The Non­Fossil Fuel Obligations

37. Until 2000, the main policy mechanism in England and Wales for promoting renewable energy was the Non­Fossil Fuel Orders (NFFO). Similar schemes operated in Scotland and Northern Ireland. Under NFFO, interested parties were invited to bid for contracts lasting up to 15 years to supply specific forms of renewable electricity. Electricity suppliers were obliged to buy the output, the extra costs being financed from a levy on customers' electricity bills—though most of the proceeds of this levy were actually used to provide support for the nuclear industry. Across the UK, obligations have been made for a total generating capacity of 3640 MW. Of this, 90 per cent relates to the five orders made in England and Wales under NFFO.[55]

38. The fact that contracts exist to develop projects on specific sites does not guarantee that those projects will be developed. Indeed, only 25 per cent of projects have been developed so far. Performance in NFFO 4 and 5 has to date been particularly poor as the following table demonstrates.

Source: DTI. Energy Trends, June 2002, p 24.

39. There are a number of reasons which account for this poor performance:

• The average bid prices for contracts under each Order had fallen dramatically, from up to 11p per kWh under NFFO 2 to 2.8p per kWh under NFFO 5.[56]

• Contractors holding contracts might subsequently decide not to proceed with a project, perhaps because of difficulties in obtaining planning permission or because changing circumstances might have rendered the project uneconomic. The latter applies particularly to NFFO 4 & 5, where prices set in contracts were very cheap —particularly in comparison with the rather larger incentives potentially available under the Renewables Obligation.[57]

• Until 2002, NFFO projects were 'non­portable' as the development site was specified within the contract. This prevented a developer from, for example, moving the proposed site of a wind farm 500 metres down a mountain site where planning permission might be easier to obtain. The Government has now addressed this issue, although any proposal to move a contracted site will be subject to Ofgem's approval.[58]

• Sites can become 'sterile'. This means that, while there exists an undeveloped NFFO contract relating to a specific site, it is impossible to use that site for any alternative scheme. The developer might, for example, not wish to proceed with the original NFFO project but would be ready to proceed with a similar project to exploit the potentially larger incentives now available under the Renewables Obligation. At present, he cannot. There clearly needs to be a mechanism for rescinding unwanted NFFO contracts where developers are unlikely to develop them.[59]

40. The DTI suggested that the ability to relocate projects might result in the development of 340 MW of contracts, but only if planning consents could be obtained; and that it was too early to judge the success of NFFO 5 as many projects were still in the early stages of development. They considered that NFFO might deliver in total around 1.5 GW of capacity.[60] This would represent an increase of over 600 MW on present capacity (860 MW), but is still only 46 per cent of the capacity originally contracted.

41. We are less sanguine about the prospects of a significant rise in implementation rates, particularly in the light of the low contract prices which were bid under NFFO 5. Innogy, for example, holds some 600 MW undeveloped NFFO contracts, but was ambivalent about the prospects for developing them.[61] It is worth emphasising that renewable generators with NFFO contracts do not receive the financial benefit of the Renewable Obligation Certificates (ROC) associated with it. The ROCs become the property of the Non Fossil­Fuel Purchasing Agency (responsible for administering NFFO) who auction them to reduce the cost to the public of the scheme. The introduction of the Renewable Obligation might offer in some cases potentially greater rewards and may therefore militate against the further development of NFFO projects. On the more positive side, we did note that the fixed, long­term contracts available under NFFO offered considerable benefit to developers, allowing them to construct a robust business case and obtain debt financing.[62]

42. The current level of implementation of NFFO projects is very disappointing. This is due to a variety of factors including the difficulties of obtaining planning permission. However, it also indicates that the NFFO mechanism itself, in driving down prices bid by developers, failed to supply enough financial encouragement for renewables—in marked contrast to the direct 'feed­in' arrangements used, for example, in Germany. Denmark and Germany may have paid too much for renewable energy, but the UK has certainly paid too little and has reaped the reward of its parsimony. It is also a matter of considerable regret that most of the proceeds from the Fossil Fuel Levy were provided as a direct operational subsidy to the nuclear industry, rather than being used to promote the development of renewables.[63]

The new approach

43. From 2001, the Government has adopted a new approach to the promotion of renewables which relies on four main elements:[64]

• The Renewables Obligation. This replaces NFFO and requires all electricity suppliers, from January 2002, to obtain a specific but increasing proportion of electricity from eligible renewables. The Obligation will become the key policy in the Government's strategy for renewables;

• Exemption from the Climate Change Levy of electricity from eligible renewable generators;

• An expanded programme of capital grants for new and renewable energy, and

• The development of a regional approach to strategic planning and targets for renewables.

