Working in start-up development, I am interested in projects that are relatively inexpensive to develop, construct and operate, have acceptable technology and planning risk, plus offer secure and attractive returns over the investment lifecycle.
The UK Feed in Tariff (FIT) provides secure price premium support for anaerobic digestion (AD), hydro, combined heat and power (CHP), solar PV, and wind. AD, hydro, and CHP projects require significantly more development and build capital than wind and solar PV and are best left to experienced developers or consortiums with larger development budgets.
Small-scale AD is financially attractive if developers can get a handle of uncertainties around fuel supply contracts, gate fees, and technology related risks. Large-scale commercial and industrial and utility-scale solar PV was the flavour of the month until DECC announced cuts to the FIT for solar projects over 50kW as part of the first FIT review.
As of August 1st, FITs for solar installations between 50kW and 150kW fell 42% to 19p/kWh, mid-size installations between 150kW and 250kW cut 51% to 15p/kWh, and installations between 250kW and 5MW slashed 72% to 8.5p/kWh.
There was better news for AD as the government increased subsidies for this technology to 14p/kWh for installations up to 250kW and 13p/kWh for installations between 250kW and 500kW.
The onshore wind sector emerged unscathed from the FIT review and remains a fantastic opportunity for developers and investors if pitfalls around site selection, planning, technology and funding can be avoided.
With the Renewables Obligation (RO) and FIT already operational and the Renewable Heat Incentive (RHI) coming over the horizon investors (private equity houses to high net worth individuals to landowners and communities), developers and technology manufacturers are developing business plans and investment memorandums around the technology categories which stand to benefit most. So which support mechanism is the most attractive to investors and provides value for money to consumers? The support mechanism needs to provide adequate incentive and certainty to make investing worthwhile without creating too much of a flow-on effect to consumers through increased electricity bills.
The FIT provides greater investment certainty relative to the RO, which is a market-based mechanism that is prone to price fluctuations according to supply and demand factors. The 20-25 year tariff structure allows for accurate forecasting of cash flow, profit and internal rate of return (IRR). IRR is a common metric used by investors to assess the overall attractiveness of an investment. An IRR in excess of 10% is worth considering and an IRR in excess of 25% is achievable for FIT wind projects in areas with strong windspeeds and available grid connection.
As far as I’m aware, this IRR is second to none in the UK renewables sector and is very competitive relative to other industries. A typical IRR for FIT solar PV projects is in the 10-15% range. UK 20-yr average property yields are currently averaging around 12%, according to data released by British Land in its 2011 Annual Report, whilst interest rates on savings and bonds accounts are around 3% according to moneysupermarket.com, the savings account comparison website.
The returns are great for investors, but at what ‘cost’ to electricity consumers? The results of a recent study carried out by the Renewable Energy Foundation indicate that the total cost of the subsidies (predominantly associated with the RO) will be in the region of £100 billion by 2030, based on actual costs to date and the government’s own projections of the levels of renewable electricity needed to meet the 2020 targets. The UK Committee on Climate Change in its recent Renewable Energy Review stated that supporting renewable electricity to 2020 will add up to £0.02/kWh to electricity bills, equating to a £50-£60 increase in annual electricity bills for the average household (around half of this cost is due to supporting offshore wind).
But then again renewables aren’t the only energy generating sector to receive fiscal incentives. Conventional fossil fuel power generators have and continue to receive some form of subsidy; however figures showing the exact level of support are difficult to come by. George Monbiot’s blog in the Guardian provides an interesting insight into the socio-political struggle around prioritising renewables over climate change and the future role of nuclear in the UK’s energy mix.
It would be great if readers could insert comments on the degree of fossil fuel subsidies on offer to UK generators. One would assume that the level of support for fossil fuel power generators has decreased over time as the power generation market developed and equipment and project costs declined, forcing the industry to compete on less advantageous terms. The same trend is expected within the renewables sector under the FIT, hence tariff levels are ‘degressed’ (i.e. scaled-back) every 2-3 years as, in theory, the market for renewables develops and economies of scale and increased competition drive down costs.
With the RO and FIT already implemented, and the RHI soon to be, the UK renewables industry is poised for growth. The challenge for industry is to work together to turn the opportunities created by the support mechanisms, the FIT in particular, into clean, secure, and reliable energy generating assets.
Notes:
There are two main regulatory support mechanisms for the renewable energy industry in the UK; the Renewables Obligation (RO) and the Feed In Tariff (FIT). The RO is the primary mechanism supporting large-scale renewable energy generation and obligates electricity suppliers to source increasing amounts of electricity from renewables.
A renewable generator can expect to receive between £0.045/kWh and £0.10/kWh, a premium of approximately 50% over the wholesale electricity price. In April 2010 the Government introduced the FIT to work alongside the RO in supporting the development of the small to medium-scale renewables sector. The FIT provides a much higher fixed 20 to 25 year premium payment of between £0.045/kWh and £0.433/kWh for electricity produced from eligible installations up to 5MW in installed capacity. Exact FIT figures can be found on the Ofgem website. The key differences between the two support mechanisms are the elevated FIT rates and the 20-25 year price guarantee.
Late 2011/early 2012 should see introduction of the Renewable Heat Incentive (RHI) in the UK to provide long-term financial support to renewable heat installations such as ground-source heat pumps and wood-chip boilers. The RHI will create investment opportunities similar to the FIT with a fixed, 20-year premium payment for heat produced from qualifying installations.
