Banding of the renewables obligation
The Department of Tade & Industry (DTI) is currently consulting on important proposals to radically alter the Renewables Obligation.
The consultation is split into two parts, the second of which we considered in our note of 16 October. In this note we will consider the Part 1 proposals, which the Government intends to implement with effect from 1 April 2009.
The Part 1 proposals are concerned with the "banding" of the obligation, the long-term role to be played by co-firing, and the manner in which future obligation levels will be set.
Banding - the policy
Hitherto, the Renewables Obligation has been technology neutral. Provided a megawatt hour of electricity had been generated from an eligible renewable source, it would be eligible for one Renewables Obligation Certificates (ROC).
Some technologies (for example large-scale hydro) were not considered to be eligible renewable sources. Some technologies were handicapped in other ways (for example the cap on co-fired ROCs), but all eligible renewable sources were entitled to one ROC per megawatt hour of generation. However, as became apparent during the 2005/6 Renewables Obligation Review, the Government has become concerned that the Renewables Obligation offers too much assistance to certain established technologies and too little to emerging technologies.
The DTI therefore proposes that, in the future, certain technologies will receive more than one ROC per megawatt hour of generation, while others will receive less than one ROC per megawatt hour.
If the neutral approach to technology is to be abandoned, the DTI's multiple-ROC approach appears the most sensible way of preserving (in so far as possible) the current structure of the Renewables Obligation.
An alternative would have been to provide for separate obligations for different technologies, as the Scottish Executive has recently proposed in order to provide additional support to marine projects. The Scottish Executive intends to operate the additional marine obligation for at least the period until UK-wide banding is introduced.
Banding - grandfathering
The Government has again stressed that any projects which become operational prior to 1 April 2009 will be entitled to at least one ROC per megawatt hour of generation. Projects utilising technologies which become eligible for more than one ROC will all be entitled to more than one ROC - regardless of when they became operational - existing projects will never be worse off than they are now.
The DTI goes on to suggest that this principle will be applied going forward. So, in the event of a reduction in the number of ROCs for which a particular technology is eligible, the change will only apply to projects that are not operational at the time of that change.
However, a caveat is added - emerging technologies that have received a Government grant based on a particular ROC eligibility, would not be entitled to an increased ROC eligibility unless the operator repaid the grant. This will obviously be of significance in the case of the offshore wind projects already developed or currently under development.
The consultation seeks views on whether first operation is the most appropriate assessment point, and mentions start of construction or planning as alternatives. However, first operation seems the most robust choice - though thought will still need to be given as to exactly what constitutes operation.
Banding - frequency of band setting
With a cut-off at the point of first operation in mind, it is clearly important that adjustments to the banding are signalled sufficiently far in advance to enable developers to adjust their investment decisions accordingly. Those who are two weeks from first operation do not wish to be told that the eligibility rules are changing in a week's time.
The DTI recognises that it needs to create a stable and predictable system, and that it will be important to avoid the bands changing too often.
It mentions a possible limit of not more than once in every three-year period. But, it does not mention any minimum period of prior warning that would have to be given in advance of a change being made. This should be given further thought. The consultation paper also questions whether there should be an ability to alter the bands in "extreme" cases, in order to ensure the bands are set at an appropriate level.
Banding - setting the bands
As the Government recognises, determining the appropriate level of the bands will be the critical factor in ensuring the success of a banded obligation.
Developers, investors and suppliers can currently take a view on how close we will be to reaching (for example) the target of 12.4 per cent by 2012. Given that the figure of 12.4 appears on the face of the Order they can take some comfort that the figure is unlikely to change in the interim. The view they reach, and the resulting forecast of ROC prices they form, will be a determining factor in the decisions they make regarding renewables projects.
However, in providing that (for example) landfill gas will receive less than one ROC per megawatt hour of generation, while (for example) offshore wind will receive more than one ROC per megawatt hour of generation, the Government is clearly altering the balance of the obligation.
Such an alteration will either result in there being more or less ROCs available in the market than would otherwise have been the case - either way investment decisions previously made will need to be reviewed, and the position of existing projects will (despite grandfathering) be altered in some way.
The Government recognises the need to avoid what it terms "banding up" (creating additional ROCs) and "banding down" (creating a reduced supply of ROCs). The fact that the Government recognises the problem is one thing; avoiding it is quite another.
The long-term role of co-firing
Interim changes are due to be made, with effect from 1 April 2007, to the manner in which co-fired ROCs are treated. These interim proposals are explored in our note of 16 October. The Government considers that co-firing does have a longterm role to play in reducing carbon emissions, but that it does not need the full support of the Renewables Obligation. The DTI therefore proposes to apply a band to co-firing that would make co-fired generators eligible for less than one ROC per megawatt hour of generation. The DTI further proposes that (unlike other bands) no grandfathering would apply to co-fired generators.
The fraction of a ROC for which a co-fired generator is eligible from time to time would therefore apply to all co-fired generators, regardless of when they began first operation. The DTI does, however, question whether there should be more than one band for co-fired generators, with a slightly higher band applying where the biomass element used to cofire comprises energy crops.
Future obligation levels
The consultation paper explores the possibility of introducing a "guaranteed headroom" into the obligation. If introduced, the Government would (rather than, as is currently the case, setting a fixed level a number of years in advance - eg 12.4 per cent in 2012) set the level by reference to estimated generation.
Each year, the DTI would, estimate the likely level of eligible generation in the following obligation period, and, where necessary, increase the level of the obligation to ensure it was at least 1 per cent higher than the level of likely generation. This would help manage the cost to consumers represented by the operation of the obligation, by limiting the ROC shortfall. It would also limit, rather than remove, the possibility of over supply (the "cliff edge"). With this latter risk in mind, the Government is also considering the "ski-slope" solution - as first suggested by Institute of Legal Executives (ILEX) in a report produced on behalf of Drax.
Removing the Retail Prices Index (RPI) link
In passing, the DTI also mentions that it intends to remove the current RPI indexation of the buy-out price. From 2015/16 onwards, the buy-out price will therefore remain static. This would be a significant change, and the off-takers under longterm power purchase arrangements should look to ensure their contractual arrangements do not apply indexation to the price they pay for ROCs beyond 2015.
This alert may contain information of general interest about current legal issues, but does not give legal advice.