Renewable Energy Obligation and Cleaning Up the Equities Market

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1 COUNTRY LAND AND BUSINESS ASSOCIATION DTI CONSULTATION ON TERMS OF REFERENCE FOR THE REVIEW OF THE RENEWABLES OBLIGATION THE CLA RESPONSE Introduction 1. The Country Land and Business Association (CLA) represents some 40,000 members with over 130,000 rural businesses of all types. Many of our members are involved in new and renewable energy projects, and all of them are deeply concerned on the likely effects of climate change. 2. At the same time, our members wish to see new and renewable energy projects as part of a newly invigorated rural economy: not only providing reductions in greenhouse gases (GHG), but also opportunities for rural businesses to develop new markets. 3. We again take this opportunity to remind Government that electricity amounts to only some 23% of energy used in the UK, and insufficient attention has been paid to the heat and transport markets, both of which are capable of delivering new and renewable energy projects that may in total far exceed the potential GHG reductions available in electricity markets. 4. Moreover, we are in the process of re-assessing our own views of the current support for wind generated electricity in the light of disturbing reports on both its cost, and the net benefit of the greenhouse gas saving. The Scope of the Review 5. It is explicitly recognised that the Obligation as currently framed rewards only the least cost generator. 6. We are deeply concerned, however, that the assessment of this cost is measured against a background of an averaged cost of distribution, rather than any assessment of the additional costs and strains that a widely dispersed and intermittent supply puts on the system. 7. We have read reports of proposals to spend many billions of pounds on grid reinforcement in order to bring wind power from remote locations to the consumer, but as currently assessed, this cost is not factored into the 3.1p/unit suggested by BWEA as the cost of wind power, but shared amongst all electricity consumers. 8. At the same time, we note that on site (or near site) steady state generation, such as may be provided by biomass power or CHP, is not rewarded for the avoided costs of distribution. Location of new generating plant in order to reinforce grids rather than stress them may deliver very significant savings to the electricity consumer as well as saving the wider countryside from increased numbers of ugly pylons. 9. We urge that grid reinforcement costs are assessed in the review of the Renewables Obligation.

2 10. We recognise that the whole life cycle GHG emissions of electricity generated from wind is very favourable. However, we are very concerned that the requirement to maintain spinning reserve inevitably in practice powered from fossil fuels, may alter the overall balance. 11. We also feel that the dispute between the costing of intermittency provided by BWEA and that suggested by the Royal Academy of Engineering needs to be taken into account (and if possible resolved) as a factor in the review. 12. Whilst this is not an issue related to the Renewables Obligation as currently framed, we urge that the overall costs of carbon savings are looked at in the review. The terms of reference should properly assess the wider costs and benefits of continuing to promote wind energy against increasing resistance from local residents against a new form of Obligation that would ensure communities had the opportunity to decide for themselves how best to meet Government targets for both renewable electricity and GHG savings. 13. Furthermore, whilst the current Renewables Obligation is framed only in the context of electricity, there are proposals to introduce a Renewable Heat Obligation which would deliver greenhouse gas savings at a significantly lower cost than the RO. 14. We urge that the proposed Renewable Heat Obligation is included in the terms of reference for the review, and attach a copy of the briefing which the proposers have put together. 15. We are deeply disappointed to note that the Department has not yet agreed to consider seriously the proposal to band the Obligation. The proposed terms of reference represent a missed opportunity, and we urge Government to reconsider. 16. Sooner rather than later, more expensive renewable technologies will be required in order to meet the Obligation. Government has recognised that there are significant R&D costs involved in this process, and has offered grant aid to seek to make up the difference. 17. Regrettably, so far as we are aware, not one single project supported under the biomass capital grant scheme has yet got off the ground. Grant aid has not provided the necessary incentive in the light of market failure. 18. It has been argued that banding interferes with market forces. This market purism is simply unsupportable in the context of the proposal for an entirely artificial market for new and renewable energy, in which large scale hydro is excluded, and energy from non fossil fuel sources is excluded unless advanced technologies are used, supported by a highly interventionist grant aid system. 19. Banding need not be significantly more expensive to the consumer. As in the offshore oil industry, close working together in partnership between government and industry can agree parameters for banding that will ensure competition within each band. This ensures that costs are minimised and that the electricity consumer (the polluter) pays. It is certainly more equitable than

