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UK, England, London, Parliament gate and Big Ben
© Tetra Images/Corbis
25 January 2016 7:00

Levy Control Framework: The unanswered questions

Simon Evans


Simon Evans

25.01.2016 | 7:00am
UK policyLevy Control Framework: The unanswered questions

Last July, the UK government started to roll back support for renewable energy, citing forecasts of cost overruns and the need to keep down household bills.

New projections showed the Levy Control Framework (LCF) cap for low-carbon support would be breached, the government said. Yet it has never published the details of its updated calculations, despite the multi-billion pound implications for the direction of UK energy investment.

Levy Control Framework: A nominal cap on the support for low-carbon energy which is paid via electricity bills. The cap has been set at £7.6bn in 2020/21. Subsidies may be allowed to temporarily exceed the… Read More

Carbon Brief has pursued a long-running Freedom of Information (FOI) request in an attempt to shed light on the pivotal forecasts. DECC and the Treasury released just two emails in response to Carbon Brief’s FOI request. (We have complained to the Information Commissioner’s Office over this limited release.) Following the email release, our 5 January article contained five questions on the LCF overspend for the Department for Energy and Climate Change (DECC), which has now responded (see below).

Nevertheless, a series of crucial questions on the LCF remain unanswered. The LCF is interlinked with most major decisions on the UK’s energy future, giving these questions extra significance.


Calls for transparency

Apart from Carbon Brief, some of the “big six” top energy suppliers, the UK energy industry’s trade association, renewable energy trade organisations, energy market analysts, opposition MPs, the National Audit Office and others have all called for greater transparency on the LCF.

For example, in October 2015 major energy supplier E.On said:

The evidence around cost overruns of the LCF is questionable and not transparent; publication of detailed analysis of the status of the LCF should be a priority.

In November 2015, Lawrence Slade, Energy UK chief executive, told Carbon Brief he wanted certainty from the government:

It’s certainty around where they – how the current LCF overspend came to be. Let’s see real transparency around the assumptions and the contracts that have gone into the current £1.5bn overspend so industry knows the starting point, if you will. Then let’s look at how that’s going to be set over the coming years. Those provide immediate investment signals around the different technologies that are going to be in the market.

In January this year, Labour MP Teresa Pearce asked DECC to “publish the methodologies and assumptions behind the projected overspend of levy control framework spending through to 2020”. Her colleague Matthew Pennycook had asked a related question in December.

The National Audit Office says transparent, prompt and accurate reporting to ministers, parliament and the public is one of five key criteria for evaluating the LCF.

Technical questions

The methodology and assumptions used to forecast LCF spending remain opaque. When Carbon Brief asked DECC to spell out the details, it merely listed some of its data sources (see below).

In a 18 January parliamentary answer, DECC minister Andrea Leadsom wrote:

Many of the assumptions that underpin Levy Control Framework (LCF) forecasts are already in the public domain…We must make a number of considerations before releasing further information, including to what extent disaggregating data would allow commercially sensitive information to be discoverable, and we will publish an updated set of LCF projections as well as the assumptions underpinning the latest forecasts in due course.

Below, we set out some of the key questions for DECC when it publishes its “assumptions underpinning the latest forecasts”. Between March and July 2015, most of these assumptions appear to have been adjusted.

The details of how and why they were changed are unclear. However, the net result was that the new forecasts showed a £1.5bn LCF overspend, whereas previously the LCF was within budget.

1. How much capacity does DECC assume will be built?

DECC says deployment has been faster than expected. The trajectory of future deployment has been clouded by the uncertainty created by recent policy changes, some of which are still in process. Any figures should be broken down by date, technology and support scheme, including the Renewables Obligation, Feed in Tariffs and Contracts for Difference (CfDs).

Load factor: A measure of the average output of a power station, relative to its installed capacity. This depends on technical and economic factors. For individual gas, coal or nuclear plants the load factor… Read More

2. What load factors is DECC assuming?

Offshore wind, which has much higher load factors than DECC initially expected, is probably the biggest mover. Larger turbines have proved far more efficient than previously thought, meaning higher subsidy payments to each project. DECC appears to have raised many of its load factor assumptions, but the details are unclear, as is whether it accounts for regional efficiency variations.

