Would early closure of the Renewables Obligation to onshore wind cost £100 million?

8 December 2015
What was claimed

The government's impact assessment showed that we would be £100 million worse off because of the early closure of the Renewables Obligation.

Our verdict

The government's best estimate is that the net present value of the early closure is about £160 million, a positive figure. The £100 million worse off estimate comes from making different assumptions about how the UK would generate electricity.

"Does she acknowledge that, using the alternative methodology in the impact assessment, the net present value of deciding to close the RO early turned out to be minus £100 million? That means that we are £100 million worse off as a result of her taking that decision, instead of allowing the RO to continue."

Dr Alan Whitehead MP, 17 September 2015

Calculating the net present value of a project is a way of working out whether the benefits of the project outweigh its costs.

In this case, the government calculated that closing the Renewables Obligation (RO) early is most likely to have a positive value of £160 million (in 2012 prices).

But as Dr Whitehead points out, using different assumptions in the calculation changes the outcome, with the potential for a loss of £100 million instead.

The benefits and costs are sensitive to different assumptions

The benefits and costs considered here are to society as a whole rather than just the government. In the government's best estimate, the value of benefits was calculated at £330 million—that's from freeing up resources that would otherwise be used to generate electricity.

Meanwhile, costs were put at £170 million. This is the cost of buying additional emissions allowances under the EU Emissions Trading Scheme due to higher carbon emissions.

After accounting for this cost, the net benefit to the UK economy is £160 million. This figure isn't totally comprehensive—it doesn't include changes to air pollution, for example—but is the government's best available estimate.

This assumes that cancelled onshore wind capacity is replaced by Combined Cycle Gas Turbine (CCGT) generators, which are relatively cheap and quick to build.

If you change that assumption it changes the value of the costs and benefits. The government looked at an alternative scenario, one where it based the estimated cost of replacing the onshore wind capacity on something called the "long run variable cost of electricity". This is the 'total' cost of providing an extra unit of electricity to consumers; the wholesale price, the cost of subsidies to generators, and the cost of transmitting that electricity to users.

This includes generation by renewables, nuclear, and fossil fuels, and in turn means that the cost of generation is higher than if that electricity was generated by CCGTs. This would lead to generation being more costly than if it was done by onshore wind.

Under this option, carbon emissions rise more they do in the CCGT scenario, which means that firms have to purchase more EU emissions allowances.

Add the two effects together and what was a benefit of £160 million becomes an overall cost of £100 million.

The government doesn't think this is the most likely outcome; it thinks that generation from CCGTs is the most likely to make up the shortfall.

More on the net present value—what do the £160 million and £100 million figures mean?

Projects often span multiple time periods, presenting costs and benefits at different points during their lifetimes. For instance, a bridge requires money to be spent on its construction before it starts bringing benefits in the form of easier river crossings.

If we want to work out whether or not a project is worth it, we need to adjust for these differences in timing. Because people prefer to receive money sooner rather than later (generally people would rather be given £100 today than £100 in 3 months time), costs and benefits that occur sooner are 'weighted' more heavily than those that occur later.

If building a bridge across the Thames costs £1 million today, but brings £1 million worth of benefits next year, and the year after that, then it could be worth building it if we don't discount the future too heavily.

The "minus £100 million" estimate here is a net present value—the present value of costs, minus the present value of benefits. So that estimated "minus £100 million" doesn't mean the country would be worse off today by that amount, or that it'd be worse off by that amount in the future. It means that the stream of costs and benefits is equivalent to losing a sum of that amount today.

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