Despite the fact that an increasing proportion of electricity is being generated from cheap renewable energy, electricity bills are still surging upwards to follow the huge increase in natural gas prices. In fact some wind and solar schemes are in fact saving consumers quite a lot of money. But the reason that renewable generation is not saving a hell of lot more for consumers is that the large majority of currently operating wind power has been funded under the inefficient ‘Renewables Obligation’ (RO). This is a so-called market-based mechanism established under New Labour. To give New Labour its due, it was very good at setting the UK on course for the volume of renewable generation we have today, but its so-called market-based energy policy has not aged well.
The RO was always an expensive mechanism to fund renewables, and it has been superseded as a means of funding new wind and solar schemes since 2017 by the ‘contracts for difference’ (CfD) style of feed in tariffs. Under the RO generators are paid a renewable energy incentive as well as the wholesale market price, the wholesale price being the price that gas power station operators will receive. On the other hand, under the feed-in tariff system the prices that renewable generators will receive are set in advance.
But now the effectiveness of the RO (from an electricity consumer point of view) has plunged to a new low because of the fact that returns to the project operators are decided by the wholesale market price for electricity, which as we know, has gone sky-high because of global gas market prices. Indeed in the last quarter of 2021 wholesale electricity prices have been well over 3 times as high as what they were before the covid era.
As you can learn from economists the electricity market is run on the basis of ‘marginal cost pricing’, which means that prices are set by the most expensive energy generation option at any one time. But, hang on, even so, if renewable energy incentive systems are designed properly, as with the CfD system, where generators are guaranteed a fixed price but no more, at least renewable generation should be reducing consumer electricity prices by quite large amounts. The fact that only small price reductions are being produced this way is because renewable energy financing is dominated by the grossly inefficient RO.
According to a blog published by the Low Carbon Contracts Company (LCCC) which administers the CfD schemes for the Government, an estimated £468 million has been saved for the electricity consumer in the final quarter of 2021. They say: ‘With more CfD generation capacity in the pipeline, which has lower strike prices, the effect of the CfD payment mechanism will increase proportionally, contributing towards stabilising the costs of the electricity system and making energy bills more affordable for end-consumers’. Energy Flux has highlighted this trend. You can read their account HERE.
But how did we end up with such a bad (RO) system that, instead of saving consumers money through cheaper renewables, is paying out to the mainly big electricity companies who own renewable energy schemes. The answer boils down to ideology and interest group politics. When the RO was set up in 2002 policymaking was dominated by Blairite neoliberal welfare politics which said that it was good to deliver social and environmental goals, but that it should be done by something that looked like market means.
The idea of setting defined guaranteed renewable generation prices, through what was known in Germany and Denmark as feed-in tariffs, was seen as an ideologically bad idea. Prices should be set by the market. So renewable energy generators, in effect, got an incentive to generate, but they would also be paid whatever the wholesale electricity price happened to be. That was always inefficient compared to feed-in tariffs as used in Germany, and it was abandoned eventually in favour of CfDs. But in the UK, not only was a ‘market’ method ideologically preferred when the RO was set up, but it also happened to suit the big energy companies. They could use the system to cream off some profits themselves to compensate for lost revenues from fossil fuel generation. They could not do this so easily under a feed-in tariff system.
But meanwhile a lot of damage had been done. The RO was very successful in the way that it increased the volume of renewables from virtually nothing to 20 per cent of UK electricity generation in a few years, but it was inefficient since it often paid the generators more than they would have needed had their generation prices been fixed in advance. This defect has now become absurd in current circumstances.
But can anything be done to improve this situation? The Government could introduce legislation which ‘fixed’ the amount payable in wholesale power price payments to renewable generators funded under the RO so that, in addition to the remuneration from their renewable obligation certificates (now worth about £50 per MWh) they received, say £50 per MWh as a payment of the wholesale cost. That would result in considerable savings to the consumer under present power price conditions and also give a good return to the renewable generators.
It would also help widen the ownership base of wind power if smaller schemes were funded through a simpler ‘feed-in tariff’ system compared to the CfD that is only used currently. Smaller schemes cannot trade very easily on the wholesale power market meaning that they cannot compete with bigger schemes for the CfDs (which require wholesale market trading) whatever price they bid.