The Renewables Obligation (RO) is Britain's
main mechanism for providing financial support to renewable electricity
generators. The RO requires electricity retailers (called suppliers)
to source a proportion of their electricity from renewable sources.
This target is set by legislation. It started at 3% in 2002 and
is increased each year. The target for 2008/9 is 9.1% rising to
15.4% in 2015. The Energy Bill before parliament will raise this
to 20% by 2020 (see paragraph 145).
The RO is a 'certificate trading' scheme. Renewable
energy generators are awarded Renewables Obligation Certificates
(ROCs) for their output, which they can sell to suppliers. At
present one ROC represents 1 MWh of renewable energy. Suppliers
require ROCs to prove compliance with the target, which they do
through presenting ROCs each one year period to the electricity
regulator, Ofgem. The demand for ROCs from suppliers means that
there is a value attached to ROCs in addition to the wholesale
value of the electricity renewable generators produce. In the
period since 2002 ROCs have typically traded at a price of between
£45 and £50 per MWh on top of wholesale electricity
prices which represents a significant premium for renewable energy
(in the same period wholesale power prices were typically around
£40/MWh and are currently around £70/MWh).
The market for ROCs is flexible. ROCs can be traded
independently from the electricity renewable generators produce
or sold together with it. Generators can enter into bilateral
contracts with suppliers for ROC purchase or sell them through
an open auction process, equivalent to a spot market. Auctions
are run online by the Non Fossil Fuel Purchasing Agency several
times a year and allow a transparent wholesale price to emerge
for ROCs. As well as buying ROCs from independent renewable generators
either directly or at auction, suppliers can become renewable
generators themselves, build their own renewable energy schemes
and generate their own ROCs.
If suppliers end each year without sufficient ROCs
to cover their obligation, they must make a payment into a buy-out
fund. The buy-out price is fixed per MWh of shortfall and is adjusted
with inflation each year. The proceeds of the buy-out fund are
paid back to suppliers in proportion to how many ROCs they have
presented. This is called the recycling mechanism. The combination
of the buy-out fund and the recycling mechanism means that suppliers
are encouraged to continue to buy ROCs even when they are more
expensive than the buy-out price. However, it also places an upper
limit on the price of ROCs because at some point it will become
cheaper for suppliers to pay the buy-out price than to purchase
ROCs. The cost of the RO is effectively paid by all electricity
consumers, since electricity suppliers pass the cost of compliance
on as a small increase in the tariff for the electricity they
The main advantage claimed for the RO (compared to
fixed price schemes, see box 2) is that the market for ROCs creates
an incentive to find the most cost-effective way to generate renewable
electricity. The main disadvantages are that it creates uncertainty
for investors, since future ROC prices are uncertain. It is also
unable to differentiate between renewable sources; ROCs are awarded
per MWh regardless of the method of generation. Because of this
the RO effectively favours mature and more cost effective generation
technologies like landfill gas over less mature technologies like
offshore wind and wave power that are currently more expensive.
The Energy Bill contains proposals to 'band' the RO by technology.
Mature options will get less than one ROC per MWh and early stage
technologies more than one ROC per MWh.
At present the UK is behind its RO target; the RO
for 2007 was 6.7% and renewable generation was 4.96%. In part,
this shortfall is due to the barriers to renewable generation
discussed in this report. Seven EU countries (Belgium, Italy,
Latvia, Poland, Romania, Sweden, and the UK) operate schemes similar
to the Renewables Obligation.