Power cut for clean energy

Five years ago, the Government announced a law that would change for ever the way the UK generated electricity. Out would go dirty coal and gas power stations, to be gradually replaced by non-carbon-emitting - or renewable - forms of generation such as wind and wave power.

Then Energy minister Brian Wilson announced that the Renewables Obligation scheme "reflects the Government's belief that the way forward for renewable energy is to create the market conditions for a thriving, dynamically competitive industry". He promised it would be in place until at least 2027.

But five years is an eternity in UK power policy. Since then, four energy ministers have departed (the last one, Malcolm Wicks, even calling this law a "blunt instrument"), while one energy review has been published and another is on the way.

And now, the Renewables Obligation scheme, enshrined on April Fools' Day 2002, looks set to be abandoned.

With critics claiming the renewable energy industry in the UK has yet to live up to Mr Wilson's dynamic vision, the energy regulator, which administers the obligation, took the wind right out of its sails last week.

Ofgem wants the scheme, which is being reviewed by the Government in its current Energy Review (to be published in April), scrapped.

It said the scheme has cost business and residential consumers £1.7bn so far - that's £7 per year on the average household bill - and is forecast to cost £32bn over its lifetime.

So has the law been an expensive failure? And if so, what should replace it?

Under the scheme, suppliers must buy a rising proportion of their electricity from renewable sources. The target in 2002 was 3 per cent, and this rises to 10 per cent by the end of the decade and to 15.4 per cent by 2015. If a supplier fails to meet these goals, it must pay a "buy-out" penalty (£34 currently) for every mega- watt (MW) of electricity by which it falls short. The targets are set high so that supply should never exceed these targets. This means renewable firms are guaranteed to be able to sell their electricity at a premium compared to that sold by normal power stations.

In a further break, suppliers which meet their targets receive a proportion of the penalties paid by rivals that don't, meaning the renewable generators can sell at an even higher premium (currently around £40 per MW above wholesale prices of some £30 per MW). Additional forms of support exist through other legislative breaks and government subsidies.

The cheapest forms of renewable generation are onshore wind and landfill gas, whose operating costs are well below the value of the electricity they can sell, allowing them to make massive profits.

According to the Energy Review, the cost of building and operating an onshore wind farm is £50 to £60 per MW. By selling electricity for around £70, these subsidised operations are making a staggering profit of over 20 per cent. Generating electricity by siphoning off the methane gas created in landfill sites is similarly lucrative, with companies such as Viridor (owned by Pennon) now making a third of their profit this way.

In 2005, 4.5 gigawatts (GW), or 5 per cent of the UK's total electricity capacity, came from renewable sources, which industry executives privately concede is disappointing. Of this, some 800MW was from landfill gas, 1,500MW (around a third) from hydro plants and another third from wind power.

The British Wind Energy Association (BWEA) says just under 2GW of wind power is now available in the UK, compared to 500MW in 2001 before the scheme was introduced. But only 300MW is from offshore wind, where the plants are more expensive and difficult to build. And none of Britain's renewable capacity comes from wave or tidal energy, which the Government says has the potential to generate 5GW by 2025.

Because the subsidy is the same for all forms of renewable energy, whatever their costs, it is hardly surprising that the cheapest enterprises, such as onshore wind, have attracted all the investment. As John Constable, the policy and research director of the Renewable Energy Foundation, says, this "one size fits all" approach has suppressed the development of more efficient capacity. "The Renewables Obligation scheme has been a catastrophe and offers undeserved hyper-profits," he says. "Consequently, speculators have simply picked the least capital-intensive form of renewable generation just to get on the gravy train. It has even encouraged wind farm companies to build onshore at low-wind sites, as opposed to offshore.

"Worse still, the emissions savings delivered are small and almost unbelievably expensive."

But Mike Davies, the managing director of Wind Energy, says that returns above 10 per cent are necessary to compensate for the UK's dysfunctional planning regime and the difficulty in connecting wind farms to the grid. Investors may spend years and millions of pounds developing a project, only for the planning authorities to turn it down. And the profits are not guaranteed as they depend on there being a shortage of renewable generation in any particular year and sufficiently high wholesale electricity prices.

It says much about the problems facing Britain's renewables industry that, despite the high returns on offer, many investors are putting their money elsewhere.

Ian Simm, the chief executive of specialist financial services group Impax, which has £500m of funds under management in the renewables and environmental sector, says: "The general view is that it is easier to invest in renewables elsewhere in Europe rather than in the UK. Because of our complex planning process, it's difficult to know whether a particular development will turn into an operating project. In addition, the structure of the Renewables Obligation means revenues are hard to predict."

In countries such as Germany, renewable generators are paid a fixed tariff for their electricity, guaranteeing profits. And in Spain and Portugal, wave power companies are given a tariff two and a half times that available to wind farms.

Embarrassingly, Ocean Power Delivery, a British wave energy company that developed and tested its generator in Britain, shipped its device to Portugal last year saying that it was not economic to operate in this country. Max Carcas, the company's business development director, says: "The scheme has succeeded in bringing forward renewable generation, but it has plucked the lowest hanging fruit on the tree. The scheme at the moment is one size fits all. It does not look to the UK's strengths. Otherwise, we might have had our first project taking place in the UK, not overseas."

The problems facing the renewable industry are not all down to the scheme, with the length of time taken to obtain planning approval for a project causing huge bottlenecks. According to the BWEA, wind farms totalling 11GW (only 3GW of which is offshore) are awaiting planning consent.

Public policy is confused and contradictory. For example, while the Government granted planning consent in December for the London array project, part of the largest offshore wind farm in Europe, the developers of the Kent plant, including Shell and E.ON, were appealing against local planning authorities which had blocked the construction of an onshore sub-station.

Chris Shears, the chairman of the BWEA, says: "The industry is hugely frustrated by the delays." But he adds that the subsidies under the renewable scheme will fall once more projects are allowed to come on stream.

The Government never intended the Renewable Obligation scheme to be the cheapest way of reducing carbon emissions (see the graphic above). The aim was to expand the UK's renewable industry, partly to tackle climate change and partly to bolster the security of energy supply.

But the scheme, hindered by the planning process, has not lived up to its promise.

The Government has now recommended a form of "banding" under which fewer subsidies would go to onshore wind farms and more to offshore and marine energy. The energy regulator rejected this proposal last week, but no one in the industry is quite sure what Ofgem is recommending in its place (one executive called its thinking "muddled"). Once again, the Government's policy on energy is scrambled.

Brian Count, the chairman of clean-coal company Progressive Energy and former chief executive of Innogy (now owned by Germany's RWE), argues that an international tax on carbon should ultimately replace the complex set of subsidies available to renewable generators. "A proper carbon market in the long run seems to be the sensible strategy," he says. "At some point, you have to take the mechanism away and let the market compete."

But the current regime on subsidies is more likely to delay than hasten the time when renewables can stand on their own two feet.