Select Committee on Environmental Audit Memoranda


Annex C

THE BALANCE BETWEEN ACHIEVING THE TARGETS AND THE COST TO THE CONSUMER

WINDFALL GAINS

  By creating a separate category of Non-Eligible Renewables which includes energy from waste and large hydro, the Government has prevented windfall gains on approximately 5.6TWh of renewable generation each year. The saving to the consumer of this policy would be up to £168 million per annum. However, the Government has failed to prevent windfall gains as follows:

    (i)  Approximately 2.2TWh of Eligible Renewables currently operating without NFFO subsidy, at a cost to the consumer of up to £66m per annum for windfall payments;

    (ii)  An additional 1.5TWh of output from Eligible Renewables that are currently receiving support under NFFO contracts. Those renewables will receive windfall payments from the end of the NFFO contracts, until at least 2026, and the cost of those windfall payments will be up to £45 million per annum index linked; and

    (iii)  The Consultaton Document assumes that an additional 7.0 TWh will each year be produced by Eligible Renewables with NFFO 3, 4 and 5 contracts that are not yet operating, but that are expected to be commissioned in future and which would normally be expected to amortise capital costs over the lives of the contracts. These projects will receive windfall payments after the NFFO contracts terminate. This level of output would imply additional windfall payments of up to £210 million per annum from the end of the NFFO contracts until 2026.

  Thus, the policy is likely to cost the consumer around £321 million (indexed) per year in windfall payments once NFFO contracts have terminated. There is also the potential for this sum to increase as existing renewables on mainland Europe will have the opportunity to obtain windfalls by selling Renewables Obligation Certificates into the UK. The windfall payments discussed in (ii) and (iii) above are ignored by the cost benefit analysis in Annex A of the Consultation Document because this considers only the costs in 2010.

  By excluding certain types of renewables from the obligation rather than addressing the problem of windfalls directly, the policy as stated in the Consultation Document is increasing the cost to the consumer by perhaps 12 per cent in 2010 and 60 per cent in later years.

MARKET PRICE OF RENEWABLES OBLIGATION CERTIFICATES

  The market price of Renewables Obligation Certificates will be maintained at or above the buy out price for so long as there are insufficient certificates to satisfy the Obligation. The best interests of the consumer will be served if the market has the maximum flexibility possible in its efforts to satisfy the Obligation. Entrepreneurs will use this flexibility to deliver lower cost technologies that eventually will lead to a surplus of renewables capacity and thus drive down the market price of certificates below the buy out price. Although the magnitude of the effect is difficult to quantify, excluding some renewables from the Obligation will unambiguously increase the market price of certificates and, hence, increase the costs to consumers above the economically efficient level. The consumer would be better served by including the technology categories currently classed as Non-Eligible Renewables within the Obligation but increasing the level of the Obligation commensurately.

LOWER COST ALTERNATIVE POLICY

  The minimum cost to the consumer commensurate with the Government achieving its renewables target will be delivered by adjusting the policy set out in the Consultation Document as follows:

    (a)  Define Non-Eligible Renewables as all existing renewables and any future renewables that benefit from NFFO/SRO contracts.

    (b)  Reduce the levels for the Obligation set out in Table D of the Consultation Document to exclude those Eligible renewables that are expected to be commissioned in the future and that will benefit from NFFO contracts, and increase the Obligation by an amount equivalent to the forecast growth in large hydro and energy from waste excluding that element that is expected to benefit from NFFO contracts.

  These adjustments would ensure that no windfall payments are made and provide the maximum flexibility in achieving the Obligation. Hence they will minimise the cost to the consumer of achieving the Obligation. It will also provide significantly greater assurance that the Renewables Targets will be met.

  It might be argued that by increasing the number of technologies included in the Obligation as suggested above, the cost to the consumer would be increased because of the need to buy more Renewables Obligation Certificates. However, the Government's aim is to meet the Renewables Targets at least cost to the consumer: meeting the Obligation as set out in the Consultation Document is simply the means to this end. As has been established in Annex A, the forecast of growth in the output of energy from waste is very optimistic. Thus, any additional cost to the consumer of paying for more certificates is part of the necessary cost of meeting the Targets. However, it is likely that even if energy from waste projects were included, there would be a net reduction in the level of the Obligation once NFFO contracted plant is removed. It is recognised that the Savings Arrangements for NFFO 3, 4 and 5 Contracts remove the financial effect of having this plant in the Obligation while the NFFO contracts remain in place, but these arrangements do not reduce the cost to the consumer of maintaining the level of the Obligation in the period between termination of the NFFO contracts and 2026.

