Renewable redistribution

It was a miserable budget. Lots of people got screwed. The main ones will be picked up by the commentariat. Let me add to that list a group who many might imagine had done quite well: renewable developers.

But didn't Darling throw lots of money at renewables?

Well, sort of.

The headline was £525 million "uplift in support for offshore wind investments" that "is expected to support £9 billion of investment and power up to 2.8 million homes". Pretty generous, right?

The way this money will be delivered is by "banding up" offshore wind under the Renewables Obligation (RO). Therein lies the rub.

[IF YOU ARE HAPPY JUST TO TAKE THE TECHNICAL DETAILS AS READ OR ALREADY UNDERSTAND THE RO, YOU CAN SKIP THE NEXT 3 PARAGRAPHS:

As a quick recap, the RO places an obligation on electricity suppliers to buy a proportion of their electricity from renewable sources. Renewable generators are given RO Certificates (ROCs) for each MWh that they produce, and sell these ROCs to suppliers to use as evidence that they have met their obligation. The suppliers have to "buy out" that proportion of their obligation that they have not met by buying ROCs, at an index-linked "buy-out price", originally £30/MWh and now around £37/MWh. This buy-out money goes into a pot and is "recycled" to the energy suppliers in proportion to the amount of renewable electricity they have bought. That means that a MWh of renewable electricity is worth not just the avoided buy-out price (£37/MWh), but also the share of the recycled pot that it entitles the electricity supplier to claim. The recycled value is a proportion of the buy-out price, inversely proportional to the combined "compliance level" of all the suppliers. If the suppliers between them meet 60% of their obligation (i.e. the compliance level is 60%), the recycled value is (100 - 60)/60 times the buy-out price (£37/MWh): £24.67/MWh. If the compliance level is only 40%, the recycled value is (100 - 40)/40 times the buy-out price: £55.50/MWh. The value of the RO to generators is the buy-out value plus the recycled value, which can be a significant part of the whole. Generators also get other values, such as the wholesale value of their electricity, which is currently around £50/MWh. The combined value is pretty generous. The cost of this mechanism is borne by the customers of the electricity suppliers. The total cost is calculated by multiplying the buy-out price by the number of MWh that suppliers are obliged to buy (the Obligation level), regardless of how much they actually buy (the compliance level).

When the RO was introduced, it was deliberately technology-neutral. A MWh from a wind turbine was assumed to have the same value as a MWh from a biomass generator. That, you might think, is logical. However, the Government decided that it didn't like the mix of renewables this was delivering, and that they knew what was better for us. So they decided to change the mechanism to pick technological winners. They wanted more offshore wind, because the VILE companies had persuaded them that only wind could deliver their targets, but onshore wind was unpopular. So offshore wind was "banded up" to receive 1.5 ROCs for each MWh that it produced. They didn't like landfill gas (LFG), even though this provided more of our renewable electricity than any other technology, so it was "banded down" to 0.25 ROCs/MWh. In other words, henceforth, a MWh of offshore-wind electricity was considered to contribute 6 times more to the climate-change battle than a MWh of LFG electricity, even though a MWh of LFG displaces significantly more carbon than a MWh of offshore-wind. In total 5 bands were created, from 0.25 ROCs/MWh to 2 ROCs/MWh, with the most economic technologies getting least and the least economic technologies getting most. The upshot, inevitably, is that we will get more of the expensive technologies and less of the cheap technologies than we would have without banding.

Banding significantly complicates the calculation of compliance, because it's no longer a question of comparing the number of MWh the suppliers should have bought with the number of MWh they actually bought. Now, the number of ROCs may not match the number of MWh. In fact, it is bound not to match, because the multiple-ROC technologies are encouraged and the partial-ROC technologies are discouraged, so you will end up with more ROCs than MWh. As compliance is now assessed by comparing number of ROCs bought with the number of MWh that should have been generated, this increases compliance, and therefore reduces the value of each ROC. The more you skew the balance in favour of multiple-ROC technologies, the more you devalue ROCs. You don't change the cost to customers (because buy-out price and obligation level remain the same), but you reduce the value to generators. If your technology gets multiple ROCs, that more than compensates for the reduction in value of a ROC, but all those that get 1 ROC/MWh or less (i.e. all the cheaper, more efficient, more competitive technologies) lose out. And if you further increase compliance levels by changes to the banding system, you further devalue ROCs, which reduces the amount that each renewable project will receive for its output. ]

Hopefully, the reason for this rather technical excursion is now clear. By banding offshore wind up (from 1.5 ROCs/MWh to 2 ROCs/MWh), the Government has not contributed a single penny more to renewables. That is arguably a good thing in the current (or indeed any) climate, but they shouldn't get away with claiming they have found £525 million for renewables.

