United Kingdom

United Kingdom

The rush for renewables

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Just six months after its start, the British Renewables Obligation has sparked a stampede of new players and a steady stream of wind farm projects. But will it lead to cheap wind or expensive wind? Unbankable or highly bankable projects? Long term or short term power purchase contracts? A big-players-only market or a free-for-all for small fry too? There are as many opinions among market participants as there are unanswered questions

Six months on from the start of Britain's new system of support for renewable energy and the market for wind energy in the UK has never looked more buoyant. Electricity retailers are vying to buy up renewable output at prices that just a few years ago most renewable generators could only dream about. With the bottom having fallen out of the market for conventional generation -- and the prospect of new nuclear capacity ever more remote -- wind energy is poised to emerge from the margins into the mainstream. As the dash for gas ends, the rush for renewables begins.

The Renewables Obligation (RO), introduced in April 2002, is the government's main tool for achieving its target of 10% of UK electricity from renewables by 2010. It requires electricity retailers -- known as suppliers in the UK -- to source 3% of their power from renewables in the first year, rising annually to over 10% by 2010. They can meet their obligations by buying renewable obligation certificates (ROCs) either direct from a green power generator or a trader. Suppliers who are unable to buy enough ROCs will have to pay a penalty of £30/MWh to "buy out" of their obligations. As an added incentive to meet the obligation, this buy out money will be shared out to those suppliers who have complied with the obligation by acquiring enough ROCs.

But a severe shortage of renewable energy capacity means that most suppliers will fail to meet their obligations fully this year. And unless large numbers of new renewables projects are built over the next few years, the shortage is set to continue. With the prospect of buy-out proceeds rewarding competitors who are more diligent in securing higher proportions of renewables capacity, fierce competition is pushing up the price of renewable power and ROCs. The recent auction of power contracted under the UK's previous system of support, the Non-Fossil Fuel Obligation (NFFO), saw average prices rise to £65/MWh for renewable power and £66.5/MWh for wind. Before the NFFO system was retired, its contract prices for wind were hitting lows of £0.0263/kWh (today's prices) -- less than half the auction prices that have been driven up by the shortage of supply to meet the RO mandate.

Filling the gap

Wind energy companies are gearing up to fill the generation gap. According to the British Wind Energy Association (BWEA), some 1000 MW of known wind projects are to be submitted for planning consent by the end of 2003 solely as a result of the obligation. ScottishPower alone has already lodged 500 MW of planning applications. It intends to build a total 800 MW of wind plant by 2010 -- mostly under the Renewables Obligation Scotland. This amount is equivalent to the size of the obligation on its own supply side of the business. "It has stimulated the market hugely," says ScottishPower's Alan Mortimer. "But the other element of the equation is getting projects through planning. That will be crucial."

While large companies are planning projects under the RO, activity from small scale independent developers appears to be limited. For individuals and small developers thinking about entering the wind business for the first time, the complexity of the market and the hoops to go through to secure financing can be daunting.

But the response to National Wind Power's WindWorks service indicates that there is no lack of interest. WindWorks was launched in 2001 to give farmers and landowners a simpler route to the market. It is a one-stop-shop for small projects, typically of one, two or three turbines, with National Wind Power doing the development work and finding finance. So far, the scheme has seen one project approved, one refused, 17 projects in different stages of planning with decisions on most expected before the end of the year, and 25 further projects on the books. "We have had a tremendous response, and we are in discussions with a very large number of landowners around the country," says National Wind Power's Matt Partridge.

Maureen De Pietro of DP Energy, Ireland, a small family firm based in Cork, is also upbeat about the prospects for independent players -- at both ends of the size scale. DP Energy is a development partner in a proposed 100 MW wind farm with Scottish and Southern Energy, but de Pietro also hopes to develop small projects in Britain without large company backing. "We see the obligation as an opportunity rather than a problem because there are suppliers who desperately need renewable energy," she says. "The prices are better because of the [buy out] penalty and allow you to avoid the windy top-of-the-mountain sites and look at locations where there is a realistic chance of gaining planning consent."

expensive system

A more critical analysis comes from Catherine Mitchell from Warwick Business School. She dubs the obligation an "unbelievably expensive system" that favours developers with large company backing who are able to build large projects. On good windy sites these can produce power at a cost far lower than the price it can be sold for. For independents, says Mitchell, financing is difficult. "It's a big companies' game," she says. "That might mean that in the long term we meet our targets, but there is no incentive for anyone to do better." She adds that in its present form there is no way for the renewables obligation to fit in with carbon trading -- and there is no exit strategy.

Nonetheless, an obligation on suppliers is Mitchell's preferred system of support for renewables, but it must be structured correctly for achieving the government's aims of efficiently accelerating renewables development. She stresses she would like to see it "banded," so that different technologies in different "bands" can receive different levels of support.

While the obligation's "one size fits all" approach to all renewables favours near market technologies such as wind energy, it does not provide enough stimulus to biomass and the offshore technologies, claims the Renewable Power Association (RPA), echoing Mitchell's concern. Wind is the only renewable resource with scope under the obligation to contribute significantly to the government's target, it warns in its response to the Department of Trade and Industry's energy policy review consultation. On present policies, the RPA says, the uptake of renewables under the renewables obligation will only achieve some 7% of UK electricity against the 2010 target of 10.4%. The RPA adds that the Renewables Obligation could deliver the targets, but only if changes are made and emerging technologies such as biomass and offshore wind receive additional long term support -- instead of the government's present plans for limited capital grants.

