Unprecedented price volatility and high inflation impacts low-carbon subsidy schemes, RO and CfDs

In the second of our Non-Commodity Costs blog series, Mark Cox, Strategic Account Manager and host of our Non-Commodity Costs webinars, and Alex Walmsley, Senior Pricing Analyst, look at recent environmental costs, including the Renewables Obligation and CfDs (Contracts for Difference), for I&C business electricity customers and the predicted forecasts over the coming years, at a time of unprecedented high volatility. 

Renewables Obligation (RO) 

The Renewables Obligation (RO) is one of the leading subsidy schemes to support large-scale, commercial renewable electricity projects in the UK. The RO came into effect in 2002 in the UK, placing an obligation on UK electricity suppliers to source an increasing proportion of their electricity from renewable sources and is now closed to all new entrants. 

In our latest Non-Commodity Costs webinar, industry pricing expert Alex Walmsley and I discussed our latest revised RO forecast driven by the current state of the market and inflation expectations. We forecast RO at £26/MWh this coming year 2022-23, as previously predicted, however, due to higher inflation expectations, we see an increase by 7% for 2023-24, and, by 2024-25, we expect RO to be over £30/MWh. 

The RO scheme reflects the percentage change in the Retail Prices Index (RPI) over the previous calendar year. We expect RPI to hit 7% in 2022, before easing slightly down to 5% in 2023, which will have a compounding effect on future years, reflected in our increasing RO forecast year on year. 

Ofgem has recently published an overall shortfall of RO mutualisation payments, which in 2021 were £218 million, which when spread across consumers, works out around 90p/MWh. As we know, many more suppliers have not survived the energy crisis, so there will likely be a similar shortfall for next year. 

We estimate around 33 suppliers will default on their RO obligations for 2021-22, which will leave a shortfall of £110 million, approximately 50p/MWh. As it stands, we also expect Bulb Energy to pay their RO obligations whilst under special administration, however, should that not be the case, we would expect the shortfall to double at £200 million, £1/MWh, which may prove very significant, adding extra cost onto the RO. 

Contracts for Difference (CfD) 

The Contracts for Difference (CfD) scheme is a newer subsidy scheme supporting low-carbon electricity generation by incentivising new-build renewable energy projects and is set to replace RO. 

CfDs provide generators with a guaranteed strike price for the power they produce, acting as an incentive by stabilising their income. When the wholesale market is lower than the fixed strike price, scheme costs go up as a top-up payment to the generator but, when the wholesale market goes above the strike price, the cost will come down as generators must pay back the difference into the scheme. 

Given the current extreme market conditions, there will almost certainly be a huge fall in CfD scheme costs, and as a result, our forecasts have decreased significantly. Our estimate for 2022-23 scheme costs, modelled for around £5.50/MWh, has dropped by £4/MWh compared to our last quarterly predictions. However overall trajectory for CfD is still on the up and by 2024-25 will be costing businesses around £12/MWh. 

It is important to note that it is difficult to predict and our teams are currently reforecasting CfD daily due to price volatility at unprecedented levels across Europe. For example, roughly a £10 increase in reference prices will reduce CfD by approximately £1.20/MWh. However, this relationship does not always hold for extreme events. For periods with record day-ahead prices, you would expect to see payback but this winter has seen the model over-estimate generator payback as they tend to periods with minimal wind generation. This means CfD generators rarely pay back as much as expected. As a result, we anticipate the recent CfD volatility to be a feature of the scheme in future as offshore wind increases its dominance and capacity firms. 


That wraps up our latest forecasts and future outlook for environmental costs, and it is evident that unprecedented price volatility and high inflation has significantly impacted these low-carbon subsidy schemes. 

Keep informed and keep an eye out for the next instalment of our Non-Commodity Costs blog series looking back on renewable price increases throughout 2021. In the meantime, please feel free to contact your Account Manager directly or use our 'Contact Us' form with any related questions about our price forecasts and your energy bill.