The need for a significant reduction in greenhouse gas emissions to combat the threat of global warming has become increasingly apparent over the past decade. It is widely recognised by law-makers that tackling the climate change problem will only be achieved through a holistic approach. Consequently, we are now seeing regulation in several new areas, including energy production, energy efficiency, transport, carbon capture and storage and emissions capping.
With two-thirds of emissions coming from the energy that we use, increasing the amount of energy generated from renewable sources is one of the primary focuses of the climate change battle. Concerns over the security of gas supplies have also helped to move renewable (as well as nuclear and clean coal) electricity generation up the political agenda.
Renewable Energy Targets
At the time of writing, the finishing touches are being applied to a new European Renewable Energy Directive (the Directive), which will come into force in the middle of 2010. Within this Directive, the EU has committed to a binding target that 20% of the EU’s energy consumption must come from renewable sources by 2020. To achieve this target, each country has been allocated its own share, with the UK’s contribution being to increase the share of renewables in its energy mix from less than 2% today, to 15% by 2020. To help the UK meet these ambitious targets, the government has recognised that changes to the legislative framework are required to maximise the UK’s renewable energy potential.
Renewables Obligation
The UK’s principal measure for promoting the generation of renewable electricity is the Renewables Obligation (RO), which was introduced in 2002 by secondary legislation made under the Electricity Act 1989 (the 1989 Act). In practice, the system in the UK works on the basis of three complementary Obligations: one for England and Wales and one each for Scotland and Northern Ireland.
The RO, administered by Ofgem, requires electricity suppliers to source an increasing percentage of the electricity they sell from renewable sources each year. The percentage for 2008/09 is 9.1%.
ROCs
Under the RO, accredited renewable energy generators are awarded one Renewables Obligation Certificate (ROC) for each megawatt hour (MWh) of renewable electricity they produce. Generators of renewable energy are therefore able to sell not just their electricity, but also the ROCs accredited to them. ROCs are attractive to suppliers because it is these certificates that must be surrendered by suppliers at the end of each 12-month period (running from April to March) as evidence that their obligation has been met.
At the end of each period, those electricity suppliers who have failed to surrender sufficient ROCs to achieve their targets must ‘buy out’ their shortfall by paying a set amount (the buyout price, currently £35.76) per missing ROC into a fund (the buyout fund). The buyout fund is then redistributed among the suppliers who surrendered ROCs, in proportion to the number given up. Each ROC allows the holder not only to avoid paying the buyout price, but also to share in the money paid into the buyout fund by those with a shortfall. In 2006/07 the buyout price was £33.24 and the redistribution of the buyout fund was worth an additional £16.04 per ROC submitted. During that year, renewable generators could therefore expect to receive in the region of £50 for each ROC sold, on top of the electricity price. It is the premium realised through the sale of ROCs that has greatly incentivised the development of renewable energy projects.
Banding
To date, the RO has been based on a technology-neutral approach whereby all renewable sources attract one ROC for each MWh of electricity produced. Understandably, this has led to increased development of the most economical and reliable sources of electricity, namely onshore wind and landfill/sewage gas. The government has recognised that to meet its 15% target and diversify current renewable supplies, there needs to be greater investment in other, less-developed technologies. The government aims to address this challenge in the Renewables Obligation Order 2009 (the 2009 Order) through the introduction of a concept known as ‘banding’. The changes will take effect from 1 April this year, and have been made possible by alterations to the 1989 Act that were recently introduced by the Energy Act 2008.
Under the concept of banding, there will be more financial support to new and underdeveloped renewable energy technologies, and less support to mature, low-risk technologies. For example, cheaper, commercially established technologies, such as landfill gas, will have to produce 4MWh of electricity in return for one ROC, whereas more expensive, less-established technologies, such as advanced gasification, tidal and solar power, will only have to produce 1/2MWh of electricity for each ROC. It is hoped that the increased subsidies will encourage developers to invest in the newer developing technologies that require heavier front-end investment.
The table below shows how the different renewable technologies are proposed to be treated in the 2009 Order.
