21 Dec 2022
Robyn Lucas

The Electricity Generator Levy: the new tax on all things clean?

In the recent Autumn Statement, the government introduced the Electricity Generator Levy. This is a significant new tax on renewable energy generators.

Here, we share an overview of what we know about the Levy so far including:

  • The headline figures on the new tax.
  • Why the government has introduced it.
  • What this means for different types of renewable generators.
  • What this means for battery energy storage.

Give me the headlines

  • The rules will affect companies and groups that own renewable or nuclear electricity generators.
  • The Levy will apply if those generators produce more than 50 GWh and generate more than £10 million in revenue in a year.
  • The Levy of 45% will apply to revenues above £75/MWh once total revenue exceeds £10 million. Revenue is calculated on an annual basis.
  • The tax will run for the next 5 years, from 1st Jan 2023 - 31st March 2028.
  • Exemptions apply to certain wholesale revenues. Sites built under the Contracts for Difference scheme will be exempt. Revenues from Renewable Obligation Certificates and the Capacity Market are also exempt.
  • Battery storage (as well as pumped hydro) is exempt. It is not yet clear how the rules will apply to battery assets co-located with renewable generation.

If you’re looking for all of the details, you can find these in the technical note released by HM Treasury, along with December’s update, here. The threshold changed from 100GWh to 50GWh, and an allowance permitted for certain ‘Allowable costs’.

Why tax the tech that's going to solve the energy crisis?

Skyrocketing gas prices have triggered the current energy crisis (as well as rising inflation and the cost-of-living crisis). Gas-fired electricity generators are the 'marginal' plant on the system. They are (usually) the most expensive and are the last to be switched on. They also (usually) set the power price. Power prices have been 5 times higher in 2022 vs 2019, and well above the £75/MWh benchmark price for the Electricity Generator Levy (shown in figure 1 below).

Figure 1: UK SAP gas and day-ahead hourly N2EX power prices from January 2018 to September 2022. The graph includes the £75/MWh benchmark price for the Electricity Generator Levy.

But, if we had enough wind and solar generation, we wouldn't need to turn on the expensive gas generators. So why would the government want to tax the generators that will help us out of the energy crisis?

Renewables use the sun, wind, or water to push electrons down a wire. Generally, these fuels are free - renewable sites don’t pay for the sun to shine or the wind to blow. Since around September 2021 (when gas prices rose), they have been receiving record-high prices for that cheap power. But their costs haven’t increased, so they have been making much larger, or 'extraordinary', profits.

Given the massive (and expensive) support scheme to shield consumers from record-high energy prices during the cost-of-living crisis, the government has brought in this new tax on the ‘extraordinary’ revenues of renewable generators to help balance its books.

What does this mean for reaching net zero?

Renewable generators can produce cheap power once a site is up and running. However, they have significant upfront costs usually paid for by private investment. To grow GB’s renewable capacity to the size we need to reach net zero (300 GW or more), investors must be confident that they can return a profit from renewable assets.

The government believes investors will continue to fund the build-out we need, even with the new tax, despite lower shareholder returns. The threshold for the tax (£75/MWh) is higher than average wholesale prices across previous years (shown in figure 1, above). Many renewable sites are still likely to be more profitable than they were before the energy crisis, even after the Levy is applied.

Which types of renewable generators will be affected by the Electricity Generator Levy?

The tax applies to corporate groups that own renewable or nuclear generation assets. These assets together must generate over 50 GWh per year and have revenues of over £10 million per year for the tax to apply.

Most corporate groups who own energy-generating assets are likely to be affected, particularly for renewable portfolios not operating under a Contracts for Difference (CfD) scheme. There are over 35 GW of renewables listed in the Renewable Obligation (RO) register in the UK (meaning 35 GW does not have a CfD), which could face the tax.

The amount of tax a group has to pay will depend on the capacity of sites (i.e. the peak power they can produce) and the load factor, where a single site or collection of sites (ie a portfolio) is owned by a corporate group.

Jargon buster: The load factor of a site is the average power it produces compared to its capacity. Over the course of a year, for example, the load factor will be <100%. This is due to factors like fuel availability or operational downtime. For example, consider a 100MWp solar farm (i.e. it generates 100 MW at peak, MWp) in the south of England. It generates, on average, 15 MW over a year (equivalent to 131 GWh). Its load factor would be 15%.

