Renewables Obligation (Amendment) Order 2021
(Limited Text - Ministerial Extracts only)
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Lord Callanan
That the draft Order laid before the House on 3 February be approved.
The Parliamentary Under-Secretary of State, Department for Business, Energy and Industrial Strategy (Lord Callanan) (Con)
My Lords, this draft instrument relates to the renewables obligation renewable electricity support scheme. The renewables obligation was introduced in 2002 to provide a subsidy for electricity generation from renewable sources. It covers onshore and offshore wind, solar, hydro, biomass et cetera. The scheme is now closed to new applications, although support for existing stations continues. The scheme closes finally in 2037.
The scheme was part of a programme of measures aimed at stimulating the renewables industry to enable ambitious climate change targets to be met. Without subsidy, the nascent renewables sector would have struggled to make headway in a market dominated by the established heavyweights of coal, gas and nuclear. The renewables obligation had an initial target of 10% renewable electricity by 2010, but today around 30% of the electricity supplied in the UK is supported under the scheme.
Of course, the scheme needs to be paid for, and this falls upon electricity suppliers. They currently provide almost £6.5 billion of subsidy per year to renewable generators. These costs are then passed on to their customers via their bills, adding about £70 per year to the average domestic electricity bill. Costs will fall from 2027 as generators start reaching the end of their period of support and then exit the scheme.
The draft SI deals with a technical matter, which relates to supplier payment default. More specifically, it aims to prevent electricity suppliers being unduly exposed to the unpaid bills of competitors who fail to meet their obligations. The renewables obligation actually comprises three separate but interlinked schemes: the renewables obligation covering England and Wales, the renewables obligation Scotland, and the Northern Ireland renewables obligation. The Scottish and Northern Irish Governments are responsible for their own schemes. The UK Government cover the England and Wales scheme; the matter under debate today therefore applies only to England and Wales.
The renewables obligation is a traded scheme. It places an obligation on electricity suppliers to obtain a certain number of green renewables obligation certificates in proportion to the amount of electricity they supply to their customers. Certificates are issued to renewable generators, for free, by Ofgem in relation to the amount of renewable electricity they generate. Suppliers typically buy these certificates, providing generators with an income stream over and above electricity sales revenues. Certificates are usually in short supply, so suppliers may make a cash payment, called a “buy-out” payment, in lieu of each certificate. The buy-out price is about £50 per certificate for the current renewables obligation year, and about 10% of the scheme is met this way. At the end of the scheme year, the cash fund is recycled back to those suppliers who met their obligation with certificates. This gives certificates additional value over and above the original buy-out price.
In recent years, an increasing number of suppliers have defaulted on their obligations under the scheme. Payment default leaves a shortfall in the cash fund, meaning that recycle payments are lower than they would otherwise have been. This lowers the value of certificates, which ultimately impacts generators’ returns. The scheme therefore features a “mutualisation” mechanism, which offers protection against payment default. Under the mechanism, shortfalls in the cash fund are recovered from all other suppliers and recycled back to those suppliers who met their obligation with certificates. However, the mechanism is triggered only when the shortfall exceeds a £15.4 million threshold. Mutualisation has been triggered in each of the past three years. In total, £173 million has been mutualised across suppliers in England and Wales. Electricity suppliers and their customers are therefore unhappy about the situation.
In December 2020, the Government consulted on a proposal to amend the mutualisation threshold so that mutualisation would be less easily triggered. It was proposed that the £15.4 million threshold should be replaced with a new threshold, calculated annually as 1% of the cost of the scheme. This 1% is broadly equivalent to the arrangements that were in place when mutualisation was first introduced into the scheme in 2005. Since then, the threshold has been gradually eroded in relative terms; it is now equivalent to just 0.25% of the scheme costs. This means that mutualisation can now be more easily triggered. In other words, the risk associated with supplier payment default has become increasingly tilted away from generators and towards other suppliers.
Our proposal and draft SI seek to redress the balance of risk. In the first year, the threshold will rise to about £62 million. This will ensure that suppliers and their customers are not unduly exposed to the unmet renewables obligation bills of other suppliers. Generators will face an increased risk that unmet obligations will remain unrecovered. This will have a small impact on the value of certificates. However, the new level of risk is broadly equivalent to where it was originally in 2005. In this respect, the SI can be considered restorative.
This draft instrument makes minor technical changes to the Renewables Obligation Order 2015 so that a fixed £15.4 million threshold is replaced with a threshold calculated on an annual basis. As I said earlier, the new threshold is determined as 1% of the forecast scheme cost for the year ahead. It also places a new requirement on the scheme’s administrator—in this case, Ofgem—to calculate and publish the threshold ahead of each obligation year.
In conclusion, the emergence of payment default and cost mutualisation under the renewables obligation is of increasing concern to electricity suppliers. Through no fault of their own, electricity suppliers have become increasingly exposed to the unmet obligations of their competitors, whereas renewables generators have seen their returns increasingly protected. The draft instrument will restore the original balance of risk between generators and suppliers. It will make it harder for mutualisation to be triggered, so suppliers will be less likely to be exposed to the unmet obligations of other suppliers. This is, of course, good news for consumers; they should benefit because the likelihood of mutualisation costs being passed on to them will be lower.
These legislative changes need to be effective on 1 April to enable them to take effect in respect of the next renewables obligation year, which runs from April 2021 to March 2022. Consequently, and subject to the will of Parliament, this draft instrument will enter into force on 31 March 2021. With that, I commend this order to the House.
