The Economics of Renewable Energy - Economic Affairs Committee - Contents

Memorandum by the Office of Gas and Electricity Markets (Ofgem)

How do and should renewables fit into Britain's overall energy policy?

  1.  The 2007 Energy White Paper set out four overall energy policy goals:

    —  to put ourselves on a path to cutting the UK's carbon dioxide emissions—the main contributor to global warming—by some 60% by about 2050, with real progress by 2020;

    —  to maintain the reliability of energy supplies;

    —  to promote competitive markets in the UK and beyond, helping to raise the rate of sustainable economic growth and to improve our productivity; and

    —  to ensure that every home is adequately and affordably heated.

  2.  More recently, the Government's Renewable Energy Strategy consultation (RES), which was published on 26 June, focuses on two serious challenges:

    —  tackling climate change by reducing emissions both here and abroad; and

    —  ensuring that our energy supply remains secure.

  3.  Measures to achieve individual policy objectives inevitably interact with the pursuit of other goals. In the case of steps to meet the Government's environmental objectives, there are synergies and trade-offs with the goals of ensuring affordable and secure energy. It is for the Government to decide on the appropriate level of greenhouse gas reductions and the trade-offs it is prepared to make in order to achieve its objectives. Given our statutory duties, our role is to provide advice to the Government on how to deliver its objectives—and in particular those that relate to the sectors for which we have a statutory responsibility—seeking the best value for money, which often means at the lowest possible cost to present and future energy customers.

  4.  In general, we support using broad-based economic instruments as the most cost-effective way of meeting environmental challenges. We think the best approach is for the Government to decide on its desired objective—such as a specified reduction in greenhouse gas emissions—and then allow the market to find the most cost-effective abatement options and technologies. This is because Governments, and regulators, do not have the necessary knowledge, expertise or information to judge the most effective and cheapest ways of meeting a particular goal. This is particularly the case for reducing carbon emissions where there are a range of competing technologies at different stages of development and whose costs may change rapidly over time if, for example, fossil fuel prices change or if there is rapid technical innovation. We have therefore argued for broad, carbon based instruments such as the European Emissions Trading Scheme (EU ETS) in all sectors where they are appropriate. These instruments are essentially technologically neutral and allow the market process to determine the most cost-effective technologies to meet a defined reduction in carbon emissions.

  5.  We have recognised that other policies may be appropriate to provide a bridge to the time until the EU ETS has a longer time horizon and covers more carbon emitting sectors. We also recognise that for some sectors that emit carbon, such as domestic heating or retail petrol, the transaction costs associated with trading schemes may be prohibitive. In such cases it may be more appropriate to consider carbon taxes, with the level of any tax linked to the price in the emissions trading scheme to make sure that emissions reductions are achieved in the sectors with the lowest abatement costs. In addition, as set out in the Stern report, there is a need for additional intervention directed at consumer awareness and technological development. This is discussed further under question 3. Now that the UK Government and other EU Member States have agreed on targets for renewable energy, we want to help ensure those targets are met in the most cost-effective way.

  6.  Meeting the 2020 renewable energy target will not be cheap. It requires unprecedented investment in all areas of the supply chain; financial support mechanisms add to cost to consumers; and the increase in intermittent generation may have an impact on price volatility. This all comes at a time when prices are already rising and around 4.5 million households could be in fuel poverty. It is therefore important to ensure that the policy instruments designed to meet the target also protect customers from facing excessive or inefficient costs.

  7.  The Government acknowledges that renewable generation is not the only way to achieve a low carbon economy. Demand side measures such as energy efficiency can achieve carbon savings at a lower, or even negative, cost. This represents a crucial synergy in helping to tackle climate change whilst helping customers save money. In addition, the RES consultation recognises the smaller, but equally important, role that other technologies can play in facilitating this transition, for example distributed energy and bioenergy, as well as the larger role that can be played by renewable energy in other sectors such as heat and transport.