Different types of renewables have different load factors. Figure 2, below, shows how an annual generation of 50 GWh corresponds to a site capacity for various renewable technology types with different load factors.

Figure 2: Estimated capacities for different renewable technologies that are expected to generate 50 GWh per year.
  • Renewables with comparatively higher load factors will be subject to the new Levy at smaller capacities.
  • Solar generation is less likely to be impacted, as it has a comparatively low load factor. The largest solar farm in GB is 72 MW (compared to 38 MW in Figure 2 above). Only larger single solar farms are likely to be taxed under the Levy - but it could be applied to groups of solar farms.
  • Wind farms have a higher load factor, and are usually huge. The offshore site at Hornsea 2, which recently went live, is a whopping 1,386 MW compared to 16 MW in Figure 2 above. However, wind sites (like Hornsea 2) are usually built under a Contract for Difference so are likely to be exempt.

The tax will apply to the corporate group that owns the generation. Often, a renewable site is held in its own Special Purpose Vehicle (SPV) company. However, a corporate group may own multiple renewable sites (in a portfolio of SPVs). So, the capacities in figure 2 could be the capacity of a standalone site, if owned independently, or a portfolio of sites owned by a single corporate group. In this case, a portfolio of solar sites exceeding 38 MW will be taxed.

So how much tax are we talking?

A 45% tax will apply, for revenues above £75/MWh, once the total revenue of the corporate group exceeds £10 million. In figure 3, below, we estimate the reduction in total revenues due to the Levy.

Figure 3: The effective tax rate on revenues varies with the amount of energy generated (in TWh per year), and the average energy price is across the year.
  • The amount taxed does not exceed 40%, even for very high power prices of £500/MWh, regardless of annual generation. Annual generation is dependent on portfolio capacity and load factor.
  • A lower % tax applies to portfolios below around 3 TWh (or 3,000 GWh) and falls off towards 0% below around 0.5 TWh.

How will this affect battery owners and operators?

Battery energy storage is exempt from the Electricity Generator Levy. Because of this, it should not directly affect the business case for standalone battery storage. These sites will be exposed to the same wholesale market spreads as they are now, so revenues will not be impacted.

There is uncertainty on how the Levy will apply to co-located assets. There are several possibilities:

  1. The Levy calculations and totals do not include exports from a co-located battery (even where the battery was charged by the co-located renewable generator).
  2. The Levy calculations and totals do include some of the exports from a co-located battery (e.g. to include the revenue generated by time-shifted solar energy).
  3. All exports from a co-located battery are subject to the Levy, or some other arrangement.

We’ll dive into how these possibilities might work in a follow-up piece. However, options 2 and 3 above would make investing in co-located assets less attractive or more complicated. The government expect to issue draft legislation in January, so we should get more clarity then.

The wider impact of the Levy on batteries

The Levy is a significant shift in policy that is likely to negatively impact renewable investments, as they will see a material drop in profits. Investors have considered renewable assets to be fairly secure. As a result of the Levy, investors will now see renewables in GB as riskier and less profitable.

Battery energy storage usually sits under the same ‘clean technology’ umbrella, with the same infrastructure funds that back renewables also backing battery energy storage.

The USA has created huge tax incentives for clean energy projects through the Inflation Reduction Act, and Europe is likely to bring in similar incentives. This might make it more attractive for funds to invest their money elsewhere. We could see reduced investment in clean infrastructure investments in the UK - including battery energy storage.

Key takeaways

  • The Energy Generator Levy will be an additional tax on corporate groups owning renewable generation. This could impact up to 35 GW of renewable capacity in the UK.
  • The level of tax will depend on how much electricity a group generates and the revenue it receives for its power.
  • The government has chosen to tax the ‘extraordinary’ profits of renewable electricity generators to help fund the cost-of-living support package for consumers.
  • While standalone batteries are exempt from the Levy, clean energy funds might look to other geographies to make more profitable investments. Investment in future battery energy storage systems could decrease as a result of the Levy.

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