More important is where that £525 million does come from. If it doesn't come from taxpayers, electricity customers or electricity suppliers, where does it come from? Answer: other renewable generators. What the Government has very generously done is devalued ROCs so that all the other renewable technologies will get £525 million less than they would have expected, so that offshore wind can have £525 million more.

The offshore wind developers are mostly the VILE companies, with the odd billion-dollar Middle-Eastern fund thrown in. -This is redistribution from independent generators to the Government's corporate friends.-

Note, this isn't just taking from the mature technologies (which some people might think ought to be willing to take a cut in order to support less "advanced" technologies, forgetting that the banding has already done this). Technologies were supposedly banded according to "need" (because, in the Government's cloud-cuckoo land, all projects of a technology have the same economics regardless of circumstance, and we ought to be paid according to what we need, not what we contribute; but those are other stories). The Government calculated what multiple of ROCs each technology would "need" based on assumptions about ROC values, which were based on assumptions of compliance levels, which were based on assumptions of the amount of ROCs to be contributed by each technology in each band. The implication of putting an immature technology in a high band was that it "needed" that value to be developed (in fact, most of the technologies in the top band were calculated to need more than 2 ROCs/MWh, but the Government must have been hoping that the efficiency fairy would come and sprinkle some magic dust and make them viable without paying what they needed to be developed). By proposing these changes, the Government is effectively saying that it is happy to reduce the amount that all other technologies will get, some of them below the amount that they calculated they would need, in order that they can throw more money at their favourite.

It's not as though offshore wind had done badly in the rent-seeking stakes so far anyway. 1.5 ROCs/MWh (6 times more than landfill gas) plus the wholesale value of the electricity, plus exemption from the Climate-Change Levy, and a few other bits and pieces meant that current offshore schemes should be worth around £120/MWh, more than double the value of conventional power. If what we get for this support is carbon-"savings" (there isn't much security benefit from a technology that is intermittent, unpredictable and impossible to protect from attack), this values the carbon-"savings" at over £200/tonne (even ignoring the carbon-impact of the standby fossil-fired generation). That compares with £35/tonne for LFG, which is pretty reliable and diverse and therefore offers a material security benefit. And on top of this, they've had oodles of grant-funding (3 rounds approved before they had even demonstrated the viability of the first round) and support to "socialize" (i.e. pass on to others) the cost of the network improvements that are needed to connect them.

But what about that £9 billion of investment that this will supposedly deliver? Won't that provide a huge boost to our economy and our green manufacturing industry?

Firstly, we won't be using British technology. There aren't any credible British manufacturers of offshore turbines. Some ancillary industries (e.g. sea-floor cable-laying) will get a boost, but it's only a fraction of the total, and a boost that is likely to go as quickly as it came, because this banding-up is limited to projects whose funding is committed within a narrow timeframe.

Anyway, every developed country in the world is claiming that it is going to base its recovery on becoming world leader in green technologies. This sort of industrial policy is fantasy. What matters is what it delivers now, not some dream of industrial superiority in technologies in which we are already well behind.

That £525 million from the Government and £9 billion from investors is apparently safeguarding 1300 MW of capacity that otherwise might not have been built (we'll come to the reliability of that claim later, but let's take it at face value for now). That's around £7,300/kW. Mature renewables typically cost £500-1000/kW and immature but promising technologies around £1500-3000/kW. So what this is safeguarding is a completely bonkers investment that is highly unlikely to be replicated anywhere else.

Measuring the investment against capacity is kind. What people use and pay for is energy, not capacity. Capacity standing idle is worthless. By comparison with the energy that is likely to be produced, this looks even more insane.  That 1300 MW may produce around 91,000,000 MWh over a 20-year lifespan (making some charitable assumptions). That's around £100 of capital cost for each MWh generated, even before we start thinking about operating costs, etc. By contrast, mature thermal renewables like LFG or biomass combustion would produce twice as much power per MW, and cost a fraction of the capital cost per MW to build, producing a capital cost per MWh of around £4-25/MWh over a 20-year lifespan. These technologies would have significant R&M and fuel costs, but we don't yet know what offshore wind's R&M costs will be over the lifespan of a project, given the harsh conditions in which it operates.

That £9 billion isn't boosting the economy, it's pouring money down the drain. Ultimately, it's our money being poured down the drain, because the investors will only spend it if they believe they can get it back, and they certainly won't be getting it back from the wholesale value of the electricity.

The justification sometimes given for throwing money at offshore wind and other uncompetitive technologies is that it will help to "drive it down the learning curve", at which point it will become economic and the initial investment will be justified.

