurred.
20. It is therefore important to minimise the
level of change introduced, such as moving to a premium FIT.
Will the Government's proposed package of carbon
price floor, EPS, FITs and capacity mechanism provide sufficient
transformation to achieve goals on climate change, security of
supply and affordability?
21. RES is broadly supportive of the Carbon Floor
Price, EPS and capacity mechanism proposals.
22. We believe a carbon floor price is feasible
in the context of the EMR. With a carbon floor price and EPS the
level of additional support some low carbon technologies will
require will be substantially reduced.
23. Currently there is insufficient information
to judge whether the proposed CfD can be made to work, and we
have a very low confidence in it.
What synergies and conflicts will there be between
proposed mechanisms and policies already in place?
24. There is substantial potential for synergies
between the proposed mechanisms, but there is also substantial
risk that such synergies will be missed due to the various mechanisms
being poorly implemented.
Will a carbon floor price be feasible in the context
of EMR and at what level should it be set?
25. We believe a carbon floor price is feasible
as it will enable low carbon technologies to more rapidly reach
a point of economic independent. We believe that the level should
be set so as to send a clear and decisive signal to investors
as early as possible, ie rising to £40/tCO2 in 2020.
What effects will EMR have on the development
of capacity for electricity storage and the development of interconnectors
between the UK and other electricity markets?
26. It is not currently possible to know the
impact of the EMR on electricity storage. We would hope that the
reforms enable energy storage to be developed within the market.
Energy storage could play an important part in delivering the
security of supply objective.
RES BRIEFING NOTE: ELECTRICITY MARKET REFORM
The Electricity Market Reform (EMR) proposals published
by the Government on 16 December have the potential
to cause substantial difficulties for the UK renewables sector.
Given the scope of these changes RES feels it is very important
for the renewables industry to respond decisively to the proposals.
In this paper we present our main concerns. The aim is to help
provoke and progress a full and informed debate within the industry.
We believe that any move away from the Renewables Obligation (RO)
could undermine the sector at a point at which deployment and
the supply chain are reaching a critical mass. However, there
is very strong political pressure for the RO to be replaced with
another mechanism. We therefore outline a possible structure for
a premium type feed in tariff which could form the basis of a
workable replacement to the RO and support all low carbon technologies.
Our fundamental concern is:
The reforms are needed to bring on new nuclear,
but do so to the detriment of renewables
The Government states that new nuclear investment
is difficult under the current market framework. Whilst we acknowledge
these difficulties, we firmly believe that, because they are specific
to nuclear investments (and possibly Carbon Capture and Storage
(CCS)) but not renewables, they should be addressed in a way which
does not negatively impact the renewables sector. We strongly
disagree with the headline claims that the reforms will benefit
renewables. The cost and disruption to the renewables industry
of the reforms will far outweigh any perceived benefits. This
is supported by the impact assessment that acknowledges that many
of the benefits outlined for renewables are unlikely to materialise,
are likely to have been overstated in the modelling or will be
outweighed by far larger risks and market barriers.
Other important concerns include:
The reforms remove suppliers' obligation to contract
for renewable electricity
Under the proposals suppliers would no longer be
obligated to contract for renewable electricity. This undermines
the strategy of utilities that have supported Government policy
in pursuing renewable development as well as fundamentally undermining
competition in the renewable energy market. The PPA market is
reasonably liquid at present due to the demand from utilities.
If suppliers no longer have an obligation or target to purchase
renewable electricity then they will be less inclined to contract.
There is a very real risk of the PPA market becoming much less
competitive with higher discounts applied to PPA terms. This loss
of revenue is likely to significantly offset any notional gains
from a reduction in hurdle rates and will increase the overall
cost to the consumer. Whilst it is vital that that existing projects
are properly grandfathered, we believe this is possible. Our concern
is for new projects.
Auctions are fundamentally flawed as a price discovery
The auction structures mentioned in the EMR will
not lead to reliable price discovery. In competitive market segments
there will be a tendency to bid over-enthusiastically, impairing
project delivery whilst in uncompetitive markets there is the
potential to abuse market power. In order to mitigate these risks
the Government has proposed to enter all low carbon technologies
into a single auction and hints at penalties for non-delivery.
Neither of these options works. The single auction approach overlooks
the fundamentally different financing, operational and investment
characteristics of different technologies. Whilst the penalty
for non-delivery is not suited to the UK's protracted planning
and grid development regimes and significantly increases the risk
adjusted development cost as well as acting as a barrier to entry
to new market players.
We do not see how an auction system can be effectively
implemented, and an ineffective auction system will seriously
undermine the ability to deliver the Government's carbon and renewable
Contracts for Difference (CfDs) are unworkable
and will provide no benefit for renewables
As it is proposed, CfDs will pay the difference between
the contract 'strike price' and a market reference price (this
could be an annual or perhaps monthly price index). Any difference
between the renewable generator's outturn PPA price and the market
reference price will not be covered. The CfD does not, therefore,
substantially increase revenue certainty for renewable generators
as the headline proposal might suggest. Rather generators will
remain exposed to short term market price risk (e.g. as a result
of intermittency) and any discounts applied within the PPA as
a result of suppliers' market power. We see substantial difficulties
with basing the CfD reference price on either half hourly or annual
prices, making both approaches unworkable. CfDs as proposed are
untested. Their complexity will further add to the development
hiatus as the increased regulatory complexity is understood by
the renewables industry.