  8.  The Government's commitment to more renewable energy is shared by other EU Member States. The European Commission has also signalled the importance of the movement toward a low carbon economy through the binding targets that it proposed should be adopted in the Strategic Energy Review that it published in January 2007. These targets specifically required:

    —  a reduction in Green House Gas (GHG) emissions of 20%, compared with 1990 levels, by 2020 (binding);

    —  an increase in the share of renewable generation in the overall fuel mix by 20% by 2020 (binding); and

    —  an improvement in energy efficiency of 20% by 2020 (non-binding).

  9.  In March 2007 all Heads of Government within the EU signed up to these targets and the process to embed these within EU legislation began in January of this year, with the publication of the EU Green Package. This Package seeks to put in place arrangements for Phase III of the existing EU ETS to facilitate further abatement of GHG emissions, amend the existing Renewables Directive to incorporate binding targets on renewables deployment as well as improving existing provisions relating to renewables and to examine the progress made in Member States with respect to energy efficiency. Information on some of the different support mechanisms used to achieve the targets in different Member States can be found in our answer to question 4.

What are the barriers to greater deployment of renewable energy?

  10.  The potential barriers to increases in renewable electricity capacity include:

    —  obtaining planning consents (for generation sites and for grid connections/upgrades);

    —  obtaining access to the electricity transmission grid;

    —  constraints in the supply chain for generation (eg wind turbines) and connections (especially offshore);

    —  sourcing finance from investors and debt suppliers;

    —  cost-effective support mechanisms; and

    —  achieving the best balance between the heat and electricity sectors.

  11.  The planning regime remains the principal obstacle to meeting the Government's renewables targets. The British Wind Energy Association estimate in their evidence that, of the 15GW of onshore wind projects that have entered the planning system since 2002, only 2GW are currently in service. We recognise that the UK Government's Planning Bill aims to improve the planning process for major infrastructure projects, but this legislation would apply only to England and Wales, where planning delays are less acute at the moment.

  12.  The electricity transmission networks—the wires which carry electricity from generators to customers—do not have enough capacity or appropriate access rules to meet the target. New lines need to be built in order to help connect more renewables, and better use needs to be made of existing lines. Ofgem is playing its part by allowing a 160 per cent increase in investment in the electricity networks and by reviewing the arrangements for allowing generators to gain access to the networks. The existing access arrangements do not provide appropriate signals in sufficient time to allow the transmission companies to invest to expand capacity when it is required. In addition, the arrangements prevent better use of the existing capacity being made through allowing new renewable generation to connect quickly and share capacity with existing generators. Without major reform, as proposed in our Transmission Access Review published this month jointly with the Government, these problems would continue. The issues relating to the electricity networks are explored in further detail elsewhere in this submission.

  13.  Our discussions with other energy regulators through the Council for European Energy Regulators suggest that grid access and planning constraints for new transmission lines are also significant issues in many other Member States.

Are there technical limits to the amount of renewable energy that the UK can absorb?

  14.  We are unlikely to hit a limit on the amount of renewable and intermittent generation that can be absorbed given sufficient time and money. However, there could be technical challenges in the medium term, for example to 2020, and the costs may be excessive.

  15.  High wind penetration and current typical demand patterns could lead to more volatile wholesale electricity prices. Demand during night time in summer can fall to 30% of winter daytime peak levels. Prices may even fall to zero at night when there is more wind generation than demand. Suppliers will therefore have a strong incentive to offer new services and tariffs to encourage customers to redistribute their demand across the day by, for example, using more time-controlled domestic appliances, although this would require a rapid roll out of smarter metering technology.

  16.  The short space of time available to meet the target may require the use of similar technologies or the same manufacturing design for a significant proportion of our generation fleet. This reduces diversity and increases the risks associated with any "type faults" being discovered later, for example with the design of a particular wind turbine. There are also risks associated with individual technologies that are not yet fully tested in operational conditions, notably offshore wind. Such issues need to be weighed against the potential carbon savings and other benefits associated with action to tackle climate change.

