Colbert, financial controller to Louis XIV, famously remarked that "the art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing." The Colbert prize is an occasional award, going to the government department that runs the tax scheme with the highest feather-to-hissing ratio.
The department of energy and climate change (DECC) wins the 2008 Colbert prize for its clever system of renewable obligation certificates (ROCs). Last year it used ROCs to pluck £470m from the public, and did it with no hissing at all. Furthermore—a point that a 17th-century aristocrat like Colbert would no doubt have particularly enjoyed—the plucking is regressive, taking proportionally more feathers from poor geese than from rich ones.
All this is a consequence of the British government's decision to place the responsibility for delivering (and financing) environmentally-friendly power in the hands of the generation utilities.
I will spare you the detail of how the ROC system works but here are the essentials. Through its power industry regulator, Ofgem, DECC obliges electricity supply companies to get a percentage of their electricity from renewable sources. At present this percentage is 9.1 per cent, but it will increase in future. This is the so-called renewable obligation.
Ofgem gives an electricity generator one renewable obligation certificate for every megawatt of renewable electricity it produces for an hour (MWh). The generators then sell these ROCs to the electricity supply companies. The supply companies in turn surrender them to Ofgem to demonstrate that they have satisfied the renewable obligation. If they do not surrender enough ROCs they have to pay a shortfall fine and the money raised is then recycled back to the generators.
Now we come to the goose-plucking bit. The electricity supply companies are just the middlemen, buying electricity from the generators and selling it to us, the public. Like any sensible middleman, when our supplier incurs the costs of buying ROCs and paying shortfall fines it promptly rolls them into our quarterly electricity bills. And because these costs are not identifiable on our bill, we pay them with absolutely no hissing.
The hidden renewables tax
The subsidy payment is not the only privilege given to the renewable electricity business. To make it easier for banks to finance schemes to build renewable generation plants, the government guarantees that the ROC system will continue at least until 2027, and that it will increase the percentage of total generation that must come from renewable sources from year to year to maintain the value of the ROCs.
How valuable is the subsidy? We have seen that generators of renewable electricity sell two things—electricity and ROCs. The wholesale spot price of electricity (the price to buy or sell electricity at four hours' notice) fluctuates considerably, but is now averaging about £75 per MWh. Many generators—including renewable generators—avoid the spot market and sell under long-term contracts at prices that are usually lower but occasionally higher than the average spot price. By contrast, the value of a ROC is more stable and averages about £52 per MWh. Taken together, the two currently give the renewable generator an income of £127 per MWh if it chooses to sell its electricity on the spot market. This is a 69 per cent premium over its non-renewable competitor selling into the same market.
Where the secret tax goes
So far, we have described renewable electricity without explaining how it is generated. In contrast to oil, gas, coal and uranium—all of which must run out—renewable electricity comes from sources that are, in theory, everlasting. In Britain today, the three most important sources are hydro, landfill gas and wind.
Hydroelectricity is the longest established and best known of these, but because the technology is so well established large hydro schemes are not eligible to receive ROC privileges. That leaves landfill gas and wind, plus a slew of minor contributors (that may be important in the future) such as biomass, waves, solar panels and so forth.
Landfill gas is methane generated by material rotting in municipal landfill sites. Technically, one could argue that it is not a renewable resource. Any single landfill site only generates gas for perhaps 20 years, after which all the rottables will have rotted. And with fierce EU directives in place, the volume of waste going to new landfill sites is likely to decrease sharply in future. Nevertheless, electricity generated from landfill gas does get full ROC privileges. It is extremely profitable. In a 2007 study for the DTI, accountants Ernst & Young calculated that it costs £48 to generate a MWh of landfill gas electricity. With an income from the spot market—including the ROC—of £127 this gives a profit margin of £79 per MWh, a delicious "cost plus 165 per cent," courtesy of us—the non-hissing geese. Perhaps a little embarrassed by this windfall, DECC is cutting the subsidy. From next April, a MWh of electricity generated from landfill gas will be entitled to only a quarter of a ROC. This will reduce the spot market profit margin to £40, still a very attractive margin over cost of 83 per cent.
Windpower, which currently accounts for about 4 per cent of electricity generation, also receives full ROC privileges. There are currently 189 wind farms in Britain of which only seven are offshore. Offshore has the disadvantage of substantially higher installation and maintenance costs, but the advantage of higher wind speed and a more consistent "blow" (typically an offshore turbine will yield about 35 per cent of its design capacity, compared with 26 per cent onshore). The net effect of all this is that onshore wind power costs about £74 per MWh and offshore costs £91—both figures calculated by Ernst & Young. These figures yield a spot market profit margin over cost of 72 per cent for onshore wind turbines and 40 per cent for offshore turbines. DECC evidently agrees that the offshore profitability is too low, so in April each MWh of offshore wind electricity will receive 1.5 ROCs—boosting the spot profit margin over cost to 68 per cent.
The high onshore profitability figure—the temptation to refer to a wind windfall is hard to resist—explains why, despite rising start up costs, installed turbine capacity has grown at an annual rate of 32 per cent since ROC privileges were introduced in 2002. According to the British Wind Energy Association the current 189 wind farms will soon be joined by another 43 that are under construction, with a further 131 that have planning permission and 266 that are at the planning stage. In other words, ROCs are doing what they are supposed to do. And that capacity growth will, inevitably, require us non-hissing geese to pay ever larger subsidies.
