UK: An Outlook Of Change, Uncertainty And Tough Decisions For Renewable Energy

Last Updated: 3 October 2014
Article by James Snape

Summary and implications

The regulation surrounding renewable energy in the UK has undergone a significant transformation over the past decade or so, specifically with the introduction of the Renewables Obligation in 2002 and the more recent Electricity Market Reform, all of which are intended to help the UK reach its 2020 targets (specifically, reducing greenhouse gas emissions by 34 per cent and generating 15 per cent of its energy from renewable sources, all by 2020).

A recent PwC report estimates that approximately £64.4bn of investment is required in the renewable heat and electricity sectors to meet the UK's 2020 target, with £40.8bn of investment required in the renewable electricity industry alone. Whilst it is anticipated that wind and solar PV projects will dominate such investments, biomass is expected to contribute around seven per cent of the total investment target for renewable electricity; achieving this target will heavily depend on the support offered through government subsidies and effective implementation of supportive regulations to encourage investors and developers.

Regulation and framework in the UK

With the introduction of the Energy Market Reform, biomass generators currently have a window of choice between two regimes of government subsidies and incentives primarily under either the Renewable Obligation scheme (which closes in 2017) or the new Contracts for Difference scheme for generating electricity from renewable sources (including biomass). The UK Government also offers a scheme to support the generation and supply of heat from renewable sources the Renewable Heat Incentive scheme (RHI); however, this article focuses on the reforms affecting the generation of electricity which is a regulated sector in the UK and the EU.

The Renewables Obligation scheme (RO Scheme)

The RO Scheme essentially places a requirement on electricity suppliers to procure electricity from renewable sources and incentivises such provision through the purchase and sale of Renewable Obligation Certificates (ROCs). Once a station is eligible under the RO Scheme and therefore eligible to receive ROCs, there are additional forms of support available for those operating in the biomass industry, such as the grandfathering provisions, combined heat and power (CHP) uplift and the removal of the co-firing cap, to help encourage investment.

Participants in the RO Scheme are subject to certain restrictions however. A 400MW cap will apply across the entire scheme and, whilst it will not be set out in any formal legislation, will operate so that stations that have been allocated a place within the cap will receive 1.5ROCs/MWh until such time as the cap is reached. Participants are also now subject to mandatory sustainability criteria and reporting requirements. The Department of Energy and Climate Change (DECC) announced in August 2013 that it would be setting sustainability criteria for biomass as well as biofuels (in contrast to the EU's Renewable Energy Directive which only sets criteria for biofuels); biomass stations generating 1MW capacity or more must ensure compliance with the criteria by April 2015, to continue claiming support under the RO Scheme.

At the same time DECC also announced additional reporting requirements. From April 2014, generating stations with a 1MW capacity or above will be required to submit an independently audited report on their sustainability, including details as to where the biomass is sourced and that it meets the published sustainability criteria, to continue to be eligible for the RO Scheme.

The Contracts for Difference scheme (CfD Scheme)

The CfD Scheme will operate in a fundamentally different way to the RO Scheme; rather than biomass generators trading ROCs, the generating station will enter into a contract with the Low Carbon Contracts Company Limited, owned by the UK Government (the CfD Counterparty) for the electricity produced and the feed-in tariff. The CfD contract sets a "strike price" for the electricity generated from renewable sources, currently set at a maximum of £125/MWh for new dedicated biomass stations (with CHP) and £105/MWh for biomass conversion stations. If the market price is less than the strike price, the generator receives the difference between the two prices from the CfD Counterparty whereas if the market price rises above the strike price the generator must pay back the difference to the CfD Counterparty.

In theory, the CfD Scheme should offer great incentives to biomass stations; however, there remains uncertainty over how successfully CfD contracts will be allocated to renewable energy suppliers. The current method of allocation for the majority of suppliers is through submission of an application followed by a competitive auction process. Suppliers must first submit an application for a CfD contract which should evidence not only that they are eligible for support from the CfD Scheme, but also that they have reached an expected stage of development. In most cases this means that suppliers will need to evidence that all the relevant planning consents have been obtained for the development, along with the appropriate grid connection agreement for the station.

Once applications have been submitted, applications within certain groups of renewable technologies may be automatically awarded CfD contracts, provided there is budget within the group's allocation for all of them. However, this will not be the case for many technologies; the scheme is currently designed to offer support to new biomass projects (with CHP) and biomass conversions only, so suppliers in these areas will have to submit sealed-bids setting out their proposed strike price.

Each type of renewable technology has been allocated a grouping, with most falling into Group 1 which automatically go to auction; however, DECC are still undergoing consultation as to where biomass conversion stations fall within the technology groupings. DECC has suggested that a separate Group 3 be created but that this group will still be subject to the competitive auction process. In any event, the UK Government's intention for CfD allocation in the long term, once all technologies are proven, is for all awards to be subject to the auction process regardless of technology type.

Transition between the RO Scheme and the CfD Scheme

The RO Scheme is still open to new entrants until 31 March 2017. This means that until the RO Scheme closes, energy suppliers can potentially choose which scheme they wish to apply for. Developers need to carefully consider which scheme to apply for as they can't apply for both schemes simultaneously. However it also means that if they fail to obtain support under one they are not precluded from applying for support under the other. The UK Government has confirmed that there will be specific grace periods offered in relation to the RO Scheme's closure date in 2017; in particular, dedicated biomass CHP and dedicated biomass power-only projects will be granted an 18-month grace period for eligibility, as well as 12-month grace periods for other technologies delayed due to grid connections or financial decisions. These periods will be formally implemented in the RO Closure Order 2014 due to come into force in August 2014.

