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Policy & Regulation 10 | 4TH - 10TH MARCH 2016 | UTILITY WEEK Analysis T he revelation last year that the govern- ment was set to overspend its budget for renewables subsidies, the Levy Control Framework (LCF), by £1.5 billion had alarming repercussions. Ministers scrambled to cut subsidies to put the budget back in the black, and even put the second auction for a key set of subsidies, Contracts for Difference (CfDs), on hold. This is bad news for a crucial set of stake- holders: investors. Unless the government paints a clearer picture of what money is available for renewables subsidies in the future, there will be a "real hiatus" in invest- ment, industry figures have told Utility Week. They are particularly concerned with the absence of an LCF budget beyond 2020/21; a lack of transparency about how the LCF is set; and the rising cost of CfDs. Fisrt up, the overspend itself. Last July, the Office for Budget Responsibility projected that by 2020/21, yearly spending on the three elements of the LCF – CfDs, the Renewa- bles Obligation (RO) and the feed-in tariff (FIT) – would reach £9.1 billion; well above the £7.6 billion budget cap. Since then, the government has been urgently cutting back subsidies to try to bring costs under control – closing elements of the RO early and signifi- cantly reducing many of the FIT rates. Investors crave certainty, and the first problem with the LCF is the lack of clarity over what happens beyond the end of the current budget in 2020/21. Chairman of the Institutional Investors Group on Climate Change, Donald MacDonald, recently told the Energy and Climate Change Committee (ECCC): "Without having clear plans, with- out having a clear pipeline, without having the mechanisms of the levy understood on a longer-term basis, then the cost of capital will increase because of the uncertainty." Shadow energy minister Alan Whitehead says the lack of a clear budget is "potentially quite crippling for the industry", adding that it could "create a real hiatus in terms of decision making and a very uncertain climate for the future". Last week, trade body Energy UK called on the Department of Energy and Climate Change (Decc) to review the LCF "as a matter of urgency" and set out a budget post-2020 "as soon as possible". So, why no budget yet? Perhaps because the government is currently considering its fih carbon budget, which runs into the 2020s. "They could well be thinking about the Levy Control Framework at the same time," says Richard Howard, head of envi- ronment and energy at the Policy Exchange. Nevertheless, with the delayed second CfD auction due before the end of the year, there is some urgency. Senior consultant at NERA Economic Consulting and former head of LCF strategy at Decc, Alon Carmel, tells Utility Week the next round seems likely to be dominated by offshore wind projects that start spending from 2020 onwards. "How can the government really commit to and start signing CfD contracts unless they have an agreed envelope beyond 2020?" he asks. According to RenewableUK's director of policy, Dr Gordon Edge, the budget needs to be set by the middle of the year: "You can't wait around until the day before the round starts." He says investor confidence would take a "massive knock" if the second CfD auction was delayed again because of the lack of a budget: "People will say govern- ment doesn't know what it's doing." A spokesman for Decc said: "The govern- ment is now setting out the next stages in its long-term commitment to move to a low- carbon economy, providing a basis for elec- tricity investment into the next decade." The department would not say when it expects to publish the budget for the next period. The second problem is the lack of trans- parency over how the budget is calculated. Principal of The Townsend Group, Morgan Angus, told the ECCC the government needs to show its workings; explaining on what assumptions the budget is based, how those assumptions are formed, and how they are used to calculate the spending cap. Doing so, he said, would allow investors to react to changes in the market and "start pricing [them] in way, way, way before any sort of government announcement is made". However, ministers have shown little enthusiasm for more transparency. Respond- ing to a parliamentary question in January, energy minister Andrea Leadsom played down the issue, saying much of the key infor- mation was already in the public domain. The third problem that needs addressing is the cost of CfDs. Under the mechanism, generators receive, or pay back, the differ- ence between an agreed 'strike price' and the wholesale cost of electricity. The collapse in wholesale prices over the past year or so has made that difference much larger, cutting into the LCF budget. There are currently 35 projects that have been awarded CfDs; eight of them through the final investment decision enabling for renewables (FIDeR) process and the rest through the first CfD auction. According to analysis conducted by NERA, if prices are 10 per cent lower than Decc's latest forecast, the annual cost of these CfDs could be £295 million, or 16 per cent, higher in the final year of the LCF period than was expected in 2014. If prices remain at current levels they could cost as much as £200 million more. According to Edge, a possible solution is to stop using the market price to calculate the cost of CfDs for the purpose of the LCF: "The benchmark should be what's your alternative investment – new gas plants. "You set a price and say stuff above that is what you need to measure through the Levy Control Framework," he adds. Another alternative might be to index the size of the budget to the wholesale cost of electricity, so as the price goes down the limit goes up. A spokesman for Decc said the govern- ment "regularly monitors changes in whole- sale fossil fuel prices and the impact on support for renewable energy", and that it will publish updated LCF projections "that reflect market developments in due course". They are complicated problems, and time is running out to solve them. If ministers want to keep investors on board, and avoid another embarrassing hole in their budget, they need to come up with answers – and quickly. Back into the black The absence of a Levy Control Framework budget beyond 2020/21, a lack of transparency about how it is set, and the rising cost of CfDs are casting a shadow for investors, says Tom Grimwood.