UK: UK Renewable Heat – Funding in "FITs" and Starts

Last Updated: 6 July 2010
Article by Humphrey Douglas

The Department of Energy and Climate Change's recent consultation on the proposed Renewable Heat Incentive scheme (RHI) said that:

"A decision on how the RHI will be funded will be made at Budget_2010. Ultimately whatever the funding mechanism, we believe the costs will be passed on to consumers."

In the event, the latest budget passed without any mention of funding for the RHI. Although this may be disappointing for some, it is perhaps unsurprising given the complexity of the task. The Energy Act 2008 envisaged funding from heat fossil fuel suppliers (ultimately via increased consumer energy bills), but this now appears less likely following industry lobbying and complications inherent in the sheer number of such suppliers.

Who will pay for the RHI?

The recent Feed in Tariff scheme (FIT), which incentivises electricity generation from small-scale solar, wind and other renewable energy sources already means that energy bills will rise to fund FITs, and it is possible that the government is awaiting more information on the popularity (and therefore the cost to electricity consumers) of the FIT before making any announcement on RHI funding at or after the October spending review. With fuel poverty concerns likely to come to the fore again next winter (when spending cuts may also be more apparent), it will be a brave move for the coalition government to soldier on with prioritising emissions reductions whilst the recessionary impact of lower emissions has already taken some pressure off hitting the UK's carbon targets.

The interesting thing about trying to increase renewable heat is that from an efficiency and emissions point of view it seems to make a lot of sense (not to mention the impact it is likely to have on the UK's carbon target obligations). Around half of the UK's energy consumption and CO2 emissions are said to be attributable to the heating of buildings. Rather than, for example, converting the sun's light via solar PV into electricity to then power an electric heater, it is said to be massively more efficient to capture the sun's heat (and other heat) as heat and to then use it for heating. It is perhaps curious then, that with limited resources for de-carbonisation, the FIT was introduced before the RHI. As climate change speed is of the essence, however, the decision was seemingly made to pursue differing angles of attack at once, because implementing the RHI is significantly more complicated, without real precedent and consequently more time consuming.

Waste not want not

The fact that the RHI trail is being blazed in the UK at all, is particularly noteworthy when one considers the fundamental differences in market structure between renewable The Department of Energy and Climate Change's recent consultation on the proposed Renewable Heat Incentive scheme (RHI) said that: "A decision on how the RHI will be funded will be made at Budget 2010. Ultimately, whatever the funding mechanism, we believe the costs will be passed on to consumers." electricity and heat generation. The FIT incentivises over-generation with an export tariff being applicable to excess electricity fed into the grid. By comparison, heat may not generally be transported via an existing grid (other than in the case of district heating and grid-injected methane). Incentivising overgeneration of renewable heat could simply result in windows being left open. The RHI, therefore, aims to discourage excess production and heat waste.

Added to this is the added complication (and hence expense) of metering heat generation. Whilst metering technology is relatively commoditised for electricity measurement, heat meters generally need to measure not only flow, but temperature also.

Hence a "deeming" process is proposed for most small renewable heat installations which do not justify metering costs, whereby households would have an installation's heat load estimated for the purpose of receiving a fixed RHI payment, provided the system is verified periodically as continuing to function properly.


However, regardless of precisely how the RHI payments (which generally target a return on initial investment of 12%) will be funded, the scale of potential revenues from RHI (which is not limited to smaller facilities - as is the case with FITs) means that such revenues may be particularly suitable for commercial loan financing of up-front capital costs. Indeed, the Energy Act 2008 anticipates security structures involving conditional sale and hire purchase agreements. In addition, "degression" (being the process by which tariffs are reduced over time) is not currently intended to be implemented as rapidly for RHI as is proposed for FITs meaning that the window of opportunity for monetising RHI payments is perhaps more enduring.

Another notable finance development is the increasing use of Energy Savings Performance Contracts (ESPCs) for off-balance sheet funding of energy efficiency upgrading of buildings. Under ESPCs, energy service companies fund, implement and typically guarantee eco-upgrades in return for a fixed period proportion of energy bill savings. This principle also appears to underpin the government's "pay as you save" proposals under the Energy Security and Green Economy Bill, particularly for households that can't otherwise afford the capital outlay.

On 30 June 2010, it was confirmed that a restructured Carbon Emissions Reduction Target (CERT) will be extended to December 2012, under which energy suppliers still have to provide C02 savings from domestic properties. Whilst for the time being, targeting increased home insulation (over compact fluorescent bulbs) is the order of the day, energy suppliers may be concerned that their balance sheets could conceivably be called upon (in addition perhaps to the proposed Green Investment Bank) to aid up front micro-generation costs in the future, unless funding can be structured without recourse.

What is most apparent from these developments is that the earliest adopters of structures for monetising and aggregating FIT and RHI related payments are likely to be the most insulated from regulated degression and open market competition which over time may erode the proportion of energy saving or tariff payments that sponsors and financiers are able to retain. These remain exciting times for project and finance teams, particularly those already preparing for the RHI scheme's planned opening on 1 April 2011.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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