Budget 2014 - Fifty shades of green

Andrew Horstead -

Chancellor George Osborne has delivered the 2014 Budget setting out his plans to support a “resilient” economy. George Osborne’s fifth Budget as chancellor comes as the UK economic recovery is gathering pace with latest BCC forecasts expecting the UK to hit a pre-recession peak by this summer. This Budget focuses on supply-side reforms intended to boost what Mr Osborne sees as the UKs historic economic weaknesses including manufacturing output, export growth and regional development.

Watershed moment

This year’s Budget though was a watershed moment for the Coalition Government, finally shrugging off its mantel as the ‘greenest government ever’ by providing a fillip to the coal industry, a nod to the oil and gas sector with a promise to review the tax regime to make sure the North Sea can be exploited for “every drop of oil we can”, and a promise to large energy intensives to reduce the impact of costly environmental charges.

The renewable sector will be digesting the ramifications of the Treasury’s decision to scale back the so-called carbon tax leaving the power sector in limbo but what was most alarming was that climate change or the green economy were not mentioned once.  The Government though did reaffirm its commitment to the package of electricity market reforms saying that despite all the measures introduced they would be ‘delivered without any reduction in the investment in renewable energy’ through the government's renewable energy subsidy schemes and levy control framework funding.  This argument is looking rather fragile.

The two initiatives however that will excite the business community the most is the decision to freeze the carbon price support (CPS) rates under the carbon price floor (CPF) and the offer of an extended package of compensation measures to business to tackle the impact of rising carbon taxes and clean energy subsidy schemes on energy bills.  The rationale for change is the need to ensure that UK industry remains competitive and remains in pole position to manufacture many of materials needs to produce clean technologies.

Is this all about security of supply?

We suggest that the freeze, while championed as a measure to help lower costs to industry is actually a slight-of-hand to keep coal generation on to boost supplies given on-going uncertainty around the capacity mechanism and timing of new build rates.  Keeping coal on would be welcome (from a supply security perspective) after recent declarations by DEFRA that a further 9GW, 50% of our current coal-fired generation capacity, will be closed by 2023.  An indirect consequence however could be to impact gas-fired generation as uncertainty as to how coal will now run, bearing in mind it will be constrained by new emissions controls from 2016, will make operational decisions around gas generation harder to predict, potentially pushing investors way from gas rather than bringing it forward.

Good news for business not so for renewables

Confirmation of the tax freeze is on the face of it good news for end users as wholesale prices will fall but it is a worrying development for the renewable sector.  The sector is crying out for stability after years of uncertainty around the RO banding and small scale FIT market and most recently the Government’s package of electricity market reforms.  Just a year after introducing the CPF, the Government is already playing with the rules, casting another layer of uncertainty over a beleaguered sector especially with a general election just over a year away and potential further review of the CPF depending how successful the European Commission’s measures are to boost the price of EU ETS carbon permits.

But most alarmingly it could indirectly impact investment in renewables and not actually make a difference to end user bills.   The Government says it is committed to its target for renewables under CfDs and confirmed in the Budget that funding through the Levy Control Framework will not be changed stating that the LCF will be supporting the same amount of new clean energy as before.

The problem however, is that because the CfD works by ‘topping up’ the reference (or wholesale) price with a subsidy to the strike price, by lowering the wholesale price, which will be an effect of the CPS freeze, not only will it increase the subsidy pay-out per MWh, it will mean the subsidy pot will run out faster.  Less funding means less investment in new renewable projects.  Either the Government accepts that or it increases the budget and therefore cost to consumers; ironically exactly what the freeze is meant to avoid.

Don’t believe the hype

However, we must caution that despite the freeze power prices will still be at an elevated level compared to what they would have been without the CPF.  The freeze will also come in the second half of the decade at a time when UK supply margins are expected to tighten sharply as a result of scheduled plant closures, although confirmation that 15 year capacity agreements will be available for new capacity under the capacity market should provide some comfort to unlock investment in new gas plant.

Meanwhile, the European Commission is implementing measures to reduce the oversupply of carbon permits in the ETS.  This should start to lift European carbon prices in the second half of the decade, again potentially limiting the impact of the rate freeze.