Thursday, 20 June 2013

Renewable generators to be short-changed though use of inflation price index

The Government has effectively decided to slash the value of prices paid to renewable energy generators purely through the adjustments made for inflation. As a result by the end of the contracts for a particular project the prices paid to generators will be around 10 per cent less than current arrangements purely because of a deficient level of inflation adjustment.

Under the Renewables Obligation (RO), the value of the 'renewable obligation certificates' (ROCs) are uprated using the Retail Price Index (RPI). But now the  'strike prices' for the contracts for differences (CfDs) will be uprated using the 'Consumer Price Index' (CPI). This change has been increasingly used by the Government as a wheeze to effectively reduce the real value of welfare payments in the future. However, now it is being applied to renewable energy. It is all very well saying that incentives should decline for a developing technology in the future '(degression)', but the problem here is that the prices paid to particular projects will decline over the lifetime of particular projects using the same piece of equipment. This will mean that an investor in a given renewable project will get a lower rate of return compared to an investor in a fossil fuel power plant. That is because the fossil fuel power plants income stream is much more likely to be typical of the RPI rather than the CPI.

To understand this you have to know about the crucial difference in calculating RPI versus CPI. Often this is passed off through the fact that CPI uses a narrower basket of goods (which is relevant to some extent of course), but the key difference is that CPI just accumulates average increases in inflation rather than calculate how prices really change though being influenced by the increases in inflation in previous years. The CPI is calculated through using an arithmetic mean whereas the RPI is calculated using a geometric mean. Inflation increases geometrically, not arithmetically.The impact of this is that as time goes on there is an increasing deviation between CPI and RPI.

In short, the prices paid to a renewable energy generator after 15 years will be roughly ten per cent less under the CPI rather than the RPI. For more detail on these differences, see explanation on impact on investments and charts on

As discussed in the previous blog, inflation indexing has been trumpeted by spokespersons for the nuclear industry as some sort of breakthough for them. It is not at all. Indeed, for the renewable energy industry it represents a significant setback and a reduction in incentives compared to the Renewables Obligation. It is accepted that under a feed-in tariff system (even the Government's contorted version of a feed-in tariff) prices paid to generators will be lower than under a certificate system since the feed-in tariff offers greater certainty over income streams to investors. However, on top of this, investors will now be short changed because inflation in the real world will increase faster than the output of the method used to calculate it. It is another boost to gas power stations, natural gas imports and shale gas!

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