Energy and Climate Change Committee - Draft Energy Bill: Pre-legislitive ScrutinyWritten evidence submitted by REG Windpower Ltd
Overview
This paper has been prepared by REG Windpower Ltd in response to the Energy and Climate Change Select Committee’s call for evidence into the draft Energy Bill. Although REG Windpower welcomes the Government’s stated desire to increase the amount of energy generated from renewable sources, we are concerned that their commitment to certain technologies, including onshore wind, is currently seen as uncertain by investors. This is making it difficult to fund larger scale renewable projects and create the green jobs necessary for the country’s low carbon future.
Moreover, there continues to be a lack of clarity and policy flaws in regard to the Electricity Market Reform proposals which will be taken forward in the draft Energy Bill, further hindering investment in the CfDs by wind farm developers and other technologies.
Our submission makes the following recommendations:
The current issues around the cost and terms of finding a route to market for independent developers urgently needs to be addressed, not least of all because this is adding a significant cost to consumers’ bills due to a lack of competition in the PPA market.
There should be a commitment to maintain the Renewables Obligation (RO) concurrently within the EMR until the Contract for a Difference Feed-in-Tariffs have demonstrated that they can act as a suitable replacement.
More information needs to be made available about the proposed CfDs, including clarification about how tariffs will be set and allocated, and how price variations for power generation that is inherently variable such as wind will work in practice.
The 15 year rate of return on CfDs should be extended to 20–25 years to bring the incentive in line with other EU mechanisms and provide the longer-term rate of return that is needed to attract investment in renewable projects.
To maintain market certainty and investor confidence, there should be no reduction in the tariffs set out in the Renewables Obligation Banding Review. This is particularly critical for wind power, where a reduction to 0.8 ROCs would make it difficult to raise finance for projects.
The Transition from the Renewables Obligation
As noted in our response to the original EMR consultation, we believe that the Renewables Obligation should be retained within the EMR framework until the new CfD scheme has demonstrated that it can act as a suitable replacement. Although the RO has helped the wind industry become a leading contributor of the UK’s renewable energy supply, making up one third of renewable deployment and 2.5% of total energy generation, the ongoing uncertainty about how the EMR will work in practice at this late stage is discouraging investors from putting up the necessary capital to get projects off the ground.
The ability of independent onshore wind developers to raise bank finance is severely constrained at present, with fewer than five banks lending to projects less than 20MW in size, meaning some schemes have now stalled for want of finance capital. This is further compounded by a number of factors including the rising cost of capital items needed for onshore development, continued issues around planning consent, an unfavourable exchange rate, and significant at-risk expenditure incurred in developing projects from greenfield sites through planning.
Whilst REG welcomes proposals for an overlap period between mid-2014, when the new FiT scheme first becomes available, and the end of the RO in March 2017, there is a significant risk of a “cliff-edge” point in 2015 where the CfD will not yet be proven but it will be too late to choose between the mechanisms in time for the 2017 switchover. We would therefore like see the RO retained for an indefinite period until the new FiT scheme has been thoroughly reviewed and proven to provide the necessary framework to direct investment into renewable energy infrastructure projects. However, we do welcome provisions in the draft Bill to fix the price of RO certificates issued between 2027 and 2037, as this will provide confidence to participants in the final years of the scheme.
The Need for Greater Certainty
Alongside this, REG remains concerned about how EMR will work in practice and at the lack of information about CfDs just a few years before the scheme is due to come online. The EMR White Paper contained little information about classification, timescales, counterparties for the scheme, and how it is to be rolled out, and the Bill fails to provide much further clarification on these issues. This is particularly important given that investors often look over a 15–20 year time period when assessing potential returns in the medium term, and, as the appetite for utility equity is limited at present, this uncertainty means projects beyond 2017 are currently unattractive prospects compared to other sectors.
Of particular importance is how tariff levels will be set and allocated. While the Bill notes that National Grid Electricity Transmission Plc will allocate CfDs in line with agreed objectives, it also states that competitive price setting for CfDs could be adopted in the longer term once “market conditions allow”. This lack of clarity around whether and when competitive price setting will be used contributes to the already uncertain investment climate. It also appears that during the transitional period to 2017, there will effectively be competition for CfDs given the proposal for limiting the number of CfDs issued under the cost controls outlined in the Bill. This would place independent developers at a significant disadvantage compared with vertically integrated utilities, not least of all because the gateway criteria for awarding a CfD would be more difficult to achieve for independent developers relying on bankable power purchase agreements (PPAs) and bank finance. As outlined in our original response to the EMR consultation, an auction or tender process to set tariff levels would act as a huge barrier to investment, increasing price volatility. REG would like to see tariffs set independently on a long term basis with absolute certainty that if a project is ready to build, it will be eligible for the CfD (in the same way as the RO today). We understand that DECC intends to consult on the underpinning data for the first set of CfD strike prices for renewables as part of a draft delivery plan towards the end of 2013 and will not announce prices until late 2013. We would urge the department to undertake this consultation process as a matter of urgency to provide sufficient notice of prices to those considering longer term investments. For this reason, we do however support the proposal in the draft legislation to grandfather the support offered through CfDs.