The energy department's justification for ROC privileges is the urgent need to reduce greenhouse gas emissions, in particular CO2. All renewably generated electricity is "zero carbon" (with no CO2 emission) but not all zero carbon electricity is renewable—the two main examples being nuclear and coal (or gas) with carbon capture and storage (CCS).
One of the most useful measures of effectiveness is the cost that must be incurred to mitigate one tonne of CO2. For renewably generated electricity the sums work out like this: if we didn't have renewable electricity we would have to build additional conventional power stations—probably gas-fired ones as they are the cheapest and quickest to build. When a gas-fired station generates a MWh of electricity it emits 450kg of CO2; a wind turbine emits nothing, so we avoid those 450 kg—but to do so we have to pay the ROC subsidy of £52 per MWh. Spending £52 to avoid 450 kg equates to a mitigation cost of £115 per tonne of CO2. Come April, when offshore wind will start to earn 1.5 ROCs per MWh, the mitigation cost will rise to £177 per tonne. Bearing in mind that the EU carbon trading scheme currently prices a tonne of CO2 at €28 (£22), ROCs do look quite expensive.
The international experience
Britain is not alone in offering fiscal privileges to renewably generated electricity, although other countries do it rather differently. There are two main alternatives: the "feed in" system and the "tax credit" system. Germany is a good example of the first; it has more installed wind-generating capacity per head than any other country (although the US may overtake it in the next year or so) which suggests that its method of privileging is a successful one. Like most of continental Europe, Germany uses the feed-in system—whereby a generator (however big or small, it could be a householder with a solar panel) receives a fixed price for all renewable electricity that it feeds into the system. The feed-in price is set by the government and applies for 20 years. Currently for onshore wind power the feed-in price is £65 per MWh—compared with the £127 spot-plus-ROC price in Britain. For offshore the feed-in price is £73 per MWh. The German system is less generous than Britain's but it is simpler and less volatile. Like Britain's ROC-based approach, the feed-in system is also Colbertian; it is the electricity supplier, not the government, that has to collect the hidden subsidy from the consumer—and thus the geese are again plucked without hissing.
The Americans prefer a tax credit system. The federal government gives generators a credit of the equivalent of £11 for each MWh of renewable electricity. This permits the generator to reduce its price, making its electricity competitive. So in the US, the government suffers the pain (through the loss of tax revenue) and the consumer is not directly charged, whereas in Europe it is the reverse. Again we see that by British standards the subsidy to renewable energy in the US is modest. Nevertheless, capacity is growing very rapidly—$9bn (£5.7bn) worth of wind turbines were added in 2007 alone.
Britain's wind power capacity is growing fast, as we have seen, but not as fast as Germany's or America's. Assuming that start up costs are similar in the three countries this suggests that, in spite of the tax privileges, there must be other non-economic factors—planning problems, military objections, difficulties of attachment to the grid and so forth—that constrain growth. But when an onshore wind scheme hurdles these various problems, the privileges mean that it becomes a valuable cash cow.
The carbon question
The two issues—renewability and zero carbon—are quite separate, but have become conflated. Of the two, the need for zero carbon generation is by far the more pressing. Renewability will only loom large when fuel reserves dwindle (either because of absolute shortage, or because of cartels restricting access to reserves, or because balance-of-payments difficulties make imports unaffordable). Few believe that reserves—at least of coal or uranium, plutonium, and thorium—are going to be a serious issue before the end of this century at the earliest. Without global warming concerns, the reserve security issue is just too distant and too fuzzy to justify the level of renewable subsidy provided by ROCs.
In view of this, it is rather perplexing that the national debate is dominated by renewability rather than by zero carbon. Part of the reason may just be that they are, wrongly, seen as the same thing. Another reason may be fear that the geese will start hissing if confronted with the real costs of going to zero carbon because—make no mistake—it is going to be expensive. No government likes to bear bad news so it must be tempting to avoid the debate and continue to finesse this inconvenient truth by minimising the public awareness of the large sums that are being plucked today—and the much larger sums that will have to be plucked tomorrow.
This lack of openness is particularly regrettable because the two technologies that we are going to have to rely on if we are to achieve zero carbon generation—nuclear and CCS—are both hamstrung by poor economics and, in the case of CCS, by the need to demonstrate large-scale viability. Unfortunately, Britain's ambition to be a leader in the CCS field looks ever more unlikely—indeed we seem rather lethargic compared with some countries. Our plan is to have a CCS demonstration plant operating by 2014, yet Germany commissioned its first demo plant in September. But there is no doubt that leadership rests with the US. Poor old America may get blamed for doing nothing about global warming, but in truth it is pouring money into tackling it. This year's federal budget for CCS alone is $149m in what the International Energy Agency recognises as "the world's most ambitious programme."
What needs to be done? Yes, ROCs are expensive but they do work; they cause zero carbon generating capacity to be built that otherwise would not be built. But surely we need to frame our subsidy system around zero carbon not just renewability? If we want to see decisive action on the zero carbon front, nuclear and CCS should both receive the same privileges as renewables.
