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Budget blog - What might the Treasury say?

Posted By Gordon Edge, 15 March 2016
Updated: 24 March 2016

In all the frenzy about Brexit, one can be forgiven for forgetting that there is a rather important political/economic date imminent – the Budget. Given the apparent takeover of energy policy by the Treasury, the Budget this year is taking on even more significance, with some crucial announcements potentially on the cards.

The key issue to look out for is budget available under the Levy Control Framework (LCF), both in the immediate future and the longer term. This is a complicated area. Government’s recent policy changes have been primarily driven by a perceived need to rein in spending to within the current LCF envelope, which grows to £7.6bn in 2020 (in 2011 money). Early in the term of the current Government, figures were released indicating that they projected an overspend of £1.5bn above that figure. A number of factors were pointed at, including higher than expected demand for support through the Renewables Obligation and Feed-in Tariff, higher than expected load factors for offshore wind, and lower than expected electricity prices – this last driving greater draw on the LCF from the new Contracts for Difference (CfDs). However, Government has been less than fully transparent about how it has modelled the budget use, making assessment of whether there is any money left in the pot difficult.

We have been trying to model future LCF use within RenewableUK. With a number of the policy changes behind us, and the RO level set for 2016-17, the possible range of outcomes is narrower than it was in the middle of last year, but there are still uncertainties. However, best modelling efforts appear to indicate that budget use still overshoots the trajectory every year out to 2020. It’s worth noting that if the wholesale price projections that Government published when the LCF was set in 2012 (which are higher by about £20/MWh) were to be used instead, the story would be very different. There is a further problem, though: current and forward power prices are about 50% lower than those being used by DECC for the next two years. The risk is of further downward revision in DECC’s power price forecast and a worsening of the ‘overspend’.

So it appears unlikely that Treasury would sanction any budget for further CfD allocation ahead of 2020, unless there was an over-riding reason to do so, outside of meeting environmental or renewable energy targets. Security of supply could be one such reason, though a more pertinent one is likely to be to protect supply chains and project pipelines that will be needed post-2020, when new budget is available and tough decarbonisation targets need to be met. The things to look out for on Budget day are the latest OBR figures for the LCF, and any word on budget for the promised CfD allocation round later this year.

If Government determines that there is no more money before 2020, then budgets for future allocation rounds will have to come exclusively from the settlement that is made for the LCF post-2020 – and only projects delivering in the 2020s will have access. So far, that post-2020 budget has not been set out, and Budget would appear to be an obvious point at which to do so. While having clarity on that budget would be helpful, there is a worry with an imminent announcement: Government has made no attempt to consult with the industry about anything to do with the future level of budget, and nor has there been any indication of a change to the accounting for the CfD. The risk is that the structural problems of the current LCF are just continued, leading to a similar problem of uncertainty over the ‘buying power’ of the LCF as the volatile wholesale price leads to budget use depending on exogenous factors that are likely uncontrollable. The win-win opportunity of making the LCF a more dependable investment signal, reducing risk and therefore cost of capital and strike prices, would be lost. So look out for any statement on the LCF, but be careful to interrogate the meaning of a large budget number.

In all, there may be important news on Wednesday. It just may not be quite as good as it sounds.

Article originally posted on Business Green 14/03/2016

Tags:  2020  Budget  CfD  DECC  government  LCF  Treasury 

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