  17.  An increase in renewable energy supplies could help security of supply by increasing overall generating capacity; delivering a more diverse energy mix; and lowering Britain's reliance on imported fossil fuels. There are potential risks to security of supply as well. There is limited experience of the operational challenges of running an integrated transmission system reliably and within existing quality standards with a high proportion of intermittent generation, mainly wind powered. The scale of the 2020 target and the limited time available to meet it could also impact on security of supply. Ambitious renewables targets, especially if supported by attractive financial incentives, could divert investment away from other generation technologies, some of which would be needed to cover the intermittency features of certain renewable energy supplies.

  18.  In the longer term, the challenges associated with intermittency can be met through a range of established and emerging technologies combined with behavioural changes. Intermittent generation requires back up, for example when the wind is not blowing, and this could be provided by pumped storage and open cycle gas turbines as well as coal. However, as the proportion of wind energy increases, the back up generation becomes correspondingly more expensive as it sits idle for much of the year. Emerging technologies including batteries and fuel cells could become economically viable if their costs continue to fall or if electricity prices generally continue to rise. Finally, behavioural and technological changes can help by managing demand in response to intermittency. For example, smart meters, time of day pricing and also new technologies that control domestic and industrial appliances—such as shutting down fridge motors—to manage demand in response to intermittency. However, all of this costs money and takes time.

Are there likely to be technological advances that would make renewable energy cheaper and viable without Government support in the future? Should, and how could, policy be designed to promote such technological advances?

  19.  Without specific support for renewables, the major factor determining investment in renewable generation would be current and expected prices for carbon and electricity. A combination of a strengthened and deepened EU ETS and continued high commodity prices could therefore make some sources of renewable energy competitive. Many forms of renewables are in need of technological development and there is great potential for advances in this area to benefit future electricity customers. However, there is a real risk that technological development is used as a residual explanation or "catch-all" for large subsidies, even for mature technologies. We would advocate that subsidy attributed to technological development should be justified on the basis of the development and potential of the technology. Perhaps as a consequence of the lack of justification here, it also seems that insufficient attention is focussed on customer awareness.

  20.  In its current RES consultation document, the Government notes that "The current RO was designed on the basis of wholesale prices fluctuating around a relatively stable level of £40/MWh [Megawatt hour]. At the time of writing the wholesale electricity prices for a year ahead are closer to £70/MWh."[1] As the expected long-term value of a Renewables Obligation Certificate (ROC) would have been around £40/MWh, this implies that renewable investments to date have been made on the basis of revenues of about £80/MWh, not far above current prices without any subsidy. While the costs of windfarm construction have increased recently, we understand that well-located onshore windfarms would probably be viable if future revenues could be locked in at today's wholesale electricity prices.

  21.  In this context, the best support mechanism for renewables is one where the level of support is inversely linked to changes in the wholesale electricity price. This would make sure that if wholesale prices either stay at their current levels or increase—due to higher fossil fuel prices or a strengthening of the EU ETS and higher carbon prices—the consumer would not provide renewable generators with a greater subsidy than they actually require.

Has Government support been effective in leading to more renewable energy? What have been the most cost-effective forms of support in the UK and other countries and what should the balance be between subsidies, guaranteed prices, quotas, carbon taxes and other forms of support? Should such support favour any particular form of renewable energy over the others? For instance, what are the relative merits of feed-in tariffs versus the UK's present Renewables Obligation Certificate (ROC) regime?

  22.  There are four main types of support schemes for renewable energy currently used in various Member States. These include feed-in tariffs; obligations or quotas; tenders; and tax incentives or rebates. A feed-in tariff is an additional premium (fixed or variable) paid on top of the electricity market price that renewable energy producers receive. An obligation or quota system normally involves a finite set of renewable energy generation certificates being generated and traded, with penalties in place for not possessing them, when it is mandatory to do so. Tenders involve inviting companies to bid for a fixed level of subsidy to deliver defined volume of renewable generation. Finally, tax incentives or rebates provide tax advantages for those choosing to generate renewable energy.