3 requiring purchasers of lottery tickets (who are amongst the poorest members of society) to pay for renewable energy R&D through the New Opportunities Fund. 20. The CLA s concern is that without banding, and notwithstanding the grant aid that is necessary (and welcome) to ensure at least some R&D is done, the Government will not achieve its 2010 target for either renewable electricity production or GHG reduction. 21. Financial markets are short termist, and have been offered an exit route from a fully binding obligation in the buyout price. There is therefore no incentive to invest in technologies that are not fully developed for the market. 22. By the time that all the easiest opportunities for onshore wind and other near market technologies have been exploited, we will be too close to 2010 for market signals from recycled buy-out payments to deliver the additional biomass generation capacity required to meet the obligation. As has often been explained to Government, renewable projects, and in particular biomass projects, take several years to move from planning to production. 23. The review should therefore also focus on whether any grant aid paid to date had delivered the dissemination required, and whether there was any nongrant aided alternative generation capacity under development. The review should be required to assess whether banding would deliver, and whether the existing renewables obligation was on target to do so without banding. Investor confidence 24. Much weight has been given to the question of investor confidence. We would argue that DTI should also look to the question of regulatory confidence, and be clear about the objectives of its policy. 25. These are not explicit in the review, which is a failing we suggest should be addressed. Curent policy treats all electricity that is generated from resources approved in the Renewables Obligation as equal, but this is clearly patently not the case. Some will cost more, but deliver different benefits. Others may have a greater headline cost but deliver cheaper carbon savings. 26. Thus we propose that the net carbon saving cost should be made explicit in the review of the Obligation. Eligibility 27. The CLA proposes that the review should be asked to look at the possibilities of providing a Virtual licensed supplier to enable self-suppliers to benefit from the RO without inevitably passing a proportion of the benefits therefrom to licensed suppliers in the market. This is a reasonable and logical response to deal with a disincentive to both self-supply and Combined Heat and Power installations that is entirely the creature of Statute. A Virtual Licensed Supplier might be run by OFGEM as a not for profit company, whose only purpose would be to check the details of any self supply undertaken by those contracted to it and to report to OFGEM in accordance with the standard procedures.

4 28. The review should consider why the use of biomass that might be separable from existing waste streams (such as biomass from parks and gardens which currently goes to landfill) should be eligible only if high technology processes are used. Such biomass wastes may be much better suited to simple handling. The justification of increased R&D used in the current RO appears to sit ill with the stated purist market rejection of banding. Conclusions 29. We again call on Government to consider an alternative proposition to the current grant aid regime. We argue that banding may well be cost neutral as against the figures now proposed were the buy-out to be lower for near market technologies and higher for those technologies requiring R&D. 30. We are surprised that, with generation costs as low as 3.1p (quoted by BWEA), recycled ROCS fetching significantly more than 3p, and an electricity price in excess of 1.7p there is not room for a reduction in the buy-out price for new onshore wind projects, combined with a higher buy-out price for offshore wind, wave and biomass technologies. 31. Moreover, a Renewable Heat Obligation could have a buy-out price as low as 1p (th) and deliver a significantly greater climate change result. 32. The CLA agrees with the Royal Commission on Environmental Pollution that banding provides a far simpler, more logical and better market based solution to the proposed obligation, with its differential eligibilities, technology specific requirements, and associated grant aid requirements which are at least partially to be met by regressive taxation. A separate band at a suitable price would create a separate market and do away with the need for grant aid, whilst ensuring R&D was done by the industry at its own cost in competition with others in the band. Country Land and Business Association 16 Belgrave Square London SW1X 8PQ 1 October 2004 A

5 Proposal for a Renewable Heat Obligation Energy for heat makes up approximately a third of the UK s demand for energy. The Government recognises the contribution of renewable heating systems to the UK s climate change programme, but has not introduced a dedicated policy to support this low cost and proven carbon abatement option. This paper makes the case for extending the concept of the renewable obligation to include renewable heat, creating a similar incentive for the industry to that operating within the electricity industry. This idea was similarly conveyed in the Royal Commission on Environmental Pollution s report on biomass as a renewable energy source (see and strongly recommended in a recent research study produced for DEFRA (see ) This Briefing provides background to the Heat Obligation amendment discussed at the Third Reading of the Energy Bill on 13 th July Introduction Like electricity suppliers, coal, gas and oil suppliers should have an Obligation to supply an increasing proportion of their business from renewable energy sources. For ease of terminology this proposed mechanism is referred to as a Heat Obligation, with a market in Heat Obligation Certificates (HOCs). The existing Renewable Obligation has two distinct features: A an obligation on licenced suppliers of electricity to source a rising percentage of their supply from renewables; and,

