UK: Levellling The Playing Field? UK Government Reduces Effective Of Price Of Renewable Power By £5/MWh

Last Updated: 10 July 2015
Article by Mark Cheney and Adam Brown

On 8 July 2015, George Osborne's Summer 2015 Budget had little new to say about UK energy policy: extension of some North Sea tax reliefs, a review of energy efficiency taxation, repetition of existing commitments to seeking a UN climate change deal at Paris later this year. However, one measure stood out as an unwelcome surprise for generators of renewable electricity. From 31 July 2015, suppliers who sell "green" power to business users will have to pay the same "climate change levy" (CCL) of £5.54/MWh as they do when supplying "brown" power from coal, gas or nuclear plant.

The CCL is a tax on business and public sector energy use. The general rule is that supplies of electricity to non-domestic customers are subject to a levy of £5.54/MWh. (There are separate or additional rates for supplies of other "taxable commodities" such as coal and gas.) But electricity generated from renewable sources is exempt. Generators of such electricity receive "levy exemption certificates" (LECs) from Ofgem which entitle suppliers to claim relief on the tax when they supply the associated power. As a result, when renewable generators sell their power to suppliers under power purchase agreements (PPAs), part of the payment which they receive from the supplier for each MWh of power that they sell is made up of a proportion of the value of the associated LEC to the supplier.

Brief details of the change announced in the Budget are set out in a policy paper from HMRC. The removal of the exemption is justified on the grounds that it will contribute to "fiscal consolidation" and "maintain the price signal necessary to incentivise energy efficiency", and that a third of the value of the exemption (£3.9 billion over the life of the current Parliament) goes to supporting "renewable electricity generated overseas" (possible sub-text: "and those pesky EU single market rules might make it hard for us to stop overseas projects receiving LECs without also removing the entitlement from domestic ones"?). HMRC also suggest that the value of LECs will be "negligible by the early 2020s, when the supply of renewable electricity will exceed CCL eligible business demand for it", but even if that is so, it is not clear why it justifies scrapping LECs now, while they are still worth having.

The Budget indicates that there will be some transitional provision: "There will be a transitional period for suppliers, from 1 August 2015, to claim the CCL exemption on any renewable electricity that was generated before that date. The government will discuss the details of this transitional period with stakeholders over the summer and autumn, to determine an appropriate length for it.". The relevant legislation will be included in the Summer Finance Bill 2015 and the Finance Bill 2016.

However, the key point is that within a few months, all existing and future renewables projects will be deprived of a small but significant element of their anticipated revenue, and the suppliers who buy their power will have one less reason to purchase renewable power. Some projects may find that the reduction in the rate of corporation tax, also announced in the Budget, offsets, or helps to offset, the reduction in revenue. But for projects in the early stage of their operating lives that are on relatively low rates of Renewables Obligation or Feed-in Tariff support, there is likely to be an appreciable impact. Moreover, the removal of LECs is one of a number of recent changes that may make renewable PPAs less attractive. These include the shift from the Renewables Obligation to CfDs – admittedly partly counterbalanced by the backstop PPA or "offtaker of last resort" regime – and Ofgem's decision to increase significantly the imbalance prices that suppliers can be exposed to as a result of contracting with intermittent generators.

The good news is that removing renewable generators' entitlement to LECs will help to reduce the deficit. The Government's estimates of the impact of the measure show a positive impact on annual tax revenues of £450 million in 2015/2016 rising steadily to £910 million in 2020/2021.

Behind these fairly large increases in Exchequer revenues lie some significant negative effects on individual projects. Shares in Drax fell substantially on the announcement and the company indicated that the change could reduce its 2016 earnings by £60m. It is also possible that projects whose bids set, or were close to, the clearing prices in the first auction of Contracts for Difference (CfDs) may feel the loss of LECs if they included LEC revenues in the financial modelling assumptions for their bids.

The LEC change comes on top of the Government's announcement of early termination of the Renewables Obligation for onshore wind and suggestions by the Competition and Markets Authority in the summary of its provisional findings on competition in GB energy supply markets that even the competitive allocation process that was used by DECC to allocate CfDs earlier this year may be too generous (in reserving particular "pots" of funding to specified technologies). While they wait to see what allocation of funding will be made available for new projects in the next CfD round, and when it will take place, renewable generators are likely to want to spend some time reviewing the Change in Law provisions in their existing PPAs (or even CfDs) to see how the loss of LECs affects them.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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