On Thursday, UK prime minister Liz Truss promised to protect consumers from surging energy costs. The support package is optimistically expected to cost only £150bn over two years. The government would hit that target more easily if it can decouple renewable energy prices from soaring natural gas costs.
The price of electricity has risen out of all proportion to its blended cost. That is because the price for the entire market is set by the most expensive power-generating asset.
The marginal cost of operating wind, solar and nuclear is close to zero. But many of these generators are receiving the same price as a power station burning gas. This is stratospherically expensive due to the Ukraine war.
At issue is a legacy subsidy system known as the Renewables Obligation scheme. This offered generous incentives to encourage renewable energy generators to invest. Though it was scrapped in 2017, some contracts run until 2037.
Renewable companies have subsequently sold energy under “contracts for difference”. These limit benefits from high gas prices, providing renewable investors with a fixed, agreed price. That protects against falling prices, but also limits the upside.
Shifting everyone to CFDs would require renewable generators to agree to power prices they could deliver over long-term contracts currently set at 15 years. That would cut costs to consumers by £22bn per year, according to calculations by the UK Energy Research Centre in April, when gas prices were much lower. Another assessment of the scheme’s potential by trade body Energy UK puts savings at just £18bn annually from next year.
There is upside for the generators in agreeing to the move: greater investment certainty and a smoothing of cash flow should follow. But their willingness to tear up existing contracts will depend on the proposed terms of CFDs.
Renewable generators will drag their feet, pleading practical difficulties. They have done nicely from energy mispricing.
The government should be prepared to brandish sticks and carrots in negotiations. The Truss administration, starting work at a moment of national crisis, can exploit exceptional political leverage. It must, meanwhile, offer investors a smaller replacement incentive in the form of extended CFD contracts.
A system that pegs electricity prices to gas is not fit for purpose. Speedy reform is needed.
The Lex team is interested in hearing more from readers. Please tell us what you think of the plan to delink renewable prices from gas in the comments section below
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