The government has based its calculations of the bands on a prediction of the volume for each source. As a result, the intention is that the number of ROCs should be no greater than is currently in circulation. The bands are intended to stay in place until 2013, when a planned review will take place. Subsequent reviews will occur on a five-yearly basis. The legislation sets out various circumstances in which emergency reviews may be carried out to ensure the integrity of the system.
Microgenerators are excluded from the banding principles but all microgenerators will be issued with one ROC for every 0.5 MWh of electricity produced, regardless of the renewable technology used. Outside of the RO, microgeneration up to 3MW is also likely to be encouraged under separate government proposals for feed-in tariffs for small-scale renewable generators. It remains to be seen how potential overlaps between the two schemes will be dealt with.
While a consistent approach has been encouraged, decisions on banding are down to the devolved administrations. It should be highlighted that Scotland is currently considering proposals to provide even greater support to marine and tidal projects located in Scottish waters.
Grandfathering
To help protect and bring certainty to past and future investment decisions, the 2009 Order complements banding with the principle of ‘grandfathering’, under which existing accredited generating stations larger than 50kW may avoid the reduction in financial support brought about by banding. So, for example, an accredited landfill gas generating station will be able to use these grandfathering rights to continue to receive one ROC per MWh of electricity produced, despite the fact that under the banding principles, new landfill gas generators will only receive one ROC for every 4MWh of electricity produced.
The only existing accredited generating stations that will see a reduction in support are those co-firing biomass without combined heat and power (CHP), which will see the level of support halved to one ROC per 2MWh of electricity generated. This is on the basis that these generating stations require little capital investment compared to other technologies.
The increased financial support on offer to new generating stations through the banding reforms will only be available to those existing generating stations that received full accreditation after 11 July 2006 (the date when the banding proposals were first published). This is to avoid existing generation stations from receiving a windfall where the decision to build was not influenced by the banding proposals.
Several renewable projects have been supported by statutory capital and research grants. To ensure that projects are not over-subsidised and to remain within rules on state aid, those projects that have received grants will be given the option to either keep the grant and remain at one ROC per MWh, or to repay the grant (plus interest) within two years and benefit from being banded-up.
Other Reforms
Trying to legislate in an emerging sector inevitably has its difficulties, and the RO has required amendment on an almost annual basis since 2002 to try to smooth out various creases and address practical and technical issues that have arisen. A sign of the increasing complexity in the system is that the number of articles making up the 2009 Order has increased from 13 to 60 since the RO was first introduced.
In addition to the new banding and grandfathering principles, there are also several other significant changes introduced by the 2009 Order:
Co-firing
Since the start of the RO, the inclusion of co-firing (the combustion of biomass with fossil fuels) has been much debated. The concern over co-firing is that the amount taking place in any year is driven by the cost of the biomass and the relative costs of fossil fuels, and therefore may cause unwanted volatility in terms of the demand and price for biomass and the number of co-fired ROCs on the market.
Co-firing without CHP or energy crops under the RO is currently limited through a cap placed upon suppliers. Until 2006 this cap allowed only 25% of a supplier’s obligation to be met by co-fired ROCs. This fell to 10% in 2006, with exclusion from the RO after 2016. With the introduction of banding, the government has decided to retain co-firing within the RO for its existing lifetime (subject to conditions) and therefore the post-2016 exclusion of co-firing will no longer apply. The 10% cap on suppliers will nevertheless be retained, increasing to 12.5% from 2010/11.
Administrative costs
From 2009 Ofgem will be able to recover its administrative costs from the buyout fund rather than through the licence fee charged to the gas and electricity network operators. This is expected to reduce the value of each ROC by around £0.07.
Calculation of RO targets
To deal with the changes introduced by banding, the 2009 Order will introduce a new method of calculating the renewables targets for suppliers. Currently, suppliers are required to prove that a specific proportion of their electricity is sourced from renewables, which in 2008/09 is 9.1%. This system would fail to distinguish between the different renewable sources. Therefore, in the future, suppliers must present a prescribed number of ROCs per MWh of electricity supplied. For 2009/10 the target will be 0.097 ROCs (or expressed another way, 9.7 ROCs per 100 MWh supplied). The figure of ROCs will be reviewed annually by the Secretary of State using a formula laid down in the 2009 Order. The target for 2010/11 will be announced on 1 October 2009.