  23.  These schemes have had varying levels of success in encouraging renewables and at very different costs to customers and costs per tonne of CO2 emissions avoided. A recent evaluation of their relative effectiveness concluded that feed-in tariffs were generally more effective at encouraging larger volumes of renewable generation at generally lower costs than the other options.[2] However, these studies are very context specific and a policy that is ineffective and/or expensive in one Member State may be more effective and cheaper in another Member State if, for example, there are fewer planning constraints and more spare transmission capacity.

  24.  The mandatory nature of obligations means that is the costs are largely passed through to business and domestic customers. This has been the case in Britain, where the Renewables Obligation currently adds around £10 to a domestic electricity bill per year and is set to rise to around £20 a year by 2015. Lessons can be learned from the British experience with the RO. Its advantages have been that, first, it is market-based in that certificates can be traded. Second, it is technology neutral and so investment is incentivised in the most cost-effective technology at any given time. Third, it was designed to sit alongside the competitive wholesale market and allow subsidies to fall away as technologies became competitive.

  25.  However, in practice, the RO has not been as effective as the Government had hoped. The proportion of Britain's energy coming from renewables has increased but by far less than is required to meet the target. It is worth noting that the two principal reasons for the relative failure of the RO were not predicted at the time it was introduced. First, the principal barrier to the expansion in renewables has been the planning regime. Second, the existing arrangements for giving generators access to the electricity grid have not provided the appropriate early investment signals or allowed for the best use to be made of existing capacity. These factors have inhibited the cost-effectiveness of the RO. For example, in 2006-07, the cost of carbon abatement through the RO was in the range of £65-140 per tonne of CO2 depending on the fuel that is assumed to have been displaced, compared with just £18/tCO2 under the UK Emissions Trading Scheme. The high cost of abatement under the RO could at least partly be addressed either by replacing the RO with a feed-in tariff or tender system or simply by reforming the RO arrangements.

  26.  The Government is now considering what form the RO should take in the future. Given the risks and uncertainties in meeting the very challenging EU target, any new policy instrument needs to be robust to any future obstacles. There could be continued problems with planning if the Government's reforms take time to implement or are unsuccessful. In addition, for the next few years there may be bottlenecks in the renewable manufacturing supply chain—for example for wind turbines—as European and global demand surges and manufacturers seek to increase their manufacturing capacity. Finally, there is a risk that the Government's proposed approach for the RO could exacerbate these difficulties. Although "banding" the level of support for different technologies could reduce costs to consumers by cutting the level of support to forms of generation that are increasingly viable, it would meaning losing the advantage of having a technology-neutral support system. The introduction of a headroom or "ski slope" is likely to mean that if wholesale electricity prices remain high, and if the planning regime remains a constraint, then customers could end up paying a bigger subsidy than is necessary. This problem could be addressed by linking the level of support inversely to the electricity price, thus ensuring the subsidy only goes where it is needed. Another option would be to capture the money that is currently recycled to generators through the "buy out" fund and use it for other purposes—such as tackling fuel poverty—instead of adding further to the profits of existing renewable generators.

On top of the costs of building and running the different types of electricity generators, how much investment in Britain's transmission and distribution networks will different renewable energy sources require compared to other forms of generation? Are the current transmission and distribution systems capable of managing a large share of intermittent renewable electricity generation and, if not, how should they be changed? Are the rules about how we connect capacity to the grid supportive of renewables?

Funding to renew the energy networks

  27.  Ofgem has played its part in providing the necessary funding for the transmission companies to invest to increase capacity to connect new renewable and other low carbon generation. In recent price reviews Ofgem has allowed an unprecedented 100% increase in investment in the energy networks to upgrade the existing pipes and wires and connect new generation, much of it from renewable sources. The Transmission Price Control Review for 2007-12 allows the electricity transmission companies to invest £3.8 billion to maintain and upgrade their networks. The funding is flexible and transmission companies' funding will increase automatically if more generation seeks connection than was assumed when the price control was set.

