Vertical integration, recycling mechanism, and disadvantaged independent suppliers in the renewable obligation in the UK

Under the Renewable Obligation (RO) scheme implemented in the UK, electricity suppliers are required to present a certain number of RO certificates (ROCs) depending on the quantity of electricity they sold. Insufficient availability of ROCs, guaranteed by the amendment of headroom, helps boost investors' confidence about their values, but we observe that there was a large variation in compliance by suppliers. Using data from 17 reporting years from 2002–03 to 2018–19, our estimation results show that compliance of subsidiaries of the big six energy companies was 15.46% higher than that of independent suppliers. We trace the movement of ROCs from six generators to show that they prefer to sell ROCs to suppliers within the vertical integration. We develop scenarios and a theoretical model to show that, when the recycling mechanism is in place, integrated generators have the motivation to sell ROCs to integrated suppliers, rather than independent suppliers, while holding spare ROCs is the least favourite option. These predictions are consistent with observations that (i) integrated suppliers have better compliance than independent suppliers, and (ii) nearly all issued ROCs were presented. Therefore, we suggest that, when both vertical integration and the recycling mechanism exist, independent suppliers were disadvantaged in accessing ROCs given insufficient supply. Nonetheless, as a way of refunding unjustified penalties due to insufficient supply of ROCs, the recycling mechanism can promote competition among suppliers for ROCs, compared with a simple refunding method.