UK Renewable Energy Strategy Consultation. Response by E.ON SUMMARY

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1 UK Renewable Energy Strategy Consultation Response by E.ON SUMMARY Renewable energy has an important contribution to make to climate change targets. It will also contribute to energy security by improving diversity of energy sources and reducing dependence on imported oil and gas. E.ON expects to invest 6bn in renewable energy in Europe and the United States up to 2010 and to have 10GW of renewable capacity in operation by However, we need to reduce carbon dioxide emissions at least cost to the consumer. Renewable technologies have the potential to contribute to this aim, but the UK target in the proposed EU Renewables Directive requires a level and rate of renewables deployment that will lead to a higher cost of reducing CO 2 emissions than would have been the case, given that some renewable technologies are more expensive than alternatives such as nuclear or energy efficiency investments. It is therefore essential that the UK puts in place policies which ensure that the financial support required for renewables delivers as much value as possible for the UK economy and for energy consumers, incentivises reductions in renewable costs, and contributes to the cost-effective delivery of longer term climate change goals beyond The UK s proposed target poses major challenges, particularly given the relatively short period between now and The extent to which it is delivered will depend on whether major barriers to investment planning, transmission and supply chain constraints - can be overcome and sufficient incentives exist to attract the very large capital investment required not only in renewable capacity but also the fossil plant required to back up generation from wind and tidal resources. The key issue in the residential market will be the willingness of customers to take up these technologies, given the high discount rates they will typically apply to high capital cost measures. We broadly share the Government s view of the relative potential of renewable electricity technologies. We welcome the emphasis on the potential in the heat market, but the BERR analysis has, we believe, overestimated the potential of biomass in the residential market, and underestimated the potential role of heat pumps. Based on deployment rates in Germany and elsewhere, heat pumps could in principle contribute up to 55 60TWh of heat, or up to 4 million heat pumps in customers homes, although this would be a very challenging objective given uncertainties about customer response. The high levels of variable and relatively unpredictable wind and other renewable generation envisaged by Government will have very significant effects on the wholesale power market. Prices will become more volatile. At periods of low demand and high wind generation, available renewable

2 and nuclear capacity may exceed demand requiring nuclear or renewable generation to be curtailed. This will lead to wholesale prices falling to zero or to negative prices. This will affect the economics of either or both plant types. Studies of our current operations show that about 10% of wind capacity can be relied on to meet winter peak demand which means that the 28GW of wind capacity the Government estimates could be built by 2020 will reduce the need for other generating capacity by only about 3GW. There will be a need for investment in or retention of a large volume of more flexible capacity which will, however, operate at reduced load factors. This raises the question of whether it will be possible to recover the fixed costs of this plant over its operational life. If further analysis shows that energy prices are not likely to be sufficient, then some additional market mechanisms to reward this capacity will need to be considered. Although these effects may not be significant until the decade beginning 2020 and they could be alleviated by increased interconnection with other systems, demand side response, or development of electricity storage, they will need to be factored into decisions for investments in new or existing power plants now. They are also likely to impose an upper limit on the desirable level of must-run renewable and nuclear generation on the system. Support for renewable electricity should therefore not be open-ended. Investors need to understand how the energy policy framework can be expected to develop in the longer term. Government should set out its view on what the maximum total level of future renewable generation connected to the system should be. We think this should not exceed the level in the scenario discussed in the consultation, which is around one third of total electricity generation. We suggest that support for new renewable investments should be reviewed when it is apparent that the UK target for renewable electricity will be met (or indeed if it becomes apparent that it will not be met). This review should assess the optimum role of renewable technologies and other forms of low carbon generation in meeting longer term carbon reduction targets to The Renewables Obligation should be retained as the policy mechanism for delivering the UK target for larger scale renewable electricity projects. It has proven to be a robust mechanism for incentivising investment and the removal of constraints planning delays, grid constraints and supply chain limitations - will improve its efficiency. There is a major risk that change to an alternative approach would lead to considerable investor uncertainty and an investment hiatus, making it less likely that the UK would meet the 2020 target. To provide the level of certainty needed for investors but also to limit the amount of support provided by customers, the 2027 end date should be removed for projects operational after 26 June 2008 which should receive a maximum 20 years support under the RO. The headroom mechanism should be the policy mechanism for progressively increasing the level of the RO to that needed to achieve the level of renewable electricity required by 2020 to achieve the EU target. As renewable

