COMMONS

Early contracts for renewable electricity

03 October 2014

Public Accounts Committee publishes its report on early contracts for renewable electricity.

The Rt Hon Margaret Hodge MP, Chair of the Committee of Public Accounts, today said:

"By awarding contracts worth up to £16.6 billion to eight renewable electricity generation projects without price competition, the Department of Energy and Climate Change failed to adequately secure best value for consumers. Yet again the consumer has been left to pick up the bill for poorly conceived and managed contracts.

The Department argued that the early contracts were necessary to ensure continued investment. But its own quantified economic case shows no clear net benefit from awarding the contracts early.

Indeed, if the Department had used price competition, it should have led to lower energy prices for consumers who are already facing hefty charges.

Furthermore, the terms of these contracts do not serve consumers well. For instance, consumers will pick up more of the risk associated with inflation, with little risk being borne by the developers.
 
The Department had no detailed knowledge and understanding of the developers’ costs and estimates, and it did not robustly challenge developers who claimed investment would not happen if the contractors bore more of the risk of inflation.

The Department should have learnt the lessons from PFI. It failed to challenge developers’ claims that investors would not come forward if contracts were designed to ensure that energy bill payers enjoyed part of the benefit arising from higher than expected profits.

The Department simply did not include claw-back provisions which would have ensured that hard-pressed consumers shared in any excessive profits achieved by project developers.

We are concerned that most of the budget available under this new scheme – 58 per cent – has already been spent on the early contracts awarded without price competition. So much was allocated without competition that little is left for testing the market and securing the best value for consumers.

The Department awarded these early contracts without clearly identifying how much capacity it needed from each technology to keep on track to meet the 2020 renewable energy target and to support the development of renewable electricity.

Given that the Department’s own data shows significant new renewable generation capacity is in construction, awaiting construction, or seeking planning permission, it is not clear that these early contracts were all necessary to meet the 2020 targets.

Quite simply, the Department failed to defend consumers’ interest under the terms of these contracts. What is now needed is a shift to full price competition, contracts which allow some claw-back for consumers of any excessive profits, and a balance of technologies which hits climate targets at least cost for consumers."

Margaret Hodge was speaking as the Committee published its 16th Report of this Session which, on the basis of evidence from: Stephen Lovegrove, Permanent Secretary; Hugh McNeal, Director, Office for Renewable Energy Deployment; Hugo Robson, Commercial Director, SRO for FID Enabling for Renewables and Simon Virley, Director General, Markets and Infrastructure, Department of Energy and Climate Change, examined early contracts for renewable electricity.

By awarding early contracts worth up to £16.6 billion to eight renewable electricity generation projects without price competition, the Department of Energy and Climate Change (the Department) failed to adequately consider how to secure best value for consumers. In committing 58% of the total funds available for renewable contracts under these transitional arrangements, the Department has severely constrained the amount available to be awarded under new arrangements through price competition, reducing the opportunity to test the market and secure the best value for consumers. Under the terms of these contracts the Department failed to defend consumers’ interest. For example, the risks associated with inflation will be met by consumers with inflation measured on the Consumer Prices Index. At the same time any benefit from excess profits will be retained by the developers as there are no claw-back clauses.

Conclusions and recommendations

In April 2014, the Department announced the award of contracts to eight renewable electricity projects under an early version of the new ‘Contracts for Difference’ scheme. Under the new scheme the Department fixes the price which renewable electricity generators can receive for each unit of electricity they produce (known as the 'strike price'). A newly formed ‘Counterparty Body’ will pay generators the difference between the market price and the strike price for the electricity they generate, where the strike price is higher. If the market price is higher than the strike price, generators will pay the difference to the Counterparty Body. The Counterparty recoups its costs from energy suppliers who in turn may pass on the cost to consumers, so the consumer picks up the bill. This scheme is replacing one which requires electricity suppliers to pay for Renewables Obligation Certificates which give renewable generators a premium over the wholesale price for each unit of electricity they supply, as the government’s main method for supporting new renewable electricity generation. The Department awarded these eight early contracts to reduce the risk of a delay in investment in renewable electricity projects during the transition to the new scheme. Two of the contracts are for power plants converted from burning coal to biomass, five are for offshore wind farms and one is for a purpose built biomass plant providing heat as well as power.

We are not satisfied that sufficient consideration was given to securing value for consumers during the transition from the existing arrangements to the new scheme. To avoid a gap in investment during the transition from the Renewables Obligation scheme to the Contracts for Difference scheme, the Department decided to offer early contracts without price competition. The Department argued that the early contracts were necessary to ensure continued investment and that they provided better value. But its quantified economic case shows no clear net benefit from awarding early contracts compared to allowing competition when the main scheme comes into force in December 2014. It is not clear that choosing to award so many early contracts was the best way to secure value for consumers. As the Department recognises, competition under the main Contracts for Difference regime may well secure better prices at less cost to consumers than those set administratively under the transitional arrangements.