Some biomass stations may also qualify as "dual scheme plants" whereby part of the station can qualify and receive support under the RO Scheme, with the other potentially receiving support under the CfD Scheme. Electricity generated in each part of the station is measured separately and support is provided under the corresponding scheme accordingly. However until suppliers and investors actually experience the financial benefits of the new CfD Scheme, it is hoped that the extension of the RO Scheme will continue to attract investment into renewable energy technology and the biomass sector in particular.

The effect on investment into biomass projects in the UK

It is expected that biomass projects will contribute to approximately seven per cent of the UK's target renewable electricity investment in the next six years. Analysis compiled by PwC suggests that biomass is expected to be a smaller recipient of renewable energy investment compared to offshore wind and solar projects and most of this investment is likely to be concentrated in large coal conversion projects. Such investment has already been evident over the last few years, most notably with the conversion project at Drax power station.

Investment into the industry depends heavily on clear government policies in relation to renewable energy, as well as supportive frameworks and mechanisms to incentivise such investment. The biomass industry has previously fought off potentially prohibiting regulatory reforms, such as the ORR's proposal to increase charges for the transport of biomass by rail in 2013, but it is argued that the industry now faces another potential hurdle with the CfD Scheme. Whilst the UK Government hopes that the CfD Scheme will bring in an additional £110bn of investment across the electricity sector by 2020, concerns have been raised over how available support will be for biomass projects in particular.

Under the CfD scheme, new dedicated biomass stations will only qualify for the new CfD contracts if they use CHP. Whilst this does encourage new stations to supply heat and power efficiently, it costs more to the developer and investor at the outset, and potentially creates additional obstacles in the form of UK planning laws. CHP is considered practical only when it is located close enough to pipe the heat to nearby buildings, who must also be prepared to pay for it. However this makes finding a site for such large new biomass projects considerably more challenging if it must be situated in a built-up area but on a site that is still likely to be granted planning permission.

In addition, there are concerns over the eligibility criteria used to establish whether a project can even make a bid for CfD. As mentioned above, suppliers must provide evidence of the relevant planning consents and grid connection agreements having been obtained so that they may be considered eligible for CfD support. Whilst obtaining such consents would be necessary for the project to develop anyway, paying the costs involved to obtain them when there is no guarantee that the project will be given any government support, is quite a risk for any investor or developer. Although the UK Government insist this new criteria provides "necessary investor certainty", combining this issue with the strict CHP requirements for new biomass plants, it is easy to see why investors may be nervous about participating in biomass schemes in the UK going forward.

What is promising however is the recent award of three investment contracts (sometimes referred to as the "early CfDs") to biomass projects, with the potential for a fourth award following Drax's successful appeal against the DECC's subsidy decision on its second biomass conversion unit. The first round of these investment contracts for renewable energy projects were awarded recently in April 2014 with three out of the eight awards going to two biomass coal conversions and one to a dedicated biomass plant with CHP. Given the UK's need to reach its 2020 targets, it is hoped that these investment contracts will bolster investors' faith in the new regime and in investment into the renewable energy industry in general. In addition, the RO Scheme offers some comfort to investors whilst the CfD Scheme is finding its feet, particularly following confirmation that support under the RO will remain available until 2037.

Whilst both schemes may provide uncertainties for investors and developers of biomass projects, what is clear is that the UK Government is trying to encourage investment into the biomass industry and it seems to be working. In 2013 alone, the industry received £2.2bn of investment and renewable energy investment funds, such as the Ludgate Environmental Fund, are continuing to invest in projects and companies within the UK in 2014.

Biomass industries outside the UK

Outside of the UK, efforts are being made in the EU and the US to promote renewable energy projects and encourage investment. The EU recently announced two funding initiatives aimed at benefiting bioenergy projects. The European Commission awarded a total of $1bn to 19 renewable energy projects, of which four are biomass developments with a further two relating to other bioenergy technologies. Following this announcement the EU launched the European Joint Undertaking on Bio-Based Industries (BBI), which aims to provide €3.7bn of funding for biobased projects and materials to be developed and sourced within Europe, specifically hoping to make use of the vast amount of untapped biomass resource in Europe.

A similar approach has been adopted in the US, with the Department of Energy (DOE) opening a loan guarantee solicitation, providing up to $4m of funding available for renewable energy projects. Whilst its main aim is to encourage development in biofuels and waste-to-energy, it anticipates biomass and co-firing projects qualifying for funding. Both of these funding initiatives may well prove beneficial to the UK biomass industry as well; the BBI could potentially provide direct funding to UK projects and the US scheme may provide indirect benefits to the UK biomass industry if the funding trickles down to help assist the managed forestries and wood-pellet industries which are a large supplier to the UK. However, regardless of the impact these initiatives could have on the UK specifically, it is clear that reform and support of the renewable energy sector is a global concern and that efforts in this area will continue to provide opportunities for the biomass industry to grow and develop.

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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