3 technologies mature and become more competitive, the level of support for new projects in terms of ROCs/MWh under the banding mechanism should be reduced. For smaller scale renewable microgeneration we favour the retention of the RO but with the support capitalised upfront on the basis of deemed future output to help overcome the capital investment constraints faced by domestic customers. A renewable heat obligation will work better in the residential market, will more effectively engage suppliers in delivery and can more easily be integrated with CERT and its successor. However an incentive based approach is not unworkable although it may need to be set at a very high level initially to avoid early failure. We envisage a significant change in the role of DNOs and in the investment needed in networks to facilitate the deployment of distributed renewable electricity technologies. There is significant uncertainty around the timing and specific impact but the DR5 price settlement does need to enable a more proactive role for DNOs in exploring and working with developers in respect of the connection of such technologies through a more supportive regulatory framework. A much stronger focus on energy efficiency is vital. An outcome based supplier cap and trade model to succeed CERT after 2011 would complement renewable support policies, creating a framework within which renewable energy supplied would be attractive to suppliers (as it would not count against the cap), allowing an integrated energy efficiency, renewable heat and renewable microgeneration policy. A cost of carbon in energy prices in the residential market should be introduced to incentivise renewable and other low carbon energy supply. A cap and trade approach to the supplier obligation could effectively factor in a carbon price into the market through the level of the cap and the buy-out price. The fact that gas consumption does not incorporate a price of carbon unlike electricity consumption would be reflected in the relative weighting of gas and electricity supply within the cap. Delivery and resourcing of the reforms set out in the Planning Bill are essential, if we are to approach the target. In addition the role of local authorities in supporting the delivery of regional renewable targets should be strengthened. Strategic network investment ahead of user commitment will be required to provide for more timely connections. We see no reason why the Authority s duties would preclude the more strategic approach to approving transmission investment this requires. Limited supply in the off-shore turbine market has constrained growth and has contributed to higher costs. We expect the market to respond if there is a clear long-term policy framework for supporting investment. Government should encourage UK industry to respond to the opportunities this market creates and a competitive tax regime for investment would support this.

4 Questions posed in the consultation Q1 How might we design policies to meet the 2020 renewable energy target that give enough certainty to business but allow flexibility to change the level of ambition for a sector or the level of financial incentive as new information emerges? 1 A long term sustainable policy framework is fundamental if the UK is to attract the required investment needed to achieve or even approach the target. However, targets for different forms of renewable energy should as far as possible reflect our best understanding of what could be delivered economically in each sector to improve their credibility. 2 The Government must also continue to address robustly those major barriers to investment planning delays, transmission constraints, supply chain issues, skills shortages where it can influence outcomes to ensure that these are not perceived as undermining the credibility of the financial support mechanisms. 3 Costs to consumers should be minimised to give the targets political credibility. Unacceptable price consequences for domestic or industrial consumers would cast doubt on the long-term political sustainability of the policy framework. 4 The potential of the heat sector is particularly uncertain and policy will need to respond to changing understanding. In general broad based market oriented policy mechanisms such as the RO which focus on outcomes and cover a large tranche of the market, rather than targeting individual technologies, will respond more flexibly to changing costs and availability of different technologies and will provide companies with more options for delivering outcomes. 5 The Government should signal the circumstances in which it would change policy and preferably indicate at what points in the period to 2020 it will do that. It should commit in advance to ensuring that transitional arrangements grandfather benefits to committed projects. Q2 To what extent should we be open to the idea of meeting some of our renewable energy target through deployment in other countries? 6 Renewable deployment in other countries provides a more cost-effective route than some domestic options to delivering a proportion of the target but only if other Member States believe they can exceed their own targets and have a surplus to make available. 7 This could also encompass other non-eu countries with comparable schemes. This should apply whether or not there is a physical electrical transfer of power associated with the renewable source. We would prefer an approach based on trading of Guarantees of Origins. This is consistent with the development of the internal energy market and would help maximise the available cost-

5 effective renewable potential. This is also the most robust legal option under the EU Treaty and less open to legal challenge. The scope for trading could be limited in its potential contribution to domestic targets to avoid undermining national schemes. Q3 In the light of the EU renewable energy target, where should we focus further action on energy efficiency and what, if any, additional policies or measures would deliver the most costeffective savings? 8 Tackling the issue of climate change requires an holistic approach. As well as taking steps to decarbonise the economy, it is important that there is a much stronger focus on energy efficiency. 9 In the household sector energy efficiency obligations on suppliers need to become more flexible and encourage innovation. The scheme needs to facilitate the transformation of the energy supply business model to one of providing energy services. This can be achieved by using an outcome based supplier cap and trade model to succeed CERT after 2011 allowing suppliers to use their knowledge of their customers to tailor offerings to enable and encourage customers to be more energy efficient in their behaviour and choices. Some elements of CERT could be maintained for a transitional period to provide continuity to the supply chain. 10 Such an approach would complement renewable support policies in the residential market and would create a framework within which renewable energy supplied would be attractive to suppliers as it would not count against the cap, allowing an integrated energy efficiency, renewable heat and renewable microgeneration policy (we elaborate on these ideas in our answers to questions 15,16, 19 and 20 below). 11 The role out of smart metering would provide a significant amount of information which suppliers could use to offer services to encourage energy efficiency for example through the presentation of usage information and tariff structures designed to reward more efficient consumption. Government should move quickly to a decision on how to deliver smart metering. 12 In the longer term a cap and trade scheme could be extended to cover small businesses, whereas a measures based scheme is more difficult to extend beyond households because of the need to assess the lifetime carbon savings of a wider range of energy efficiency measures. 13 Government should sharpen fiscal incentives and build on the use of Energy Performance Certificates to strengthen customer interest in energy efficiency, for example by reducing the level of council tax for housing which is more energy efficient than the average for the type of property. 14 Energy efficiency mechanisms should be separated from fuel poverty policies to ensure that each provides the right measures to deliver the relevant policy objectives. However, a supplier obligation could raise money through auctioned allowances to support social policy and a hybrid cap

