Home grown: changes to RO render it a FIT

Some say a feed-in tariff should replace the Renewables Obligation - others that it should supplement it. Ian Temperton calls for a rethink of the fundamentals.

For those of us operating in UK energy policy, the coalition government presents a fascinating set of new challenges. There is the potential for radical market reform, institutional reform, and the slightly disconcerting promise of ministerial continuity where we may have to deal with the same energy minister for weeks, months or even years at a time.

There are some constants in life, however, and the most reassuring of these is that we are going to be able to continue debating changes to the provision of incentives for the generation of renewable energy. There is talk of a feed-in tariff (FIT) regime for large-scale renewable energy generators, as well as, instead of, or perhaps as another option to, the existing Renewables Obligation, which has been in operation since 2002.

The term FIT derives from the principle that a renewable electricity generator can feed-in its output to the grid and be guaranteed a certain payment for it. As with many such terms, it is open to misuse, and when people in energy policy say "FIT", they tend to be implying a number of other aspects of incentive design.

Price or quantity capped

Generally, two types of incentive regime are employed in the climate change arena: those that set a price and let the quantity find its own level (this is generally what people mean when they say FIT); and those that set a quantity and allow the price to find its own level. FITs, as widely employed for renewable energy in continental Europe, set price and let quantity vary. Systems such as the European Union Emissions Trading System set a quantity (a cap on emissions) and let the price vary.

There is a broad and well-­established body of academic literature when it comes to price versus quantity, which can be summarised as: if you care about price being too high then set price and let quantity float; if you care about reaching a certain quantity then set quantity and let price float. Helpful. The evidence is that where governments set price, quantity does not tend to end up where politicians want it to, and where they set quantity, price does not end up where they would like.

In Spain, the government set a FIT for solar power with the aim of getting 1,000MW by 2010. By 2008 it had already got more than 2,500MW. This has given rise to a cost commitment that is of national significance in Spain, and the talk is of the ""fixed" price being changed":http://www.utilityweek.co.uk/news/uk/electricity/investors-worried-as-spain-cut.php to manage the nation's financial exposure (see feature, page 22). In the Emissions Trading System, there is almost continuous debate about whether it provides the right price, and our new government is already talking about the need to underpin the price of a regime that is inherently designed to set quantity and let price find its own place.

All about the money

There is a reason why setting either price or quantity independently does not appear to give the right answer, and that is that price times quantity equals money, and it turns out that money is what people care about. Spain does not care about the fact that it has over 2,500MW of solar installations: it cares about how much money that will cost over the next 25 years.

Interestingly, the UK's Renewables Obligation, as originally conceived, was a system that set neither price nor quantity. It set the amount of money that the consumer paid for subsidising renewable energy. It achieved this by placing an obligation on energy retailers to supply a certain percentage of renewable energy each year. If they did not buy enough, they had to pay a fine in the form of a buyout price. This created a pot of money each year (price times quantity) which supported the renewable energy industry, and there was a substantial degree of visibility as to what both price and quantity were going to be in future years.

The idea was that the price and quantity of renewable energy in the UK would be governed not by how much of it we wanted, or by what price we thought was fair, but instead by how much we were prepared to pay in cash every year and in future years.

RO changes

Unfortunately, over recent years this has changed. While the Renewables Obligation looks similar on the surface, the cap on "price times quantity" has been removed in place of setting different prices for different technologies, and overall quantity is now uncapped (this is the effect of "banding" and "headroom").

Going from a system where the cost to the consumer is capped and known to one where it is uncapped and unknown seems somewhat against the general tide in these austere times, and ironically given the current debate, the Renewables Obligation now already has the price and quantity characteristics of a FIT.

Fit for purpose?

To avoid continued fits and starts in UK renewable energy policy, three things are clear. First, whether through bravery, patience, blind faith or blissful ignorance, investors have put substantial sums into UK renewables in the past decade, so any change to the system must robustly grandfather the current Renewables Obligation for those investors.

Second, as we enter a decade of even greater investment in the sector, we need to debate whether the UK's current system is fit for purpose. Finally, we cannot have a "FIT versus Renewables Obligation" debate, because after a decade of regular ad-hoc changes the obligation is already, in substance, a FIT. Hence, to get this right a level of thought and analysis is needed that has not been seen before in the development of either the Renewables Obligation or FIT regimes.

Ian Temperton is head of advisory at Climate Change Capital.

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