ECEM: Renewables obligation tilted in favour of vertical integration, Drax Power warns

22 August 2014 18:05 Source:ICIS
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UK-based renewable power generators that do not benefit from a vertically integrated structure are “being disadvantaged” financially under the renewables obligation (RO) subsidy mechanism, the country’s largest independent generator has warned.

The disparity is tilting the market in favour of larger, vertically integrated companies, according to Drax Power, which is partly the result of the credit-intensive nature of the subsidy regime. The warning over the design of the market was contained in a response filed by Drax – which runs the largest single unit of generation under the RO – to an initial statement of issues published by the Competition and Markets Authority (CMA) as part of its recently launched inquiry into the UK energy market.

“ROC [renewables obligation certificate] buying is credit intensive for smaller retail and generation businesses, where cash-flow is a material influence in their commodity buying behaviour,” Drax said.

This is because the recycle cash value of a ROC is not retrieved by suppliers until five months after the end of a given RO compliance period (CP). CPs run for 12 months beginning April 1. Therefore there is a “natural bias” to defer contracting ROCs until late in a CP for the supplier, because of the delay in cashing in.

This hits renewable generation units in the pocket, Drax said – unless they are part of a larger vertically integrated operation, which prevents any such exposure to the potential market design flaw.

“All the Big Six have their own ‘in-house’ renewable projects competing for future ROC redemption capacity,” Drax said.

“Companies hold on to this option to self-supply ROCs to meet [their] own target RO level through own projects, and only seek to buy when it is clear that their own projects will not meet their ROC requirements.

“This concentrates ROC buying activity later in the compliance period, and reduces future trading of ROCs for subsequent compliance periods.”

One RO market participant, despite agreeing with the credit intensiveness of the RO, said there were steps suppliers could take to ease the possible burden for smaller generators: “ROC buying is credit intensive; as such, cost of capital is factored into ROC pricing,” he said. “But suppliers are there to smooth the cash-flow for generators as they receive payment in the form of the RO from retail customers, which they can use to contract ROCs from generators on a monthly basis.”

The CMA investigation will delve into areas where the authority feels competition is failing to produce value for consumers. Key areas that have been identified include opaque pricing and low liquidity in the electricity market as well as vertical integration and the dominance of large incumbent utilities. This could see the authority take aim on areas such as the RO.

The plight of smaller renewables generators has long been a concern in the UK electricity market. In 2012, the market for power purchase agreements (PPA) – which act as smaller suppliers’ preferred route to market by guaranteeing an income stream for their electricity and, as is most often the case, their ROCs as well – came under the spotlight in the wake of a deterioration in commercial terms offered by the major suppliers ( see sister publication EDEM 6 July 2012 ).

The UK government then took the step of amending its energy bill, which at the time was still moving through parliament, by enabling the establishment of a scheme obliging suppliers to buy electricity from renewable generators under specific conditions if they were unable to agree a commercial contract ( see sister publication EDEM 19 July 2013 ). Jamie Stewart.

By Jamie Stewart