6 B an accreditation process that grants generators of renewable electricity with certificates matching their metered output in any given month. It is possible to recreate these two features in the market for heat: A the obligation would be placed on suppliers of fossil fuel heating fuels eg gas suppliers, coal and coke and oil suppliers. There is no one license that identifies these bodies, however, they are limited in number and easily identified as all have a relationship with customs and excise that would allow for their easy identification (see below). Retailers of small volumes of heating fuels i.e. garage forecourts, would not be included in the obligation. B certified suppliers of renewable heat. A register similar to that used in the electricity obligation could be set up for all metered sources of renewable heat, administered by OFGEM. As with the renewable electricity obligation, this could initially be limited to generators over a certain size, but over time extended to enable even small-scale providers of renewable heat such as domestic solar heating systems to be accredited, providing adequate metering systems are in place. 2. Defining the obliged market 2.1 Gas and coal Industry currently pays a Climate Change Levy (CCL) on each unit of electricity, natural gas, and coal used. The Levy however is actually collected from the supplier of the fuel that is delivered to the end user. Because there is a difference in the level of the levy payable on fuels used for electricity compared to those used for heat suppliers of gas and coal are already required to record sales of their product into the heat market. Domestic heating fuels are exempt from the levy and can similarly be identified because of this differential. 2.2 Oil Oil is also currently exempt from the CCL. However oil sold for heating purposes can easily be identified: - 90% of domestic heating oil is kerosene (similar to jet fuel, but not subject to the same stringent quality specifications). This is not dutiable and has a chemical marker (but is not dyed) to avoid road vehicles using it. The dyeing/marking of these fuel oils is conducted at a very limited number of bonded locations (refineries and import points) and additionally, can only be sold through Registered Dealers in Controlled Oils (introduced in 2003) who must declare quantities and end receivers in an attempt to prevent abuse. Quantities of oil leaving bond as marked, low duty exempt heating oils could therefore be very easily included in a heat obligation. - The remaining 10% domestic demand, plus light industrial and farm use is provided by Gasoil (similar to diesel, indeed often diesel, but not subject to the same quality specs). This is dutiable at a much lower rate than road transport diesel (4.22ppl compared to 47.1ppl) and is both dyed (Red) and chemically marked to prevent its inclusion in road fuels. As it is difficult to identify whether red diesel is used for transport or heating and currently represents a small portion of the total market, for ease of administration it

7 could be excluded from the proposed renewable heat obligation. An alternative would be to develop a labelling system similar to that used in France, where diesel being sold for heat and transport purposes is separately labelled. 3. Defining accredited generators 3.1 Fuel based renewable heat generators e.g. biomass heating boilers These forms of generators typically meter their output making accreditation straightforward. This is included as standard in the pumping and heat output control system in order to assess heat losses and reductions in efficiencies which might point towards faults in the system. For any biomass heating system where there is more than one heat load, individual heat meters are also used to allocate costs to these heat loads. As in the RO a proviso can be included that any fossil fuels are only used for control purposes and are less than 10% of the total fuel input in a given month. Heat meters are now available cheaply with a high degree of accuracy. 3.2 Non-fuel based renewable heat generators eg heat pumps, solar thermal These may or may not provide metered outputs - as discussed above the obligation should only credit metered systems. Metering of even small-scale non-fuel based systems is however possible and relatively cheap. 3.3 Co-firing of renewable heating fuels Where a renewable fuel is being used in conjunction with a fossil fuel to provide heat (eg biogas blended with natural gas, biomass blended with coal) rules similar to those governing co-firing for renewable electricity will need to be developed. Certification would continue to be at the point of generation. However, the biofuel content of the fuel would need to be verified to enable output to be calculated. Generally where solid biofuels are being blended with coal, there will be a weighbridge ticket available so that the supplier of the biofuel can be paid by the user. Hence the biofuel input can be measured and a paper trail is available. For cofirers such as Slough Heat and Power for example, weighbridge tickets plus independent analysis of the energy content is carried out to give accurate assessments of the energy content of the biofuel. For biogas, meters again are generally in use to allow accurate payments and also ensure that the right mix takes place. 3.4 Renewable heating fuels in CHP The use of renewable fuels to generate both heat and power provides a highly efficient form of carbon abatement. CHP units meter their output in such a way that electricity and heat outputs (ie for ROCs and HOCs) with heat output being metered at the point where the heat enters the heat distribution network. Certificates for both outputs can therefore be apportioned accurately. 4. Designing the Obligation 4.1 The principle The Renewables Obligation provides an incentive ten times greater than the Climate Change Levy to stimulate renewable energy technologies, but only to those which produce electricity. The idea of a renewable heat obligation is to ensure that heating fuel suppliers are required to supply an increasing proportion of their customers demand for heat from by non-fossil fuel sources (just as electricity suppliers are required under the RO).

