The UK Department of Energy & Climate Change (DECC) published new “strike prices” for renewable energy on 4 December, claiming these will lead to additional investment of £40 billion in renewable electricity generation up to 2020. But according to Michael Knowles, Member of the Institution of Mechanical Engineers, the support scheme is too generous for suppliers and DECC should do much more to drive costs of renewables down.
In the UK there is a heated political debate going on about energy prices. Critics say the UK’s ambitious climate targets and renewable energy subsidies are driving up prices. At the same time, with old coal-fired power plants having to close and domestic gas production declining, the government has little choice but to attract investment in renewable energy. It has done so over the last 11 years via the Renewables Obligation (RO) and before that through the Non- fossil Fuel Obligation (NFFO) borne out of the Nuclear Obligation of the 1980s.
The UK Government is now trying to attract a broader range of low carbon power generation via the Electricity Market Reform (EMR) with Contracts for Differences (CfDs) based on strike prices for renewable electricity. For nuclear electricity it has set a strike price through the recently announced contract with EDF Energy, the UK subsidiary of the French electricity giant EDF, for building two new nuclear reactors at Hinkley Point C.
The EMR strike prices offer even more generous support to producers than the latest values of subsidy set under the RO, although the latter last for 20 years and the former for a shorter 15 year period. The EDF contract lasts for 35 years but there is no upfront payment by consumers until the plant has been built in 10 years’ time, according to Vincent de Rivaz, the CEO of EDF Energy.
Energy and Climate Change Secretary Edward Davey said on 4 December, when the 15-year guaranteed prices for producers of renewable electricity were announced: “Our reforms are succeeding in attracting investors from around the world so Britain can replace our ageing power stations and keep the lights on. Investors are queuing up to express their interest in these contracts. This shows that we are providing the certainty they need, our reforms are working and we are delivering ahead of schedule and to plan.”
Investors are well aware that the UK government is desperate to attract investment in new energy production so naturally demand as high a rate of return as they can get
According to DECC, “there is currently over 20GW (of which 2GW already in 1998) of renewables capacity operational in the UK – a figure that could double by 2020 as a result of the Government’s reforms.”. The amount of electricity generated from renewables will grow from 15 per cent to over 30 per cent by 2020, DECC expects. In offshore wind, DECC says that deployment of 10 GW by 2020 is “achievable”. Another 20 GW is quite a lot to expect in the next 7 years when it has taken 11 years to achieve 18GW!
Carbon price floor
The question is, though, whether UK energy consumers are not paying far too high a price for the renewable energy they are getting. Investors are well aware that the UK government is desperate to attract investment in new energy production so naturally demand as high a rate of return as they can get. Developers/financiers were reported recently to have turned down a Government proposal to share cost reductions under contracts for differences (CFDs). The Government is ‘over a barrel’ as some commentators have said.
Let’s take a look at what this means in practice. In July 2012, DECC “re-banded” the old RO (Renewable Obligations) scheme, under which suppliers had to meet renewable energy obligations by presenting Renewables Obligation Certificates (ROCs) to regulator OFGEM, reducing subsidies by 10% in the process. However, this reduction in subsidies was more than offset by the introduction of a Carbon Price Floor (CPF). The CPF is a carbon tax set by HM Treasury that DECC agrees will add £11/MWh to the wholesale cost of generation by 2020. The Institution of Mechanical Engineers (IMechE) estimates it will be £12/MWh. Since the wholesale cost is added tothe RO cost, this will give in excess of £500 million a year windfall to the RO generators up to 2037. Some commentators, such as the Renewable Energy Foundation, put it even higher.
Then there is the strike price for onshore wind, by far the most economic route to more renewable energy production (other than co-firing biomass on coal-fired power stations such as at Drax and Eggborough). This has been set at £95/MWh in the new scheme (to be lowered to £90 for new projects from 2017 onward). This compares to a price of £86/MWh under the old RO scheme that closes in 2017. Although the subsidy period has been reduced from 20 to 15 years, right now the consumer is facing higher costs. No apparent effort has been made in the new scheme to reduce the costs of onshore wind.
For offshore wind the strike price has been set at £155/MWh for 15 years (later it will be reduced first to £150 and then to 140/MWh), when under the old Renewables Obligation (RO) it should only have cost £135/MWh for 20 years. The offshore wind industry should be doing much better than that after building 3.3 GWs of windfarms, much of which is probably already making a good return of about 12%.
