Legal Briefing

On-site renewable energy generation: ten considerations

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Projects, energy and natural resources | 01 September 2010

The majority of electricity used by businesses in the UK is currently generated by large coal, gas and nuclear power stations, and is often supplied over long distances, via the transmission and distribution networks.

For various reasons, including energy security, price stability, transmission efficiency and carbon reduction, the government has been keen to incentivise the greater deployment of localised renewable electricity generation. This article examines the potential advantages for businesses in developing on-site renewable energy generation and highlights ten key issues that in-house lawyers will need to be aware of when assisting any such development project.

POTENTIAL ADVANTAGES

Security of supply at a stable price

On-site generation can potentially provide the generator with a ‘guaranteed’ electricity supply at a more stable price, thus minimising exposure to market price fluctuations. The reliability of this guaranteed supply will depend, in part, on the nature of the fuel source. ‘Natural’ fuel sources (eg wind and solar) vary in strength, meaning an element of fluctuating power generation, whereas with ‘physical’ fuel sources (eg biomass and waste) a generator has to deal with supply pricing and fuel specification. The ability of a developer to minimise the impact of any such variations is discussed on p22 (see ‘Top ten issues: fuel source’).

A generator may also opt to use its on-site generating capacity to actively exploit the wholesale electricity market by creating an increased ability to respond to smaller, short-term demand changes. Consequently, this may enable a generator to purchase electricity from the national grid when prices are low and sell electricity when prices are high.

Financial incentives

Various financial incentives are available that are intended to provide ‘clean energy cashback’ to generators of renewable energy. The exact form and level of incentive that a specific on-site project may claim will depend on the technology type and generating capacity, as summarised in the next part of this article.

Feed-in tariffs

  • The feed-in tariffs (FITs) (Specified Maximum Capacity and Functions) Order 2010 (SI 2010/678) came into force on 1 April 2010 and offers incentive payments to anaerobic digestion, hydro, solar photovoltaic (PV) and wind projects with a generation capacity of 5MW or less.
  • The tariff consists of two payments, that have been calculated to provide an expected rate of return of 5-8%:
    1. Generation tariff – this is a fixed payment for each kWh of electricity generated and is due regardless of whether the electricity is used on-site or exported to the network. The level of tariff and the lifetime during which payment is made varies depending on technology type and generating capacity. Once secured, the tariff rate will remain fixed (or ‘grandfathered’) for its lifetime and will be unaffected by any future review.
    2. Export tariff – this is a minimum payment for each kWh of electricity generated and exported to the local electricity network. This tariff has initially been set at a uniform rate of 3p/kWh, with payment lifetime tracking the generation tariff. Generators may opt (on an annual basis) whether to receive this minimum payment or sell any surplus electricity not used on-site on the open market.
  • Responsibility for payment of FITs rests with licensed electricity suppliers and the total cost will be shared equally between all suppliers according to their market share of electricity supply. Ultimately, these costs will be passed through to the electricity consumers.
  • Microgenerators (50kW or below) may only apply for FIT support, whereas generators between 50kW and 5MW may opt (on a one-off basis) to apply for support under the FIT scheme or the renewables obligation (RO), as detailed below.

Renewables obligation

  • The RO is a complex incentive mechanism, a detailed review of which is beyond the scope of this article. In summary, however, the RO is currently implemented via the Renewables Obligation Order 2009 (as amended by the Renewables Obligation Order 2010), which requires all licensed electricity suppliers to produce evidence to Ofgem (in the form of Renewable Obligation Certificates (ROCs)) that they have supplied customers in England and Wales with specified amounts of electricity generated from ‘eligible renewable sources’.
  • ROCs are issued by Ofgem to generators of electricity from eligible renewable sources. The specific number of ROCs issued per MWh of electricity generated varies according to technology type. However, the basic principle is that the recipient generator can on-sell its ROCs to an electricity supplier and, thus, attract a market price.
  • The level of ROC support (with some exceptions) is grandfathered for the deemed lifetime of the project (being 20 years or, if earlier, 31 March 2037).