8 Each fuel supplier s Heat Obligation would be a percentage of its fossil fuel sales. This Obligation would be met by the surrendering of Heat Obligation Certificates (HOCs) purchased from accredited renewable heating schemes. An appropriate authority (such as OFGEM) would register qualifying schemes, and issue HOCs on basis of their monthly metered heat output. 4.2 The Obligation level Details relating to what percentage the obligation should be set at initially, and the future target it should seek to attain, need further consideration, and should be underpinned by capacity assessments and subject to public consultation. However, it is likely that the target would be set at a relatively low level initially and then build up over time as the industry grew. 4.3 Who to oblige? The Obligation should be placed on suppliers of fossil fuels for heat. The volume of fuels sold for heat (as opposed to electricity or transport) is easily determined as suppliers are required to fill in detailed records in order to comply with the requirements of the Climate Change Levy. Oil supplies being sold for heating purposes would need a separate administrative system but this should be achievable and is already practiced in France for example. The administrative systems for a heat obligation for industrial and commercial customers are therefore relatively straightforward. 4.4 The buy-out price As with the existing renewables obligation a buy-out price would be set to limit the cost of the scheme to suppliers. Because of the lower emissions per unit of output associated with generating heat, the Climate Change Levy on heating fuels is roughly a third of that on electricity (0.15p/unit compared with 0.43p/unit). Following the same logic the buy-out price of a HOC would be around 10/MWh (i.e. one third or that for the Renewables Obligation.) 4.5 Timescales Every new energy development and investment in the UK that fails to make use of a renewable fuel for both power and heat is a missed opportunity in terms of developing the UK's low carbon economy. A renewable heat obligation should therefore be introduced at the earliest possible opportunity. Government should aim to launch a public consultation in parallel with it's review of the Climate Change Programme in late The Obligation should run parallel to the existing Renewable Obligation with targets being set to FAQs on Heat Obligation 5.1 Which technologies and fuels would a renewable heat obligation cover? Eligibility criteria could be the same as currently defined in the Renewable Obligation e.g. solid, liquid or gaseous fuels from biomass, heat pumps collecting stored solar or geothermal energy from ground or water sources, solar thermal and wind (in a small number of cases where wind-based electricity is used to heat water). 5.2 What size is the renewable heat market today? 716 thousand tonnes of oil equivalent of renewable heat were used in This is equivalent to 8327 GWh(th). This is mainly for the domestic and light industrial market. The majority of this was provided by wood heating plus some solar thermal.

9 5.3 What is the potential of this market? There is a huge potential for additional low cost carbon abatement to be achieved by stimulating and supporting the market for renewable heat. For example, with modern biomass heating, there is a potential using currently available forest residues, roundwood, arboricultural residues, secondary product from the wood industry, and clean recycled wood, of around 8000MW of heating. With the introduction of energy crops, this level could be tripled. For solar water heating, more than 50% of UK buildings are suitable for solar water heating, providing 65-70% of annual hot water needs. Water heating makes up 8% of UK energy demand. The 120,000 new homes built each year should have solar water heating built in as standard and indeed the revised Building Regulations are looking at including this option. However, to build up the UK industry from its current rate of 5,000-10,000 units per year to this level would need a measure like the Heat Obligation. 5.4 Isn't defining the heat market incredibly complex? No. The Obligation is proposed for suppliers of fossil fuels for heat. The reporting requirements of the Climate Change Levy and differentiated duty rates for oil products mean that systems are already in place that can be used to easily define the market and identify suppliers. 5.5 Aren t there already too many Obligations? The renewable obligation applies only to the supply of electricity and yet two thirds of our emissions of greenhouse gases come from non-electricity uses of fossil fuels. Proven and cost effective renewable energy technologies are available now to displace the use of fossil fuels in transport and for heat. However, there is no market based instrument to incentivise their development. If we are intent on achieving a low carbon economy then comparable measures to the RO must be introduced for renewable heat and transport fuels and technologies. There have been calls from many quarters for other obligations to be introduced (CHP, coal mine methane etc) but these involve relatively simple deviations from the basic principles of a renewable obligation. A heating obligation by contrast is complementary to the existing obligation, and will ensure that least-cost carbon abatement options are fully exploited by, for example, incentivising biomass CHP and biomass fuelled refineries for biofuels. 5.6 Won't this mean higher heating bills? (Costs to consumer) The same argument applies to the RO. However, the RO s costs have been limited by the buyout price which prevents the cost of the obligation from becoming too onerous. In the case of HOCs, the cost of compliance will be roughly a third of that for the existing renewable obligation for the same level of carbon saving, so it represents good value for money. It is inevitable however that some costs will be handed on to customers and that this will cause bills to rise. However this needs to be taken in the context of rising gas and oil prices, and the fact that the cost of climate change is so potentially high that a modest rise of this kind can be easily justified. The Government estimated the costs of climate change in its Energy Paper Our Energy Future Creating a Low Carbon Economy as 70/tC (a range of /tC) and increasing at 1/tC per year. It suggested that these damage costs, while not setting the limits for the level of investment in reducing carbon did provide a basis for investing in renewable energy and energy efficiency. The suggested HOC price would be within the damage costs range indicated by the Government where investment is acceptable to prevent the expensive costs of climate change.

