ESRC ENERGY RESEARCH CONFERENCE

March 31 2003

PROJECTS AND POLICIES FOR STEP CHANGES IN THE ENERGY SYSTEM:

DEVELOPING AN AGENDA FOR SOCIAL SCIENCE RESEARCH

RENEWABLE ENERGY:

STEP CHANGE IN THEORY AND PRACTICE

Dr. Catherine Mitchell

Warwick Business School

Dir.tel: 02476 524985

With comments from Discussants

Michael Laughton and Nick Hartley

following the paper

1.Introduction

The UK has had a renewable energy research and development (R&D) programme since the 1970’s and a demonstration programme from the 1980’s. However, it was not until 1990 that a market delivery programme for renewable energy technologies was introduced – the Non Fossil Fuel Obligation (NFFO) for England and Wales[1]. In 2002, a new market delivery programme was introduced along with a higher expenditure on capital grants: the Renewables Obligation (RO) and a Scottish Renewable Obligation (SRO)[2]. So far, these mechanisms have led to renewables deployment rising by around 1% of electricity over the last twelve years.

The Government has a target of renewables supplying 10% of electricity by 2010. The recent 2003 White Paper on Energy[3] has also stated its goal of reducing carbon dioxide emissions by 60% by 2050 from 1990 levels and its aspiration of renewables supplying 20% of electricity by 2020. Thus, the Government’s goal is a step change for the energy system and envisages that over a 20 year period renewables will move from being a very marginal presence in the electricity system to one providing one fifth of electricity demand.

This paper has been asked to address the following four questions:

  • What step change contribution to the energy system could be made by renewable energy?
  • How much would this cost?
  • What are the necessary technical, social and economic (including policy) changes necessary to achieve this step change?
  • What still needs to be researched and understood to ensure that renewables can make the step change?

Authors are not expected so much to provide absolute answers but to tease out sub-questions which could provide the basis for an agenda for research. Areas which appear to need further work are raised throughout the document and brought together in the final section. This paper does not go into great detail, rather it presents references to important pieces of work or analyses which have already been undertaken. It is set out in the following way:

  1. It briefly introduces the type of renewable system we might have in 2010, 2020 and 2050.
  2. It provides a short overview of renewable energy policy in the UK.
  3. It briefly reviews the costs of meeting various renewable energy targets and compares the UK’s renewable energy policy to other countries renewable policies and deployment levels
  4. It sets out the theoretical literature on technology system transformation
  5. It attempts to link theory and practise by asking a number of key questions raised from the theory
  6. It makes recommendations for the Social Science Agenda

2.10% by 2010; 20% by 2020; 60% carbon cuts by 2050 – Timescales and Step Change

‘Step Change is here used to mean a radical increase in the rate of decarbonisation such that UK carbon emissions may be projected to fall by some 60% by 2050’[4].

The above definition for ‘step change’, which was one of the recommendations of the Royal Commission of Environmental Pollution’s Report[5], is used within this paper. The White Paper has accepted the RCEP’s recommendation.

What such a step change translates into in terms of technologies and fuels is clearly set out in Chapter 5 of the PIU’s report[6]. This paper would argue that policies currently in place are very limited compared to the changes required to meet the vision and aspirations of the White Paper. The current targets are for renewable electricity to provide 10% of electricity by 2010. Over the same period, the White Paper has announced more energy efficiency measures and combined heat and power (CHP) capacity is expected to rise with the White Paper committed to at least 10 GW of CHP by 2010. Micro CHP will increase deployment with implications for the interaction of gas and electricity networks but also the way that domestic customers interact with their energy use. In this situation, the rate of deployment of renewables will have to increase significantly (see Section 3) but although the electricity network characteristics may change somewhat, it is possible to imagine that there will be limited changes to the energy system by 2010.

In order to meet the White Paper vision[7], at least 20-30% of the electricity system needs to be supplied from renewables by 2020. Moreover, a far greater percentage of heat demand and energy for transport (ie biofuels/hydrogen) should be provided from sustainable sources, as described by the background analyses of both the White Paper and the Energy Review. This is likely to be linked to different ways of designing, managing and operating networks, markets and demand, made possible by information technologies[8]. Strbac and Jenkins describe how 10% of the electricity demand supplied from renewables could be connected to the distribution network with limited change. However, by the time 20% is reached, renewables need to be integrated in to the day to day design and operation of the electricity network[9].

In this latter situation, the proportion of sustainable technologies to fossil/nuclear generation; the type of technologies and energy sources (supply, demand, control, electricity, heat, liquid), their scale (watts to megawatts of electricity; equivalents of heat), their position (in houses or far offshore), their operational characteristics; and markets can be expected to be very different. The design and operation of such an energy system, its integration between its constituent parts and its regulation can be expected to alter as well. In this way, not only would the rate of deployment of renewables require a step change but the wider energy system itself will have had to accommodate the step change, in itself altering or transforming the energy system. This broad area – or the step change – needs to be understood in far greater detail.

