The Renewables Obligation Scheme: How RO can you go?
The Renewables Obligation (RO) is a policy introduced by the UK government to support the domestic development of renewables generation technology.
It forms one of a number of policy mechanisms intended to help discharge the UK's obligations under the Renewable Energy Directive 2009 (RED 1).
RED 1 committed the EU to sourcing 20% of its energy requirement (15% in the UK) from renewables by 2020.
The RO introduced an obligation on UK energy suppliers (those which hold a supply licence under the Electricity Act 1989) to ensure a certain proportion of their electricity supply originates from renewable generation.
Unlike similar schemes, particularly the Feed in Tariff (FiT), the RO falls on all energy suppliers and there is no supply volume threshold (although an exemption for energy-intensive industries was introduced at the end of 2017).
Although it has its roots in RED 1, the financial rationale of the RO was to subsidise the higher cost of renewable generation to mitigate its competitive disadvantage against cheaper conventional power (coal and gas-fired generation or rival low-carbon generation (nuclear).
The RO is complementary to policies that specifically make generating electricity through carbon-intensive sources more expensive, namely the EU Emissions Trading Scheme and the UK Carbon Price Floor.
The RO scheme has two characteristics that ensured it was successful in delivering its objectives.
They are, first, a means of guaranteeing the distinction between electricity produced from renewable and conventional sources and, second, an unambiguous way to allow suppliers to demonstrate compliance with targets.
The key to the success of the regime is that Renewables Obligation Certificates (ROCs) are limited in supply, easily transferable and indirectly linked to a financial reference price (the penalty for failing to satisfy the obligation, referred to as the buy-out price).
On the ROCs
ROCs are Ofgem-issued certificates confirming electricity has been generated from renewable technologies.
ROCs are issued to generators who may then sell them to suppliers, so that suppliers can submit them to Ofgem to satisfy their obligations under the RO.
ROCs are only issued to accredited sites, and are issued and redeemed through an online portal administered by Ofgem.
If a supplier is unable to submit a sufficient number of ROCs to satisfy its obligations in an obligation period, they must pay a buy-out price.
Where suppliers are unable to submit ROCs or pay the buy-out price (perhaps due to insolvency), a mutualisation system exists, where all other suppliers are required to make good the shortfall.
Although the RO has now closed to new projects, projects that were accredited before the cut-off date will continue to receive ROCs until the earlier of their 20-year term expiring, or the RO scheme's closure in 2037.
How does the obligation on suppliers arise?
The RO regime is driven by an obligation on suppliers of electricity, not generators.
Nonetheless, it is generators of renewable electricity who benefit and it is customers who pay for the regime. In this sense, the RO has a whole-market impact.
Amendments to the Electricity Act 1989 introduced the power to oblige electricity suppliers to obtain a specified proportion of their supply from renewable sources.
This is implemented through a number of statutory instruments, the most important being the Renewables Obligation Order 2015 (RO Order).
The order revoked and consolidated an earlier Renewables Obligation Order and a number of amendments to it.
There are separate statutory instruments which moderate the closure of the RO scheme and address grace period requirements.
The essence of the RO regime is found in Article 7 of the RO Order, which requires all electricity suppliers licensed under the Electricity Act to submit a specified number of ROCs to Ofgem for each MWh of electricity that it supplies in a period:
"The renewables obligation is imposed on each electricity supplier supplying electricity in England and Wales (…) The renewables obligation is that (…) each designated electricity supplier must, by the specified day, produce to the Authority, in respect of each megawatt hour of relevant electricity that it supplies during an obligation period, the number of UK ROCs determined in accordance with articles s13 to 13B".
The obligation is set annually by the UK's Department for Business, Energy and Industrial Strategy (BEIS) and obligation periods run from 1 April to 31 March.
The total obligation level (the number of ROCs suppliers must present) is published at least six months in advance, by 1 October of the year preceding the relevant obligation period.