44. The Renewables Obligation requires electricity suppliers to obtain an increasing proportion of electricity from 'eligible' renewable sources.[65] The proportion will rise from 3 per cent in 2002­03 to 10.4 per cent in 2010­11, and will remain at that level for at least the duration of the Renewables Obligation (until 2026­27). The Government has stated that it may increase the level of the obligation after 2010.[66]

45. Eligible renewable generators will receive ROCs for each MWh of electricity generated. These certificates can then be sold to suppliers or third party traders. In order to fulfil their obligation, suppliers can either present enough certificates to cover the required percentage of their output, or they can pay a "buyout" price of £30 per MWh (3p/kWh) for any shortfall. In the early years of the Obligation, it is anticipated that there will be a shortage of eligible electricity from renewable sources, obliging most suppliers to use a combination of ROCs and buyout to meet their obligation. As suppliers can choose to pay the buyout price rather than buy renewable electricity it also limits the price they have to pay for renewable electricity.

46. Supply companies may pass on the costs of buying renewable electricity to their customers. The DTI has calculated that, on the basis of a £30 per MWh buyout, the maximum overall cost to consumers by 2010 would be £870 million: a 4.9 per cent real­terms increase from 1999.[67] All proceeds from buyout payments are to be recycled to suppliers in proportion to the number of ROCs they present. This may increase the value of ROCs beyond the buyout price, and initial evidence suggests that they may be worth between as much as £50 per MWh (5p per kWh) to suppliers.[68] This should provide an additional financial incentive for suppliers to purchase renewable electricity, and thus stimulate investment in new generating capacity. The DTI has estimated that the Renewables Obligation will create extra demand for renewable energy worth over £1 billion by 2010.[69]

47. The second main element of the Government's new approach is exemption from the Climate Change Levy. This is worth only 0.45p per kWh. However, taken together with the ROC, it suggests a price of 5p per kWh or more for renewable energy. Compared to the current wholesale price (about 2p per kWh), this means that most of the value of renewable energy now lies in these new financial instruments which the Government has created.

48. The third element of the Government's new approach is increased capital funding for renewables. Capital grants are designed to meet part of the cost of the more expensive technologies, offshore wind and energy crops, so that they can compete under the RO. No expenditure is likely to be incurred before 2002­03 at the earliest, but it the Government intends to commit over £200 million by 2005. In addition, the DTI is also currently spending £55 million over 3 years on renewable energy Research and Development.[70]

49. The fourth and final element of the Government's new approach is the development of regional strategies and targets for renewable energy. First trailed in the preliminary consultation on the Renewables Obligation, the DTI have since published a study which assesses the potential in each English region, Wales and Scotland for generating renewable energy.[71] This study explored the implications of a bottom­up approach on what the UK can realistically expect to achieve by 2010. It is less clear to what extent it will serve as the basis of regional targets, or which bodies will be made accountable for achieving such targets.

Achieving the targets

50. The Government has long­standing targets for achieving 5 per cent of electricity production from renewables by 2003, and 10 per cent by 2010. In addition, under the Renewables Obligation a new target has been set—10.4 per cent of electricity sales to be from renewables by 2010. The latter differs significantly from the longstanding 10 per cent target mainly because it does not include large-scale hydro-electric power. It is therefore significantly more challenging. The figure below shows UK performance since 1990 in relation to these targets.

UK renewables performance and targets

Source: Outturn data is derived from DTI Energy Trends, June 2002.

51. The figure shows that, as a percentage of total generation, electricity from renewable sources has only increase by just over 1 per cent in the last 10 years. In 2001, it actually decreased—from a total of 2.8 per cent to 2.6 per cent—due to an unusually small contribution from hydro.[72] It is already certain that we shall miss the 2003 target—probably by as much as 2 per cent—as the Energy Minister confirmed in his evidence to us.[73] But even if the slightly greater rate of increase since 1996 is extrapolated to 2010, on the present rate of progress we would achieve only just over 5 per cent by 2010 against the longstanding UK 10 per cent target. A number of witnesses endorsed this view of the current rate of progress.[74]

52. Achieving the 10.4 per cent Renewable Obligation target by 2010 represents an even greater challenge. Eligible generation, which has only increased from 0.3 per cent to 1.5 per cent over the last 10 years, would need to increase from 1.5 per cent to 10.4 per cent in 8 years. It is of course possible that there might be a step change in the rate of their deployment. But given the planning difficulties and the uncertainties surrounding the introduction of the main new policy instrument—the Renewables Obligation itself—this is by no means certain.

53. The Government is facing a similar situation with regard to their other main environmental energy target—achieving 10 GW capacity of Combined Heat and Power (CHP) by 2010. Current levels have stalled at below 5 GW and earlier modelling work by Cambridge Econometrics indicated that it was unlikely to grow to more than 7GW.[75] In the 2002 Budget, the Treasury has introduced an exemption for sales of electricity from CHP to the grid, and it has also addressed the long­standing issue surrounding leasing and enhanced capital allowances. The DTI have since commissioned further modelling by Cambridge Econometrics which suggests that the target may now be achieved, although the long­awaited CHP strategy which DEFRA finally launched for consultation in May 2002 contains no new measures.[76]

54. The dire position of CHP in the last two years has been widely acknowledged. One of the main companies involved in developing CHP systems told us that it had axed all further investment in this area,[77] while the Ofgem August 2001 small generator review indicated that CHP sales to the grid had slumped by over 60 per cent.[78] In this context, it seems surprising to us that the relatively minor changes the Government has announced are apparently going to lead to the achievement of the target. We look forward to examining the assumptions on which the Government has based this conclusion when they are made available.