Recommendation: Before embarking on future major reforms, the Department should consider fully its options for managing the process of transition, weighing up the impact on value for money of different types of transitional arrangements with different scales and durations.

Most of the budget available for contracts to be awarded under the new arrangements through price competition has already been spent on the early contracts awarded without price competition. The Department has awarded 58% of its budget for renewable electricity projects from 2015-16 to 2020-21 on the eight early contracts agreed under transitional arrangements designed to prevent a gap in investment in renewable electricity generation. The Department maintains that these transitional arrangements have encouraged project developers to progress their projects and build supply chains to a point where the market may be ready for price competition under the main Contracts for Difference scheme. But we are concerned that the Department has awarded 58% of the available budget to achieve this effect and that little now remains for the main competitive regime.

Recommendation: The Department must now seek to award the remaining funds using price competition.

The Department had no detailed knowledge and understanding of the developers’ costs and estimates. They were too ready to accept arguments put forward by project developers that consumers should bear the risk of inflation in the prices they paid. The Department did not robustly challenge developers who claimed investment would be deferred if the contractors bore more of the risk of inflation. The Department also failed to challenge developers’ claims that investors would not come forward if contracts were designed to ensure that consumers shared in higher than expected profits. The early contracts include strike prices which are fully indexed to the Consumer Price Index (CPI), resulting in consumers rather than project developers bearing the risk of high inflation. The Department argued that this was necessary to avoid project developers demanding higher strike prices. The Department also decided not to include claw-back provisions which would have ensured that consumers shared in any excessive profits achieved by project developers, for example through re-financing gains. The Department asserted that including claw-back provisions would have made the projects ‘uninvestable’. However, no evidence to substantiate these assertions was available and in our experience of reviewing public contracts, particularly PFI contracts, claw-back arrangements are essential to protect the interests of taxpayers and consumers.
 
Recommendation: For future Contracts for Difference, the Department should ensure it requires information from project developers on projects’ costs and returns and includes contract clauses to allow it the opportunity to claw-back for consumers a share of any excessive profits.

The Department awarded these early contracts without clearly identifying how much capacity it needed from each technology to keep on track to meet its strategic objectives. The Department awarded the early contracts to mitigate the risk of not meeting the 2020 renewable energy target and to support the development of renewable electricity. The Department’s data shows significant new renewable generation capacity is in construction, awaiting construction, or seeking planning permission. It is not therefore clear that these early contracts were all necessary to meet the 2020 targets. It is also not clear why the Department awarded so many early contracts to offshore wind projects, when offshore wind is currently the most expensive technology to support and other cheaper technologies could be deployed instead. Its early decisions have pre-empted resources and constrained future choices. For example, biomass conversion of coal plants could be an effective way of delivering energy until the next generation of nuclear energy joins the grid.
 
Recommendation: The Department should ensure its future decisions on the budgets for support for different technologies and its process of  allocating contracts are based on a clear understanding of how best to achieve the balance of technologies required to meet  its strategic objectives at least cost for consumers. In the event of a capacity crunch, clearly consumers will end up paying more.

The Department awarded these early contracts on the basis of wider benefits which it considered outweighed risks to value for money. The Department went ahead with the early contracts because it expected them to achieve wider benefits, on which it could not put a monetary value. The Department argued that there would be benefits to the renewable electricity supply chain, that it was necessary to show the new system could work and that early investment was required to meet the 2020 targets. The Department proposes to conduct an evaluation of the benefits from these early contracts.

Recommendation: The Department should ensure it conducts and publishes a robust evaluation of the actual benefits and costs of this scheme. This evaluation should assess the quantified and unquantified costs and benefits against the Department’s business case for the scheme and make an evidenced assessment of what it has achieved and whether awarding early contracts has genuinely been worthwhile.

The government owned Counterparty Body will play a crucial role in protecting consumers’ interests. The Counterparty Body will need to actively manage contracts, to ensure claims for increases in strike prices are reasonable, to identify and apply reductions in strike prices, and to calculate who needs to be paid what and organise those payments. The Counterparty Body should also monitor information from project developers on projects’ costs and returns to determine whether returns are reasonable with a view to introducing claw-back clauses in new contracts if there are excessive profits. The Department is in the process of setting up the Counterparty Body. It has appointed a Chair and is in the process of recruiting staff.

Recommendation: The Department must ensure the Counterparty Body is wholly independent of the industry and has the skills, resources and information it needs to manage all Contracts for Difference effectively and hold it to account for ensuring that the interests of consumers are fully protected.

Further information

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