Select Committee on Environmental Audit Memoranda


APPENDIX 11

Memorandum from TXU Europe

  TXU Europe strongly supports the expansion of renewables capacity in the UK and is committed to doing its part to ensure that the recently announced Renewables Obligation (RO) is a success. We have recently provided a detailed response to the Government's Preliminary Consultation on the Renewables Obligation, which I have attached for your information, and welcome the Environmental Audit Committee's inquiry.

  In relation to the specific questions raised by the Committee we would like to make the following comments.

1.  LEVELS OF ACHIEVEMENT SO FAR AND THE CURRENT RATE OF PROGRESS

  We believe that the Non Fossil Fuel Obligation (NFFO) has been instrumental in facilitating the development of renewables on a competitive basis resulting in increased capacity at lower cost. However, the NFFO has not been as successful as it could have been due to the planning difficulties experienced by many schemes. To some extent this may have been exacerbated through the mechanism of the NFFO which incentivised developers to bid in lower cost projects based on optimal locations rather than sites which were more likely to gain planning consents. The change in emphasis of the proposed RO to the delivery of projects, as opposed to the cost, may improve the planning success rate. Without resolution of the current planning difficulties, which we discuss below in more detail, we believe that the Governments 10 per cent renewable target will not be achieved.

2.  EXPECTATIONS OF THE PROPOSED RENEWABLES OBLIGATION AND THE DEFINITION OF "ACCEPTABLE COSTS TO THE CONSUMER"

  We believe that the proposed methodology for the obligation has the potential to deliver the Governments renewables target, although some fine-tuning will be required in order to create a fully effective and efficient system. Provided these concerns are addressed we believe that a 3p/kWh buy-out price is generally an acceptable cost to the consumer, although we do have some concerns that energy intensive users may find the cost unacceptable. We believe there are three key areas that need to be addressed:

    (a)  the market impact of the proposals, both as respects the market for green power and the market more generally, the risks that may arise, and how these are likely to affect outcomes;

    (b)  the importance of avoiding undue competitive advantage for any player; and

    (c)  current experience and likely developments on the NFFO, and the impact these may have on the optimum profile of the obligation.

Market impact and risk

  The obligation is intended to work by giving suppliers an incentive to pay up to the buy-out price for renewable generation or ROCs. Indeed the amount paid could be more if the Government retains the proposed recycling of penalties from non-compliant to compliant suppliers (which we will call "repayment by compliance") and there is a shortfall. It intended that the incentive in the prompt (out-turn) market will provide "pull" back into the construction market as suppliers move to cover their positions in advance and/or merchant renewable operators build against the demand in the out-turn market.

  However, the efficiency of such a mechanism in encouraging the construction of renewable capacity will depend entirely on the amount of risk seen by market participants at the time construction decisions are taken. While consumers can be expected to pay the full cost of the renewables obligation in the prompt market, at the time construction decisions are made, that money needs to remunerate two things:

    (a)  the construction of renewable capacity; and

    (b)  the risks, as seen at construction time, that the high prices in the prompt market will not materialise.

  The greater the level of risk, the less money will be left to cover the cost of constructing renewable capacity and/or the more attractive it will be to suppliers to leave their positions uncovered and take their chances in the prompt market.

  There are three significant risk areas, which we believe need to be addressed if the system is to work as desired:

    (i)  The risk of over-success. If the Obligation target is systematically met, the price of ROCs is likely to collapse. In such circumstances, anybody taking the risk of investment in renewable capacity would find their assets stranded. It is essential that the target be set at a level which is not expected to be fulfilled and that the Government is open in making clear that there is an element of over-targeting in order to keep the system taut. Measures like raising the buy-back price or choosing repayment by compliance in order to make sure a particular target is met are likely to be self-defeating because of the risk of over-delivery. To put it another way, the pricing of renewable energy will be inherently unstable - and therefore highly risky - if the target is expected to be met or nearly met.

    (ii)  The risk of market flooding by imports. Another factor that could crash the price on renewable generation, and therefore strand the investments of those wishing to invest, would be large scale imports of renewable power down interconnectors. The interconnector with France has a capacity of 16TWh annually, more than enough to make UK renewable investments loss-making and the possibility of future interconnectors cannot be ruled out. We have been told that there will be provisions aimed at reducing this risk, but it is so fundamental to the economics of any investment that clarity is essential. In particular, we need to be sure whether the Common Position on the new Renewables Directive (which we understand now includes large scale hydro) will create European Green Certificates which will have to be accepted for Obligation purposes.

    (iii)  The risk of change of policy as a result of the impact on consumers. The main consumer pain is likely to be felt by large industrial consumers. Because supply margins in this sector are so small - practically zero - it is highly unlikely that suppliers will want to take the risk of renewables construction in order to supply the market, when a safer course is to shed the load unless the customer is willing to pay the cost of its green tickets in the prompt market.

    The cost of this for large industry could be comparable with the unrebated Climate Change Levy (CCL). Accordingly the price impacts for large industry from the Obligation could be so great that there might be strong, possibly even irresistible, pressure for the scheme to be changed in a manner suppliers cannot now predict. This risk factor, explored more fully in our response, is likely to have a significant impact on the price suppliers can offer for the construction of renewables. We believe that it would be highly desirable for Government to solve the large industrial customer problem now, so as to eliminate this risk factor, and we would be very willing to help identify possible solutions.

