UK Energy transition- Economics vs Sentiment

OFGEM have this week published their ‘minded to’ position resulting from their Targeted Charging Review which has caused shock waves and outrage throughout the renewables industry.

In simple terms, for those who have not been following closely, OFGEM are proposing a new way of recovering some of the costs of running the network, which shares the costs more fairly between consumers and generators. On average, consumers should see a reduction in costs, whilst generators will see a reduction in income (so called 'embedded benefits')

If you read the economic appraisal, it is hard to argue that what is being proposed is not more equitable- and OFGEM is the economic regulator, so what’s the problem?

The problem, as has happened time and time again is that purist economics does not take account of human sentiment and commercial reality.

Yesterday, I contributed to the excellent conference hosted by The Association of Decentralised Energy (The ADE) and The Energy Institute. One of the themes highlighted by key note speakers, including the ex Secretary of State (Ed Davey) and the new CEO of the Climate Change Committee (Chris Stark) was that the growth of decentralised renewables has been far faster and more successful than anyone envisaged.

Why is this the case? One of the primary reasons has been that bankability of business cases has been significantly bolstered by the ‘secure’ income offered in return for avoiding using the network- so called ‘embedded benefits’. A £ per unit generated could be banked with reasonable certainty. This helped counter the exposure to floating wholesale markets for the price achievable for power generated. With enough of the risk of investment removed, investors have been comfortable to push the button to go ahead. Going forward, with the removal of these bankable revenue streams, there is increasing risk associated with investment.

OFGEM’s latest proposal comes on top of the announcement of closure of the Renewable Obligation (RO) scheme and Feed in Tariffs (FITs)- two other sources of bankable income that have significantly contributed to the growth of renewables. The, hopefully temporary, suspension of the Capacity Market exacerbates the issue, which leaves Contracts for Difference (CfD) as the only remaining route of firm income. However, the £60m announced for the next CfD auction round is not going to go very far.

There are good economic arguments for all the proposed changes, as costs of renewables fall and charging is made fairer. However, what doesn’t work with the changes is how to address the need for bankable revenue streams to support long term investment.

The real problem in all of this is that whatever the economic purity, it is actually people, sentiment and behaviour that makes business work. As the UK drops down EY’s index of Renewable Energy Country Attractiveness, one of the primary reasons given is of regulatory and policy uncertainty. There have been too many changes to regulation, often announced at short notice, which spook investors. And ultimately, it is investors (who are actually people) or more accurately their confidence, that will result in the UK’s ability to achieve its decarbonisation targets.

So whilst OFGEM are not wrong in their approach per se- they are after all doing their job, we do need more consideration of the impact of change on commercial reality, sentiment and behaviour, when making these changes, to avoid unintended consequences. If we take away a key driver of investment, we need to identify a replacement, or at least have an eyes wide open assessment of the likely market response.

The danger is that whilst economically pure, investors will lose all confidence in the UK market due to lack of certainty and stability. There must be a better way.