The government’s Levy Control Framework (LCF) spending cap for green power subsidies will be breached, according to new official forecasts from the Office for Budget Responsibility.
The cap limits spending on renewables and other low-carbon electricity schemes. It is the government’s way of trying to provide the certainty investors need to open their wallets, while limiting the financial impact on those who will ultimately foot the bill.
After years of insisting the cap would not be breached despite a range of voices arguing the contrary, the government appears to have finally admitted there could be a problem. Carbon Brief explains the purpose of the LCF and explores whether the budget really has been blown.
What’s the LCF for?
Announcing the £7.6bn LCF cap for 2020/21 back in 2012, the coalition government said:
“It will provide certainty to investors in all generation technologies and provide protection to consumers.”
The idea was that investors would be given the reassurance of a highly visible pot of money, agreed in advance. Meanwhile, concerns over rising energy bills would be acknowledged and the impact on households limited through the cap on spending.
Unfortunately it has always been hard to predict the cost of green power subsidies in advance. Uncertainties include how many people would decide to install solar panels on their roofs, how many large renewable schemes would be built, how much power they would generate and how much wholesale electricity would cost in future.
This uncertainty risks undermining both aims of the LCF. If ministers prioritise cost controls, amending policy to limit spending, the promised investor certainty evaporates. If they attempt to avoid spooking investors by holding policy steady, household bills could suffer and the budget agreed with the Treasury could be busted. A worst-case scenario would combine both problems.
Is the budget bust?
Until now, however, the government has maintained that it has things under control. It has moved to manage spending by closing certain subsidy schemes early to large solar farms and onshore wind, while bringing in cost control mechanisms for other types of support.
In its latest Annual Energy Statement, published late last year, the Department for Energy and Climate Change (DECC) said there would be up to £1bn of spare LCF money in 2020/21. There is also a 20% headroom above the £7.6bn cap for 2020/21, above which a plan to reign in spending must rapidly be agreed with the Treasury.
A range of commentators including energy analysts, some academics, and politicians have long disagreed with DECC’s reassurances on the cap, arguing for a variety of reasons that the £7.6bn limit and perhaps even the 20% headroom was likely to be broken.
Now a new official forecast backs the pessimists and says spending will reach £9.1bn in 2020/21, some 20% over the £7.6bn cap for that year and at the top of the headroom range. It was produced by the Office for Budget Responsibility alongside last week’s summer budget, with input from DECC and the Treasury.
So what’s changed? Let’s run through the reasons in turn. First, solar prices fell faster than expected, making subsidies relatively more generous. This has meant spending on Feed-in Tariffs (FITs) has been growing by £160m a year, rather than the £60m a year DECC had budgeted for.
The new forecast appears to put expected annual FITs increases even higher than recent growth, at £200m. It’s possible this might be an overestimate: cost controls, known as degression, are in place to reduce solar support when deployment is high.
Second, in advance of the early closure of the Renewables Obligation (RO) to large solar farms in April, there was a surge in UK solar capacity and generation, up by more than 50% last year. The new forecast boosts expected spending out to 2020/21 as a result of this leap in solar.
Third, recently built offshore wind farms supported through the RO are turning out to be more productive, generating on average close to 45% of maximum capacity rather than the 38% DECC had assumed. The new forecast doesn’t try to account for the early closure of the RO to onshore wind as it is unclear if it will reduce the capacity of wind that gets deployed.
Fourth, the forecast includes large increases in expected outlay on Contracts for Difference (CfD), the subsidy scheme that is replacing the RO. This reflects reduced expectations for wholesale electricity prices over the next five years, meaning the top-up CfD becomes more expensive.
It also appears to assume that two demonstration projects for carbon capture and storage (CCS) are awarded CfDs and that they will start operating before 2020. This is earlier than expected by the Committee on Climate Change (CCC). The new forecast may even be assuming that the planned Swansea tidal lagoon is awarded CfDs and is built within five years.
It remains hard to interrogate the assumptions behind the new forecasts, and even if they were completely transparent they would remain forecasts. FITs and the RO are demand-led, in other words spending depends on uptake, giving government limited ability to control costs.
CfD spending is, in theory, more tightly controlled through the budget assigned in annual auctions, but the eventual costs depend on unpredictable future wholesale electricity prices. So we won’t know for sure if the 2020/21 cap and headroom will be breached until nearer the time.
What next?
It is perhaps no coincidence that the new government, with its statement of priorities putting low energy bills front and centre, should have decided to raise its forecast for green power spending, perhaps as a prelude to further limits on renewables.
A 2011 Treasury document explains the consequences if forecast spend would breach the cap:
“The Treasury will need to be satisfied that there is a robust, agreed plan in place to bring spend back down to within the cap, even where forecasts remain within the acceptable headroom.”
The cap itself could also be changed. There is a “strong presumption” that this should happen as part of a government spending review – one is due this autumn. A reduction in the cap to 2020/21 would be impractical, since so much of that budget is already committed, and the last government said it was committed to avoiding retrospective changes in support.
Richard Howard, head of energy and environment for right-leaning thinktank Policy Exchange, has written a series of blogs on the LCF budget problem. He tells Carbon Brief:
“Hopefully, it won’t involve reneging on existing commitments, but you’ve got to assume government will do something.”
Whatever government decides to do in the short term, perhaps a bigger factor for investor certainty is the long-term future of the LCF, with no budget cap for the 2020s yet agreed. A CCC spokesperson tells Carbon Brief:
“Our recommendation is that government should ensure industry can invest with at least a 10-year lead time. This reflects the committee’s view that committing to an LCF beyond 2020 is the key priority.”
The CCC wants the post-2020 LCF to be agreed by early next year. The decision could overlap with debate over the UK’s fifth carbon budget, with the CCC due to publish its advice in December. This risks tying concerns over the future costs of supporting low-carbon energy to debate over carbon budget ambition.
A final possibility is that the LCF could be scrapped altogether. If it is failing to provide investor certainty over the timescales they need, and if it has failed to limit the impact on consumer bills, there may be legitimate questions over its usefulness.
Will the budget be sufficient?
While it’s tempting to get lost in the details of whether the cap will be breached or not, it’s important to remember why we’re investing in low-carbon power, namely to avoid dangerous climate change.
The most cost-effective way to start meeting the UK’s legally binding carbon budgets out to 2050 is to largely decarbonise the power sector by 2030 while investing heavily in energy efficiency, according to the CCC.
The CCC says the £7.6bn LCF cap to 2020/21 should have been sufficient to meet the power sector’s part of UK carbon budgets. The CCC tells Carbon Brief that any extra spending to 2020 could mean less deployment is required in the 2020s. It plans to look more closely at this in future work.
If more expensive types of renewable power, such as solar or offshore wind, are behind current overspending, then the extra money may not actually have bought the UK overachievement in carbon reduction terms. That would mean we’d continue to need more money to meet targets.