Ofgem urges scrapping of Renewables Obligation

The government should scrap its Renewables Obligation and replace it with a system of supply contracts to reduce costs, says energy regulator Ofgem.

The Department of Trade and Industry issued proposals for banding the RO in October (ENDS Report 381, pp 42-43 ). It intends to give "emerging" technologies more renewable obligation certificates (ROCs) per megawatt-hour than others.

Renewables trade bodies criticised the plan in January, saying banding would make it "more difficult" to meet renewables targets because it would restrict support for renewables and undermine investor confidence (ENDS Report 384, pp 43-44 ).

But in its response,1 the scheme’s administrator, Ofgem, says the RO needs a radical overhaul because it is too expensive.

It argues that the cost of abating carbon under the scheme, up to £481 per tonne, is "very high" relative to other policy measures. "The subsidy generates returns to investors that are greatly in excess of the economic costs of generation," it says.

All renewable technologies currently operational are economic at a wholesale electricity price of £45/MWh says Ofgem. This is close to current prices, "suggesting that nearly all of the RO subsidy is excess."

However, government plans to give "emerging" technologies more support per MWh could "significantly increase" costs to consumers.

Ofgem points out there is only "limited" information on the future costs of technologies, making it difficult to set the bands accurately. If the bands are set too high an "excessive number" of projects would come forward, leading to higher electricity prices for consumers, especially as the government has proposed measures to maintain ROC prices. If bands are set too low, there would be no development.

"It is impossible to determine what the impact on investment might be," Ofgem concludes. "We do not think that the proposals have been rigorously analysed and we advocate a more fundamental rethink before proceeding further."

It says even if the government could set bands at the right level, "the result would be very similar to a purely administrative allocation." The RO would essentially become a set of fixed feed-in tariffs, removing any incentives developers have to minimise costs.

Instead, says Ofgem, the RO should be scrapped and companies should bid for long-term renewables contracts with fixed rates of return linked to the wholesale electricity price. Under this system, the level of support would fall as electricity prices rise, preventing developers from making excessive profits.

A scheme administrator would make payments to generators by levying suppliers according to their market share. Bidding would occur in rounds until a price or volume target was reached.

The proposal is similar to the Non-Fossil Fuel Obligation, which preceded the RO. The scheme was scrapped because many contracted projects were never built. However, under Ofgem’s proposals, developers would face strict penalties if they did not complete projects on time.

Ofgem denies its proposals would favour existing technologies like onshore wind because developers would have to consider the effects of planning delays. However, last year’s energy review promised action to streamline the planning system and minimise hold-ups (ENDS Report 378, pp 37-38 ).

Micro-renewables would also be eligible. Suppliers could bid for contracts based on aggregating several small-scale installations.

If banding goes ahead, the government should not extend the renewables obligation from 15.4% in 2015 to 20% in 2020, says Ofgem, because this would be unnecessary for the development of mature renewables.

The extra support provided by an extension may not even be justifiable for "emerging" technologies as the cost of renewables comes down and electricity and carbon prices rise. "Any decision to increase the level," it says, "would add to the deadweight currently in the scheme."

Ofgem also does not support the government’s mechanisms to prevent a crash in ROC prices in the event of ROC oversupply. If renewables are commercially viable, it says, supply would be expected to exceed targets.

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