3. Does DECC assume that all projects will go ahead?

Not all planned projects are built, with DECC figures showing around half of planned onshore windfarms never go ahead. While schemes awarded a Contract for Difference face financial penalties for failing to deliver, delays or even cancellation remain possible. Several solar CfD schemes have already been ditched.

4. Does DECC assume that Drax will receive EU state aid approval?

The European Commission recently raised doubts over possible overcompensation, launching an in-depth investigation into the proposed subsidy for Drax’s third unit conversion from coal to biomass. However, the Lynemouth biomass conversion received state aid approval in December.

Carbon Capture and Storage: Where factories or power stations use technology to capture some of their CO2 and store it underground, reducing emissions. Read More

5. Does the overspend include carbon capture and storage (CCS) support?

In early November, DECC launched a consultation on supporting CCS projects through CfDs. Days later, it scrapped its £1bn CCS demonstration programme. The LCF overspend forecasts probably include support for CCS projects that are now unlikely to proceed on time, if at all.

6. Does the forecast include support for tidal lagoons?

The LCF forecasts may also include funding for tidal lagoons, with the Swansea Bay scheme due to have been operating as early as 2018. However, David Cameron told MPs earlier in January: “My enthusiasm [for tidal lagoons] is reduced slightly by the fact that the cost would be quite high.”

7. Will the forecasts be updated to reflect continuing falls in wholesale energy prices?

DECC substantially reduced its wholesale price projections between 2013 and 2015. Prices have fallen further since DECC published its latest forecasts last November. This is likely to increase the projected overspend and offset some of the savings expected from recent subsidy cuts.

Renewables are themselves responsible for some of the wholesale price reductions, since the electricity they generate has zero marginal cost. It is possible that DECC has updated its modelling to take account of this effect, which was not at first recognised.

The impact of wholesale price swings on LCF spending is large. In 2012, the Committee on Climate Change (CCC) estimated the cost of meeting power sector carbon targets at anything between £6bn and £10bn, with the variation solely due to different price assumptions.

Carbon Brief analysis found that around a third of the currently projected overspend is the result of cuts in wholesale price projections. This interplay raises awkward questions around the purpose of the LCF, which we’ll discuss in more detail in a moment.

Sir Ed Davey, the former secretary of state for energy and climate change, told Carbon Brief that DECC should use the LCF’s 20% cost headroom to cover overruns due to lower wholesale prices.

The Solar Trade Association, which has pursued its own, unsuccessful FOI request on the LCF, says the cap should be adjusted each year in line with changing wholesale price forecasts.

Wider questions

As well as the mechanical questions around how and why DECC’s LCF forecasts have changed, there are wider questions around its purpose, function and future. These overlap with almost all of the big policy debates facing the UK energy sector over the next 10-15 years.

1. Is the LCF really overspent?

First, it’s worth noting that there’s scepticism in some parts of the energy sector over whether the LCF is really overspent. E.On told MPs the overspend is “questionable”, while Renewable UK has told Carbon Brief it is “far from proved”.

There can’t actually be “proof” that the LCF will be over budget in 2020/21, since we are talking about projections. Energy-related forecasts are notoriously difficult (see, for example, the surprise fall in oil prices) and the LCF is no different.

However, there are plenty of others who would back the government’s analysis. Various groups, from analysts to academics, have been saying the budget is blown for a couple of years now. Disagreement over the truth of the matter illustrates why greater transparency is required.


2. What is the LCF for?

Announcing the £7.6bn LCF cap back in 2012, the coalition government said it would “provide certainty to investors in all generation technologies and provide protection to consumers”. The cap was, therefore, both a signpost of funding availability and a cost control mechanism.

The Treasury’s formal 2011 framework, however, set out a slightly different rationale. It said the LCF should ensure DECC’s targets were met at minimum cost:

The purpose of the Control framework for DECC levy-funded spending (‘the control framework’) is to make sure that DECC achieves its fuel poverty, energy and climate change goals in a way that is consistent with economic recovery and minimising the impact on consumer bills.