6 and trade and measures-based scheme could be designed to continue focus on improving the energy efficiency of the housing stock. 15 We are participating in discussions with DEFRA on the supplier obligation and will continue to input through further consultation in the autumn. We would also be happy to discuss our ideas with BERR. Q4 Are our assessments of the potential of different renewable electricity technologies correct? 16 At the high level the Government s assessment of the potential of different technologies is similar to our own analysis. We accept the Government s view of the relatively limited economic potential for renewable microgeneration over the period concerned. However, that is not to say they cannot make a valuable contribution which can be further extended after 2020 as we seek to achieve the UK s 2050 targets. Technologies continue to evolve and it remains important to continue to stimulate more research as well as innovation, development and deployment. 17 There are of course some significant uncertainties which could affect outturns. For example in the wind market the availability levels of operating in deeper waters may initially be lower than expected. If this proves to be a problem in early periods of operation, actual generation levels could be lower than anticipated. Q5 What more could the Government or other parties do to enable the planning system to facilitate renewable deployment? 18 We support the proposed reforms in the Planning Bill and believe this will help create a more efficient, timely and predictable framework for considering new renewable and other major infrastructure investments, which will also allow objectors to express their concerns more easily. However, the new institutional arrangements will have to be fully resourced. The development of National Policy Statements, following full consultation, and scrutiny by Parliament, will provide an energy policy context for individual decisions to be taken on the balance of a project s contribution to national policy goals and local impacts. It is important that the National Policy Statement on renewables is updated as quickly as possible to ensure it is aligned with the renewable energy strategy. 19 The threshold for onshore and offshore wind projects which will be determined by the Infrastructure Planning Commission (IPC) should be aligned at the proposed level for onshore of 50MW as we believe projects of this size and higher are nationally significant in both cases. 20 Whilst welcoming the intention to establish a Marine Management Organisation (MMO) with overall responsibility for the marine environment, we are concerned about the different timescales for establishing this body compared with the IPC, which could create problems in terms

7 of securing the right expertise and of supporting the IPC for determining offshore projects. As an interim measure BERR should retain the ability to determine planning applications for offshore projects below the threshold at which applications are under the IPC remit. 21 However further changes are required to ensure that energy policy and planning policy are aligned for smaller scale projects. Locally-owned renewables delivery 22 While regional planning bodies have an obligation to set regional targets for renewable generation within each Regional Spatial Strategy (RSS) in line with PPS 22, local planning authorities are not required to demonstrate how they could best contribute to these regional renewable targets. In fact the relevant requirement in PPS: Planning and Climate Change is quite weak: planning authorities should, alongside any criteria-based policy developed in line with PPS 22, consider identifying suitable areas for renewable and low-carbon energy sources. We believe local authorities need to address local energy requirements in terms of a range of low carbon solutions, including renewable and energy efficiency investments, to identify the optimum approach, and also identify those areas within their jurisdictions that could best contribute to regional and national renewable targets. 23 The introduction of PPS: Planning and Climate Change and other initiatives mean that all councils will be expected to provide or facilitate on-site renewable energy. Such changes have had a positive impact both on the uptake of distributed renewable energy sources and on influencing behaviours but more needs to be done. For example, councils should consider where a development is located so that it can optimise the potential for renewable generation, for example by utilising windy or south-facing areas or those near to business and industrial development in order to utilise surplus heat. 24 Communities that are contributing to addressing the challenge of climate change should see more direct benefits from their commitment in addition to those associated with employment opportunities. We discuss this further in response to Q6 below. Delivering timely and robust decisions 25 We recommend that planning authorities should have regard to National Policy Statements as a primary rather than material consideration. 26 Planning authorities need to have access to sufficient skills and resources to assess renewable planning applications efficiently. We support the BERR programme of running practitioner workshops on renewable energy for planning officials, councillors and planning inspectors to equip them to assess planning applications. We also believe that there is merit in