The obligation level is based on a prediction of the amount of electricity that will be supplied in the UK and the number of ROCs that will be issued to eligible renewable generators.
Each supplier has a different RO level and the level increases every year. A supplier's RO determines the number of ROCs it is required to submit to Ofgem.
Ofgem uses a formula that determines a supplier's obligation is equal to the volume of total electricity it supplies in the obligation period (in MWh), multiplied by the applicable obligation level (in ROCs/MWh).
A supplier can meet its obligations by submitting ROCs to Ofgem for the relevant period, or paying a penalty for the difference between its obligation and the number of ROCs it was able to deliver.
ROCs can be submitted in compliance with the supplier's obligations for that period, or for the following obligation period (but only up to 25% of the supplier's obligation for the subsequent period).
The role of customers and Ofgem under the RO
Although the RO scheme aims to incentivise generators, it is underpinned by consumer electricity bills.
Suppliers pass through additional costs of purchasing ROCs, such that a component of customer's bill represents the price of supporting the scheme.
The UK government traditionally managed these subsidy costs through the Levy Control Framework, now replaced by the Control for Low Carbon Levies (CLCL).
A key principle of the CLCL is that no new low-carbon levies may be imposed on consumers until the total burden of costs under existing support schemes falls, in real terms, over a sustained period.
Current estimates indicate that no new levies will be introduced until 2025.
At about the same time as the CLCL replaced the Levy Control Framework in 2017, Dieter Helm's Cost of Energy Review criticised the rising cost of energy and recommended significantly changing the approach to low-carbon support, including ring-fencing legacy costs of ROCs, FITs and Contracts for Difference (CfDs).
The RO regime is administered by Ofgem, whose main role is to monitor the regime and ensure compliance with the regulations.
It does this by accrediting generators, issuing ROCs to accredited projects, maintaining the Renewables and CHP Register, calculating each supplier's obligation and administering the buy-out price and mutualisation process.
It also receives and redistributes buy-out and late payments (after recovering its administrative costs).
What are ROCs?
ROCs are the means by which electricity is certified as having come from renewable sources.
The purpose of a ROC is to demonstrate that:
"The generating station has generated from renewable sources the amount of electricity stated in the certificate" (Section 32B, Electricity Act 1989).
Rather than introducing a policy of direct government subsidy to the generator (irrespective of downstream activity), the generator receives ROCs for each MW of renewable electricity it produces (Article 18 of the RO Order).
ROCs are tradable, meaning the supplier does not need to point to one specific source or site of renewable energy, but can instead buy ROCs from any generator or participant to discharge its obligation.
Eligibility for ROCs has been a fundamental consideration in the development of renewable projects.
ROCs are only issued to generators of eligible renewable sources, and the relevant station will only be accredited when it has satisfied eligibility and commissioning requirements.
The mechanism for determining how many ROCs a particular station is eligible to receive is set out in Articles 28 and 29 of the RO Order.
Although the obvious beneficiaries of the RO regime are wind and solar PV projects, it also extends to certain fuel forms of generation, including dedicated biomass and co-fired generation.
These fuelled plants, have to satisfy additional fuel sampling and sustainability criteria to benefit from the RO.
Whereas ROCs are used to equate MWh of renewable electricity generation on a 1:1 basis, the divergence of renewable technology types has given rise to the concept of "banding".
The financial consequence of a ROC:MWh equivalence was that investment was channelled to the cheapest form of renewable generation, which at the time was onshore wind.
This led to concern that development of other more expensive (and less established) forms of renewable technology wAS being prejudiced.
Accordingly, from 2009 a system of banding was introduced, on the premise that technologies with similar development costs should receive similar levels of policy support.
Each technology is now categorised by reference to a maturity scale (ranging from emerging to established).
This classification determines its band and the number of ROCs it receives per MWh. The bands are set out in the RO Order and may be reviewed every four years (or more frequently in certain cases) under Article 42 of the RO Order, to ensure the approach remains relevant as market conditions evolve and technologies mature.