Renewable heat incentive

  • The renewable heat incentive (RHI) is a scheme proposed by the previous Labour government to motivate a switch from using fossil fuel for heating to certain renewable sources, including (i) solid biomass; (ii) biogas; (iii) bioliquids; (iv) air, water and ground source heat pumps; (v) geothermal sources; (vi) solar thermal; and (vii) combined heat and power (CHP). The scheme was due to come into force in April 2011. However, the proposed timing, form and scope remains to be confirmed by the new coalition government, who have pledged their support to a heat incentive.
  • The proposed incentive is provided by a regular tariff payment. The tariff level (which will be grandfathered) and payment lifetime varies across technology type. However, it is intended to provide an investment return of 12% (except solar – 6%) over a 10 to 23-year period.
Benefits under the Carbon Reduction Commitment (CRC) Energy Efficiency Scheme

The CRC is a new UK-wide emissions trading scheme, which imposes mandatory obligations for businesses and public sector organisations that (i) are supplied with electricity by at least one settled half hourly meter (HHM) in specific qualifying years; and (ii) are supplied with over 6,000 MWh of half hourly electricity through all of its HHMs during that qualification year. Depending on the electricity price, this equates to an approximate electricity bill of £500,000 per year.

The scheme came into operation on 1 April 2010 and aims to reduce carbon dioxide emissions by encouraging increased energy efficiency. It imposes various reporting obligations on its participants, who are required, each scheme year, to purchase and subsequently surrender to the government sufficient carbon allowances to cover the emissions relative to their energy use. The government will then recycle back to participants the money generated from the allowance sales, with each participant’s entitlement being calculated by reference to its contribution to overall emissions and its position in the published performance league table. A participant will therefore be entitled to receive an increased share of allowance payments if it can demonstrate lower carbon emissions when judged against its competitors.

The CRC gives electricity generating credit (ECG) to participants that use on-site renewable electricity where no ROCs or FITs are being claimed. The ECGs can then be used to reduce the number of allowances that a participant is required to surrender under the CRC. Where ROCs or FITs are claimed, no ECG will be due and all utilisation of on-site renewable electricity will need to be reported, attracting the same obligations as grid-sourced electricity.

Corporate social responsibility

Alongside the purely financial reasons for developing on-site generation, businesses are attaching increasing importance to the environmental sustainability of their activities and their impact on the environment. Therefore, while any on-site generation project will need to be commercially viable, the positive reputational impact associated with the use of renewable energy may tip the balance where the business case for the development is marginal.

TOP TEN ISSUES

Issue 1: fuel source

The form of fuel source adopted for on-site generation will depend largely on the location of the site and land availability, generating capacity requirements, upfront installation costs, and ongoing operation and maintenance costs. Typically, however, the fuel source will include one or more of wind, biomass, heat pumps, geothermal sources, solar PV, CHP and hydro power.

When selecting the fuel source, one should be aware of the intermittent nature of some ‘natural’ fuel types (eg solar PV and wind), which vary in their fuel strength and generating capacity. Electricity yields may therefore be unpredictable in the short term. However, modelling and testing should give a reasonable level of predictability over the medium to long term.

If a ‘physical’ fuel is being used (eg biomass, waste etc), the following points should be considered:

  • Securing a long-term supply – long-term fuel supply contracts will provide certainty of supply and pricing to any third-party funder or equity investor.
  • Fuel specification – each financial incentive scheme imposes strict fuel specification criteria that must be fulfilled to secure the relevant incentives. Careful regard should therefore be given to any applicable criteria prior to signing a long-term fuel supply contract to ensure compatibility and adequate means of recourse should delivered fuel fail to meet the required specification.
Issue 2: technology type

Once the fuel source has been selected, the underlying technology will need to be chosen. In making this choice, consideration should be given to the identity and credibility of the technology provider, the technology’s market reputation (eg whether it has a proven track record of good performance and reliability), the scope and length of any warranty offered, the form of any deposit required, and the lead-in time for supply.

