The OBR's curious predictions

The Office for Budget Responsibility (OBR) recently published its predictions about how the cost of environmental levies might change over the next few years. The picture painted was somewhat less appalling than it might have been because, or so the OBR claims, renewables generators are going to be paying back into the Contracts for Difference (CfD) scheme at a steadily increasing rate.

The CfD scheme essentially gives generators a fixed price for power. If market prices are below the agreed “strike price” they get a subsidy for the difference, but if they are above it, they have to pay the difference back into the scheme. In five years’ time they will allegedly be handing back nearly £4 billion per year.

However, the forecast of a steadily increasing repayment involves some remarkable assumptions about the future. Let me explain why.

The pattern of steadily increasing repayments predicted by the OBR must be due either to increasing volume – in other words, an increasing capacity of generation operating in the CfD scheme – or to market prices rising further and further above strike prices.

A moment’s reflection shows that increasing volume cannot be the explanation. A generator will only sign up for the CfD scheme if market prices are low and are expected to remain low. Otherwise, they will not sign up. This is precisely what we have seen since the start of the energy crisis. With high market prices readily available, almost no new capacity has become operational inside the scheme. That’s because doing so would probably involve handing cash over to consumers, and what business likes to do that?

Could the OBR be thinking that lots of generators will sign up for the scheme as the result of a fall in market prices? No, because if prices are low then the scheme will be paying out subsidies. A fall in prices followed by a rise? That doesn’t work either, because it doesn’t equate with the OBR’s prediction of steadily increasing repayments.

With market prices high, and expected to go higher, it is therefore extraordinarily unlikely that any further capacity will be added to the scheme. The OBR must therefore be basing their prediction on an expectation of rising market prices for those generators who are already signed up.

But how high would those prices have to go to explain to get to the £3.8 billion figure for 2027/28? If no capacity is added to the fleet in the next six years – as seems likely – then we can assume that it will be generating the same amount of electricity in 2027/28 as it did in 2022. We can also make a guesstimate that strike prices will increase by about 25% over the same period, roughly the same has they have done over the last five years. If those figures are correct, then the OBR’s figure of a £3.8 billion payback in 2027/28 requires market prices to average over £500/MWh, more than twice what they were during the energy crisis last year.

Of course there is a third explanation for the OBR’s numbers, which is that they are entirely baseless – a work of fiction designed to make the burden of green levies look a little less appalling than it otherwise would. But the Westminster machine would never do something so deceptive…would they?