Revocation of ROCs
Ofgem has always had the power to revoke ROCs if they were issued on the basis of inaccurate information. However, it was made clear in statutory guidance that once redeemed, a ROC would not be revoked even if it had been falsely issued. This provided a level of security for generators and suppliers. This principle has now been reversed, increasing the importance of accurate reporting.
Definition of biomass
The 2009 Order introduced a new definition of biomass to deal with potential confusion over the status of generating stations using biomass feedstocks that contain a quantity of fossil fuels.
Article 4 of the 2009 Order clarifies that biomass may contain fossil fuels when:
- the fossil fuel was added to the relevant material as an incidental consequence of a process to which the relevant material was subject (for example, if the relevant material is wrapped in plastic); or
- when the biomass fuel is waste, provided that the fossil fuel has not been added to the waste for the purpose of it being a fuel.
If the fuel concerned falls outside of this definition, then the use of that fuel to generate electricity will be considered as co-firing. The distinction between biomass and co-firing with biomass is significant under the new banding regime. While dedicated biomass attracts one ROC per 2/3MWh (1/2MWh if used with CHP production), co-firing of biomass requires 2MWh for each ROC.
Biomass sustainability reporting
To help address concerns that the use of biomass from unsustainable sources should not be encouraged, the 2009 Order introduces a sustainability reporting mechanism on biomass generators. On 31 May following each period, the generator must supply a report to Ofgem containing details such as the origin of the biomass, whether it was produced pursuant to an environmental quality assurance scheme and the current use of the land on which it originated. Ofgem reserves a discretion to postpone the issue of ROCs if the above information is not issued by the deadline. In addition, there is a longstop deadline of 31 August after which no ROCs will be issued.
As a result of this hardline approach, it is vital that generators take their reporting requirement seriously. However, to ease the administrative load on suppliers, an answer of ‘not known’ will be permissible if reasonable efforts have been made to find the answer. At present, the reporting requirements are just that, and there are no requirements for a generator to actually demonstrate that the biomass is from sustainable sources. However, there are likely to be increased political and social pressures to ensure that this is the case and the government has indicated that it may introduce sustainability standards as and when international criteria and standards become more developed.
Measuring the renewable content of fuels
ROCs are only issued in respect of the proportion of a fuel that is from renewable sources. To deal with concerns over the difficulty of measuring the renewable content of biomass, waste and fuels produced through advanced conversion technologies such as anaerobic digestion, gasification and pyrolysis, the government has consulted heavily on the measurement and sampling techniques to be employed, which should lead to clearer guidance and greater flexibility for Ofgem and generators alike.
Private wire arrangements
In 2007 the RO was amended to remove the need for generators to enter into sell and buy-back agreements in order to claim ROCs for the on-site use of renewable electricity. The 2009 Order introduces provisions simplifying the contractual arrangements that are required to enable a generator supplying electricity over a private wire network to a third party to obtain ROCs. Whereas previously the supply would need to go through a licensed electricity supplier (with contractual documentation to evidence this), the supply of electricity between a generator and a customer or unlicensed intermediary over a private unlicensed network of up to 10MW will now be eligible for ROCs, without requiring the electricity to be sold to a licensed supplier. This will give renewable generators for whom connection to the licensed distribution or transmission network is prohibitively expensive, greater freedom to negotiate supply contracts directly with customers.
Conclusion
The RO has been the subject of criticism as being unnecessarily complicated and administratively burdensome when compared to equivalent measures implemented in other European countries. However, it is clear that the RO is here to stay. The Pre-Budget Report on 24 November 2008 confirmed the government’s intention to retain the RO as the support scheme for large-scale renewable electricity generation and announced a significant extension of the RO from the current end date of 2027 to ‘at least 2037’, although this does not necessarily mean that there will be an additional ten years of support to all existing projects.
There are several additional measures that are likely to find their way onto the statute book within the next year or so, including those aimed at encouraging the greater deployment of renewable heat and microgeneration. It remains to be seen, however, whether the revised RO and the additional forthcoming changes will enable the government to meet the Directive’s targets.
By James Phillips, associate, Burges Salmon. E-mail: james.phillips@burges-salmon.com.