We would also like to see more clarification about potential variations in CfD prices, particularly for those technologies dependent on power generation that is inherently variable such as onshore and offshore wind, and to obtain a greater understanding of how any agreed variations will be able to demonstrate that they are providing value for money, as proposed in the draft legislation. The draft Bill also notes that in exceptional cases the Secretary of State will allocate CFDs to individual projects where the generic terms are not suited and will have to be individually negotiated, raising further questions about the legality of such measures and furthermore about the process for the allocation of tariff levels and whether they will help create a level playing field for different technologies.
As mentioned earlier, the CfD proposals are also unappealing due to the short 15 year rate of return, compared to the 20–25 years offered in other countries, and we would like to see this rate extended to align the level of incentive with the needs of the long-term owners of these assets. Longer term tariffs would permit lower cost of capital investment in projects, due to the added certainty this would bring, thus allowing projects to be owned and operated by investors at the lowest cost to consumers. For example, in Canada, tariffs for onshore wind are awarded for periods of 25 years, which allows public and private sector pension funds to play a major role in funding these projects. Finally, CfDs should allow generators to take the upside when power prices are high (as is currently the case in the Netherlands) and the FiT should be paid on output, rather than availability.
Route to Market
There is considerable uncertainty in the UK electricity market today regarding future imbalance costs paid by participants in the balancing and settlement regime, operated by Elexon. This “cash-out risk”, which results in individual penalties on individual suppliers for failing to balance generation with supply, has resulted in a reluctance by the big six vertically integrated UK utilities to offer long-term PPAs to independent power projects. This situation is likely to get worse over the next decade as the amount of variable generation on the system increase, thus increasing the likely costs of balancing the system for individual suppliers. In the past 12 months, one PPA provider has signed over 70% of all renewable energy PPAs in the UK, with only 2–3 other players still responding to PPA tenders. This compares to a buoyant market in 2006–2010 when as many as 10 possible PPA providers would bid for projects.
The lack of a functioning PPA market has led to a rapid decline in the terms of PPAs being offered, with greater discounts applied and more risk transferred to the developer. Some 10–15% of the benefits (power, ROCs, LECs, embedded benefits) payable to renewable energy projects is retained by the PPA provider and not passed on to the generator. In other markets, such as the Nordpool, this discount is only 2–3%. This means that a significant element of the cost of the RO is unnecessarily paid out to suppliers due to a lack of competitive pressure.
Current uncertainty over EMR and the explicit exclusion of a “wind balancing market” to mutualise the imbalance costs of wind power across all suppliers in proportion to their customer base, has made the financing of independent wind projects extremely challenging. This is unlikely to be addressed unless Government can provide a clear signal to suppliers that EMR will be designed to address the causes of these issues.
Finally, it is currently proposed that under the CfD, there would be no need for a contract counterparty. REG is of the view that a PPA will always be required, particularly for bank financing, and that a CfD written in statute rather than in contract with a defined party, would be legally unenforceable, thus making the project impossible to finance.
Conclusion
Ongoing policy uncertainty around plans to replace the RO with CfD FiTs is undermining investor confidence in the renewable energy sector and preventing wind power projects from getting off the ground. For the Government to achieve the ambition set out in the EMR White Paper to enable large-scale investment in low-carbon generation capacity, more needs to be done to provide a stable policy and regulatory environment for the renewables industry.
A key goal of the draft legislation should be to usher in a period of stability. The sector has already seen considerable upheavals in the regulatory environment over the past few years, and it is disappointing that the industry has again been thrown into confusion just as the RO was beginning to realise its potential. For this reason, we very much believe that the RO should be maintained concurrently with the EMR until CfDs have had a chance to become established as the main investment return for renewable energy projects.
We also believe that DECC urgently needs to consult with the industry on the setting of CfD strike prices and provide clarification on how tariffs will be allocated in the longer term in order to ensure wind power remains an attractive option to investors. Given the long time frames involved in wind farm development, the Government also needs to introduce measures to support longer term investments through the CfDs to ensure wind power can continue to contribute towards the decarbonisation of the electricity market and create the green jobs necessary for the growth of the low carbon economy.
About REG Windpower Ltd
REG Windpower is a subsidiary of the £50m AIM-listed renewable energy company Renewable Energy Generation. The company has around 25 staff based in Bath and Truro and has more than doubled in size over the past two years. The REG team now contains the necessary expertise to develop, build and operate our growing portfolio of sites, which includes 51.5MW of operational capacity, with approximately 900MW in development.
Through its experience in developing, financing, building and operating wind farms over the past seven years, it has established an in depth knowledge of the true cost of onshore wind across the full project lifecycle, including decommissioning. Our wind farms generate clean, safe, renewable electricity which is used to supply nearby towns and villages through the local distribution network. We use a rigorous site selection process is designed to create the right scheme in the right location—generating much-needed renewable electricity while respecting the local environment that hosts our projects. We are committed to public consultation and always aim to meet local residents to seek their feedback before we submit our proposals.
May 2012