Mutualisation? Oversupply? Banking? Latest developments in the ROC market

We track the ROC markets closely through our within-year and long-term market forecasts of ROC values and supplier costs. In this blog we provide a view on the latest market developments and our current forecast levels.

If you are interested in the Renewables Obligation, or our market forecasts for the scheme, please contact l.dolton@cornwall-insight.com.

ROC season again

With the initial compliance deadline now having passed for Compliance Period (CP) 18 (2019-20) of the Renewables Obligation, and with further deadlines approaching, now is an apt time to take stock of recent developments and reflect on expectations for the compliance process. As the CP18 compliance process plays out there is also a considerable amount of uncertainty for CP19 (2020-21), especially from the impact of COVID-19 on demand levels and ongoing concerns around market oversupply.

CP18 compliance levels

As CP18 ended on 31 March, the Roc market for this year was somewhat protected against the impacts of COVID-19. In fact, the total obligation on suppliers for the year was recently confirmed by Ofgem to be the highest ever, with suppliers required to source 130,183,968 ROCs to meet their obligations. This total obligation is split by 116,940,506 ROCs in England and Wales, 11,782,299 Rocs in Scotland, and 1,461,163 ROCs in Northern Ireland.

Versus this obligation, the number of ROCs presented by suppliers for the CP was also recently confirmed by Ofgem. On 10 September, the regulator confirmed that it had received 115,942,339 ROCs toward CP18 compliance, a compliance rate of 89%. This remains above the compliance rate seen in CP17 of 84.3%, a year in which mutualisation was triggered as suppliers left a £206.0mn initial shortfall in the buy-out fund and a final shortfall of £97.5mn in the late payment fund.

With compliance levels <90%, a relatively healthy recycle value, the amount of money redistributed from the buy-out fund to suppliers that presented ROCs, is expected.

Will mutualisation be triggered for CP18?

Initial compliance deadlines have now passed, 1 September was the deadline for presenting ROCs against suppliers’ obligations, and 31 August was the deadline for those opting to instead pay the buy-out price, and any suppliers with remaining obligations will need to make a payment by the late payment deadline of 31 October. It is currently unclear as to how many suppliers made buy-out payments to meet their obligations, but the gap between ROCs presented and the total obligation means that £695mn was owed. Initial unverified figures from Ofgem suggest that the outstanding obligation value that will need to be met through late payments is lower than the equivalent point in time in 2019.

Contrary to the two previous compliance periods where the mutualisation trigger, standing at £16.94mn, was breached it is not currently expected that the impact of supplier exits in CP18 will surpass this amount. However, this does not mean the risk of mutualisation is not present; should further suppliers exit the market in the months ahead, or suppliers simply fail to meet the late payment deadline, then this could still be the case. Coupled with the challenging market conditions experienced amid COVID-19, there is a heightened risk that some suppliers may now be unable to meet their obligation and instead contribute towards triggering mutualisation.

So far, seven suppliers are confirmed to have exited the market with supply volumes in CP18, with the total estimated impact of these exits currently at approximately half the mutualisation trigger. These seven exited suppliers each had relatively small supply volumes in CP18. But should a supplier comparable to Extra Energy, Economy Energy or Spark Energy, all of which exited the market the previous year, exit the market it would likely tip the scale and push the shortfall in the buyout fund toward the mutualisation trigger.

COVID-19, CP19 & risk of oversupply

A similar level of dynamism has already been experienced in CP19 (2020-21) which, at least initially, looks set to be another abnormal year in the ROC market. Following the demand crash this CP due to the COVID-19 lockdown, we anticipate that demand will outturn notably lower than that of recent years. As a result, both the demand for ROCs, which is highly dependent on electricity demand levels due to RO targets being set on a ROC per MWh basis, and the number of ROCs issued during CP19 will be key to tracking the risk of oversupply.

Based on our current forecasts, the ROC supply-demand gap will be much closer in this CP than in the last few years. The gap is expected to be well below 10% as intended by BEIS’s “headroom mechanism” it uses to set the RO targets.

Despite some recent resurgence, should electricity demand trend lower for longer, or we see another lockdown from a second wave of the virus, the market could be pushed into oversupply. On the supply side, high output from intermittent generation technologies could also lead to oversupply. Our forecasts show that a plausible ‘high wind generation year’ within historic ranges would also see the market becoming oversupplied, even under our current central demand scenario which assumes no further material demand reductions.

Given the tighter supply-demand gap we are likely to experience this year, ROC prices have traded much closer to the buy-out price, at £50.05/ROC for CP19, than in recent years. Indeed, should the market become oversupplied then outturn ROC values could fall to this price with a recycle value close to zero. As a result of this uncertainty, we have observed a fall in traded ROC prices to date and greater discounts being applied to these certificates in our tracking of recent PPA deals.

Potential alleviation from banking

Despite this outlook and oversupply risk, a mechanism that allows ROCs to be “banked” from CP19 into the next compliance period (CP20) could provide some respite for Roc values. Lower traded ROC values in CP19 and expectations of a higher ROC value in CP20 could offer a good commercial incentive to bank ROCs into the next CP. An extreme example was observed back in CP14 where high wind output and a low RO target led to market oversupply, leading to 8.8mn ROCs being banked for use in the following CP.

Therefore, we anticipate that banking levels in CP19 could be greater than in some recent years and have knock on effects for future years. Any future impacts may be dependent on BEIS’s setting of the RO for CP20, which is expected on 1 October this year.

If you are interested in the Renewables Obligation, or our market forecasts for the scheme, please contact l.dolton@cornwall-insight.com.

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