Renewables investment has just become a much more risky business

Subsidy regimes are always subject to change, but the government’s sudden and retrospective attacks on support for renewables could be a game-changer for investors, says Alex Harrison.

Is UK regulatory risk a bigger issue for renewable energy investors than we thought? To draw an analogy from the movie Field of Dreams, it used to be that if you built it, the subsidy would come. Recently things have got a little bit more complicated for renewables developers and investors in
the UK.

The original landscape of Renewables Obligation Certificates (Rocs) and feed-in tariffs (FITs) was premised on the certainty that if you got accreditation, you received a known level of subsidy, for a fixed period of time, and were protected from change by grandfathering.

Electricity Market Reform committed to phase out Rocs and introduced competitive auctions for contracts for difference (CfDs). Prices fell (much lower than expected in the first round CfD auction) and the government was happy. Investors were now faced with development risk, but with a large number of the early CfD projects already in the Roc pipeline (and with substantial development costs sunk) it made sense to keep going.

The landscape has continued to shift, not least as a result of the various announcements since the Conservatives swept to power.

The withdrawal of subsidy support for onshore wind was widely trailed in the Conservative manifesto, so in that sense we all saw it coming. That said, an outright Conservative victory was never on the cards until the exit polls were published and the result is that a policy, which may have started life as a play to the Conservative heartlands and something that could be traded away in a coalition or confidence and supply arrangement, is now a firm commitment that must be delivered.

July’s emergency budget contained a number of announcements, but the surprise among them was the immediate withdrawal of the economic value of Levy Exemption Certificates (LECs), which exempt low carbon generation from the climate change levy. This exemption represented between 4-7 per cent of the economics of many renewable assets. Drax’s share price fell by more than a quarter in response to the news, as it announced that the move would cost it £30 million this year and £60 million in 2016.

The emergency budget proposed the closure of Renewables Obligation support for small-scale solar a year early, from 1 April 2016, and an end to the grandfathering of Renewables Obligation subsidy levels for small-scale solar with immediate effect. This followed the earlier closure of Renewables Obligation support for large-scale solar on 1 April 2015.

The emergency budget also withdrew grandfathering support for the Renewables Obligation subsidies available to new biomass conversion and co-firing stations and existing units that move into the mid-range, high-range co-firing or biomass conversion bands for the first time, with retrospective effect from 12 December 2014. This move is intended to reduced Levy Control Framework spend by £500 million a year in 2020/21.

The Department of Energy and Climate Change (Decc) also launched a consultation to remove pre-accreditation and pre-­registration from the small-scale FIT scheme, thereby removing the tariff guarantee, such that installations will be exposed to the risk of tariff degression and will only receive the tariff rate as at the date they apply for full accreditation. Decc considers this to be an acceptable commercial risk for developers to take because it reflects the risks currently faced by generators with sub-50kW solar and wind projects as well as installations under the Renewables Obligation.

Finally, there was expected to be an announcement in July, setting the Levy Control Framework budget for the period after 2020/21, to give investors longer-term certainty of the scale of the government’s commitment to low carbon in the years to come. This has been put on hold.

There have also been changes in the CfD auction process. First came the announcement that there would be no Pot 1 (established technology) budget for the last two available delivery years in the round two auction. Then, the possibility of separate auctions for Pot 1 (established technology) and Pot 2 (less established technology). Finally, the entire auction round was postponed, to a date as yet unknown, with more news expected in the autumn.

So where does all of this leave us? The changes, taken together, make it less certain whether developers will get a subsidy, when they will get it and how much it will be (both at the point of award and in the future). That makes taking investment decisions increasingly difficult.

There appear to be two linked policy drivers: the desire to keep consumer bills down (with affordability having seemingly displaced decarbonisation at the top of Decc’s energy trilemma) and the anticipated overspend (albeit within permitted headroom) of the Levy Control Framework budget, which sets the upper limit on the aggregate subsidies that can be provided to low-carbon generation.

What is new is the tendency of the recent changes to have retrospective effect, to arrive unannounced and without consultation, and to undermine the principle of grandfathering. Investors can often get their heads around policy changes where they are trailed and consulted upon. They at least have the opportunity to play or to fold. Retrospective changes or changes that remove or change a subsidy level previously granted are much more difficult to adjust to and have an impact on confidence in the market.

Ultimately developers and investors are attracted to the UK market by the opportunities and comparative advantages. Their allocations are not fixed. The UK has, to date, been a popular destination for renewable investment, helped by policy stability, low interest rates and macro-economic uncertainty in the eurozone. The cumulative effect of the recent changes may not be enough to alter that position for projects that are already in the pipeline, but the government will need to remain watchful that developers and investors have the degree of certainty they need to put the first pound into the ground for the next wave of projects.

Alex Harrison is an energy lawyer at Hogan Lovells