Arguably, the 2050 renewable energy system as set out in the background documents to PIU and the White Paper[10] appears more likely to be an expansion of the 2020 vision: more renewable electricity supply, more heat provided from renewable sources; increasing levels of biofuels; more domestic heat and power. The big difference revolves around changes to transport technologies and fuels[11].

What changes need to be achieved in the (renewable) energy system, and by when, in order to achieve a self-sustaining energy system by 2050. Do these changes have to happen in order (ie incremental change), in which case what order, or simultaneously (holistically)[12]? What are the major constituents of this step change? Will they have to have occurred by 2010 or 2020 rather than by 2050? In other words, will, for example, economic, social and regulatory policy changes have to occur early on so that the technical changes can come through later or is step change a linear path[13]. Moreover, the UK needs to be reaching this self-sustaining path in as efficient and least total cost manner as possible. We need to understand what a least total cost path is and how we measure it. We also need to understand whether the point at which we are starting down from, the renewables obligation, capital grants and R&D, is the right one.

3.A Short Overview of Renewable Energy Policy in the UK

To be able to tell whether the UK is on the right path to achieving a step change in renewable deployment, we need to understand how renewable energy policy works in the UK[14]. This section provides a very brief description.

Renewable energy was supported in the UK since 1990 by the Non-Fossil Fuel Obligation with a target, set in 1994, to supply 3% of electricity by 2000. The NFFO was successful in bringing prices paid to renewable energy projects down rapidly but had two key problems: (1) the seeming inability to deliver deployment and (2) its separation from the electricity trading market in that generators were paid a price per kWh by regional electricity companies which were also obliged to take the generation. The remit of any delivery mechanism which followed on from the NFFO was to maintain the positive competitive and price reducing aspects of the NFFO but also to overcome the problems associated with it Thus, the two fundamental goals of the Renewable Obligation (RO) which took over from the NFFO in 2002 was:

  • to increase deployment whilst at the same time maintaining a competitive incentive to keep prices down;
  • to enable (force) renewable generators to become more integrated into the electricity market

The Operation of the RO

The Renewable Obligation is an obligation on licensed electricity suppliers to buy a certain percentage of their supply from 3% in 2002-3, rising to 10.4% for the period 2010-2011. The RO is intended to stay at the 10.4% level until 2027 – in theory, guaranteeing the obligation for 25 years, though this is dependent on continued political support throughout that period. The legal basis of the renewables obligation is set out in the Order, obligatory reading for anyone interested in the RO[15].

Compliance with the obligation is monitored by Ofgem which facilitates the system through:

  • monitoring generation output and the creation of renewable obligation certificates (ROCs[16]) from eligible projects;
  • monitoring supplier compliance (suppliers have to provide Ofgem with proof of an appropriate number of ROCs);
  • monitoring the links between ROCs and Levy Exemption Certificates (LECs) available to companies who have agreed to reduce their climate change levy by undertaking various energy efficient measures (including buying renewables).

Suppliers have to buy a certain number of ROCs each year. The ROCs could be bought directly from an eligible renewable energy generator or from another supplier. This means that the ROCs are a tradable commodity, and as such up to 25% of a supplier’s obligation can be banked for up to 1 year but they cannot be borrowed. The RO is therefore agreeably simple in principle and has a number of distinct advantages for a market-orientated Government:

  • it acts as an accounting system to verify whether the obligation has been met;
  • all suppliers are legally bound to fulfil the obligation on them, although they are able to choose to ‘buy-out’ at 3p/kWh rather than buy eligible electricity
  • the suppliers have to pay whatever it takes up to 3p/kWh to meet the obligation. The RO is therefore a way to generate finance to pay for renewables external to Government;
  • ROCs facilitate trade which allows the obligation to be filled either by buying physical electricity with ROCs or by ROCs alone in the alternative tradable ROC market.

The RO generators have, de facto, four revenue streams, set out below. All have to be negotiated by the renewable generator in the same electricity market as other forms of electricity.

  • Payment for energy;
  • Payment for the LEC;
  • Payment for the ROC;
  • The recycled buy-out payment or green premium[PMC1].

The value of the first and second revenue stream are certain for as long as there is contract. The value of the third bullet, the ROC, is certain provided, and for as long as, there is a fixed price contract. The third and fourth (discussed below) values are not certain and alter depending on supply and demand. If supply alters because of a RO rule change to eligibility, the value of ROCs will alter. If there is not another, higher target, the ROC value will begin to fall once the 10.4% target is met because supply will be greater than demand[17].