8 creating a dedicated team that can provide support to local authorities who are having difficulty in assessing applications in an efficient and timely manner. If local authorities have access to these resources, they should be accountable and subject to financial penalties for continued poor performance in determining planning applications for significant projects. The Government should consider evaluating what the right target for local authorities should be for dealing with renewable projects. Any target substantially in excess of 16 weeks would prejudice the Government s ability to achieve its national target under the EU Directive. 27 If planning authority decisions do not have a robust basis, and are subsequently overturned on appeal following a public inquiry, all costs should be met by the local authority. Conversely, developers would bear all the costs of an unsuccessful application process and so be incentivised to only submit projects that meet all the necessary criteria, and so reduce the burden on local planners. 28 We have had a number of projects where statutory consultees have met a 21 day target for response, only to reverse their position later on in the application stage. These problems partly stem from the volume of applications that lightly resourced organisations are having to manage. Given the magnitude of applications that they will be expected to deal with, resources and expertise available to statutory consultees will need to be significantly increased. With such a resource, it should be possible for them to understand all of the issues relating to any specific project and to provide a view that is consistent. 29 Statutory bodies should provide a prompt response to a project that is based on a reasonable probability that the project is acceptable or not, rather than delaying to confirm their view with complete certainty. This exceptionally precautionary approach is affecting a considerable number of projects. A change signalled from Government could unlock a significant amount of renewable capacity. 30 All statutory bodies should be required to meet together with a developer to agree a way forward for how a project which is acceptable subject to conditions should be developed, and to identify the mitigation measures required. This would provide more certainty from a developer s perspective and encourage a more measured approach by statutory consultees. Extending permitted development rights 31 We support the concept of using a Local Development Order (LDO) to fast track applications where the principle of siting a wind farm at the location has already been established and the application is seeking to replace existing turbines with more efficient ones. This concept could also be applied to extensions to an existing wind farm below a predefined threshold, based on a percentage of existing capacity.

9 32 In the residential market, there is a pressing need for zero carbon in the context of the 2016 zero carbon homes policy to be fully defined so that long-term investment decisions can be made. At the microgeneration level, there is a need for greater consistency for Permitted Development across England and Wales and Scotland, and issues regarding wind and noise abatement need to be addressed. For example, the need for specific coloured wind turbines as demanded by certain councils should be removed given both the practical difficulties that this presents and the fact that colours demanded at the regional level do not necessarily blend in better with the background environment than the colour proposed originally. Q6 What more could the Government or other parties do to ensure community support for new renewable generation? 33 The Government needs to make clear publicly at the national level its belief that renewables can contribute both to climate change and security of supply objectives. 34 Local authority performance incentives to address climate change and requirements to factor in renewables development as part of their spatial planning should lead to more effective action by them to encourage support from local communities. Local authorities should actively engage local communities in identifying suitable locations for renewable development in their plans, and engage with local businesses to explain the financial and promotional benefits that they could gain from uptake of renewable and other forms of low carbon generation and energy efficiency measures both in new build and retrofit developments. Local authorities could also facilitate development of cooperative schemes with financial incentives provided to encourage community involvement. They could also assist projects financially by providing bank guarantees to unlock lowcost finance. Employment opportunities could be enhanced by providing a data base of local suppliers with relevant skills. Schools could also be more fully engaged in the need for renewable investment, including through the installation of renewable technologies on site, where this is costeffective. 35 As a responsible developer we recognise that communities that are directly affected by any scheme should be compensated in some form. Indeed as part of any design of a wind farm scheme, We build into the investment proposal a community support package to address this issue as a matter of course. Whilst we are not in favour of adopting a benchmarking approach to community support, we believe that there are other measures that could be taken forward by Government to increase local support for essential energy infrastructure projects such as renewables. In many other countries, local communities benefit from retaining local taxation that has been generated as a consequence of renewable generators operating in the area. There is merit in adopting this approach in the UK. At the moment, business rates that are paid by renewable generators are collected by central Government and are then redistributed back to local authorities. We propose that a proportion of these rates to be retained by the local authority. This would allow communities

10 willing to permit renewable developments to directly benefit from this policy, either in the form of improved services, reduced taxation or both. 36 Developers also have an important role in consulting fully with communities at an early stage, supported by better information available at national level about the environmental impacts. Q7 What more could the Government or other parties do to reduce the constraints on renewable wind power development arising from: marine navigation environmental legislation aviation and radar any other aspects of regulation? Marine navigation 37 The National Policy Statement for renewable energy should be developed taking full account of all stakeholders involved in the maritime sector. We welcome marine traffic management schemes aimed at improving marine navigation in areas affected by offshore renewable development. However if a proportion of these costs has to be absorbed by the offshore wind industry, this would need to be factored into any future assessment of the level of ROC banding needed to support continued investment. Environmental legislation 38 An appropriate balance needs to be struck in environmental regulation between protecting the local environment and other interests and helping meet the challenge of climate change through development of renewables. 39 Invariably there is a degree of subjective judgement in some areas of environmental assessment since there is incomplete knowledge of, for instance, how species behave. The levels of certainty often required to be demonstrated to consultees by developers, in order to try and eliminate the risk of subsequent regulatory challenge, often leads to inordinate amounts of work which does not, however, ensure acceptance of arguments made by developers. A more pragmatic approach, in line with the need to justify conclusions beyond reasonable scientific doubt (NATURA regulations), whereby a degree of risk is deemed acceptable as the norm, would facilitate greater deployment of renewables without materially damaging the environment. This would also help gather more knowledge through agreed post construction monitoring of key species. 40 In summary, a revised balance between residual environmental risk and scheme acceptability needs to be struck, moving away from the extreme precautionary approach often adopted by consultees.