  28.  Prior to that, in 2004 Ofgem approved £560 million of additional investment in transmission capacity outside the normal price control process to avoid delay in the upgrade work necessary to connect renewables The main project affected was the upgrade to the line running from Beauly, west of Inverness, to Denny, west of Falkirk: a key part of transmission network in Scotland where much proposed renewable generation is located. Most of this allowance has not been used because of major difficulties in gaining planning permission. In 2006 the Scottish Executive referred the project to a public inquiry.

  29.  There is the potential for more investment as more generation comes forward. For example, we are facilitating more "localised energy" (smaller-scale distributed energy and household-scale microgeneration) which we are addressing through our work on the next Distribution Price Control Review for the period 2010-15.

A new offshore electricity transmission regime

  30.  Offshore, there is the potential for over 30GW of renewable offshore wind generation to connect to the system, potentially operating at a load factor higher than 35%. Together with the Department for Business, Enterprise and Regulatory Reform (BERR), we have been developing and implementing a new regulatory regime for offshore transmission to make sure this generation can access the onshore market. Offshore transmission has different technical characteristics and it costs much more to build lines offshore than onshore. The transmission costs for the initial two rounds of offshore sites currently being developed, which could connect approximately 8GW of offshore wind generation to the onshore network, are estimated at £2.5 billion. This figure could potentially rise to around £10 billion if a further 25GW is connected through the "round three" process recently launched by the Crown Estates. These figures are indicative at present and they do not take account of any onshore network reinforcement costs that may be needed, or the costs of connections to the Scottish Islands.

  31.  BERR and Ofgem have therefore decided to base the arrangements around competitive tenders for major offshore transmission projects. Ofgem will organise tenders and appoint the most competitive bid to build, own and maintain the offshore transmission lines. Subject to the Energy Bill becoming law, the first tenders are likely to commence in April next year.

  32.  The challenge lies in rebuilding the transmission system to accommodate this major change in the location and nature of flows across the transmission system. Funding of onshore reinforcement works should not present difficulties since Ofgem can allow the expenditure provided it is efficiently incurred. However, the sheer magnitude of the task will place an immense burden on the planning system.

Reforming access to the grid

  33.  A vital requirement for meeting the Government's renewable energy target is to change the rules governing access to the electricity transmission network. The long overdue reform of the access regime has, however, been blocked in the past by the electricity industry. The Commons Innovation, Universities and Skills Committee recognised this in its recent report on renewables. "[Our] frustration is compounded by the knowledge that Ofgem attempted to pilot transmission access reform in 1999 and 2000 but, under threats of legal action, was unable to proceed." At the time, many in the industry argued that reform was unnecessary. In addition, existing conventional generators have had an incentive to oppose reform as they do not want to share their access rights with, for example, new renewable generators.

  34.  We want a new grid access regime which requires all generators to make a clearer financial commitment of their future demand for capacity—or else give up their access rights to new renewable generators who may be more willing to make such a commitment. This approach has two significant advantages. First, it gives National Grid a lot more information about generators' demand for access to the network, which in turn allows them to invest in new capacity to meet that demand where necessary. Second, it allows for much greater sharing of capacity, for example between renewable and conventional generation. Much renewable generation is intermittent, and so wind farms could share capacity with conventional generators which can start running when the wind is not blowing.

  35.  We are pleased that the industry is now making much more positive comments about access reform and we hope they will follow these with real action to amend the industry rules. As the joint Ofgem/BERR transmission access review draws to a close, National Grid has raised a suite of proposed changes to the key industry codes to reform the current arrangements based around three distinct models of reform. The proposals are now being analysed and discussed and National Grid will present its recommendations to Ofgem in September. We will then carry out an impact assessment on the proposals before reaching our final decision on which model to implement. We aim to have new arrangements in place by April 2010, which will also allow time for the necessary IT system development, although the timetable may be threatened if any of our decisions are subject to legal challenge. The Government has made clear that it will consider primary legislation if the industry does not improve its performance and bring forward appropriate reforms quickly. Ofgem is doing all in its power to facilitate the reforms.