The RO contains a penalty for those suppliers who choose not to meet their obligation. They have to ‘buy-out’ at the rate of £30 for every MWh of their obligation that can not be met through the presentation of ROCs. This figure will vary annually in line with inflation, taking the £30/MWh as a base figure. The use of the buy-out price effectively means that, from the perspective of the supplier, it is in their economic interest to buy renewables up to £30/MWh above the premium of conventional power. If the price of electricity available from renewables is above this figure, then it is in the economic interest of suppliers to buy the conventional power from the electricity market and to pay the buy-out price. The suppliers are able to pass the value of the buy-out onto their customers.

The monies created by the buy-out fund are collected by Ofgem and then re-cycled to suppliers on the basis of the volume of ROCs they presented as a fraction of all the ROC s presented in the specified period. For example, if a supplier presents 5% of all the ROCs presented in a one year period, then that supplier would receive 5% of the buy-out fund for that period.

The recycling of the buy-out introduces an element of ‘gaming’ into the RO. Suppliers have to understand in detail the provision of total renewable electricity supply for any one year. They can then estimate the short-fall on meeting the RO and therefore the total ‘buy-out’ and hence their green premium income. In effect, the green premium to a supplier raises the price per kWh at which a supplier remains economically indifferent to buying renewables rather than paying the buy-out price. It is also means that all those involved within the RO require the rules to stay the same. As soon as the rules change the supply of ROCs will change and this will affect their value.

Other Aspects of Renewable Energy Policy

Another £350 million pounds is available to renewables from 2002/3-2005/6. The bulk of this is for capital grants for the more expensive technologies (for example, offshore wind and energy crops) to bring them down in price/kWh under the supplier price cap so that suppliers buy them for the RO. In addition, there are other R&D and demonstration funds, administered by a number of different organisations, for example the Carbon Trust and Energy Saving Trust.

The White Paper announced a review of renewable energy in 2005/6. It also placed carbon trading at the centre of its long term energy policy to achieve a low carbon economy in 2050. The relationship between a carbon policy and the renewable energy policy is currently uncertain.

4.The Barriers

Renewable energy projects are expected to overcome barriers to their deployment as a result of the RO and attendant measures. Renewables are not given any help with respect to the market place, its connections to the grid or planning. It is therefore one of toughest regimes for renewables in Europe.

There are a number of barriers to the take-up of renewables, energy efficiency measures and CHP. These have to be removed as soon as possible, if renewables are to get going at all in the UK. ‘Barriers’ is the catch-all phrase to link the various difficulties renewable energy technologies encounter in their efforts to deploy. They may be market failures, for example the lack of internalisation of external costs of energy use; they may be the normal difficulties a more expensive technology encounters in the market (and therefore disputed by many as a ‘barrier’). Together, these market failures and difficulties link-up so that the sum is greater than the individual parts. Barriers[18] can be categorised as: economic, institutional, network related, market rule related, social and financial. Clarity, and agreement, of what the barriers to renewable energy (electricity, heat and liquid) are needs to be reached as soon as possible and then acted upon.

Attempts are being made to deal with some of them, either wholly or partially, but some are neglected. If limited effort continues to be made to remove barriers to renewable energy deployment, then renewables will not deploy. The renewable energy programme is to be reviewed in 2005/6. In these circumstances, it would be wrong to argue that renewables cannot make a contribution to an energy system step change. Renewables will deploy if barriers are removed, as shown by evidence in other countries in Section 5. Thus, this paper would argue that policies to remove barriers, in the short-term, is a fundamental first step towards step change.

Economic barriers reflect a lack of competitiveness for certain renewables related to issues of scale, immaturity of technologies, lack of R&D and demonstration programmes, delivery mechanisms (and constituents of those delivery mechanisms) and the lack of internalisation of the external costs of energy use.

Institutional barriers include: divided ministerial responsibilities (for example energy supply in the DTI and planning policy in Office of the Deputy Prime Minister (ODPM); lack of co-ordination throughout Government; those relating to the regulatory environment (Governance of the Regulator; Regulatory Duties; Relationship between Government’s energy policy objectives and Duties; how over-arching principles of regulation may be inappropriate for certain utility regulation); and planning policy issues which themselves suffer from lack of co-ordination between different planning institutions at national, regional and local level.

Network issue barriers are those which arise from the economic regulation of the monopoly transmission and distribution networks; the regulation of gas and electricity together; and markets spinning off from the networks, such as metering. For example, the current incentives on distribution network operators in Price Control establish incentives in favour of centralised generation; further issues relate to connection costs, use of system charging, output incentives on network operators, lack of markets and how infrastructure costs, which result from a sustainable energy future, are paid for.