Issue 3: land availability

The extent of land required for an on-site project will largely depend on the technology type and generating capacity. For example, limited (if any) additional land will be required if solar panels are being installed on the roof of existing buildings, whereas the erection of wind turbines will require a greater land uptake, and consideration will need to given to the number and specification of turbines required and any clearance zone necessary on safety grounds.

In calculating the area of land required, regard should also be given to any land needed for the laying of conducting cables and installation of connection infrastructure. It will also be important to confirm that sufficient property rights exist over the land on which the infrastructure is to be located to enable its initial installation, continued operation and maintenance and subsequent decommissioning.

Issue 4: planning

A key consideration for any on-site generation project is whether planning permission is required. Furthermore, if the on-site development is likely to have a significant effect on the environment, it may be necessary to carry out an environmental impact assessment (EIA) to assess those effects – this will depend on the nature of the on-site works and their location, with the development of on-site generation within or close to environmentally sensitive areas being more likely to require an EIA. Currently, local authorities aim to determine a planning application within 8-13 weeks of its submission (16 weeks if an EIA is required). In reality, however, the determination periods can be materially longer, particularly where there is significant local objection to a proposal.

In determining whether a planning application is required, one should consider whether any permitted development rights can be relied on. These rights remove the need to secure planning permission for works that fall within defined parameters – for example, micro-generation installations for domestic use and the installation of certain types of solar PV panels on the roof of commercial buildings. If the development requires an EIA, any permitted development rights lapse and a full planning application will be required. If the on-site generation project is part of a wider development that it is intended to serve, one may also seek to rely on the Merton principles. These principles have now been enshrined in government and local plan policy, which indicates significant government support for the inclusion of on-site generation within both new housing and commercial developments.

If planning permission is required, the key considerations for on-site generation are directly related to the nature of the development and its particular features and impacts. For wind turbines, the key considerations are likely to be landscape, visual impacts and noise. For biomass, considerations include air quality, delivery routes and traffic generation.

As with all planning applications, those for on-site generation should be determined in accordance with the development plan unless material considerations indicate otherwise. To date, significant support for such projects has come from the regional targets for renewable energy generation set in regional spatial strategies and regional planning guidance. However, the coalition government’s abolition of the regional planning bodies and regional spatial strategies has left something of a void in terms of the recognised planning need for this type of development. It remains to be seen whether the government’s aim of providing more power for local communities to make decisions about their area, coupled with the pledge to ‘encourage community and renewable energy schemes where local people benefit from the power produced’, will provide a further focus and impetus for on-site generation.

Issue 5: licensing

The Electricity Act 1989 requires a party undertaking generation, distribution and/or supply activities to be formally licensed. Furthermore, the standard licence terms require the licensee to be a party to relevant industry codes, which are technically complex and quite onerous in the obligations they impose.

Potential exemptions from the requirement to hold a licence do exist for on-site projects under the Electricity (Class Exemptions From the Requirement for a Licence) Order 2001. While many on-site projects will fall within one or more of the relevant exemptions, the application of an exemption should not be assumed and careful consideration should be given to the exemption criteria to ensure fulfilment in each instance.

Issue 6: corporate structure

Developers will need to decide whether to set up a special purpose vehicle to own and operate the on-site generating assets. This decision will depend, in part, on how the project is to be financed, whether there is intended to be any onward sale of the project at a later date and whether there are project risks that the developer intends to be kept separate from its core business.

If the project is being developed to serve the energy requirements of the local community, one may opt to establish a form of co-operative that owns the on-site generating assets on behalf of the community members. In this scenario, individual members may benefit from reduced electricity and heat prices, and any revenue generated by the project may be used to finance other community projects.

Issue 7: bankability and financing

The costs associated with an on-site project can be split into (i) capital expenditure for planning, installation and commissioning of the underlying infrastructure, which will require a significant upfront cash injection; and (ii) ongoing operational and maintenance costs, which a developer would seek to fund via the revenue (or energy savings) generated by the project.