Lord Callanan (Con)
My Lords, I thank everyone who contributed to this short debate. I feel as though I should apologise to the House for what has turned out to be something of an ex-MEP fest in terms of the contributions made. I will try the patience of other Members a little longer because it is, of course, a particular personal pleasure to respond to this debate and welcome the excellent maiden speech of my good friend and former ex-colleague—now my colleague again —my noble friend Lord Kamall. I have known him for 16 years. We worked together in the European Parliament. I think the House knows from his excellent, well thought-through, intellectual and witty contribution —I particularly liked the remark about bus drivers—that we will have lots of further excellent speeches from him in the months and years to come, and can look forward to his contributions to our debates, delivered with his usual panache and good humour.
I was going to make a number of other points but, as usual, my noble friend Lord Hannan has stolen all my best lines. One thing that my noble friend Lord Kamall always did when we had the pleasure of serving together in the European Parliament was continue my education because, as a proud Muslim, he is a great exponent of the role that early Islam played in the development of free markets. He is passionate in his belief in and support of that. The other thing that I found particularly ironic and amusing in this House is that, as a proud Muslim, he made his maiden speech from the Benches normally occupied by the Church of England Bishops. He should continue with his challenging behaviour in the months and years to come but, in the meantime, I welcome him and thank him for his remarks. I am sure that the House will continue to benefit from his wisdom in future.
Moving on to the real subject of the debate, I welcome the support of those noble Lords who recognise that the draft SI will ensure that electricity suppliers—and, by association, their customers—are not unduly exposed to the unmet obligations of other suppliers. However, I want to address the concerns of the noble Lord, Lord Moynihan, and others—both in this House and elsewhere—about the impact of this draft SI on renewable electricity generators that are supported under the RO scheme.
The Government are conscious that, under the draft SI, an amount equivalent to 1% of scheme costs could remain unrecovered in the event of supplier payment default. In real terms, this represents an increase from the current £15.4 million to around £62 million in the first instance. On a per-certificate basis, this is equivalent to an increase from around 14p to 55p; bear in mind that, notionally, the value of a certificate is currently around £55.
There is therefore no avoiding the fact that generators will face an increase in the amount of recycle payments that are at risk in the event of supplier payment default. However, let me reiterate for the benefit of the House that the draft SI is restorative. By this, I mean that it restores arrangements that were introduced in 2005 and which have since become eroded to the detriment of suppliers. In this respect, what is proposed here is nothing new.
The Government remain committed to ensuring the RO runs smoothly and continues to provide renewable generators with the level of support they have come to reasonably expect. The Government are also mindful of the impact that mutualisation costs can have on electricity suppliers, whose margins are particularly squeezed, and are equally to committed to ensuring that both they and the customers continue to receive a fair deal. It is the Government’s view that this draft SI strikes a balance between these needs.
I am dealing with the individual queries raised by my noble friends Lord Moynihan and Lord Kirkhope, who asked about the impact on generators. As I said, there is a potential small impact on generator returns under the proposed new arrangement, as it increases the sum that might remain unrecovered in the event of supplier payment default. But we are of the view that the benefits for suppliers and their customers of proceeding with this SI outweigh the costs.
My noble friend Lord Moynihan also mentioned the views of Citizens Advice. Our intention is to consult further about the guarantee on liabilities. It is our intention to consult further in the next few months on measures that could be introduced to tackle the perceived underlying causes of mutualisation. This would consider both regulatory-based approaches, which would, for example, require suppliers to post guarantees of security, and legislative-based approaches, which would, for example, require more frequent settlement by suppliers.
My noble friend Lord Kirkhope asked whether Ofgem does an annual report. The answer is yes; it always has and always will. He also asked whether we were taking action too late—perish the thought. We took action in 2018, when it was clear this was not an isolated incident, and Ofgem has recently launched a licensing review.
My noble friend Lady McIntosh asked about suppliers exiting the retail market and what the SI does for consumers. It is a fact of life in the market that, from time to time, suppliers in a competitive retail market will fail, and when suppliers exit the market, for whatever reason, without paying their renewables obligation, a payment shortfall will occur, and this may result in mutualisation being triggered. The SI we are considering today does not address the causes of supplier failure and payment defaults. However, separate action is being taken to tackle those issues. As I mentioned, Ofgem’s supplier licensing review is seeking to minimise the likelihood and impact of disorderly supplier failure.
My noble friend Lady McIntosh also asked about the impact on consumers and business users. I reassure her that the SI is good news for consumers and business users alike, as it will lessen the likelihood of mutualisation occurring, which reduces the cost risks that suppliers are exposed to, and we expect that this will reflect in a small reduction in their electricity tariffs.
The noble Lord, Lord Grantchester, asked where the figures came from and whether the SI would prevent mutualisation. The sums at risk are percentages, some of which I quoted, of the cost of the scheme. There are of course no guarantees the new threshold will not be exceeded, but we think it is much less likely under the new provisions.
Finally, the noble Baroness, Lady Bowles, asked about the additional generator costs. Generators must absorb the additional costs should mutualisation be triggered. But we think it is less likely. The SI restores the arrangements that unintentionally have been eroded over the years, tilting the risk back towards the suppliers.
With that, I think I am done with most of the queries I was asked. Therefore, I commend this draft order to the House.