Generation projects may protected from banding reviews by one of the applicable grandfathering regimes.
Grandfathering refers to the protection afforded to certain projects from subsequent subsidy price review. It confirms that a certain station will receive a fixed level of support over the lifetime of its generating RO eligibility.
For example, the number of ROCs allocated to small-scale (<5 MW) solar projects changed in 2016, but plants that were accredited before 22 July 2015 were not affected.
Grandfathering provides useful protection to investment for accredited projects (in terms of revenue certainty), particularly in the context of concerns about how quickly the RO scheme was closed to new applications.
Most technologies benefit from the grandfathering principle (new biomass conversion and co-firing remain exceptions).
The price of ROCs
The accessibility of ROCs makes them particularly tradable.
They have no fixed price when issued, so can be freely negotiated between a generator and supplier, as part of the general negotiation for the purchase of energy from a renewable site.
The ROC scheme will close in 2037 and, for the last 10 years of the regime, a fixed price certificate scheme will operate, where the government will buy ROCs directly from generators at a fixed proportion of the buy-out price, plus 10% (Section 56, Energy Act 2013).
ROCs are freely tradable between registered users, subject to compliance with procedural rules of the CHP Register.
ROCs issued under the RO schemes of Scotland, Northern Ireland and England and Wales can also be transferred (Articles 2 and 7, RO Order).
Since June 2019, a VAT reverse charge on supplies of ROCs has applied. This imposes an obligation on the customer, as recipient of a good or service, to account for VAT.
Accordingly, the transfer of ROCs now needs to have procedures for the customer to account for VAT.
Where are ROCs?
Ofgem administers the RO and other renewable schemes (including Renewable Energy Guarantees of Origin (REGOs) and FiTs) through the CHP Register.
The register is a web portal through which generators, suppliers and traders can manage their respective roles in relation to ROCs.
One purpose of the register is to "house" a ROC once the corresponding MWh of electricity has been produced, such that it becomes commoditised.
Users must set up an account and comply with the Register User Guide on the website.
A generator can use the register to apply for and manage its RO accreditation, submit data on output and make annual declarations to receive ROCs.
It can also transfer ROCs to other parties – for example, to a supplier who has bought them under a utility power purchase agreement (PPA) for that site.
Similarly, a supplier can submit data on the amount of electricity it has supplied and redeem ROCs to comply with their annual obligation The register contains a list of all accredited projects, the regimes under which they are accredited, the accreditation date and plant capacity.
Failing to meet the RO: Buy-out and mutualisation
The RO is effective (in terms of incentivising supplier compliance and providing project revenue to generators) because of the financial consequences of a supplier not producing enough ROCs to satisfy its obligation.
Under Article 67 of the RO Order, a supplier must pay a financial penalty in respect of the shortfall between its RO level and the number of ROCs it produces.
Ofgem operates a "buy-out fund" for this purpose, and a buy-out price is set on an annually indexed basis to motivate suppliers to ensure they have a sufficient number of ROCs to satisfy their RO level.
Similarly, Ofgem will enforce any attempt to by-pass the requirements of the RO, and has imposed fines on suppliers for under-reporting the amount of electricity supplied to customers.
Similarly, a "mutualisation" mechanism exists to accommodate short-falls in supplier contributions to the RO in an obligation period.
The supply-side of the energy market has seen increasing penetration by start-up suppliers, many of which have become insolvent.
When a supplier is unable to satisfy its buy-out obligations (perhaps because of insolvency) by a significant enough amount to exceed the shortfall threshold (a "relevant shortfall"), suppliers who have satisfied their obligations are required to submit additional payments to accommodate the shortfall (Articles 73 and 74 of the RO Order), up to a mutualisation ceiling for that obligation period (currently around £290 million).
In the last compliance period (CP16, for 2017-2018), 14 suppliers failed to meet their obligation, amounting to a shortfall in payments of £58.6 million. This had to be recouped through the mutualisation process.
