How will UK households benefit from the proposed price cap on low carbon power?

How will UK households benefit from the proposed price cap on low carbon power?

Published on October 13, 2022

As reported in the Financial Times last weekend and confirmed by the government’s business department on the 12th October, a price cap on low-carbon electricity generators will be introduced. While the business department’s “Cost-Plus Revenue Limit” announcement, which is part of the Energy Prices Bill, does not specify details such as the level of the price cap, the FT had reported a potential price cap as low as £50-£60/MWh.

Given the currently elevated price levels in the wholesale power market, the question arises of what impact such a measure would have on those generators and household electricity bills.

For baseload delivery in 2023, the price difference between a £50/MWh price cap and current wholesale power price levels around £400/MWh is very substantial indeed.

A key decision of course is which low-carbon generators the price cap would apply to exactly. Since no restrictions are mentioned in the announcement we have assumed that all generation currently supported by the Renewables Obligation (RO) scheme will be included in the price cap. Existing nuclear generation, which is not part of any support scheme, is also a clear candidate for inclusion in the price cap and has been included in our impact analysis. The successor Contracts for Difference (CfD) scheme already has an in-built mechanism to prevent excessive generator profits via the use of fixed strike prices and the policy objective of shifting more generators onto such CfD has been reinforced in the announcement.

The RO scheme was implemented in 2002 to incentivise investment in low-carbon power generation and was closed to new entrants in 2017. Low carbon power generation supported by the Feed-in Tariff, another legacy scheme which closed to new entrants in 2019, could also be included in the price cap but this would have less of an impact on consumer costs given its lower overall scheme cost compared to the RO. It is also unclear if the price cap will be rolled out to the residential solar PV installations which dominate the scheme and the other low-carbon generation technologies which have a 5 MW installed capacity limit.

Based on the difference between a £50/MWh price cap and daily average 2023 baseload power prices since Q3 2022, typical volumes of RO supported and nuclear generation and an average annual household electricity consumption in the UK of 3.954 MWh, the cost savings for 2023 would be around £648 per household. Given the lower wholesale price level in 2024 the annual benefit would drop to £377.

The significance of these potential cost savings also becomes clear when compared to an expected £118 annual household cost in 2023 of supporting all RO generators covered by the scheme. Consumers have been making payments to RO-supported generators via their suppliers in addition to paying for high electricity costs. A £50/MWh price cap could save consumers 5.5 times the annual cost of funding the entire RO scheme using 2023 forecast data.

Is the overall revenue for affected generators still adequate and how does this compare to the revenue of generators which are funded by the CfD scheme? Using 2021 base data the RO scheme payments were £106/MWh for offshore wind, £55/MWh for onshore wind, £80/MWh for solar PV, £56/MWh for hydro and £69/MWh for the remaining technologies. Adding £50/MWh to these scheme support levels compares very favourably to the total revenue awarded to CfD generators in the latest allocation round held in early 2022. In this allocation round offshore wind, onshore wind and solar PV generators achieved total revenues of £48/MWh, £55/MWh and £60/MWh, respectively (adjusted to 2023 prices).

It will be interesting to find out at what level the price cap will be set and what market arrangements will be put into place to implement it. If the previously sold volume was to be included it would create larger consumer cost savings compared to only including future sales. The price cap could also apply based on when generation takes place irrespective of when it was hedged. For how long the price cap will remain in place, the time horizon covered, the % of revenues above the cap covered and if a single cap will apply to all covered generators are also crucial decisions.

According to the FT, the direct beneficiary of the excess revenue above the cap will be the Treasury. This would make sense given the consumer support mechanisms already put into place comprising the Energy Bills Support Scheme which provides a £400 discount to households over winter 2022-23 and the Energy Price Guarantee announced in September 2022. The government estimates that the Energy Price Guarantee will save households £1,000 a year based on average usage. The Energy Price Guarantee also includes a bill reduction of £150 which will be delivered by temporarily suspending environmental levies such as the RO obligation payment from being passed onto consumer bills. The 12th October BEIS announcement states that the RO support to generators which takes place via tradable certificates will remain in place. There is, of course, the danger of increasing power demand, during a time of constrained supply, by distorting the price signal. This would suggest that the present government would likely only implement this cap for a short period while elevated consumer costs and the inflationary consequences are so troubling.

It is unlikely that new investment into renewable generation would be negatively affected as claimed by some generators. After all, the latest strike prices of these technologies in the CfD scheme have shown a very strong downward trend reflective of technology cost reductions. On the other hand, there is some validity to the warning of generators exposed to the wholesale market of revenue losses from a price cap due to power price and earnings variability including increasingly negative prices. Overall, the economic logic behind a cap appears to be sound although higher legacy investment costs imply that higher revenue expectations were factored into those investment decisions.

Written by Ulrich Arnheiter, Senior Associate