Short term measures to bridge the gap

  36.  The signs of progress on transmission access reform are promising. However, the 2020 target is too pressing for us to wait for a new regime to be in place. A lot can be done in the meantime to help bridge the gap. For example, we have encouraged National Grid to move away from a "first come first served" approach to dealing with the queue for grid connections. At present, generators who have finance and planning permission may be further down the queue than generators who do not have either in place but who approached National Grid first. National Grid is now taking a more robust approach to removing unviable or purely speculative projects. National Grid is also progressing an amendment to the industry codes which would make it easier for existing and new generators to share access to the grid.

  37.  We estimate that these shorter term measures are capable of bringing forward 1GW of new renewable connections including just under 600 MW of projects that already have planning consent. We remain open to any other ideas which will accelerate longer term investment in the grid to meet the target.

Longer term measures looking to 2020

  38.  Even with transmission access reform, there are still significant challenges ahead. For example, the Government is committed to providing support mechanisms to help deliver the 2020 targets but it has not yet confirmed the precise form these will take. This means that renewable generators may not be able to signal their future capacity needs to National Grid and sign contracts because of the uncertainty over what financial support they will receive. By the time the subsidy mechanism is clear, there may not be sufficient time to build the capacity early enough to meet the target.

  39.  Ofgem is engaged in several projects to help ensure the grid can be properly configured for the renewables challenge. We have asked the transmission companies to produce an investment study to identify the options to invest to provide the extra transmission capacity that will be required to deliver the 2020 targets. For example, National Grid have suggested investing around £2 billion in two offshore subsea cables that could transmit electricity from renewable generators in the north of Scotland, where there is a surplus of electricity, to the main demand centres in England. Another option would be to focus on incremental onshore grid reinforcements which National Grid estimate could cost around £1.8 billion. We are working with the transmission companies and will implement a new investment incentive framework that will allow them to reach decisions on the necessary investments given the long lead times for significant transmission investment. This will make sure, subject to the planning regime, that we have the necessary grid capacity in place in time to meet the 2020 targets. The framework will allow this investment to take place whilst protecting customers from the risk of having to pay for substantial investment in new transmission that is not required. This is clearly important given the context of rising energy bills.

  40.  All this is in addition to Ofgem's existing work through our price controls. In the current transmission price control, we are allowing a 160% increase in investment in the onshore electricity grid, with flexibility for the network operators to go beyond this amount in response to demand for additional capacity. We are also implementing, with BERR, the new offshore electricity transmission regime which will allow the potential of marine renewables to be fully and quickly achieved.

  41.  These contributions should allow a significant expansion in renewables by eliminating undue network barriers.

Protecting consumers

  42.  The measures needed to meet the renewables target will not be cheap. This raises particularly important choices at a time of high energy prices and rising fuel poverty. The companies understandably wish to protect their shareholders from as much risk as possible, and to transfer the risk and potentially more of the costs to the consumer. However, at a time when around 4.5 million households could be in fuel poverty, we believe it is vital that consumers are protected from excessive or inefficient transmission costs.

  43.  That is why, for example, our new incentive package encourages the transmission companies to manage some of the stranding risk, ie that there is not enough demand from generators to use the new capacity once it has been built. In return for taking on more of this risk, the companies will be allowed to invest early and earn higher returns. Measures such as this allow us to be more confident, on customers' behalf, that the investments requested by the transmission companies are genuinely required. At the same time, we want to see more long term commitments from generators to use their capacity rights—or else make way for new renewable generators who are ready and willing to connect.