Even so, this language seems to suggest the cap should be consistent with meeting DECC’s goals. This raises a further question around what should happen to the cap if DECC’s goals are in doubt. As it happens, this is not a theoretical debate.

The UK has a legally-binding target to source 15% of its energy from renewables by 2020. Publicly, DECC claims only to be “uncertain” about whether this target will be met. Privately, however, it admits that forecasts show a significant “shortfall”.

The shortfall is mainly in renewable heat and transport, with the government arguing it remains on track for renewable power. Either way, there is a case that the LCF cap could expand, allowing overachievement in renewable power to make up for underachievement elsewhere.

DECC has been clear that the UK is off-track for its legally-binding carbon budgets in the mid-2020s. In theory, this also constrains the government’s wiggle room on the LCF.

Even if the government insists on a narrow cost-control focus, the current structure of the LCF creates some contradictory logic.

The link to wholesale prices means levy spending increases when energy is cheap. Subsidy cuts are being imposed, the government says, “to ensure consumers are protected from higher energy bills”. Yet its own projections showed bills would fall, despite the expected LCF overspend.

What’s more, the LCF only caps a sub-set of policy costs. The government’s decision to increasingly shield energy intensive industries from policy costs will add as much to household bills as is being saved through cuts to renewables, for instance.

In turn, the cuts risk being self-defeating. They might damage investor confidence, raising the costs of capital, while also hindering potential cost reductions from learning-by-doing, the CCC explains. If one aim of the LCF was to boost investor confidence, its track record is starting to look shaky.

This problem has caught the attention of MPs on the House of Commons Energy and Climate Change (ECC) committee, which is holding an inquiry into investor confidence and the LCF.

Committee chair Angus MacNeil, citing Carbon Brief’s FOI request, reportedly told a conference in London last week: “DECC are pennywise and pound-foolish for today. They see all investment today as costs and that’s a huge problem.”

3. What is the future for the LCF in the 2020s?

The CCC says damage to investor confidence can be limited if the LCF into the 2020s is clarified as soon as possible. Certainty would drive cost savings through reduced costs of capital and a strong pipeline of projects that supports supply-chain investment and innovation, it says.

The CCC says the cap will need to reach £9.9bn in 2030 in order to meet the UK’s legally-binding carbon budgets, if the cost is pegged to wholesale electricity prices. The cap would be lower, at £8bn in 2030, if it was measured against the cost of new-build gas-fired generation facing CO2 prices consistent with the UK’s legally-binding carbon targets.

Carbon Price Floor: The UK's top-up carbon tax, applied to power stations and designed to supplement inadequate prices on EU markets. When implemented in 2013, the floor was set to rise gradually to £74/tCO2 in… Read More

Tweaking the design of the LCF could, therefore, have billion-pound implications — at least on paper. Moreover, decisions on the future trajectory of the carbon price floor, the timing of the planned coal phase out and any reforms to the capacity market could all affect the need for and size of the LCF pot.

Other factors include whether or not the LCF is extended to cover the capacity market, whether it is used to fund energy efficiency “negawatts” and whether demand-side response or energy storage are supported through the framework.

The timeframe of the next LCF is also important. If it runs for five further years until 2025, it is likely to go mainly to offshore wind. The UK’s first planned new nuclear plant, Hinkley Point C, is not now expected to come online before 2024.

If, on the other hand, the LCF runs for a further ten years to 2030, there will be an assumption that much of its value after 2025 will be reserved for Hinkley Point and other planned nuclear schemes. Investors in renewable energy might then see little prospect of winning support in the 2020s, even if the size of the LCF cap is increased.

Several offshore wind developers have said they hope to be effectively subsidy free by 2025. At that point, they might join onshore wind and solar in asking for subsidy-free CfDs, or some other form of long-term contract with zero net cost compared to alternative sources of electricity.

That’s if the government finds a way to sign contracts with onshore wind and solar, despite having singled them out for subsidy cuts and adverse changes to planning rules.

