Uncertainty is ‘built into’ the Levy Control Framework, warns expert

Uncertainty is “built into” the Levy Control Framework because the factors which determine the cost of renewable subsidies are themselves “variable and uncertain”, an expert from the University of Exeter has warned.

The sudden shift in government policy last summer demonstrates “both the strength and weakness of the LCF [Levy Control Framework] as a mechanism for underpinning investor confidence”.

“The factors that determine policy costs are variable and uncertain but the LCF caps are fixed, which means that uncertainty about whether caps will be breached is built into the design of the framework,” said Matthew Lockwood from the Energy Policy Group at the University of Exeter.

“By taking a forward look at likely expenditure and signalling limits to that expenditure, the framework arguably prevented a situation emerging later where the UK government would have to take retrospective actions, which are particularly damaging to investor confidence,” he added.  

Lockwood said the government’s decision last June to close the renewables obligation to onshore wind a year earlier than planned, nevertheless resulted in a “negative impact on investor sentiment”. The decision came after the Office for Budget Responsibility projected an annual overspend of £1.5 billion (2011/12 prices) by the final year of the current LCF budget (2020/21).

Writing in a paper for the journal Energy Policy, he said although some of the uncertainty over the LCF is down to wholesale energy prices, which determine the cost of contracts for difference (CfD) payments, political decisions are also factor.  

He gave the example of the European Commision’s decision on state aid approval for the CfD awarded to Drax for a co-fired biomass unit. The decision will determine whether or not the subsidy needs to be absorbed by the budget.

Lockwood also highlighted uncertainties over whether the budget will need to accommodate the Swansea Bay Tidal Lagoon; whether it will need to accommodate new nuclear plants; the level of the budget itself beyond 2020; and when future CfD auctions will be held, what technologies will be eligible and how much money will be up for grabs.

He said this problem has been exacerbated by the government’s failure to publish the assumptions and methodology used to calculate the LCF spending projections. As a result, investors have been left “frustrated by their inability to develop their own analysis of the uncertainties built into the LCF”.

The senior research fellow also criticised the LCF as a tool for protecting consumers from bill increases: “If the LCF is aimed at this purpose, it is not well-designed, since it does not include all policy costs and does not reflect full system costs for consumers.”

He drew attention to the failure of the LCF to take account of the effect of changing wholesale prices on contracts for difference payments, as well as the omission of the costs of the capacity market. “Even if protecting the welfare of consumers is not the primary purpose of the LCF it should be reformed to meet these criticisms,” he added.

The LCF places annual caps on the cost of renewable subsidies levied on customers’ bills via the supplier obligation. The contracts for difference, renewables obligation and feed-in tariff schemes are all covered by the framework.

The budget has currently been set until 2020/21 when the annual cap reaches £7.6 billion (2011/2012 prices). Earlier this year the trade association Energy UK called for an “urgent review” of the LCF to provide clarity to developers and investors.