  Table 1 below calculates the revised level of the Obligation on two bases; first, that all new energy from waste projects being built are supported by NFFO Contracts (scenario 1); second, that only one third of those energy from waste plants commissioned after 2003 would have NFFO support (scenario 2). Both scenarios demonstrate a significant reduction in the level of the Obligation required to meet the same Renewables Targets. Both scenarios produce a significant net reduction in the cost to the consumer. The impact on cost to the consumer of scenario 2 is illustrated in the final column of Table 1.

VALUE FOR MONEY

  There are two aspects to the policy that unnecessarily increase costs to the consumer.

  First, by failing to target successfully windfall gains to existing projects and projects that will be supported by NFFO, the cost to the consumer will be increased by £66 million (12 per cent) in 2010 rising as the NFFO Contracts expire to £320 million (60 per cent) by 2018. Some of these costs have not been included in the analysis of costs and benefits set out in Annex A to the Consultation Document.

  Second, limiting the scope of renewables that can be used to satisfy the Obligation and, in particular, excluding those which are most likely to achieve commercial viability will increase the price at which Renewables Obligation Certificates trade and increase costs to consumers. The function of the market mechanism that is at the heart of the policy on the Obligation is to reduce the price of certificates when the costs of renewables fall. The buy out price should be a cap rather than a target. This cannot happen effectively unless markets are allowed to operate without undue regulatory interference.

  Although the Consultation Paper states that the average burden for consumers has been calculated to be modest (3.7 per cent), it will fall disproportionately on large industrial energy users who could face increases in bills of around 12 per cent by 2010 and greater amounts thereafter.

  The cost benefit analysis in the Consultation Document assumes that renewable generators will be paid the buy out price of £30/MWh and calculates the cost to the consumer to be £595 million pa in 2010. As has been noted above, this understates the cost of the policy in later years, and the cost could easily rise to £850m pa (in real terms) by 2018.

  The cost of the policy has been presented as the cost of achieving the 10 per cent Renewables Target, but this is not the correct cost/benefit analysis. If the Renewables Target is to be achieved with the proposed policy, the additional output will consist of three elements; construction of capacity without any form of support; construction of capacity supported by NFFO/SRO contracts; and construction of capacity supported only by the benefits accruing through the Obligation. The policy is responsible only for the additional capacity indicated in the third category and it is to this additional capacity that the costs of the policy should be compared. On this basis, the additional cost (ie: excluding the market price of non-renewable generation) of additional output is £42.50/MWh in 2010 and £60.71/MWh in 2018. In other words, by 2018 achieving the additional output will cost the consumer over twice as much per unit as is suggested by the level of the buy out price. Looked at another way, one third of payments made by consumers in 2010 and half of payments made by them in 2018 will produce no additional benefit.

  The policy does not achieve the right balance between achieving the targets and cost.

Table 1

THE SCALE OF THE OBLIGATION REQUIRED TO ACHIEVE A 10 PER CENT RENEWABLES TARGET IN 2010 USING AN ALTERNATIVE DEFINITION OF ELIGIBLE RENEWABLES

  
Obligation as set out in Table D of the Consultation Document
Effect of removing existing renewables
Effect of removing future renewables with NFFO Contracts
Effect of adding energy from waste to the Obligation
Revised Obligation
Scenario 2
  
TWh
Without NFFO TWh
With NFFO TWh
TWh
Scenario 1 TWh
Scenario 2 TWh
Scenario 1 TWh
Scenario 2 TWh
Net Change in Cost to the consumer £m (2000 prices)
2002
9.4
(2.2)
(1.8)
(5.4)
0
0
0
0
(66)
2003
11.0
(2.2)
(1.8)
(7.0)
0
0
0
0
(66)
2004
12.5
(2.2)
(1.8)
(7.0)
0
0.4
1.5
1.9
(54)
2005
13.9
(2.2)
(1.8)
(7.0)
0
0.7
2.9
3.6
(45)
2006
16.8
(2.2)
(1.8)
(7.0)
0
1.3
5.8
7.1
(27)
2007
19.7
(2.2)
(1.8)
(7.0)
0
2.0
8.7
10.7
(6)
2008
22.7
(2.2)
(1.8)
(7.0)
0
2.7
11.7
14.4
15
2009
23.8
(2.2)
(1.8)
(7.0)
0
3.4
12.8
16.2
36
2010
25.0
(2.2)
(1.8)
(7.0)
0
4.0
14.0
18.0
54
2018
25.0
(2.2)
(1.8)
(7.0)
0
4.0
14.0
18.0
(309)




 
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