Unfortunately, we seem to be travelling the wrong way up the learning curve. Already in 2006, I was writing that offshore wind seemed to be getting more expensive. A 2001 report for No.10's Performance and Innovation Unit (PIU) estimated the cost at £20-30/MWh. A 2002 report for the Government's Interdepartmental Analysts' Group came up with the same figures. A report prepared by Oxera for the 2003 Energy White Paper increased the estimate significantly to £60-76/MWh (for 2005), but also predicted that by 2010 it would have fallen to £44-55/MWh, £39-49/MWh by 2015 and £30-46/MWh by 2020. The Royal Academy of Engineering in 2004 came out with a similar figure of £55/MWh. By 2007, a report prepared by Ernst & Young for the consultation on the Reform of the Renewables Obligation (which eventually led to the banding modification) was estimating medium levelised costs of £91/MWh, and predicting that there would be very modest progression down the "learning curve" (6.5% cost-reduction by 2020). Now it seems that costs are much higher still.

A similar trend can be seen for historical and projected capital costs, which started at around £1,000/kW, were expected to fall below that, but actually started rising from the earliest commercial projects, and now appear (from the figures claimed by the Government) to be an order of magnitude higher. At what point of travelling the wrong way along the learning curve of a technology that gets progressively more expensive do you abandon the pretence that excessive support is justified by supposed future competitiveness?

A number of factors are combining to produce this effect. Learning curves appear mainly to be teaching that the technology is more expensive than expected, and the more we learn, the more expensive it turns out to be. Policy competition and resulting global demand has driven up the capital costs, but that hardly justifies making the situation worse, and throwing money down the drain to buy the equipment when it is most expensive. And very significantly, the cherry-picking effect (where the early projects pick the best sites and later projects have to put up with progressively less suitable locations) is important for a technology where total costs are heavily dependent on capital costs, and capital costs are heavily dependent on site location and conditions. This much is now obvious. But if we know that, why are we chasing this mirage? This isn't the basis of a green industrial revolution. It is the basis of another massive, typically-British, government-sponsored, technological white-elephant, as successor to our nuclear programme, and close cousin to Concorde.

If this is so obviously stupid and unjustifiable, how come the Government are proposing this and promoting it as a good thing?

It's a classic combination of professional rent-seeking by the corporations who stand to benefit, and naivety to the point of gullibility on the part of the Government. The VILE companies who will develop these schemes, and the finance houses who will fund them, had been running an escalating campaign in the period leading up to the introduction of the banding reforms to the RO and today's budget, whingeing that their projects might not get developed if lots more money were not thrown at them. The Government bought it hook line and sinker, and probably really do think that they have rescued these projects, and that they ought to get credit for doing so. Having been persuaded some time ago to pick offshore wind as a winner (on the basis that it was cheap, plentiful and politically painless), they have probably not asked themselves whether these projects ought to be rescued. Offshore wind is vital in their eyes, even if all the reasons that were used to persuade them of that in the first place have been turned on their head. 

This isn't the first time we've seen this. This government's energy policy is near enough written by the corporates. The effect is corrosive. The Government may or may not have safeguarded 1300 MW of offshore wind (the projects may well have gone head without the success of this rent-seeking campaign, and conversely, they may yet hit more bad financial news). But each time they manipulate their own systems to "improve the outcome" (and it is almost every year), they stick another nail in the coffin of industry confidence. No one in the industry will now believe that they will not manipulate the system again. And if you don't believe that, you can't make projections of future value on which you are prepared to rely. And if you can't do that, you find it difficult to justify investment.

Trust was already so low that, in the consultation on the banding reform, the Government went to great lengths to reassure the industry that the provisions for reviewing and changing the bands (which everyone could see were a threat to stability and an opportunity for arbitrary changes) would be used sparingly and infrequently. The Order that implemented banding only took effect at the start of this month, and already we have the first review announced, with the outcome already assumed in Darling's budget announcements. There is no trust left to lose. But there is plenty of investment to deter. I wonder why the UK has done so much worse on renewables than countries with more principled governments, like Sweden and Denmark?

My anger at this corrupt, incompetent, gullible government is only heightened by comparing the way that they rush to hand their corporate friends whatever they ask for as quickly as possible, with the languor and indifference with which they treat sectors, such as green heat, in which their corporate buddies are less interested, despite the fact that these sectors offer a very much better bang for the buck (energy- and carbon-wise). And the frustration is increased by the knowledge that the opposition parties are no better: proposing just as ridiculous, micro-managing, winner-picking energy policies, and just as keen to cozy up with the corporates. But those are separate stories, for separate posts.