Achieving the target ­ what the reality would mean

55. Total sales of electricity in 2001­02 amounted to 310 TWh. The DTI forecast that this will grow to 324 TWh by 2010—which means that the RO target of 10.4 per cent will require 33.6 TWh of electricity from renewables.[79] By the end of 2000, generation from technologies currently eligible under the RO totalled around 4.2 TWh. An increase in renewable generation of some 29 TWh will therefore be required over the next nine years if the target is to be met—an increase in capacity of over 3.2 TWh each year. The DTI has not set out publicly the contribution it expects each renewable technology to make, but modelling exercises have suggested that onshore wind, offshore wind, eligible waste technologies, and biomass might each contribute a quarter.[80]

56. To explore what this would mean in practice, let us take the case of wind. In 2000, wind contributed 0.95 TWh of electricity.[81] If the 10 per cent target were to be met by wind alone, over three times the total UK wind generating capacity currently available would need to be installed each year. Evidence presented to us suggested that, even to achieve half the target (ie 5 per cent)—would require one or two wind turbines to be erected every day between now and 2010—about 6000 turbines in total.[82] This is clearly a daunting task—if only from an engineering perspective. The possibility of setting up a relatively small number of very large wind farms, probably offshore, along the lines of that proposed for the isle of Lewis may be more manageable both psychologically and operationally. The task is not impossible—rates of build of over 1 GW a year have been achieved elsewhere[83]—but it would require substantial commitment to achieve. It also raises serious concerns about the availability of sufficient engineering resources—both human and mechanical - on the scale required to implement such a task.[84]

57. We found less information available on the implications of achieving the target in relation to other technologies. With regard to biomass, DEFRA commented on poor take­up and expected it to make only a limited contribution of 100 MW capacity to the 2010 target (in addition to biomass schemes undertaken under NFFO).[85] Similarly, it is unclear what scope there is for expanding eligible waste—either through exploiting landfill and sewage gas more, or through the growth of new waste technologies based on pyrolysis, gasification, or anaerobic digestion. In any event, it seems unlikely that these sources will contribute significantly by 2010. As there is little expectation that PV or tidal energy could contribute much on this timescale, we are left to conclude that prospects for meeting the 2010 target depend mainly on wind.

56   DTI Digest 2001 para 7.23. Back

57   Ev 28, para 16. Back

58   Q384 and Ev 53. Back

59   Ev 28 paras 16-17. Back

60   Ev 102. Back

61   Ev 28. See also Innogy's previous memorandum to EAC, HC 334, 2000-01, p11. Back

62   Ev 72. Back

63   Over 94 per cent of the Fossil Fuel Levy , amounting to some £5.9 billion, was paid directly to Nuclear Electric. Of the reminder further amounts were paid to BNFL. See HC Deb. 29 Jan 1996, col WA 510-511. Back

64   DTI Digest 2001, para 7.8. Back

65   Eligible sources include onshore and offshore wind, wave and tidal stream power, photovoltaics, biomass, geothermal, landfill and sewage gas, existing hydro less than 20MW and all new hydro. They do not include municipal waste combustion in mass burn incinerators.  Back

66   DTI, The Renewables Obligation Statutory Consultation, p 4. Back

67   DTI, Renewables Obligation Statutory Consultation, Annex A, para 25. Back

68   Recent modelling work conducted by Platts and the Renewable Power Association suggests that ROC prices might rise to as much as 7p/kWh. See press release, 1 July 2002, at www.platts.com . Back

69   DTI, Renewables Obligation Statutory Consultation, p5. Back

70   See paragraphs 88ff below. Back

71   See paragraphs 63ff below. Back

72   Ibid. p25. Back

73   QQ 376-377. Back

74   Q201, Q69. Back

75   Ev 3. Back

76   DEFRA consultation document, The Government's strategy for combined heat and power to 2010, 15 May 2002. The consultation and the DTI study can be found at http://www.defra.gov.uk/environment/consult/chpstrat/index.htm. Back

77   QQ 167-168. Back

78   Ofgem, Report to the DTI on the Review of the Initial Impact of NETA on Smaller Generators, August 2001, table 4.2. Back

79   DTI, Renewables Obligation Statutory Consultation, p23. Back

80   Oxera Environmental, Renewable Obligations Certificate Price Scenarios, June 2001. Back

81   DTI, Digest of UK Energy Statistics, table 5.1. Back

82   See Ev 24-25 and 203. Back

83   See PIU Energy Review, para 7.51. Back

84   Ev 203. Back

85   Ev 181. Back