11 41 We agree with the main proposals set out in the consultation to improve the current system. In particular we believe that there is a good opportunity to improve the guidance relating to EU environmental legislation and would draw attention to the work that the European Commission are currently carrying out in this area. The UK Government should also avoid gold plating EU regulations with unintended adverse consequences to the offshore wind industry. All key stakeholders should be fairly represented to ensure that reasonable renewable development that does not cause a detrimental impact to the marine environment can be encouraged. Government should take a holistic approach so that renewable energy and nature conservation are fully integrated in the framework going forward. Aviation and radar 42 A clear Government strategy is required to ensure that aviation and radar considerations do not lead to unnecessary delays in the consenting of offshore wind projects. The Ministry of Defence needs to ensure that developers have a clear understanding of what is and what is not acceptable in terms of location and configuration and that it can respond efficiently to new proposals. The timescale for delivering technological solutions to difficulties caused by renewable developments needs to be much clearer. 43 We support the Memorandum of Understanding as a first step towards implementing a clear strategy. However, the high cost and long timescale (measured in years) of R&D programmes necessary to try and develop or refine generic solutions for aviation and radar issues are of concern particularly as the programme still remains to be initiated (current predictions are that by the time industry funding arrangements have been put in place it will be sometime in 2009 before this happens). Since it is now clear that there is widespread UK wind industry support for key elements of the programme, which will lead to funding from onshore and offshore sector players next year, it would be helpful if the first phase funding of key activities could be guaranteed by Government now, so that R&D work could start this year. 44 The implementation of solutions going forward will result in costs. Whilst we recognise that the costs of upgrading radars, for example, could be shared amongst a range of parties including wind developers, this will have an impact on the economics of projects. If the financial support required from the wind industry is disproportionate, projects may not proceed unless this is factored into the cost analysis when setting future bands. For example if developers are required to install radar absorbent wind turbine technology, this will be at a relatively higher cost to a standard wind turbine technology, and would not have been factored into the assessment of costs for setting the current bands. 45 A further concern that needs to be addressed is how to overcome the risk of one developer free riding off an investment made by another developer. If some of the costs are to be absorbed by developers, overcoming this obstacle is essential to ensure that projects are not delayed. Some

12 form of compensation to the initial developer or developers who co-fund such investment is one way to alleviate this apparent first mover disadvantage. 46 Whilst there has been a lot of debate around military radar issues, the civilian radar issues are as important. An holistic approach to this is required, which suggests that developers should work collectively with the Civil Aviation Authority rather than on an individual airport basis. In this way acceptable cost effective solutions are more likely to be agreed which permit essential energy infrastructure investment. Otherwise there is a risk that gold-plating will occur. Q8 Taking into account decisions already taken on the offshore transmission regime and the measures set out in the Transmission Access Review, what more could the Government or other parties do to reduce the constraints on renewable development arising from grid issues? 47 The key priority is to deliver the necessary transmission infrastructure upgrades although a balance will need to reached between the impact on the consumers of the investment costs and the costs of constraining off generation. TAR Reforms 48 An interim form of connect and manage needs to ensure that the costs of constraints are taken into account and are acceptable. However we believe that until new capacity becomes available the best way forward is to have a mechanism that enables capacity to be formally shared. The TAR reforms have the potential to deliver more renewable projects and it is important that such an objective is delivered. Provided that sufficient network capacity is made available, the UK selfdispatch market will ensure that renewable schemes can export. The need for renewable schemes to have priority access is therefore not required given these market arrangements. Review of the Security and Quality of Supply Standard(SQSS) 49 Whilst a complete review of the appropriateness of the SQSS, particularly for intermittent forms of generation, is welcome, it is important that it strikes an appropriate balance between keeping the lights on, maintaining the integrity of the network, and balancing the cost of reinforcement against the cost of constraints. 50 There is some scope for relaxing the SQSS parameters which would also release additional capacity without the need to reinforce the network. Consequently there is the potential for more renewable generation capacity to be connected based on the current network configuration.