Offshore cost reduction
Where has the Government’s Offshore Cost Reduction programme proposed in 2012 gone to? The DECC was aiming to reduce electricity cost to £100/MWh by 2020 on the RO subsidy route. The last report of the Offshore Cost Reduction Task Force (experienced industry practitioners), which came out in June 2012, said “producers would consider ways in which costs could be reduced, with a £100/MWh target cost of energy by 2020.” Has this now been forgotten?
There is little competition once sites are bought and strike prices set
When it comes to load factors for offshore wind turbines, very little progress appears to have been made. The DECC Digest of UK Energy Statistics 2012 gave an average of 31.67% between 2006 to 2010 when GWs increased from 0.9 to 1.34. The average from 2006 to 2012 had only increased that to 32.25% for 3 GW at 2012. So new turbines did not seem to add much increase in average annual load factors. DECC reports generally claim that a load factor of 38% is possible on average. DECC’s 2050 Pathways exercise has even made claims of 35-45% load factors.
Meanwhile, Centrica has abandoned its £2 billion planned investment in the Race offshore wind farm apparently due to even £155/MWh not being a high enough subsidy and more recently RWE has abandoned the Atlantic Array project. Centrica still seems to believe it can persuade Government to give a higher than £155/MWh subsidy.
This is symptomatic of the underlying problem of DECC’s support scheme. There is little competition once sites are bought and strike prices set. Investors seem to be demanding too high a rate of return even in an era of low interest rates with consumers having to foot the bill. At the same time, as the load factors of offshore wind turbines show, no guarantees are given on performance and no penalties applied for underperformance.
The foregoing applies not just to renewable energy, but also of course to the price offered to EDF with its captive sites for building two new nuclear reactors. EDF is getting £92.50/MWh for 35 years. We have been told by a reliable source that the Hitachi Advanced Boiling Water reactor proposed for another site, Wylfa, in North Wales, a strike price of £75/MWh should be possible.
Already in April 2011, ImechE advised the government to review the effectiveness of renewables incentives with a view to keeping costs to consumers as low as possible. To reduce the cost burden on consumers, “measures should be introduced that result in a strong element of competition in renewables and make private investments in deployment easier”, said IMechE. “This should be done alongside continued support for a range of low carbon generation technologies, including nuclear and clean coal, to encourage a balanced power generation portfolio.”
Clearly, what the current system lacks above all is healthy competition
Unfortunately, the Government has largely failed to do this with the RO scheme and now with the new Electricity Market Reform strike prices. The renewables industry is demanding even higher subsidies. The developers and financiers are calling the shots. They are helped by an EU overall renewable energy target of 15% by 2020 of which electricity generation is being asked to take the largest share, now 31%. Developers, among them the so-called Big 6 electricity producers, have captive sites, especially for offshore wind farms. So once strike prices are set, only developers and financiers benefit from driving the costs down. Note that the then-CEO of Dong Energy, Anders Eldrup, explained in an interview with European Energy Review in 2011 the strategy of his company in this way: “We are working towards an industrialisation of the sector. With one goal: to bring costs down.”
Clearly, what the current system lacks above all is healthy competition. This is admitted implicitly by DECC in its statement of 4 December, in which it says that “it is expected that the new state aid guidelines [from the European Commission] will require the UK to move to competition for more established technologies.” Under EU law, member states are allowed to subsidise “immature” technologies, but not “established” technologies. DECC expects that some of the strike prices will be judged as illegal state aid by Brussels. So much for “competition” in the UK energy sector. No wonder those investors are “queuing up to express their interest in these contracts”.
Michael Knowles was a Member of the IMechE energy and power committees variously from 1980 to 2006. After 50+ years of experience in the UK energy industry, including as Energy Sales and Marketing Manager at Babcock, he is now as an energy consumer trying to make sure performance and cost of the UK’s electricity system is giving more value to UK taxpayers for the £110 billion investment. Michael is co-author with Robert Beith, FIMechE, of the publications listed below.
(1) IMechE Energy Policy Statement 11/02 – UK Electricity Generation – Cost effective management http://www.imeche.org/docs/default-source/public-affairs/IMechE_Electricity_Generation_PS_Feb_2012.pdf?sfvrsn=0 April 2011
(2) IMechE response to DECC consultation on RO banding levels for 2013 to 2017 http://www.imeche.org/docs/default-source/public-affairs/3236-consultation-ro-banding-response-form.doc?sfvrsn=0 19 January 2012
(3) IMechE Response to DECC consultation on the draft Electricity Market Reform Delivery Plan September 25th 2013 ——–not published yet ———