Features, November 1999 Uncertainty plagues UK renewables Government plans to reform the UK's electricity trading system have forced it to rethink how it supports renewable energy. Its proposals could make it harder for projects to attract financing. Mark Nicholls reports Concerns are mounting in the UK's renewable energy sector that the government's plans for electricity trading reform could undermine the ability to attract financing for new projects - and the development of new renewable energy technologies. Some experts are warning that without a radical rethink, it will prove impossible for the UK to meet the government's target of generating 10% of its electricity from renewable sources by 2010. "It's not clear that current government proposals will produce a range of financeable renewable energy projects in the same way that the current system has, or that smaller or intermittent renewable power producers will be viable under the new electricity trading arrangements," says Simon Roberts, the Bristol-based commercial director of Triodos Bank, a Dutch bank. But the sector has welcomed the news that the climate change levy - a tax on energy use in industry and commerce, due to be introduced in April 2001 - will not apply to electricity generated from renewable sources. Electricity from fossil fuels will be taxed at 0.43 pence (0.71 cents) per kilowatt hour (kWh). "This will provide a major stimulus to the renewable sector," says Peter Wright, project development manager at Energy Power Resources (EPR), a Bristol-based renewable energy company. Over the last ten years, the renewable energy sector has benefited from a system known as the Non-Fossil Fuels Obligation (NFFO). Under a series of five NFFO rounds since 1989, the Non-Fossil Fuels Purchasing Agency specified the amount, and mix, of renewable energy that the large, public electricity suppliers were obliged to purchase. Under competitive tender, renewable energy producers then bid for long-term supply contracts - up to 15 years - tied to specific projects, which guaranteed a set price for the electricity generated. This has made it relatively easy for projects to attract financing, and the competitive bidding process has helped to bring down the price of some sources of renewable energy, say analysts. The price of wind-generated electricity, for example, has fallen by half since 1989, to the point where it is able to compete with traditional sources of electricity. The price of wind-generated electricity is currently around 3.52p/kWh. Generating costs for NFFO 5 contracts, struck in 1998, were at an average of 2.71p/kWh compared with the average wholesale electricity price of 2.60p/kWh in 1998. But many newer sources of renewable energy are still far from competitive. Offshore wind generation, which avoids problems of 'visual pollution', will require substantial investment before it becomes viable. Secure, long-term supply contracts will allow offshore projects to attract this investment, say NFFO supporters. However, the government's plans will likely involve the scrapping of NFFO - partly because of changes to how electricity is traded. NFFO relied on suppliers being reimbursed by the taxpayer if the price of renewable energy was above that of the 'pool' price for wholesale electricity. However, the introduction of a new national electricity trading arrangement (NETA - planned to begin in Autumn 2000) will remove the heavily criticised pool system, replacing it with a more open and competitive mechanism. The details and timetable for reform are muddy. The new electricity trading framework will fall under the Utilities Bill, which the government was expected to announce in the Queen's Speech (where the Queen addresses Parliament with the government's legislative programme for the coming year) on 17 November, just after Environmental Finance went to press. The contents of the speech are not disclosed in advance, and do not go into the details of legislation. Ministers are, however, expected to set out renewable energy's role shortly before Christmas, or early in the New Year. By April, a final blueprint is expected to be ready. Progress on NETA will depend on the progress of the Utilities Bill. Early indications suggest that the governmen is on the verge of deciding on a percentage obligation system, where electricity suppliers would again be required to use a certain amount of power from renewable sources. There are also suggestions that this would be complemented by a system of tradeable 'green certificates'. Such a system could be fraught with dangers for the renewable energy industry, say experts. The key problem is that under the planned competitive trading system, it could prove impossible to lock suppliers into long-term contracts. If suppliers were free to switch between renewable generators, the latter would find it extremely difficult to attract funding. A possible solution could lie with the introduction of tradeable 'green certificates' in parallel with a percentage obligation. Under such a scheme, any generation of renewable energy would be rewarded with a certificate. The public electricity suppliers would meet their percentage obligation by delivering the required number of these certificates - which they would obtain either by generating renewable energy themselves, or by buying certificates from renewable generators. Such a scheme would essentially subsidise renewable energy, and provide an additional revenue stream against which financing could be sought. "Wind generators could receive a fairly low price for their electricity [because of the intermittent nature of much wind generation] with the sale of certificates making up the difference," says Chris Crookall-Fallon, principal consultant at Energy for Sustainable Development (ESD), a specialist UK-based sustainable energy consultancy. "This would be a NFFO-esque system," he adds. However, this would do nothing to help the development of more expensive, emerging technologies, according to Juliet Davenport, commercial director at Unit[E], a UK-based renewable energy supplier. "This wouldn't provide sufficient incentive to bring new, offshore wind power to the market. If there was a flat percentage obligation, even with a certificate trading system, it would be fulfilled by the cheapest renewable technologies," she adds. There is only a finite amount of generating capacity from cheaper sources such as waste or landfill gas generation, some analysts argue. And without investment in new technologies, such as offshore wind generation, the price of electricity from these sources will never become competitive, says Melville Haggard, head of project finance at Impax Capital Corporation, a London-based advisory and financing company. "Without a NFFO-type framework, only the cheapest sources of renewable energy will get financed. Wind energy would never have become as cheap as it has without this sort of support." Also, the new trading system is likely to penalise generators with unpredictable or intermittent supply - such as wind farms. Under NETA, those generators which supply more or less electricity than agreed will suffer financial penalties, making it impossible to predict their revenues even if they have long-term contracts. Again, this would discourage financiers from investing in renewable projects, even those which had contracts in place with electricity suppliers. Furthermore, the costs of participating in a competitive, short-term trading system would most likely be too high for smaller-scale generators, says Roberts at Triodos. "We'd like to see a system where the threshold of participating in NETA is raised - we don't want a situation where small, intermittent suppliers are overburdened with transaction costs." "The government will have to make explicit its support for renewable energy whatever system it chooses," says Crookall-Fallon, "because it can't compete at the moment. It's a question of how to do that in the most equitable and transparent way." FOR THE FULL STORY EVERY MONTH, SUBSCRIBE TO ENVIRONMENTAL FINANCE, OR CONTACT info@environmental-finance.com FOR OUR BACK ISSUES SERVICE