The buy-out price for suppliers unable to meet their obligations in the compliance period CP17, for 2018-2019, is £47.22 per ROC.
Suppliers have until 1 September to meet their obligation by providing ROCs or paying the buy-out price.
The RO target for CP17 is 0.468 ROCs per MWh of supplied electricity. Current estimates are that the RO-relevant electricity supply in the UK is approximately 273 TWh in 2018-2019, meaning around 125 million ROCs will need to be presented (the highest to date under the scheme), equal to a scheme cost of approximately £5.9 billion.
With the prevailing buy-out price and shortfall of ROCs in the market, it is estimated that suppliers could owe around £780 million in buy-out payments for the last compliance period, which were due on 31 August 2019.
Eleven suppliers have already exited the market, so there is currently a shortfall of around £40 million.
Even without further exits or defaults, this will trigger the mutualisation process, perhaps adding around 15-20p per MWh to consumers' bills.
ROCs in the power market
The RO superseded the Non-Fossil Fuel obligation in 2002, and was followed (but not replaced) by FiTs in 2010 and CfDs in 2014.
Although it is now closed to applications, subsidised renewable capacity will continue to grow through to 2023, as projects that met the accreditation deadlines start dispatching.
In 2018, subsidised capacity accounted for 32% of total UK generating capacity. This is anticipated to rise to 44% by 2025.
The RO has facilitated around 30 GW of renewable generation since 2002, with the scheme peaking at around 31.5 GW of capacity by the time it closes.
This includes 12.5 GW onshore wind, 7 GW offshore wind and 6 GW solar PV.
From a generator's perspective the relative stability of ROC values in the past few years has meant developers and investors have good levels of certainty on subsidy revenue (on top of revenue for power).
Most generators can afford to sell at negative wholesale prices because they will receive sufficient revenue from ROCs to cover operating costs.
Closure of the ROC scheme
The RO scheme closed to new generation on 31 March 2017 (having closed to large (>5 MW) solar PV in 2015, to onshore wind in 2016 and small (<5 MW) solar PV in 2016), pursuant to the RO Closure Order 2014.
This happened because the UK government took the view that its policy of encouraging growth of renewable generation had been successful and the main forms of generation no longer required express subsidy, and/or such forms of generation should compete in the CfD.
Generating plants supported by the RO cannot also be supported by the CfD or the Capacity Market (CM) under Articles 48 and 49 of the RO Order, to prevent any double recovery of support for the same capacity.
The speed with which the RO closed prompted considerable objection from industry (and several legal challenges).
However, the government decided the relative maturity of the main forms of ROC-supported projects (solar and onshore wind) and significant cost reductions in these technologies meant they should now compete on a non-subsidised basis.
The RO Order allows both co-firing and dedicated biomass plants to bid in the CM and elect to leave the RO scheme if they are awarded a CM contract.
The speed of closure also led to a rush of projects seeking accreditation and a limited grace period for projects excused the consequences of not becoming accredited prior to the cut-off (e.g., because the project was delayed by grid connection delays).
The cut-off for all grace periods, other than a small exception for onshore wind, was 30 September 2018.
The closure of the RO scheme means no new renewable generation projects can be accredited by Ofgem, but does not mean that existing accredited projects or the ROCs in circulation are closed.
Projects that are already accredited for ROCs will continue to receive them in line with their power output until the earlier of the end of the project's support lifetime (20 years) or 2037, when the scheme will finally close altogether.
The final closure date was originally 2027, but this was extended by 10 years in 2010 (by the Renewables Obligation (Amendment) Order 2010).
Projects accredited before 26 June 2008 will continue to receive ROCs until 2027, and projects that were accredited after that date will receive up to 20 years of RO support.
Hugo Lidbetter is a partner specialising in energy and natural resources at European law firm, Fieldfisher. For more information on our renewables and wider energy expertise, please visit the relevant pages of the Fieldfisher website.