A few hours after Jacob Rees-Mogg resigned as UK Energy Secretary, the Energy Prices Act 2022 was passed.
It is the only major new piece of legislation to come out of Liz Truss's short-lived term of office, implementing her promise to bring in support for domestic and business energy customers.
But the Act does more than that. It imposes a surprise cap on revenues of renewable energy generators. Plus unexpectedly wide powers for BEIS to rewrite energy licences and codes and even acquire infrastructure.
TO THE POINT
- A limit on the revenues that certain energy plants can earn, starting from January 2023 for up to five years
- Voluntary Contract for Difference scheme next year for existing low carbon electricity generators
- Legislates for the Energy Bill Relief Scheme (for businesses) and the Energy Price Guarantee (for domestic customers)
- Wide powers for BEIS to intervene in energy markets in response to the energy crisis
- Crucial detail left to regulations…to follow
IMPACT ON RENEWABLE GENERATORS
From the start of 2023, the amount of revenue that a renewable energy plant can earn will be capped. This is known as the 'cost-plus revenue limit'. According to the Government this "differs from a windfall tax as it will be applied to excess revenues generators are receiving, as opposed to applying to all profits".
We don't know which renewable energy plants will be caught or what the level of the cap will be. These details will be set out in regulations to follow. We do know that the cap will allow generators to cover their costs and receive sufficient revenue to reflect their “operational output, investment commitment and risk profile”.
The cap should not last longer than five years, although it can be extended by further regulations. Generators caught by the cap will still be able to receive existing revenue support or subsidies such as the Renewables Obligation. Generators who already have a Contract for Difference (CfD) will not be subject to the cap. So in practice the cap will apply to older renewables projects that were commissioned before the CfD regime, and newer projects that currently operate without any subsidy or revenue support.
The rationale for the revenue limit is to sever the link between high global gas prices and the cost of renewable electricity, something that the Review of Electricity Market Arrangements (REMA) is seeking to do in the longer term. In the short term, the Government will use the funds from applying the cap to fund the Energy Price Guarantee and Energy Bill Relief Schemes.
The government is working through the detail of the appropriate price for the ‘cost-plus revenue limit’ but one relevant factor being considered is the pre-crisis expectations for wholesale prices, and what a reasonable upper estimate for what those might be. The industry would like to see the limit match or be similar to the EU limit of €180/MWh otherwise investors may be put off UK investments.
This should not affect generators who sell their power under a fixed price PPA, as the price is likely to be below the cost-plus revenue limit. It also does not affect generators with a Contract for Difference (CfD). But generators who sell their power in the general wholesale market will have to forego any excess revenue above the limit. We can see this triggering change in law or material adverse change provisions under contracts and leading to potential disputes. It is also likely to put investors off investing in renewable energy and could jeopardise the UK's net zero commitments.
VOLUNTARY CONTRACT FOR DIFFERENCE
To help assuage investors, the Act also gives powers (which come into force in two months' time) to set up a voluntary CfD process for existing generators to take part in next year. This is to give investors longer-term revenue certainty and protect consumers from further price rises. The industry is generally in favour of a voluntary CfD, although the level of the strike price will be key. Generators who sign up to a CfD will no longer be subject to the cost-plus revenue limit, which may be another incentive to sign up to the scheme when it is launched.
The next CfD allocation round for new generation will still go ahead in 2023 as planned, so we could end up with two schemes, one for existing generation and one for new, presumably with different strike prices.
IMPACT ON BUSINESSES, CHARITIES AND THE PUBLIC SECTOR
The Act gives power to the Government to set up the Energy Bill Relief Scheme. In reality, it already started on 1 October. See our Insight UK Government unveils Energy Bill Relief Scheme. Some of the details we now know are:
- it applies to fixed price contracts agreed before 1 December 2021 (not 1 April 2022, so more are covered)
- the government supported price for energy (i.e. the unit price cap) is £211 per MWh for electricity and £75 per MWh for gas (as expected)
- the maximum discount is £345/MWh for electricity and £91/MWh for gas (slightly lower than we thought).
The scheme only lasts for 6 months initially and there is already a consultation to identify businesses and organisations most at risk for higher energy costs that will still need support after 31 March.
For those on heat networks, there are powers in the Act to make sure that heat network operators in England, Wales and Scotland pass through the cost savings to their customers. It will be interesting to see how this is applied in Scotland, where heat networks are already more regulated than in England and Wales.
It is not clear how the support will apply to private wire arrangements (where a power plant supplies buildings on a private grid) although presumably the pass-through requirements in section 19 of the Act will apply here.
WIDE POWERS FOR GOVERNMENT TO INTERVENE IN ENERGY MARKETS
The Act in theory gives the Government wide powers to intervene in the UK energy markets including acquiring energy or relevant infrastructure but it seems that these will only be used in an emergency. There are also powers to modify any energy licence and/or to give directions to energy licence holders or the Northern Ireland Regulator "in response to the energy crisis". MPs raised concerns about these wide powers as the Bill was debated. The Government reassured them that the powers must only be used in response to the current energy crisis (which section 28 clarifies as meaning responding to a change in energy prices on or after 1 January 2022), or in connection with the Act or regulations and schemes that fall within it.
The Energy Prices Bill became the Energy Prices Act within two weeks and without any changes as it passed swiftly through Parliament. That is because the devil will be in the detail and we await the various regulations that will set out the revenue limit, and how and when the price support will be collected and paid, with interest. However, this legislation has been rushed and it is creating unwelcome uncertainty in the very asset classes the UK Government will be relying upon as the winter approaches.