Who knew that the gritty business of energy security could sound so bucolic?
The thousands of projects operating under old-style renewables obligations (RO) contracts include places such as Potato Pot Farm, Sixpenny Wood and Riverview Pig Farm. Behind many rural names is corporate or international money: Sixpenny is part of the UK-listed renewables fund, Greencoat UK Wind, while Potato Pot is ultimately owned by a Malaysian power company.
But they are all bound up in the most concrete, near-term plan the government has to overhaul the UK’s power market: to negotiate with renewables producers to reduce the prices they receive, specifically with those on the RO contracts abolished in 2017.
This is a sensible first step to breaking the link between wholesale gas prices and domestic power. But it has prompted concern: why would generators voluntarily go for a long-term fixed-price contract that didn’t spread the windfall gains currently on offer from high prices over the period?
Spreading consumer pain (or industry gain) from stratospheric prices over a longer period isn’t, in and of itself, a terrible thing to do. Especially if you’re against a windfall tax, as the prime minister is. But there are reasons to think the government could and should do better.
For a start, it would be foolish for the sector to assume any windfall tax position is set in stone. Power companies this year have been able to argue that most output was sold under forward contracts struck far below market prices. That gets harder to maintain next year. The sector, sensitive of course to its social responsibilities, also says it wants to do the right thing.
The more important point is that a chunk of the market actually needs this change to happen at some point, exchanging wholesale market risk for more stable agreements. It also wants to establish the idea of price protection for existing generation, and not just new build projects.
Take old renewables projects, paid the prevailing wholesale electricity price, which typically has been between £50 and £60/MWh, plus the RO payment, of at least £50/MWh. (Leave aside nuclear, which the government may be able to renegotiate too, but works differently). As those contracts expire from this year, projects lose their stable funding base, become riskier and more expensive to finance.
Only about a tenth of overall RO generation capacity expires in the next five years. But contracts that stretch into the 2030s, about 70 per cent of capacity, have another problem.
Even before this crisis, there was concern in the sector that growth of renewables would lead to so-called cannibalisation. Renewables tend to produce all at once, notably when it’s windy. That pushes day-ahead wholesale prices lower, even as low as zero as green becomes a bigger part of the system.
SSE last year flagged the risk that market prices in the 2030s wouldn’t cover operating costs for the older offshore wind fleet, leading to closures. That outlook may have worsened given a bigger target for new offshore wind capacity of 50GW by 2030.
“As the share of renewables increases, the way the power market works tends to undermine [generators’] economics,” says Rob Gross at the independent UK Energy Research Centre, which came up with the contract switch idea in April. “So they have a strong incentive to agree to new fixed-price contracts and that could be at a price that is attractive for consumers.”
What that means depends on how the contracts are negotiated. An auction would be the best option, but seems challenging given time constraints. It is increasingly assumed that generators might retain their RO payments for administrative simplicity. Another question is how output already sold under forward contracts would be treated.
But this is one expert’s assessment, when talking about a new contract’s strike price: “If the government gets £50/MWh it has done well, at £60 it has done all right and at £70 it is getting fleeced.” An industry source said a price in the fifties was achievable, which combined with RO payments implied income not much higher than in a pre-Ukraine invasion “normal” world. Another person looking at the numbers said it could be lower still.
This is a complex negotiation, in a crisis, where the government’s starting position isn’t ideal. But it is possible, just maybe, that there is an outcome here that looks decent enough for everybody.
helen.thomas@ft.com
@helentbiz
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