Low Carbon Generators and the Energy Prices Bill: What impact could Revenue Limits have on the renewables industry?

The UK Parliament has recently passed the Energy Prices Bill into legislation as the Energy Prices Act 2022.

This has been well received by most of our customers as it lays the legal grounding for the Secretary of State for the Department of Business, Energy and Industrial Strategy (BEIS) to control energy costs through providing reductions and discounts for domestic and non-domestic consumers.

However, the Act also makes provision to set a cap on the revenues enjoyed by low-carbon electricity generators.

Why is a cap on earnings for renewables generation being considered?

To set the background to this policy, it is important to understand how the energy market operates.

Electricity prices in the UK wholesale markets are currently set using a so-called “marginal generator”. This is the cost for the last unit generated which is therefore the most expensive form of generation in each relevant pricing period.

Currently, in many pricing periods, the marginal generator is gas-fired power generation. Gas prices have risen significantly since the beginning of 2021 due to demand increasing in line with the economic recovery as we came out of the COVID-19 lockdown, and significant price shocks following Russia’s invasion of Ukraine and reduction in gas flows to mainland Europe.

When the market is being set by gas-fired generation at these prices, many low-carbon generators, such as nuclear and renewables, have seen dramatic increases in revenues but, unlike the gas-fired thermal generation, the cost of production has not increased as starkly.

What is being proposed to address this?

It is important to note that the government will consult with industry over the next few weeks and many of the important details will not be finalised until this consultation has been completed.

The government is proposing a cap on the sell price of electricity generated from low-carbon technologies across England and Wales, using a “Cost-Plus-Revenue Limit”.

The limit is intended to be set at a level that will not deter investment, but which does represent good value to the end user. The core aim of the Revenue Limit is to “sever the link between high global gas prices and the cost of low-carbon electricity” but it must allow generators to earn revenue that reflects their operational output, investment commitment, and risk profile.

BEIS has indicated that “pre-crisis expectations for wholesale prices” will be considered when setting the cap. But the Department has not confirmed the level of importance that will be given to historic prices compared to other relevant factors. Most notably, installation and maintenance costs – all of which are rising as pressure is felt on global manufacturing and supply chains. 

Questions are still outstanding on many issues, including the duration of any cap, the limit at which such a cap might be set, and whether this applies equally to all revenue streams available to a generator.

The EU has recently proposed an equivalent cap at €180/MWh; the UK limit is expected to be much lower than this. If pre-pandemic wholesale electricity prices are used as a guidance, Inspired PLC anticipates that the Revenue Limit will be set in the region of £50-£60/MWh.

Why is this a concern for the renewables industry?

It’s important to have clarity on the intended approach because it could significantly affect the finances of existing and new generation projects.

Where generators have entered into a Power Purchase Agreements (PPA) with consumer “off-takers” who buy the electricity directly at an agreed price, the generator may not benefit from the high wholesale prices or may benefit only in part if they share such revenues with the off-taker.

Equally, where generators have agreed a fixed priced hedging arrangement with a consumer or trader for its electricity, either on a medium or a long-term basis, they may not be benefiting from the market highs.

But as these are private contracts- not public ones- they may also not be protected against the imposition of a Revenue Limit.

What are voluntary Contracts for Difference?

Alongside the consultation on the Cost-Plus-Revenue Limit, the Government also intends to legislate for power to enable a voluntary Contracts for Difference (CfD) process in 2023.

This will be aimed at existing generators who do not already have CfDs. The intention is to enable generators to enter these contracts which would give them longer-term revenue certainty while protecting consumers from further price rises.

How long will this last?

We mentioned above that duration is one of the outstanding key questions.

The cap is expected to be temporary, and in place from the beginning of 2023. Its end date and the criteria which will need to be met for the cap to be removed are not yet known.