Ofgem, the UK gas and electricity markets regulator, has responded to the government’s proposed reforms of the Renewables Obligation (RO) with concern and suggested an alternative model for reform.

The government set out its proposals for reform of the RO, which provides financial support to renewable energy generation by requiring electricity suppliers to take a minimum percentage of electricity from renewable sources, in the 2006 Energy Review (see the November 2006 edition of this newsletter). Its proposals, which have been put to the industry for consultation, included ‘banding’ to set different levels of support for different renewables technologies and measures to continue price support beyond 2015.

In its response to the consultation, Ofgem has expressed considerable concern that implementation of the government’s proposed reforms would increase the cost of the RO to the consumer, and that the revised RO scheme would become more costly to administer in a market where electricity price increases as a result of the EU emissions trading scheme have benefited renewables and non-renewables investors.

Ofgem notes that, without more recognition of these factors, the RO may neither constitute the most appropriate level of interference required in the competitive electricity generation market to meet the policy objective of supporting renewables – a test that must be met to comply with EU competition and state aid rules – nor create the incentives required to reduce the cost of renewable generation.

Ofgem puts forward an alternative proposal for more substantive reform based on renewable generators entering into long-term contracts for difference, whereby a subsidy (levied from electricity suppliers in the same way as in the RO) is paid to renewable generators that top up the wholesale electricity price they have achieved to an agreed fixed price. This is intended to provide renewable generators with the certainty of income required to sustain investment and to reduce the cost of the subsidy as the wholesale price of electricity rises. Ofgem’s proposal appears to reintroduce some of the features of the Non-Fossil Fuel Order scheme the RO replaced. It is a key theme in the government’s paper, and duly noted in Ofgem’s response, that reform should maintain and increase investor confidence in renewables. This confidence may become the critical factor as investors assess the impact of RO reforms and the UK planning system against opportunities in other countries and in other parts of the sustainable energy sector.