Forecasts from market analysts Cornwall Energy show the impact these sorts of decisions could have. It thinks the LCF cap will need to increase by £5bn in the 2020s to reach nearly £13bn in 2030, far higher than the CCC estimate.

Tom Edwards, a consultant for the firm, tells Carbon Brief this is partly because it excludes support for the cheapest renewables, onshore wind and solar, in line with current government policy. It also assumes a steady carbon price floor in the 2020s, whereas the CCC assumes it will rise rapidly.

The floor has large knock-on impacts on the wholesale price, so a decision to freeze it again at current levels would raise the LCF cap needed to meet carbon targets. A decision on the future floor trajectory is expected at the next budget on 16 March.

4. When will the next CfD auction be held?

Getting the long-term shape of the LCF right is clearly important for UK energy policy. Meanwhile, however, a timetable for nearer-term action is also lacking. Last year, DECC indicated that a CfD auction would be held before the end of 2016.

Contracts for Difference: The new subsidy scheme to support investments in low-carbon electricity generation. Schemes are paid a fixed "strike price" for each unit of electricity they produce, giving investors the promise of steady returns.… Read More

The government recently reaffirmed its commitment to run three auctions during this parliament. It’s not yet clear which technologies will be eligible to compete in any auctions that do take place. Secretary of state Amber Rudd has told MPs they will be for offshore wind only, casting a shadow over prospects for all other technologies unless some contracts are awarded via direct, bilateral negotiations rather than through competitive tender.

However, DECC has said it will publish updated LCF forecasts “in due course”. If these were to find a continuing overspend despite all the recent policy changes, then this year’s CfD auction, as well as subsequent auctions prior to 2020, could be thrown into doubt.

If there aren’t any more auctions for the rest of the parliament, Edwards says: “Major [renewable energy] developers, such as the Scandinavian utilities, would probably walk away and they might not come back for some time. These are the guys with money — the Big Six don’t have any.”

Below we have reproduced in full DECC’s responses to our earlier questions.

1. Carbon Brief asked:

What is the full methodology behind the forecasts of LCF spending, and what assumptions are being made?

DECC’s response says:

 “We use a variety of assumptions in our forecasts including energy trends from DUKES data, the annual RO budget setting process and DECC’s assessment of the latest commercial information. We also look at the projects being supported by the renewable obligation and Feed in tariffs on Ofgem’s website and RO project details are published by DECC each month in the Renewable Energy Planning Database.
 “We publish estimated capacity of key renewable technologies in 2020/21 – see August and December 2015. Wholesale electricity price scenarios are published annually as part of DECC’s Energy and Emissions Projections update (updated in November 2015) . The LCCC website sets out the details of projects that have signed a contract. All of this helps us produce forecasts.”

2. Carbon Brief asked:

Why is DECC’s May forecast for LCF spending in 2020/21, at just over £8.6bn, some £0.5bn lower than the Office for Budget Responsibility’s (OBR’s) equivalent figure?

DECC’s response says:

 “This was provided as part of our internal reporting processes. A more detailed analysis led to a revised official projection of £9.1bn in 2020/21 – we worked on this projection with the OBR during June, for publication alongside the budget in July.”

3. Carbon Brief asked:

Did DECC supply figures to the OBR to inform its forecasts?

DECC’s response says:

 “Yes, we worked with the OBR during June, for publication of its forecast alongside the budget in July.”

4. Carbon Brief asked:

Why are both figures produced in July so much higher than the within-budget LCF forecasts, which DECC produced just six months earlier, albeit under a coalition government?

DECC’s response says:

 “The increase in the LCF projections since DECC’s 2014 Annual Energy Statement in November 2014 was due to a number of uncontrollable factors such as lower wholesale electricity prices, higher than expected uptake of Feed in Tariffs and the Renewables Obligation (such as solar panels on roofs) and a faster than expected advancement in the efficiency of the technology. All of this means renewables are projected to generate more electricity than previously projected. This is explained in our announcement in July.”
Main image: London, England, UK — UK, England, London, Parliament gate and Big Ben — Image by © Tetra Images/Corbis.
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