Renewables Obligation (Scotland) scheme changes: consultation

Consultation on amendments to the Renewables Obligation (Scotland)

Introduction

1. The Renewables Obligation (RO), covering England and Wales, and the Renewables Obligation (Scotland) (RO(S)), were first introduced in 2002 supporting most of the renewable capacity built across GB since that time. Renewable electricity accredited under the RO and the ROS accounted for 31% of the electricity supplied to homes and businesses across the UK in 2019/20.

2. Although the UK Government closed the mechanism for new generation in 2015 (replacing it with the Contracts for Difference (CfD) scheme), the legislation remains open in respect of existing accredited generation until 2037.

3. The separate obligations work by requiring electricity suppliers to purchase a set volume of Renewables Obligations Certificates (ROCs) which are awarded to eligible renewable generators for each unit of renewable power they produce. Suppliers who can't or choose not to buy ROCs can instead make a "buy-out" payment to Ofgem, which administers the GB Obligations. These buy-out payments are then recycled to suppliers in proportion to the number of ROCs that each supplier has submitted.

4. The separate Obligations are largely identical in their design, delivering a consistent approach and set of regulations across GB. This has always been the preference of suppliers and generators, as well as Ofgem in its role as administrator of the Obligations.

Background

5. The UK Government implemented changes to the RO for England and Wales in March 2021, and is consulting on further changes to the scheme to be introduced in future delivery years. These changes are designed to address the increasing risk of supplier default – i.e. circumstances where suppliers are unable to submit their buy-out payments to Ofgem as required by the legislation.

6. In recent years there has been an increase in the number of suppliers exiting the retail market and defaulting on their obligation under the RO – defaults manifest as shortfalls in the cash payment fund. The level of default in England and Wales^[1] peaked in 2018/19 when 21 suppliers defaulted on about £88.1m, which is equivalent to about 1.5% of scheme cost^[2]. Payment default denies the scheme of funds and lowers the value of ROCs.

7. To protect the cash payment fund against the risk of payment default, the scheme features a mutualisation mechanism which recovers unpaid bills (up to a maximum of nearly £306m for 2021/22) from other electricity suppliers. The proceeds of mutualisation are recycled back to those suppliers who met their obligation with ROCs on a per-ROC presented basis, ensuring they realise full value. Mutualisation only occurs when there is a payment shortfall which exceeds a threshold. Since 1st April 2021 this has been set at 1% of scheme costs, equivalent to £63.7m for the 2021/22 obligation year. Below this threshold, any shortfall is left unrecovered.

8. Mutualisation has occurred in each of the past three years (when the threshold was set at a fixed level of £15.4m, (£1.54 million in the RO(S)), with the sum totalling £173m in England and Wales.

9. In 2017-18 the ROS shortfall was £4.4 million and in 2018-19 £9.4 million.

11. A number of suppliers have engaged with UK and Scottish Government in recent years arguing current arrangements and mutualisation thresholds required a review, amidst concern about the rising costs on suppliers that have met their obligation to cover the increased levels of default on suppliers who have failed to do so.

Recent Changes to the RO in England and Wales

12. The UK Government made an amendment in March 2021 to its Renewables Obligation Order 2015 which increased the level of the mutualisation threshold, reducing the likelihood of it being triggered. The threshold for the RO is now set at 1% of the forecast cost of the scheme to suppliers in each obligation year (roughly £62 million for the 2021/22 obligation year). This is a significant increase from the previous threshold which was set at £15.4m

13. In August 2021 the UK Government published a further consultation which seeks views on additional changes that would deal more directly with the challenges of supplier default.

14. Three options are proposed;

1. Increase the frequency of mutualisation periods,

2. Introduce a new electricity supply license requirement to provide a level of security against a supplier's obligation. Under this arrangement, suppliers would be given the choice of which protection measure to put in place.

3. Do nothing

Purpose of this consultation paper

15. Due to the timing of the last Scottish Election, the Scottish Government was not able to mirror the UK Government Amendment to the RO legislation to raise the mutualisation threshold.

16. Stakeholders have raised concern that without making changes to the RO(S) the issue of supplier default would be allowed to persist with suppliers operating unsustainable business models defaulting on their RO obligation and leaving costs to be picked up by others.

17. The primary purpose of this consultation is to seek views on making the same changes to the RO(S) legislation and therefore aligning the mutualisation arrangements for the RO(S) with the RO.

18. We are also aware that the issue of supplier default is a growing concern and in order to be able to make timely changes to tackle this issue within the RO(S) in future, we are inviting views on the three addition options, as proposed by BEIS that could be used to tackle the issue of supplier default. In particular we welcome thoughts on any specific impacts of the proposals for suppliers and generators in Scotland.

Aligning Mutualisation Arrangements for the RO(S) with the RO

19. In the past few years there has been an increase in the number of suppliers defaulting on their RO buy-out payments. In England and Wales, £53 million went unpaid in 2018 and £88 million in 2019. Under the RO legislation, this shortfall in buy-out payments is passed onto other suppliers in a process called mutualisation once it exceeds a threshold set in the legislation. The mechanism was introduced to protect ROC prices.

20. Mutualisation has been triggered in each of the last 3 years. Whilst the level of payment default has been relatively small to date (in comparison to the overall scheme value) it nevertheless places a financial strain on those suppliers who are required to make mutualisation payments.

21. The Scottish Government is proposing to make changes to mutualisation arrangements, this will align the RO(S) with England and Wales ensuring that arrangements remain fit for purpose.

22. The first relates to the mutualisation threshold which has failed to keep pace with growth in the scheme. The Scottish Government agrees with BEIS justification that this enables mutualisation to be triggered too easily. We propose to align with the RO legislation and link the threshold with the annual cost of the scheme to suppliers.

23. Mutualisation only occurs when there is a payment shortfall which exceeds a threshold. Since 1st April 2021 this has been set at 1% of scheme costs. In the first instance, this would increase the threshold to around £62m, but it would rise or fall in future years as the cost of the scheme changes. This new arrangement would restore the balance of risk between generators and suppliers that was established when the mutualisation mechanism was first introduced. It will ensure that suppliers that have met their RO are not unduly exposed to the unmet obligations of their competitors. It is likely that this will be of benefit to their customers too as they are less likely to face pass-through costs.

Q1. Do you agree with the proposed change which will increase the mutualisation threshold to link with the annual cost of the scheme?

24. The second change relates to the way the mutualisation amount is calculated. Currently, the entire payment shortfall is mutualised once the level of default exceeds the threshold. The Scottish Government agrees with stakeholders that this might be unfair on suppliers because it exposes them to the full cost of supplier default - and generators to none - by virtue of a threshold having been crossed.