What exactly is ‘subsidy free’ onshore wind?

Wednesday, 16 September 2015

What exactly is ‘subsidy free’ onshore wind?

Synopsis

We recently published a new report, Powering Up, focusing on the future of onshore wind policy in the UK. The report set out the case for a continued role for onshore wind, albeit in a form where subsidies are progressively removed, communities have more of a say, and communities receive more benefit from hosting developments. 

The report demonstrated that the cost of onshore wind has already fallen from DECC’s estimate of £85/MWh, to around £75/MWh for the most recent projects, and could fall further to around £60/MWh by 2020 or shortly thereafter. Government has made a manifesto commitment to halt subsidised onshore wind, but our report suggests that future onshore wind projects may be possible on an unsubsidised basis as costs come down.

Needless to say, our report has prompted many responses from those in the industry, media and government. Several people have asked me to elaborate on what exactly we mean by ‘subsidy free’. Indeed, it appears that officials at DECC, and many in the onshore wind industry are asking themselves the same question.

In my view, the notion of ‘subsidy free’ is still open to a degree of interpretation, and there are three possible options to be considered.

The first option, which I think needs to be dispelled, is that ‘subsidy free’ means the withdrawal of support altogether for onshore wind (or renewables more widely). This would imply that new projects would receive income only from selling power into the wholesale market, where the price is currently £40-45/MWh. However, at present no form of generation is investable based on the wholesale price alone. Even fossil fuel power stations (e.g. gas, coal) receive support in the form of a capacity payment. In fact, we estimate that the cost of a new build gas project is currently £57/MWh – with the capacity payment making up the difference between this and the wholesale price. Government will be providing support worth around £1 billion per year through the capacity mechanism from 2019 onwards, predominantly to coal, gas and nuclear plant. 

Therefore, the second option is that ‘subsidy free’ could mean that onshore wind receives the equivalent level of support as, say, a new build gas project. This is the interpretation we used in our recent report. Our analysis shows that both onshore wind and new gas projects will be at a cost of around £60/MWh by 2020 (on a levelised cost basis, 2014 prices). In our view, a CfD contract at a level equivalent to the cost of a new build gas plant does not constitute a ‘subsidy’ – although the CfD contract is still necessary to de-risk the project, and to top up the wholesale price. 

There is also a third option which takes a more holistic view of costs. Generally, when we think about the cost of different generation technologies, we think about the direct costs faced by the generator – for example development costs, capital cost of construction, operating costs, and decommissioning costs associated with the project. However, energy projects also create a host of other costs and benefits, which are not felt by the generator but by society as a whole. These costs and benefits are referred to as ‘externalities’ in economic literature. 

For example, in the case of gas or coal power stations, the cost associated with air pollution is felt by local residents (i.e. in terms of health), not by the generator directly. Fossil fuel generators face part of the cost associated with carbon emissions (i.e. the cost of EU Emissions Allowances plus UK carbon taxes), but arguably current carbon prices are less than the societal cost of carbon. A report by the IMF calculated that the carbon and air pollution externalities related to fossil fuels amount to some $37 billion per year in the UK, and $4 trillion globally. 

Conversely, in the case of wind and solar power, it is argued that the generator does not face the cost of system balancing (i.e. providing backup power). Balancing charges are levied on generators, but at the same flat rate for all technologies – i.e. they do not reflect the impact each form of generation has on the system. Similarly, whilst there is some variation in transmission charges (i.e. the charges large generators pay to connect to the system), it has been argued that these charges are not fully cost reflective and therefore create externalities. On the flip side, intermittent renewables also offer external benefits which are not captured by the generator. For example, the presence of wind and solar on the system pushes down wholesale electricity prices – by virtue of the the so-called ‘merit order effect’. This leads to savings to consumers which the generators themselves do not benefit from.

There is now a growing debate about the scale of these various externalities, and also about how this could or should influence policymaking. For example, analysis by IRENA (the International Renewable Energy Agency) shows that if network, health and carbon costs are taken into account, onshore wind is competitive with fossil fuel power. Another study by consultants ECOFYS, calculated the external costs associated with carbon, air pollution, and depletion of natural resources (but not network costs) for many different forms of generation. It showed that the external costs associated with fossil fuel generation are an order of magnitude greater than onshore wind. In a UK context, a recent report by the Committee on Climate Change concluded that based on the full cost of carbon, ‘onshore wind…should be considered subsidy free from around 2020’ (note that this includes the cost of carbon but not networks or other externalities). 

However, putting this approach into practice is far from straightforward. The first task is to decide which externalities should be assessed, then you need to agree how they should be measured, and finally decide how to reflect these findings in policy terms. It would seem sensible for such an assessment to include the full cost of carbon and network system costs, but should it also include other externalities such as air pollution, visual impact, biodiversity impacts, or supply chain impacts? This creates a highly subjective debate about where to draw the line – and no doubt energy companies and trade bodies will want to tilt the debate to favour their own energy technologies.

There is also a lack of agreement about how external costs should be measured: the reports mentioned above vary widely in their scope and approach. There is still a paucity of evidence on the scale of externalities for energy technologies in a UK context. DECC has recently commissioned Frontier Economics to conduct a study on the full system costs of a range of technologies, but the study is yet to be published. Even once this evidence base is in place it is far from clear how it will be used in policy terms. Policies could potentially be amended to reflect external as well as internal costs, but this is bound to be problematic. For example, the debate around cost-reflective network charges has already been going on for years, and is unlikely to be revolved any time soon.

Clearly the debate about ‘subsidy free’ is only just beginning and will take time to resolve – particularly if Government wishes to broaden the debate to consider the external costs of different technologies. Depending on the approach taken, it may be possible for onshore wind (and potentially solar PV) to reach the ‘subsidy free’ threshold. But it remains to be seen how these largely technocratic arguments will fare against the political reality of a commitment to ‘end subsidised onshore wind’.

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what exactly is ‘subsidy free’ onshore wind?