Shifting sands

The RPA also points out that banks and financial companies are concerned about the risk of ROC values falling and a change in government leading to a change to the rules. "If banks are not prepared to lend against power purchase contracts under the renewables obligation, then renewable plants will not be built," states the RPA. It urges a 20% target for electricity from renewables by 2020 to maintain a continued upward rate of deployment.

From Citigroup, Roland Bartsch agrees that it can be "challenging" to finance renewable projects to the level of gearing that is required under the obligation. This is less of an issue for large companies with a credit rating who can choose to finance on balance sheet, he says. But smaller independent developers suffer from not having a track record behind them, in a market that is just beginning to take off, with high levels of political risk and with a regulatory regime not conducive to raising finance for energy projects.

To compound the problem, the recent decline in UK wholesale electricity prices leads providers of finance to view the entire sector with caution -- including wind, he adds. "The appetite of the big lenders for power projects is probably less than it used to be." But the renewables obligation cushions green projects from the full effects of the collapse in wholesale electricity prices, says Bartsch. Crucial to the financeability of any wind farm is a long term power purchase agreement, he says. But unlike under the previous NFFO system, a power purchase agreement entered into at present is not likely to be for 15 years, he warns.

Bartsch stresses that his view of the sector is not all doom and gloom. Although there is little evidence on the ground of small wind projects coming forward under the renewables obligation, Bartsch is convinced the UK market will pick up significantly and a layer of small developers will play an active part. He points out that some continental Europeans are eyeing the UK with a view to entering the market with a local partner.

Attractive contracts

Jonathan Johns from Ernst and Young maintains that long term contracts under the renewables obligation have a similar financial standing to the very bankable 15 year contracts under the obsolete NFFO support system. Moreover, generators can obtain "quite satisfactory" prices for power purchase agreements of five, ten or 15 years, with ten year contracts tending to be the most attractive at present. Indeed, the UK has become one of the leading markets for renewables in Europe thanks to the availability of long term contracts, he claims. He cautions, however, that suppliers are still imposing a cost penalty on wind energy in long term contracts to compensate for its perceived intermittency of supply.

Johns advises that renewable generators should negotiate astutely with suppliers over their contracts. "We are seeing widely different offers from the same supplier." Generators should look for maximum value for each of the components of the contract -- the power, the ROC and the levy exemption certificate (LEC), rather than just squandering them in one bundle, he explains. Renewables output is exempt from the Climate Change Levy on all generation as long as it has been awarded a levy certificate.

Johns expects to see a rapid increase in the number of developers entering the sector, attracted by the long term contracts. "We are already seeing a huge level of interest from developers, as well as banks and (finance) institutions." He adds: "The only caveat is that size is important. People want a decent sized generation portfolio." The most difficult small projects to finance are single turbines. Small developers should think big, he says. Rather than focusing on 3 MW projects, they should consider 10 MW or 20 MW.

Johns' main criticism of the ROCs market concerns its lack of transparency. "Joe Public thinks that the ROC money flows to the generator, and that its purpose is to make green electricity, but it doesn't. The public does not know how its money is being spent." There should be more transparent reporting, he says. That would lead to a healthier market for ROCs.

Alongside existing industry players, newcomers are entering the wind sector in increasing numbers, both from within the UK and from overseas. Some, such as British-owned international engineering group FKI plc, which bought up German wind turbine manufacturer DeWind, have moved into wind to exploit synergies between their own activities and wind turbine manufacturing. Others, like Canadian oil giant Talisman, have seen the opportunities for offshore wind farm development under the incentives of the renewables obligation and government capital grants.

going commercial

One of the latest companies to enter the wind scene is online energy supplier Bizzenergy. It is to form a new company, Bizzgeneration, to raise £50 million to build six wind farms with a combined capacity of 100 MW. According a Reuters report, the company cites the Renewables Obligation as the main motor driving the projects. Power from the wind farms will allow Bizzenergy to meet its own obligation and supply customers signed up for its green power product.

BWEA, meanwhile, reports a sharp increase in its company members to 220 from 164 just a year ago. BWEA's Nick Goodall says: "The UK government has been cautious in its approach to growing this sector, but it might have hit on something that works in the form of this obligation. And it works in a political sense in that it is low cost and politically acceptable," he says. Moreover, he adds, the UK has a mature and open power market which is remarkably stable, despite the financial collapse of some conventional generators caused by low wholesale power prices.

Taking a lead

"It is a way into the rest of Europe as well when harmonisation [of renewable energy support] takes place," says Goodall. "If the UK experiment works, everybody will want to do it, and if you've got experience in that market experiment then you are head and shoulders above a company that only has experience in a country with support mechanisms that are more hand-holding," he says, referring to support in the form of a premium fixed price for each kWh of renewables generation.

Despite its positive view of the RO, BWEA says there is still room for improvement. In its response to the government's energy policy review, it calls for active policing of the obligation to ensure that it stays a "seller's market." It also wants to see a 20% obligation for 2020. At this level of penetration wind will have become "normalised" and achievable at lowest possible prices, it says.

"It is going to snowball now," says Goodall. "But we are not running Germany a close second; it is not a race. The point is that wind capacity is being built in such a way that it will be relatively affordable as and when support ends. And that is going to be critical, because this is not about how long you can keep the handouts going, it is about how you make wind into the generation of choice."

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