Renewables obligation extended to head off investment crisis

The obligation is an innovative mechanism which, in theory, should be a powerful stimulus for investment in renewables. However, the market has been rocked by a combination of factors - and investor confidence has nose-dived (ENDS Report 345, p 13 ).

The obligation requires electricity suppliers to produce renewables obligation certificates (ROCs) proving that an increasing proportion of their electricity suppliers come from renewables. At present, the targets rise annually to 10.4% in 2010/11 - but stay at this level until 2026/27.

In 2002/3, the obligation's first year, the target was missed by some 45% (ENDS Report 343, pp 10-11 ) - and a similar shortfall is expected this year.

Under-performance increases the effective value of ROCs because suppliers pay £30 into a "buy out" fund for each MWh by which they miss their targets. The cash is redistributed to suppliers in proportion to their renewables generation during that year - an effect which had boosted the value of ROCs to £48/MWh by the summer.

However, investors do not regard these elevated ROC values as bankable because buy out payments vary from year to year - and would diminish rapidly as the obligation target is approached. Indeed, generators face a cliff edge if the target is met - an unlikely prospect for 2010, but a real possibility in the following years - when "surplus" ROCs could lose their value.

Plans to amend the obligation to boost biomass co-firing would further depress ROC prices (ENDS Report 344, pp 47-49 ). To add to investors' jitters, the Government is planning a review of the obligation in 2005/6 - with a wider review of renewables support mechanisms in the EU looming in the background (ENDS Report 344, p 56 ).

The scale of the problem is clearly set out in a report by LEK Consulting for the Carbon Trust.¹ This warned that, under current arrangements, even relatively cheap onshore wind projects could dry up as soon as 2005 "as the period of subsidised returns becomes too short".

The report was due to be presented to the first meeting of the Government's renewables advisory board at the start of December. It appeared to have the desired effect - Energy Minister Stephen Timms told the board that the obligation will be extended by five years.

The targets will rise in 1% increments after 2010/11, reaching 15.4% in 2015/16. The Scottish Executive has announced an identical extension to the obligation in Scotland.

Marcus Rand of the British Wind Energy Association welcomed the decision as "a wonderful early Christmas present" and "a massive boost". Philip Wolfe of the Renewable Power Association was "delighted" at the move, which "was essential to encourage the £10 billion of new investment needed."

However, investors and ROC traders were more cautious. "There is no doubt that this move underscores the commitments made on renewable energy in the energy White Paper," said Anthony White, head of policy at newly launched finance house Climate Change Capital. "But even with the proposed changes, we have to ask whether enough certainty will be created to hit the national targets for 2010 and beyond."

"It can't fail to help, but it doesn't tackle the immediate problem of supplier credit risk," said Gareth Simpson of Cinergy, the biggest trader of ROCs. "Suppliers now have to factor in the risk of another supplier going into administration like TXU, and the effect of this on ROCs."

TXU Europe and small supplier Maverick Energy left a shortfall of £23.1 million in the buy out fund when they went into administration (ENDS Report 345, p 13 ). Mr Simpson says that ROC prices fell by a "massive" £3 to £45, and although trading has recovered to some extent the volume is still significantly lower than before the problem came to light.

TXU's administrators, Ernst & Young, had been planning to reimburse suppliers for 35-40% of their shortfalls. However, Mr Simpson said, no payments have been made so far. Their efforts have been frustrated because suppliers have yet to agree to pass on the same proportion of the money to generators.

Despite the shortfall, suppliers received payments of £91 million from the buy out fund in November for the 2003/03 obligation period. The main recipients were Powergen, British Gas and London Electricity.

Another five suppliers failed to comply fully with the rules and are making late payments to other suppliers. Three of them - Npower, Electricity Direct and Economy Power - tried to redeem more ROCs from biomass co-firing than permitted under the rules. Two others missed the deadline for submission of ROCs and buy-out payments.