10 5.7 What about other measures and subsidies for renewables and energy efficiency don t they adequately incentivise renewable heat? No. The Climate Change Levy provides a weak incentive for commercial energy users to switch to levy exempt forms of energy which include renewable heat. Renewable electricity receives a greater incentive under the CCL and yet it is also supported by an Obligation precisely because the incentive the levy creates is too weak to encourage new developments on its own. The same is true of renewable heat. The Energy Efficiency Commitment (EEC) is an obligation on domestic energy suppliers to assist electricity and gas customers to take up energy saving opportunities. A consultation paper has been published on the extension of the existing EEC, however, radical changes which would be required to effectively support renewable heat, are not anticipated and the mechanism only applies to domestic markets. The Community Energy Programme which gives grants to install new schemes, the New Home Energy Efficiency Scheme the Central Heating Programme and the Warm Deal could all feature small renewable energy heat schemes but these schemes will not influence the industrial and commercial markets for heat. 5.8 Would the HOC incentivise both industry and domestic use? Yes. Domestic space and water heating accounts for approximately 75-80% of household emissions. The proposed Obligation would apply to suppliers of fossil heating fuels to both industry and domestic customers. Similarly domestic and industry heat generation that is metered and aggregated could be accredited to receive certificates. Concerns have been raised about incentivising domestic biomass with the accusation it might encourage low efficiency, polluting fires. However this could be simply countered by stipulating that only stoves and boilers which are accredited under the Clear Skies programme and which have minimum efficiency/performance standards can be accredited. 5.9 What about the corner shop or petrol station selling bags of coal or camping gas would there be administrative burdens on them? The proposed Obligation is not intended to apply to retailers of small volumes of fossil fuels and so there would be no administrative burden. The supply of coal to customers would be captured upstream at the point of supply where duty is paid What about coal merchants wouldn t this measure adversely affect them? No. In fact this sector is a contracting industry and biomass fuel provides an opportunity for diversification and survival. Already a number of coal merchants supply wood pellets and the trade association the Coal Merchants Association support the growing role of biomass fuels and are members of the Biofuels Alliance. Some modest capital support for the sector to invest in this new industry would help their transition Who would ensure that those using biomass heating didn t use coal now and then? As with the RO tight monitoring of accredited generators with additional random checks would ensure compliance.

11 5.12 Are you sure that copying the renewables (electricity) obligation is really the best way of stimulating heat? Aren t there criticisms of the RO? Certificate based trading schemes like the RO are effective in that they provide both a carrot and a stick in one measure. For that reason industry prefers them to taxes and pure regulation. They have also found approval with NGOs who recognise the increased certainty they provide compared to fiscal measures. The RO has proven to be an effective market based mechanism for supporting the development of renewable electricity. There will always be improvements that can be made as when it was introduced it was an innovative measure. The scheduled review in 2005/06 will provide an opportunity to make any improvements. The RO mechanism approach can be easily applied to renewable heat and will have the advantage of delivering carbon savings for approximately a third of the cost to the consumer Is the proposed obligation compatible with Government targets for CHP? CHP plants delivering renewable heat and electricity would qualify for both HOCs and ROCs therefore providing a strong incentive for investment in renewable CHP technologies, as well as running CHP plant efficiently. At present biomass CHP operators are incentivised to run the plant for electricity output as much as possible and dump heat which is not needed. The new approach would which have minimum efficiency standards lead to greater efficiencies which would contribute towards the Government's CHP target. July 2004 For more information please contact: Bryony Worthington, Friends of the Earth, bryonyw@foe.co.uk, Stewart Boyle, stewart@woodenergyltd.co.uk