13 Strategic network investment 51 We support developments to consider strategic network investment and we look forward to seeing the outcome of the work overseen by the Energy Network Strategy Group (ENSG). 52 If the UK is to meet the 2020 targets strategic network investment ahead of user commitment will be required to provide for more timely connections. Delivery of this investment, once authorised, is still primarily a planning issue which the Planning Bill will help address provided the institutions and processes it puts in place are fully resourced and efficiently managed. 53 We also support the work to consider appropriate incentives on transmission companies for timely delivery, including variable rates of return on strategic network investment based on utilisation. Ofgem environmental and social guidance 54 We see no reason why the Authority s duties would preclude the more strategic approach to approving transmission investment this requires. The Authority would need to be persuaded that the proposed expenditure would in fact be required to connect the renewable generation needed to meet the EU targets and that the expenditure needed to be committed before some or all of the required renewable generation asked for a connection. This should be possible provided there is a clearer understanding of where and when the expected generation would be built than exists at present. Transmission companies should be able to provide this evidence by reference to the Government s own intentions for example to make available areas offshore for renewable development under the Round 3 Crown Estate leasing process. The Government s renewable strategy to meet the proposed EU renewable targets to be published in 2009 could provide a more comprehensive basis for such a strategic approach and should go further in identifying the required levels and general locations of renewable investment and the required transmission reinforcement. 55 This approach would be further supported if the Secretary of State were to issue updated and more specific Social and Environmental Guidance which would refer specifically to the Government s policy for delivery of the EU renewable targets, which the Authority would then have to have regard to in considering the investment requirements of the transmission companies. The proposed draft is not sufficiently explicit on what needs to be achieved. Offshore transmission 56 We support the competitive tender appointment process for offshore transmission system operators (OFTOs), although these proposals create some uncertainty not least for transitional projects. We will continue to discuss these project specific issues with BERR and Ofgem to ensure

14 that a pragmatic way forward is found that does not damage investor confidence in the overall offshore regime. 57 An alternative approach may be needed for Round 3 offshore generation development. As a number of different wind farms could comprise a Round 3 zone, these windfarms may come forward in different timescales. The most economic and efficient offshore transmission solution in the longer term may, however, be to provide an offshore network that can accommodate a larger amount of generation than initially applies. 58 In these circumstances Ofgem could treat the offshore transmission investment in a similar fashion to strategic network upgrades that are being considered under the Transmission Access Review for onshore investment, with a range of rates of return being available to an OFTO based on utilisation. This would allow an OFTO to invest ahead of user commitment, whilst ensuring that the most economic and efficient network is available in a timely manner for increased generation capacity, over and above the present 20% incremental threshold. Q9 What more could the Government or other parties do to reduce supply chain constraints on new renewables deployment? 59 The wind sector and offshore wind in particular are affected by significant bottlenecks in manufacturing capacity of turbines and the availability of vessels capable of installing foundations and turbines in UK territorial waters. Without a substantial increase in turbine production, there will be delays to offshore wind projects including those enabled by the Round 3 process announced by The Crown Estate on 4 June Limited supply in the off-shore turbine market has constrained growth and has contributed to higher costs. Over time we expect the market to respond and this will be encouraged if there is a clear long-term policy framework for supporting investment. 60 However with a competitive tax regime, it may be possible to attract new capacity to the UK if manufacturers are convinced that the renewables market here is viable over the medium term and not subject to boom and bust. This will also require an attractive grid and planning regime so that projects continually come out of the development funnel. 61 Beyond this, the Government should encourage UK industry to respond to the opportunities this market creates. We welcome the focus on low carbon technologies in the Government s new manufacturing strategy and the intention to establish the Office for Renewable Energy Deployment (ORED) which will address barriers to deployment, including supply chain, planning and grid issues. Q10 Do you agree with our analysis on the importance of retaining the Renewables Obligation as our prime support mechanism for centralised renewable electricity?

15 62 Yes. We welcome the Government s view that it does not believe feed-in tariffs would be more effective in delivering our 2020 target. The RO has proven to be a robust mechanism for incentivising investment although its efficiency has been affected by external barriers preventing the market from responding to the market signals the RO generates. The removal of these constraints planning delays, grid constraints and supply chain limitations - will improve the efficiency of the mechanism. 63 In any event the reforms to the RO in the Energy Bill and the introduction of the headroom mechanism will mitigate these additional costs and the introduction of banding will facilitate the deployment of offshore wind and other less mature technologies provided the banding levels are broadly reflective of the costs of constructing and operating these facilities. 64 In conclusion, we do not believe there are strong arguments from changing from a banded RO to a feed-in tariff. Moreover there is a major risk that such change would lead to considerable investor uncertainty for a period of time. This would lead to an investment hiatus, thus making it less likely that the UK would meet the 2020 target. 65 Feed in tariffs are an inflexible means of providing support, are administratively complex in terms of the cost involved in equalising costs to suppliers, and would need to be set at a high level when first introduced to ensure they were capable of incentivising investment and to avoid the need for a subsequent review. They are not particularly well designed for achieving specific targets. Wrongly set they will deliver insufficient investment. While FITs can be reviewed periodically in the light of changes in renewable technology costs and the value of the purchased energy in the wholesale market, this is more likely to occur where developers believe they are being insufficiently incentivised rather than over-rewarded. They can also be relatively ineffective in encouraging innovation. Manufacturers can see the returns available from the tariff and price their products accordingly. Q11 What changes (if any) should we make to the Renewables Obligation in the light of the EU 2020 renewable energy target? Extending RO v defined period of support 66 In the long term the price of carbon should be the primary driver of low carbon investments, but we recognise that to stimulate renewable investments to meet the 2020 target, additional support is required. 67 We have a number of renewable investment decisions that it will be making in the coming months. The economic viability of some of these projects is very much dependent upon assumptions being made about the RO beyond We are pleased that the Government recognises that this