How do the costs of generating electricity from renewables compare to fossil fuel and nuclear generation? What are the current estimates for the costs of "greener" fossil fuel generation with carbon capture and storage and how do these costs compare to renewable generation?

  44.  We favour the use of market mechanisms and broad-based carbon trading schemes to determine the most cost-effective technologies to reduce carbon emissions. We do not forecast their respective future prices as this is the role of the commercial, competing generating companies. A range of estimates has thus far been provided to the Committee by several witnesses who are engaged in this market. What is clear from these forecasts is the great uncertainty about what the most cost effective technologies are and how this is likely to change over time as some technologies become established and reduce their costs, others prove not to be viable and as the price of fossil fuels and uranium change. Given this, we think it is all the more important to use market mechanisms wherever possible to determine investment in new capacity as markets are the most effective way of dealing with this uncertainty.

If the UK is to meet the EU target that by 2020 15% of energy consumed will come from renewables, will most of this come from greater use of renewable sources in electricity generation? If so, why? Should British support for renewables in other countries be allowed to contribute towards meeting the target for the UK?

  45.  This is principally a political question for Governments to decide. Considered purely from an environmental and economic point of view, ie how to meet the target in a way that is effective and on time, whilst avoiding unncessary cost to consumers, it makes sense to allow the necessary investment to be made where it is most cost-effective. This may mean a greater share coming from particular sectors or particular Member States.

How would changes in the cost of carbon—under the European emissions trading scheme—affect the relative costs of renewables and other sources of energy? Would a more effective carbon emissions trading scheme remove the need for special support of renewable energy?

  46.  Expected levels of coal, gas, carbon and power prices are the major factor driving investment in new capacity. Higher carbon prices will tend to skew investment towards lower carbon generation plant, such as gas and nuclear. As noted by both the Government and the European Commission, the renewable targets will tend to deflate the carbon price, eg from €49 to €39 on one scenario.

  47.  However, market participants are unable to predict the future. In addition, they value diversity, particularly if market and political signals are uncertain. As a result, generators are likely to favour a diverse mix of generating assets in the future, including some new coal.

  48.  We favour broad-based instruments which place a price on carbon, and ensure generators face the costs of the associated externalities, whilst allowing the market to find the cheapest way of reducing carbon emissions. Carbon trading provides the purest way of achieving this. In practice, there are ways to improve the cost-effectiveness of the European Emissions Trading Scheme. The free allocation of permits under phase II of the EU ETS, which runs from 2008-12, has led to a windfall for generators. At the start of phase II in January this year, we estimated on the basis of prices at the time that the windfall of emissions allowances could be around £9 billion pre-tax over the five year compliance period. This is because generators seek to recover the costs of these permits through the price at which they sell their generation, either in the wholesale market or to their own supply business. Even though they receive some of the permits for free they will still seek to recover the value of the permit, since otherwise it would be more profitable not to generate and to sell the permit in the EU ETS market. The impact of this increase in the carbon price accounts for about an extra £9/MWh in wholesale electricity prices. Under the UK's National Allocation Plan, large electricity generators receive slightly less than half of their emission allowances free of charge, so the resulting increase in the price of power represents a windfall gain for these generators.

  50.  Even with a more effective carbon trading scheme, there may still be justification for support for some renewable technologies to help develop options for meeting future targets more cost-effectively. However, support for these reasons would probably take a very different form from the RO. The Government has already developed some policy interventions targeted in these areas, such as establishment of the Energy Technologies Institute. The costs involved are, however, orders of magnitudes lower than the subsidies to relatively mature technologies, over and above the cost of carbon, through the Renewables Obligation.

  51.  We hope that this information is useful. We would be happy to provide any further information that the Committee may require.

Alistair Buchanan

Chief Executive

July 2008

1   UK Renewable Energy Strategy: Consultation Document, BERR, June 2008, page 94 Back

2   Feed-in Tariffs and Quotas for Renewable Energy in Europe, CESifo DICE Report, April 2007, link) Back

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