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How the UK government can get a fair deal on energy

Who knew that the gritty energy security business could sound so appealing?

Thousands of projects operate under old-fashioned renewable obligation (RO) contracts including locations such as Potato Farm, Sixpenny Wood and Riverview Pig Farm. Behind many rural names is corporate or international money: Sixpenny is part of the UK-listed renewable energy fund, Greencoat UK Wind, while the Potato Pot is ultimately owned by a company. Malaysian electricity.

But all of them are constrained most specifically, Short-term government plan must review UK energy market: negotiating with renewable energy producers to reduce the prices they receive, especially with RO contracts abolished in 2017.

This is a logical first step to break relationship between wholesale gas prices and domestic electricity. But it has raised concerns: why would generators voluntarily enter into a long-term fixed-price contract that does not generate a profit from the high price during this period?

Spreading consumer pain (or industry gain) from sky-high prices over a longer period is not a bad thing to do. Especially if you are fighting a low income tax, like prime minister. But there are reasons to think that government can and should do better.

First, it would be foolish for the sector to assume any windfall tax positions are in place. Power companies this year could argue that most output is sold under forward contracts much lower than market prices. That will be difficult to maintain next year. Of course, the industry is sensitive to its social responsibilities, also saying it wants to do the right thing.

The more important point is that part of the market really needs this change to happen at some point, trading wholesale market risk for more stable deals. It also wants to establish the idea of ​​price protection for the existing generation, and not just new construction projects.

Carry out legacy renewable energy projects, paid at the common wholesale electricity price, typically £50 to £60/MWh, plus an RO payment, of at least £50/MWh. (Nuclear aside, which the government can also renegotiate, but works differently.) As those contracts expire from this year, projects lose their stable funding base, becoming riskier and more expensive to finance.

Only about a tenth of total RO generation capacity will expire within the next five years. But contracts extending into the 2030s, about 70% of capacity, present another problem.

Even before this crisis, there was concern in the renewable energy sector that growth would lead to so-called cannibalism. Renewable energy tends to produce it all at once, especially when it’s windy. That pushes the intraday wholesale prices lower, even as low as zero as green becomes a larger part of the system.

SSE last year flag risk that market prices in the 2030s will not include operating costs for the older offshore wind fleet, resulting in closures. That outlook could worsen with a larger target of new offshore wind capacity of 50GW by 2030.

“As the share of renewables increases, the way electricity markets work tends to weaken [generators’] economics,” said Rob Gross at the UK’s Independent Center for Energy Research, which launched idea to switch contracts in April. “So they have a strong incentive to agree to new fixed-price contracts, and that could be an attractive price for consumers.”

What that means depends on how the contracts are negotiated. Auction would be the best option, but it seems challenging with time constraints. It is increasingly assumed that generators can withhold their RO payments to simplify administration. Another question is how the output sold under the forward contract will be handled.

But here is one expert’s assessment, when it comes to the actual price of the new contract: “If the government got £50/MWh it did well, at £60 it did well and at at £70, it’s being dissipated.” An industry source said the price in the 50s is achievable, which combined with RO payments implies earnings not much higher than in a “normal” world before the Ukraine invasion. Another person looking at the numbers said it could be even lower.

This is a complicated negotiation, in a crisis, where the government’s initial stance is not ideal. But maybe, just maybe, that there is an outcome here that seems good enough for everyone.

helen.thomas@ft.com
@helentbiz

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