16 issue needs to be addressed during this consultation period, and believe that this will provide investors with more certainty about the long term funding framework for renewables. 68 We believe that the best way to deal with this issue, which meets the needs of investors, but also limits the amount of support provided by customers is to remove the 2027 end date for the RO and replace it with a commitment that provides projects operational after 26 June 2008 with a maximum 20 years support via the RO. This will enable developers to recover their costs and make a reasonable rate of return relative to the risks incurred, in particular in the offshore environment. 69 By removing the 2027 end date, existing projects would continue to receive support from the RO after that date. As we have argued above, the way forward is to limit support to 20 years. For projects that would receive more than 20 years support as a result of scrapping the end date, we propose using grandfathering rights. This would be based on the following principles: all projects operational before 26th June 2008 will continue to receive RO support until 31 March 2027; projects that are operational before 26th June 2008 and that will have received less than 20 years support from the RO by 31 March 2027, will be entitled to receive additional support from the RO beyond this date up to a maximum of 20 years from the date on which they became operational; projects that are operational before 26th June 2008 and that will have received at least 20 years support from the RO by 31 March 2027, will not be entitled to receive further funding from the RO after that date; new projects operational after 26 June 2008 will be able to receive a maximum of 20 years support from the RO. 70 The level of the Obligation would need to be adjusted after 2027 to reflect the removal of projects which had achieved a 20 year life. Financial rewards under the banding regime will need to be adjusted downwards for new projects as technologies moved from one maturity category to another and were increasingly capable of being incentivised by the wholesale price of electricity combined with the carbon price created by the EU ETS, but this would not be applied retrospectively to operational projects. 71 The RO should not, however, be open-ended and the support regime for new renewable investments should be reviewed in the next decade to ensure that once it was apparent that the UK target for renewable electricity would be met, the most cost-effective low carbon technologies were deployed from then on. This review would need to assess the optimum role of renewable technologies and other forms of low carbon generation in meeting longer term carbon reduction targets to We discuss in our response to Q12 our views on the limits of economic penetration of intermittent wind and other variable forms of renewable generation on the system and our view that Government should set out its position on what the maximum total level of future renewable generation connected to the system should be.

17 Targets v headroom 72 The introduction of headroom was designed to provide some assurance to the industry in the event that there was a risk of over-complying against a target in any one year. This will also provide some protection to customers in the event that the non-financial barriers are not addressed by capping the recycle price. We believe that, provided the Government puts in place policies to overcome the non-financial barriers, there will be significant improvements in annual build rates under the RO regime. This will trigger the introduction of the headroom mechanism. 73 We believe that the headroom mechanism should be the mechanism for progressively increasing the level of the RO to that needed to achieve the level of renewable electricity required by 2020 to achieve the EU target, although the Government should quantify as a policy goal the % of renewable electricity it expects will contribute by If the headroom mechanism is to function effectively as the means of increasing the level of the RO, it is important that the forecasts made for the following compliance period utilise up to date information on when projects will be operational. Otherwise the RO may well be set at a level which takes an optimistic view of future investment timescales, which will depress ROC prices. Banding the RO 75 In our submission to the consultation leading to the 2007 Energy White Paper, we argued that the banding must be implemented in a way which minimises complexity and this should remain a key principle of banding the RO. We support the current approach as set out in the Renewables Obligation Order of grouping renewable technologies into four bands based on their maturity. 76 We do not support the concept of introducing sub-bands for any technology. Bands should be set to encourage the deployment of average schemes, implicitly recognising that not all schemes should be built, for example in poor wind speed areas. Furthermore the introduction of sub-bands will only increase the complexity of the RO which we should seek to avoid, and is likely to also lead to unintended and perverse consequences. Stability of the ROC Price 77 In the consultation, the Government points out that a sustained rise in wholesale electricity prices may lead to increased rewards to renewable generators with no corresponding reduction in the costs of renewables support through the RO. We not favour a mechanism which links the RO to the wholesale price; which would introduce additional complexity to the RO. We believe the appropriate mechanism for reflecting expected wholesale prices is through the use of predetermined scheduled reviews to adjust banding levels, except in very exceptional circumstances

