Energy Price Caps and a Cost-Plus Revenue Limit

On 12 October the Government introduced into Parliament the Energy Prices Bill. The draft can be found here. The Bill is being “fast-tracked” through Parliament. This is to ensure households and businesses receive the benefits in their bills asap.

Things we knew about before

Some of what the Bill does has been well publicised.

For households, there is the creation of the Energy Price Guarantee for electricity and gas. This will reduce the unit cost of electricity and gas for end users.

For businesses, there is a scheme to reduce the amount non-domestic customers would be charged for gas and electricity and reimburse suppliers. This is the Energy Bill Relief Scheme.

There is also protection for those alternative fuel consumers – i.e. those on a heat network. This is the Alternative Fuel Payment. It is available for domestic and non-domestic customers.

It is important to note the Bill also contains obligations on intermediaries i.e. private landlords to pass through benefits re savings to end users.

Some surprises… a cap on revenues for renewables

Some of what the Bill does was not so expected… The Bill creates powers for the Government to introduce a “Cost Plus Revenue Limit” for low carbon generators.

What is this? It is effectively a temporary revenue limit on low carbon generators. Electricity prices achieved by generators in the UK are set by the price charged by the most expensive, or marginal, source of energy for generation. At present the most expensive source of energy for generation is gas. Currently gas prices are significantly inflated in the UK in light of global energy prices. However, there is no reason low carbon generators operating in the market should charge prices based on inflated gas prices. Low carbon generators will likely have lower operating costs but will still benefit from the high price in the wholesale market.

The exact scope of the Cost Plus Revenue Limit remains unclear and subject to consultation. However, this is not a windfall tax. It does not apply to profits. It is a revenue cap – the intention appears to be that the new cap will allow generators to recover costs as well as costs a return linked to investment and risk profile. We understand this is due to kick in in March 2023.

The challenges of a revenue cap are immediately obvious. Questions arise such as:

• Where to set appropriate returns and whether to do this by project or by technology. It will be important that this cap does not artificially distort the market as between renewable technologies.
• Revenue caps will presumably have to be set on a unit basis but how will this be calculated.
• How to deal with revenue sharing mechanisms outside of the CfD e.g. Energy from Waste Plants built under PFI already have third party revenue sharing mechanisms.
• The cap is stated to be temporary but how temporary is temporary?
• How will the cap take into account actual cost – for example if a person constructed a wind farm and costs overran, is the cost overrun factored into the cap.
• How to ensure this does not act as a deterrent to constructing renewable generation.
• How will this interact with those generators on a CfD – who are incentivised to achieve “market price” but will forego the difference between “market price” and their subsidised “strike price”.
• Questions regarding the equity of capping revenues for renewable generators but not gas wholesalers (as opposed to generators).

None of this is to say the Cost Plus Revenue Limit is wrong. The Government is correct that the link between gas prices and renewable prices should be severed. The key challenge is the how. The consultation is forthcoming.

Steve Gummer is a Partner at Sharpe Pritchard LLP.

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