  It is worth re-iterating as a final point on risk, that there are great benefits in addressing risk factors at source so they can be substantially eliminated. This should achieve the optimum "pull" from the market to encourage construction of renewable generation. Increasing the buy-out price beyond the appropriate level or measures such as repayment by compliance are likely to have as their predominant effect increasing the risk premium rather than increasing the funds available for construction. This is because they increase the tension in the system, which manifests itself in instability and risk. Such an outcome could well lead to additional costs for customers but not necessarily additional development of renewable generation.

Avoiding undue competitive advantage

  A number of suppliers are competitively advantaged by the current proposals due to their existing small scale hydro capacity or the potential for favoured access to renewable capacity supplied via interconnectors. This potential undue advantage is intensified by certain aspects of the proposals such as the profile of the obligation (which may allow for insufficient lead-time associated with new capacity) and the suggested use of repayment by compliance (which could have us making direct payments to certain of our competitors even if we were investing more in UK renewables than they were). We think that the logic of creating an effective and efficient electricity market, and the policy and purpose of the Utilities Act, both point towards doing what is possible to eliminate undue advantage. In our response below, we give some suggestions as to how this might best be done.

The NFFO and the phasing of the Obligation

  Although the Obligation should help to remedy some of the issues, which have arisen in the operation of the NFFO, we think there are some transitional issues. In particular, success rates for NFFO projects have fallen in recent years as the planning climate has hardened. The RO at 3p/kWh may also intensify the problem as developers may be tempted to let setbacks kill off uncommitted projects if they feel they can make more profit with the same capital or management time in the Obligation market.

  The net effect of these interactions is to cast some considerable doubt on the capacity predicted to arise from NFFO 3-5 that forms the baseline for preparing the obligation figures. In the light of that uncertainty, it will be difficult to judge in a timely manner how much capacity needs to be acquired under the RO and it may be difficult to set up the relevant RO projects on a fast enough timescale. Accordingly, there seems to be a risk that the market will remain excessively short during this period, with a possible excess cost to consumers. There is also a concern that these costs may fall differentially on suppliers, especially favouring those with existing small hydro or links to the Continent. Such differentials would be enlarged if repayment by compliance were in force.

  In relation to "acceptable costs" we believe consumers, both industrial and domestic, and their representatives are best placed to comment on the acceptability or otherwise of the costs implicit in the Obligation.

3.  THE IMPACT OF THE GOVERNMENT'S REFORM OF THE ELECTRICITY MARKET

  We believe that the new electricity trading arrangements will not significantly impact the amount of renewables likely to be constructed in response to the renewables obligation. This is for two reasons:

    (a)  a number of market players, including TXU Europe, will be well placed to offer risk management products, such as consolidation or aggregation, to renewable generators. Indeed, we at TXU see this as a key way in which we can help facilitate the development of renewables.

    (b)  in any event, under the obligation suppliers will need to facilitate or undertake the construction of renewable projects. They will have an incentive to secure the economic delivery of projects and therefore to enable the power to be cost-effectively taken by the system. Suppliers who do not develop or purchase the appropriate energy risk management arrangements to take the power would therefore find it much harder to achieve the targeted compliance and would be exposed to buy-out charges.

4.  THE LEVEL OF GOVERNMENT SPENDING ON RENEWABLES RELATED R&D

  We believe the RO will incentivise the development of those renewable technologies that are already economic or nearing commercially viability. This will be underpinned further by the availability of funding through the Carbon Trust and the proposed financial aid available to biomass and offshore wind technology. However only time will tell where the current support will be sufficient therefore we would advocate that Government regularly reviews progress with the potential consideration of further support if required.

  We also support the provision of appropriate Government funding to longer-term technologies. This should be undertaken in partnership with academia and business.

5.  THE LEVEL OF GOVERNMENT SUPPORT FOR NON-FOSSIL FUELS OVER TIME

  As mentioned above, it is important that the target remains sufficiently ahead of delivery in order to give market participants confidence that the price of ROCs will not collapse to near zero. (We think that would be the likely outcome if the target were systematically met.) We believe that the Government's 10 per cent target for renewables by 2010 is challenging but could potentially be met in the period 2010 to 2012. In order to avoid stranding investments to be made over the next few years, it is important that early signals are given that the obligation is expected to be progressive, and that targets would be advanced - at least for the years until 2015—in the event that the obligation is met.

It is important that the detail of post 2010 targets is decided in sufficient time for suppliers to take the matter forward. We would therefore advocate that the requirement for future targets, based on socio-economic and environmental considerations, should be reviewed and agreed by 2008 at the latest. Consideration should also be given to future European Union renewables targets and any post Kyoto commitments.

6.  THE INTERACTION OF THE PLANNING SYSTEM

  We believe that the major planning difficulties currently being experienced by renewable developers have not yet been adequately addressed. The "lottery" element of the renewables development process needs to be significantly reduced by clearer and stronger guidance to councils that incentivises them to resolve this issue. It is particularly frustrating for project developers, who have spent considerable time and financial resources in developing proposals with the involvement of local stakeholders, to gain local planning consents only to find that the project is called in for public enquiry.

  Although we recognise that measures are being taken to address planning difficulties (eg DETR's published Guidance on Preparing Sustainable Development Frameworks), which have proved the major barrier to the development of NFFO projects, we have not yet seen any material evidence of success. The large amount of wind and energy from waste capacity still outstanding when compared to installed capacity—and the low rates of success in recent NFFO rounds—are of particular concern:


  It is also important to ensure that appropriate planning procedures be adopted by Crown Estates in relation to offshore wind projects.

January 2001


 
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