“What is a government without energy? And what is a man without energy? Nothing, nothing at all.”

The decision makers in the UK government responsible for keeping the lights on must have been avid followers of Mark Twain, implementing a renewable energy policy aimed at providing 20 year index linked revenue streams to incentivise the sector. Even the key mechanism, known as the RO (Renewable Obligation), sounds like the parlance akin to Huckleberry Finn.

The backdrop to the renewable energy tale is a history of using cheap domestic coal and gas to sustain the energy network from the industrial revolution onwards.  The shift away from these traditional resources to more sustainable forms of energy in recent years has been driven by a combination of legislation from Brussels and a need to avoid over reliance on imports from Russia and the Baltics given the depletion of North Sea natural gas reserves.

Overreliance on imports and under investment in domestic capacity can lead to a host of problems from price increases to blackouts as shown in Russia’s spat with Ukraine in 2006 and more recently with northern India’s full grid failure. Whilst the use of candles might be appropriate for a Tom Sawyer adventure, avoiding this across the UK is part of the raison d’etre of the government’s Department of Energy & Climate Change (DECC) who have a binding requirement to secure 15% of energy sources from renewable supplies by 2020, with 30% to be provided from electricity.

Despite recent infighting between the Energy Minster, Ed Davey, and the “greenest government ever” rhetoric issued by the Conservative party, renewables’ share of the total electricity mix was up 3.4 percentage points in the first quarter of 2012 to 11% of total generation. Whilst the UK is on the way to meeting its targets, further investment in the industry will be required through to 2020. To date the industry has attracted financing from international banks, infrastructure funds and more recently, pension funds as touched on in our previous article.

But what has piloted this raft of investment down the proverbial Mississippi?

DECC mainly uses two, RPI linked mechanisms to incentivise projects in the UK, the Renewables Obligation (RO) and the Feed-In Tariff (FIT) (for sub 5MW projects) providing additional revenues to projects in addition to the market price of power.

The RO is an obligation on electricity suppliers, predominantly utility companies, to source a specific proportion of electricity from eligible renewable energy sources, with an annually increasing percentage.  Each unit of power receives a number of Renewable Obligation Certificates (ROCs) varying for different technologies depending on the maturity and current cost of the technology. 

Feed-in tariffs (FITs) are a measure to incentivise decentralised renewable energy projects up to a maximum capacity of 5 Megawatts (MW).  Whilst there is no obligation to source a proportion of renewables using the FIT, it provides the investment opportunity for the wider population, in turn facilitating the democratisation of UK energy supplies. (David Cameron’s ‘big society’ anyone?)

But why would the average person invest their pension in an industry that is, by comparison to fossil fuels, still in its infancy?

With the property market still in a slump and the FTSE 100 hovering around the 5,800 mark a government mandated 20 year RPI linked revenue stream doesn’t look to be a bad place to ensure one’s retirement years are full of swimming, boating and sunny afternoons.

The next article will examine the historical and future funding sources for the renewable energy industry and identify why the industry is keen to engage with the pensions community.

[Please note that all opinions expressed in this blog are the author’s own and do not constitute investment advice.  Click here for full disclaimer]

Author: Tom Fletcher / Rob Hayward

Tom is an energy corporate finance specialist with a green twist. He works within Ernst & Young's market leading renewable energy team on a wide range of technologies from nuclear and biomass through to onshore wind and offshore grid connection. Whilst all falling under a low-carbon umbrella his clients span government regulators, utility companies and individual site developers. Tom started his finance career with British Energy at the 1.2GW Sizewell B nuclear station. He holds a degree in Economics from the University of Cambridge and is a Chartered Accountant.