18 where it is clear that projects are not being delivered because of adverse cost pressures that are not reflected in the overall support framework. 78 We have undertaken analysis to understand how the market would evolve with much higher degrees of wind penetration on the system (which we discuss in answer to Q12). There will be scenarios where the wind is strong and demand for electricity is weak. During these periods there is a potential for wholesale prices to collapse to zero or negative levels. Although this is a longer term issue, BERR should undertake further analysis so that the extent of this risk and the corresponding impact on revenue streams for renewables (and other generation technologies) can be better understood and potential policy responses assessed. 79 The reserve market will become much larger in a market with a high level of wind generation. A high proportion of the costs of this reserve market is likely to be incurred and met by more intermittent sources of generation, under the current market arrangements set out in the Balancing and Settlement Code. The Redpoint report suggests that imbalance costs could rise from 2/MWh to around 9/MWh. These costs have not been reflected in the current setting of bands for renewable technologies and will need to be taken into account in the re-setting of bands during the normal review process. Q12 What (if any) changes are needed to the current electricity market regime to ensure that the proposed increase in renewables generation does not undermine security of electricity supplies, and how can greater flexibility and responsiveness be encouraged in the demand side? 80 High levels of variable and relatively unpredictable wind and other renewable generation will have a number of very significant effects on the wholesale market. In general more price volatility is probable, varying in relation to the levels of renewable output and demand. At periods of high demand and low renewable output, prices may be relatively high, depending on the availability of fossil generation on the system. 81 Conversely, at periods of low demand and high wind generation, available renewable plant and nuclear plant capacity may exceed demand requiring nuclear or renewable generation to be curtailed. This will lead to wholesale prices falling to zero or to negative prices if wind generation needs to bid negative prices into the balancing mechanism to ensure they can generate to secure its ROC income. This will clearly affect the economics of either or both plant types and indeed any plants relying on relatively high load factors for economic viability. It will also need to be taken into account in the assessment of Severn Barrage economics. 82 Assuming that, say, 50% of nuclear capacity can reduce output and defer to wind generation, this effect becomes significant at wind penetrations of above 20-25% depending on whether the Severn Barrage is also built and the amount of nuclear capacity on the system. The following graph,

19 based on our modelling of our own geographically dispersed portfolio of windfarms in the UK, provides an indicative assessment of the impact: 1200 Hours of Wind spill GW Nuc, no SB 10GW Nuc, no SB 15GW Nuc, no SB 5GW Nuc, & SB 10GW Nuc, & SB 15GW Nuc, & SB % 5% 10% 15% 20% 25% 30% 35% 40% Wind Penetration 83 It is perhaps unlikely that these effects will be significant until the decade beginning 2020, assuming current nuclear closure dates and possible new build rates, but they will need to be factored into decisions for investments in new or existing plants operating over this period (i.e. investment decisions from now on). Overall it suggests that there may come a point at which the economics of investment in either or both of these technologies could be significantly affected, depending on other factors affecting investment returns. This is likely to impose an upper limit on the desirable level of must-run renewable and nuclear generation on the system. The Government should set out its view on what the maximum total level of future renewable generation is on the system. In our view this should not exceed the level in the potential scenario discussed in the consultation, or around one third of total electricity generation. This will help investors understand how the energy policy framework can be expected to develop in the longer term. 84 There will also be significant impacts on fossil plant. We calculate, using our own wind farm data, that in terms of ensuring sufficient plant is available to meet winter peak demand, only about 10% of wind capacity can be relied on to meet demand, at the bottom end of the range envisaged by BERR of 10 20% referred to in This means that the 28GW of wind capacity the Government estimates could be built by 2020 will reduce the need for other generating capacity by only about 3GW. This will require investment in or retention on the system of large volumes of flexible capacity, including coal and open cycle gas turbines, with biomass and pumped storage also playing a role, but with expected load factors in many cases reduced by the extent of wind and nuclear generation. The market will need to anticipate this and deliver the required level and type of investment.

20 85 The following chart indicates possible load duration curves for fossil plant to meet demand net of nuclear and wind output, at varying levels of wind generation with or without the Severn barrage: Fossil Gen Duration Curve Generation (MW) % Wind - No SB 20% Wind - No SB 40% Wind - No SB 00% Wind - & SB 20% Wind - & SB % Wind - & SB hours of generation 86 This shows the demand which fossil-fired generation has to meet over the year net of 10GW nuclear (baseload) and wind/tidal generation, for different volumes of wind and tidal generation as a percentage of total annual generation. All half-hours across the year have been ordered according to their load (whereas the chronological curve would look much more volatile). In general the slide illustrates the significant reductions in plant load factors which arise from higher levels of wind generation. 87 The top left corner represents all the instances of low wind output and high demand. Peak demand to be met by fossil generation is reduced relatively little by high levels of wind generation since there are still times at which there is almost no wind at all. However these times are infrequent, and there is some wind generation almost all of the time, which makes the fall-off from peak demand fairly steep. In other words, there are relatively few occasions when the last increment of peak capacity would be needed. This suggests the need for low capital cost peaking plant such as open cycle gas turbines or demand side management options. For all types of fossil plant, the reduced load factors call into question whether it will be possible to recover fixed costs over the operational life of the investment; this will critically depend on prices for energy delivered in the market (and to a certain degree on whether these can exceed short-run marginal costs or not). If further analysis shows that these energy prices are not likely to be sufficient, then some additional market mechanisms to reward this capacity will need to be considered. 88 The bottom right corner represents all the instances of high wind output and low demand. (i.e. the occasions on which fossil generation falls to zero marginal cost, as referred to above).