CfDs transfer substantial risk to electricity
It is proposed that the CfD will transfer price and
over-investment risk from low carbon generators to electricity
consumers (via a Government agency). The Government appears to
be relying on its gas price assumptions to justify the CfD proposal.
If gas or carbon prices (and therefore wholesale electricity prices)
were low, the amount paid to low carbon generators through the
CfD mechanism would increase. This represents a substantial liability
faced by consumers which the supporting analysis does not explicitly
quantify. The Treasury recently announced that it considers the
cost of the Renewables Obligation (RO) to have implications on
the UK Government's ability to raise taxes, even though the cost
is not borne by tax payers but electricity consumers. Given that
the CfD is expected to cover over 50% of the market in 2030, the
potential liability could therefore have serious implications
for the Government's ability to raise taxes. This impact has also
not been quantified.
There are fundamental flaws in the supporting
We fundamentally disagree with a number of the assumptions
made in the consultation and supporting analysis. Our key concern
is that the justification for reform hinges on the reduction in
hurdle rates brought about by CfDs, and in particular the way
that this applies to nuclear. Nuclear investments are assumed
to have a higher hurdle rate than all other technologies in the
current market (including R3 offshore). Nuclear then benefits
from a 2% reduction as a result of the CfD. This assumption reduces
the cost of nuclear, allowing it to be built sooner than would
otherwise be the case; the primary benefit of the CfD proposal.
We think that the initial hurdle rate for nuclear is too high
and as a consequence the potential gains have been significantly
overstated. The reduction in the hurdle rate for wind is less
extreme, but it ignores the substantial development and regulatory
uncertainty created. In reality these are likely to increase rather
than decrease return requirements for renewables. There are a
number of other issues which we fundamentally disagree with including
the assumed inability of investors to forecast carbon price more
than five years out and the assumption that nuclear is inflexible.
We agree that both nuclear and CCS have a central
role in the movement towards the low carbon economy alongside
further renewable development. Our concern is that the proposals
support nuclear to the significant detriment of renewables. As
it stands the RO is working well. The level of support is transparent
and, as acknowledged in the proposals, it now has many of the
characteristics of a premium feed in tariff. The proposed reforms
threaten to derail the renewables sector just at the point when
deployment, and the supporting supply chain, is scaling up to
really significant levels.
Possible Structure of a Premium Feed in Tariff
Our immediate preference is to retain the RO as it
stands and to support nuclear as a separate low carbon technology.
However, the Government is opposed to creating a specific subsidy
for nuclear and is keen to replace the RO. Other reforms of the
electricity market are also likely to necessitate changes. In
order to constructively engage with the EMR process we are putting
forward a mechanism we believe could be workable and deliver the
Government's objectives. In developing this proposal we consider
the following to be essential:
- Suppliers must have some requirement or incentive
to source low carbon generation.
- The level of support must be determined through
independent analysis and consultation with industry; auctions
can't produce stable market signals and must not be used to determine
- The level of support should be transparent.
- Low carbon generators should benefit from the
carbon floor price with the expectation that the required level
of support will be reduced for new projects as wholesale prices
- The new arrangements should ensure a smooth transition
for existing projects
- A premium type feed in tariff for all low carbon
- Projects would receive the Premium FIT based
on, but separate to, their output. Generators would continue to
enter into PPAs with suppliers for their output, and the Premium
FIT would be paid according to metered output by a central agency.
- The cost of the Premium FIT would be recovered
from suppliers according to the proportion of electricity that
they supply from non-low carbon sources.
- By charging the Premium FIT according to non-low
carbon supply, suppliers would be strongly incentivised to source
low carbon generation to minimise the cost to their consumers.
- The reporting structures for this have already
been established with Fuel Mix Disclosure.
- The Premium FIT would be complemented by a carbon
floor price, targeted capacity payment mechanisms and emissions
performance standard as proposed.
- The level of the Premium FIT would be differentiated
by technology maturity (e.g. established, developing and pre-commercial).
Our expectation is that they would last for 20 years and be indexed
- At the end of a project's eligibility for the
Premium FIT, the electricity generated would still be considered
low carbon in the cost recovery mechanism.
- The level of the Premium FIT would be reviewed
periodically, with technologies being able to move down to lower
bands as the level of deployment increased. Once operational projects'
premium levels would be grandfathered.
- If needed, projects could opt to enter into a
long term fixed price PPA or CfD for their electricity. Under
this proposal there is already an incentive to enter long-term
PPAs to protect suppliers from a higher cost burden in later years.
Additional measures should be enabled through Ofgem's proposals
for improving the liquidity of the electricity market.
RES feels very strongly about the proposed EMR and
we have prepared a more detailed critique of the proposals which
we would be very happy to share it with you. However our objective
is to move rapidly to establish an industry position around an
alternative proposal. Our view is that it would then be useful
to employ external advisors to develop this proposal further and
evaluate the benefits relative to the Government's preferred option.