Modeling and Analysis of Renewable Energy Obligations and Technology Bandings in the UK Electricity Market

Abstract

In the UK electricity market generators are obliged to produce a certain amount of their electricity with renewable energy resources in accordance with the Renewable Obligation Order. This obligation comes with an (indirect) subsidy rewarding firms with tradable green certificates for their renewable energy production. Until 2009 every unit production of renewable energy was rewarded with the same amount of certificates. Since 2009 a banding has been added to the Renewable Order, meaning that different technologies are rewarded with a different number of certificates. The obligation then shifted from one on production to one on certificates. This paper discusses and analyzes these two different renewable obligation policies in a mathematical framework. The policies are modeled into a two-stage electricity market investment model in which firms invest at the first stage and produce at the second stage. Since banding may result in an outcome where the original obligation target is not satisfied, hence potentially resulting in more pollution, we present an alternative banding policy. We provide revenue adequate pricing schemes for the three obligation policies in order to guarantee that the regulator can cover the payments to firms owning certificates with the mark-ups paid by consumers. Then we move to a stochastic framework where the two main sources of uncertainty are the availability of renewable generation output and the stochastic nature of electricity demand. The stochastic framework is used to carry out a simulation study via sampling on a small network representing the UK market. We analyze the effects of the three obligation policies; a key finding is that, indeed, the UK banding policy cannot guarantee that the original obligation target is met. Our alternative provides a way to make sure that the target is met while supporting less established technologies, but it comes with a significantly higher consumer price. Furthermore, we observe a concerning side effect of banding policies, as a cost reduction in a technology with a high banding (namely offshore wind) leads to more CO2 emissions under the UK banding policy and to higher consumer prices under the alternative banding policy.