NAO calls for better targeting of renewables obligation subsidies

The Government's 2010 target for renewable electricity is within reach, the National Audit Office has concluded.1 But it suggests that a third of the subsidy under the renewables obligation is not necessary - and urges the Government to consider restricting support for cheaper technologies like onshore wind and landfill gas.

The renewables obligation, introduced in April 2002, is the Government's main policy instrument to deliver its targets for green power.

The Government has already tinkered with the obligation on two occasions, relaxing the rules for biomass co-firing and attempting to protect the market against the collapse of electricity supply companies (ENDS Reports 344, pp 47-49  and 356, p 38 ). A statutory review this year will consider whether more fundamental reforms are needed (ENDS Report 358, p 52 )

A key concern is whether the existing framework will secure the obligation's target for 10.4% of electricity supplies to come from renewables by 2010/11. Most commentators expect a substantial shortfall - and the House of Lords Science and Technology committee predicted recently that renewables would deliver only 7.5% of supplies by that time (ENDS Report 354, pp 38-39 ).

New data from energy regulator Ofgem appears to back this up. In 2002/03, suppliers were required to source 3% of their electricity from renewables, but undershot this target by 41%. The target rose sharply in 2003/04 to 4.3% - but renewables generation could not keep pace and the shortfall grew to 44%.

Even so, the NAO is confident that the 2010 target is still achievable. Its central prediction, based on work by consultants Oxera, predicts that 9.9% of electricity supplies will come from renewables by the end of the decade.

Earlier work by Oxera for the Department of Trade and Industry predicted that renewables eligible for the obligation would contribute just 8.2% of electricity supply by 2010 (ENDS Report 350, pp 31-33 ). The new, higher forecast reflects the recent increase in electricity prices.

In response, the Renewable Power Association warned that "investment realities mean that the target will be missed by about 20-30%". However, the British Wind Energy Association welcomed the report's "encouraging messages". A BWEA survey predicts that wind power alone could supply over 7% of UK electricity supply by 2010 - and the NAO reaches a similar conclusion (see table).

However, the NAO warns that the cost of the obligation - likely to be more than £1 billion per year by the end of the decade - may be too high. Under the current framework, which runs to 2026/27, around two-thirds of the total support will go towards meeting renewables' higher generating costs. The remaining third "would represent support in excess of that needed to secure the increased level of renewable generation".

Most technologies need subsidies to be commercially viable, the report says, but "the level of support provided by the obligation is greater than necessary to ensure that most new onshore wind and large landfill gas projects are developed."

A buy-out price of £15/MWh - half the current level - would be sufficient to bring forward most onshore wind projects, the NAO says, although more marginal sites would struggle. If developers are required to meet all of their grid connection costs, a buy-out price of £20/MWh would be needed.

The NAO also argues that rates of return for the best landfill gas projects are also very attractive under the obligation, and "some of these sites approach commercial viability without any support" (ENDS Report 357, pp 13-14 ).

However, most landfill gas is already utilised and the landfill Directive means that fewer new sites will be opening. "The main impact of the renewables obligation is," the NAO says, "on the existing, mainly smaller, landfill sites where it had previously been uneconomic to generate electricity, and also in extending the economic life of sites currently generating electricity". The NAO expects only a small increase in landfill gas generation from the current 1.0% of supply.

The RPA insists that even large landfill gas projects are "more risky than the NAO suggests", and require a higher rate of return than assumed in the report.

The NAO suggests two options to better target support under the obligation. The first is to time-limit support for certain projects or technologies. The second is move to a banded obligation, under which cheaper technologies receive less support. However, a banded obligation could result in higher-cost projects being developed ahead of cheaper alternatives - and both options may undermine investor confidence.

Including sites formerly supported by the first two rounds of the non-fossil fuel obligation also imposed an annual cost of about £35 million on consumers, the NAO says. The DTI pressed ahead with this policy to avoid premature closure of NFFO projects and to smooth the creation of a market for renewables obligation certificates (ROCs). However, the NAO claims that the decision was not supported by a thorough assessment of the projects' viability, the level of support needed, or alternative, cheaper options.

The NAO also casts doubt on the benefits of biomass co-firing - concluding that 21% of the CO2 savings may be offset because it offers an incentive to burn more coal. The DTI has claimed that relaxing the rules on co-firing would not increase the commercial viability of coal stations (ENDS Report 344, pp 47-49 ).

The report paints a bleak picture of the market for other biomass projects. Just two of the 11 projects which account for the bulk of the biomass capital grants awarded in recent years are under construction. The rest are running about a year behind schedule because of technical difficulties and problems in obtaining planning permission, fuel supplies and electricity contracts.

"The risk remains that many of the projects will not go ahead," the NAO says. "If so, the scheme will fail in its objectives to provide confidence and reduce unit costs."

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