Understanding the ROC transfer payment in the renewable obligation with the recycling mechanism in the United Kingdom

The Renewable Obligation scheme was implemented to promote renewable energy for electricity supply in the UK over 15 years from 2002 to 2017. Renewable Obligation Certificates (ROCs) were allocated to accredited generators for receiving additional revenues from selling those certificates to electricity suppliers. In particular, a recycling mechanism was employed in this scheme. That is, the penalties on missing ROCs from all suppliers are paid into the buy-out fund, which is then redistributed to suppliers in proportion to the number of ROCs they presented. This mechanism complicated the ROC trading in three aspects. First, the recycling mechanism induces strategic behaviour between suppliers in fulfilling the obligation of purchase of ROCs, leading to the equilibrium of a lower transfer payment from suppliers to generators, compared with the scenario without the mechanism. Secondly, under the recycling mechanism, the existence of vertical integration encourages upstream competition between generators, reducing ROC prices and the transfer payment. Thirdly, suppliers may strategically collude with each other to take the advantage of the recycling mechanism, but the existence of vertical integration weakens the collusion and prevents the worst case of nearly zero transfer payment.