Options for financing the upfront capital expenditure include: self-funding; debt investment, eg bank loan; and/or third-party equity investment in a project company. If debt financing is being sought, the developer may wish to consider the following points that a funder is likely to seek comfort on:

  • the ability to demonstrate long-term guaranteed revenue, eg financial incentives and heat or electricity offtake payments if sales to a third-party are being made;
  • the financial credibility of the developer – this may be of particular relevance if the project is being developed by a newly incorporated project company. A third-party funder may require some form of financial guarantee (eg letter of credit or parent company guarantee) if the project company has limited cash reserves and/or other assets; and
  • the ability to grant security over the underlying assets in favour of a third-party funder.
Issue 8: off-take requirements

Electricity and heat generated on-site may be consumed on-site, at neighbouring premises owned by the developer or third parties, or, in the case of electricity, exported to the local distribution network. The applicable scenario will affect the network requirements of the project.

Where a private network is to be relied on to transmit the electricity (or heat) to the end consumer(s), consideration will need to be given to various factors, including the network design or route, infrastructure and installation costs, land availability, planning constraints, and operation and maintenance requirements.

Where electricity is to be exported to the local distribution network, early contact should be made with the local network operator to clarify various issues, including (i) any connection restraints; (ii) the proposed location of the connection and the connection capacity; (iii) any necessary connection works, upgrades and/or reinforcement works (and the time required to complete such works); (iv) the level of connection charges; and (v) any applicable metering or safety practices. For those projects that are able to connect to the 11kV distribution network and already have an electricity supply in place, grid connection issues are likely to be quicker and less expensive to resolve than those seeking to connect at 32kV.

Issue 9: sale of energy

If the developer intends to sell heat or electricity generated on-site to a third party, consideration will need to be given to the underlying contractual arrangements, which will take the form of a heat purchase or steam supply contract and power purchase agreement (PPA), respectively.

The specific PPA terms will depend, in part, on the identity and location of the purchaser or end consumer. Traditionally, exported electricity has been sold directly to licensed suppliers who then trade on the wholesale market or supply to customers – this is the basis on which the FIT export tariff is offered, thus standard terms of sale will apply. Alternatively, however, the generator may opt to:

  1. establish a private wire network (as noted above) for the sale of electricity to specific end user(s) located on-site or on neighbouring premises and, thus, negotiate project-specific PPA terms; or
  2. exploit a new form of direct PPA, which has been developed to enable electricity consumers to contract directly with generators for part of its electricity requirement irrespective of location, generating capacity and supply requirements. The consumer then sells on the electricity (and any associated financial incentives) to its own licensed supplier, who credits the consumer’s electricity account with the corresponding amount of electricity. A direct PPA structure can be more complicated to put in place than standard electricity supply arrangements and it is likely that the consumer will need to have a sizeable supply requirement for this to be an attractive proposition. However, for a public or private sector organisation with significant electricity usage and who can benefit from an identifiable (renewable) energy supply, this kind of structure can provide considerable benefit and help spread the risks associated with fluctuations in electricity prices.
Issue 10: availability of grants

From time to time, various grants have been made available to help fund renewable energy projects at an EU, national and regional level, such as the Low Carbon Buildings Programme (which is now closed to new applicants). For the most part, however, the government has been keen to avoid duplicating incentives for the same project (eg by requiring the repayment of grants to benefit from some RO payments) and, consequently, it is not anticipated that sizeable grants for projects at a commercial or industrial level will be made available alongside the existing financial incentive mechanisms as outlined above. Nevertheless, the potential availability of grants should be kept under close review by prospective developers.

CONCLUSION

The development of on-site renewable energy generation can produce significant benefits, including reduced electricity and/or heat costs, and the receipt of a guaranteed financial incentive. Before embarking on any development, however, several key issues need to be considered as outlined in this article. Although the significance of each issue will vary depending on the project scope, it is important to carefully assess the implications of each to ensure that a fit for purpose project is developed.