UK: Bankrolling Biomass

Last Updated: 21 May 2008
Article by Michelle T. Davies

The past 12 months has seen a huge surge in interest in biomass in the UK, largely driven by the doubling of Renewable Obligation Certificates (ROCs) allocated to qualifying biomass projects. Growth has also been spurred by the appetite of utilities and independent developers for a more diversified portfolio of renewable generating assets and by the need for waste generators to deal with their waste more effectively.

Those who produce waste - from local authorities to caterers to food retailers - are mindful of increasing landfill costs and the growing might of the green lobby which argues that waste should be viewed as a resource where possible, not just a cost.

Biomass projects tend to fall into two categories: large projects of 40-50MW or more and schemes where much smaller plants, typically 1-5MW, are housed under umbrella equity and debt arrangements often located on or close to the sites of the fuel supplier. The common factor is that these projects are all combined heat and power (CHP) for Roc purposes.

The smaller schemes are being actively promoted at a local and national political level because they can be housed on the site of the fuel provider and avoid what some regard as the greatest inefficiency of renewable electricity from biomass generation: loss of heat.

The push towards these types of projects is also being driven via guidance and regulations applicable to development of buildings and local authority actions.

Biomass fuels and technologies are becoming increasingly diverse. A number of gasification and pyrolysis (using heat alone without oxidation) projects are being developed principally under the umbrella portfolio structure. These tend to be smaller projects because of the need to ensure a consistent feed stock and fuel supply.

Notwithstanding the maturity of anaerobic digestion plants on the continent, there are still very few as a proportion of all biomass plants in the UK. This is expected to change dramatically and may represent the biggest difference in the composition of the technology mix over the next two years.

Feedstocks now regularly include virgin wood, energy crops, agricultural residues, straw, food waste and eco-products. The providers of feedstock are becoming more sophisticated and in return are receiving more bankable contracts.

Indeed, the UK has come a long way in a short time. The appetite for equity and bank debt has probably never been higher but developers need to proceed from the outset with a degree of caution in structuring any biomass project.

However, the key concerns for developers and investors are as they have always been: technology and security of fuel supply.

Many technology concerns have been overcome but they still exist with the newer technologies, particularly where there is a lack of financial covenant behind the technology supply. This is principally why debt-financed gasification projects are rarely in excess of 5MW.

Many projects secure a fuel supply but not on terms that are bankable. Put simply, a bankable fuel supply is one of sufficient duration to cover the debt repayment commitment from a secure and financially credible source.

Many fuel supply arrangements are currently being negotiated with overseas providers that are unlikely to meet a bank's criteria for credit worthiness.

Alternative fuel supply arrangements may need to be brought into the structure so that a plant can run off more than one fuel source, giving funders greater security.

A common trend is for developers seeking finance to take ownership or a degree of control over fuel supply. This trend originated with biofuels but has spread to the larger biomass projects where certainty of feedstock is the key concern.

Sustainability is also an issue in financing. Many finance providers will have an eye to future legislation in this respect and will be aware of the potential impact of being involved in a project that does not tick the sustainability box. For these purposes, sustainability includes not only the source and nature of the feedstock (palm oil being a good example) but also the environmental cost of shipping and haulage generally.

Increasingly, sustainability also means the moral and social cost of developing renewable energy and in particular the impact on food supply and price. There is little movement of private equity funds at the moment in biofuels, for example, because of the consequence of increased food prices for those in poorer nations.

Sustainability concerns are not going to be helped by the publication of two recent studies (in Science, 8 February). These show that changes in land use to produce crop-based biofuels can result in more greenhouse gas emissions than burning fossil fuels. Consequently, projects that use fuels that do not infringe on agricultural or forest land (save for energy crops of short rotation growth), such as waste wood and food, animal and industrial waste, are more likely to be attractive to funders.

However, the problem with these sources of fuel is a logistical one in terms of coordinating what are often numerous supplies of smaller amounts from smaller suppliers. The more challenging the logistics, the greater the concern for both debt and equity providers.

Other options typically attractive for smaller developments are grants. Several schemes offer grants to help encourage the efficient use of biomass for energy production; for example, the bio-energy capital grants scheme and now the Department for Environment, Food and Rural Affairs (Defra) bio-energy capital grants scheme for smaller-scale biomass boilers (launched on 9 April 2008).

Those pursuing this route must factor application time into project timescale and should be aware that some funders have concerns about the proportion of grant funding in a project.

For their part, grant providers are now more aware of the risk of providing funds to special purpose vehicles and often require some form of parent company protection. This is required to back up any clawback rights the grant provider may secure.

Clawback will often apply if the project is not developed in circumstances where it is proved to be technically or financially viable. Funders will be looking to isolate their liability in this respect which requires the principal developer to be prepared to take this risk.

Enhanced capital allowances for certain CHP installations will also be available, as will interest-free loans such as those made available by the Carbon Trust to eligible small and medium-sized enterprises. What is interesting is the development of more merchant positions or offtake arrangements and fuel supply. Some transactions in this sector are benefiting from a favourable market, with lenders abandoning the requirement for fully contracted power purchase arrangements and fuel supply.

Before the credit crunch and current market conditions there was a move to a smaller equity component on financing structures. In the new financial environment the debt/equity mix is back to what arguably it sensibly was 12 months ago, in the 70/30 to 80/20 region. Fuel supply risk will take the equity component higher. This is likely to continue in the near future.

The good news is that there is still a healthy amount of private equity available in the market to finance the requisite proportion of these transactions. In addition, some specialist banks are prepared to offer mezzanine finance for biomass CHP projects. This can be helpful for small to mid-size developers with limited access to equity or for larger developers developing multiple projects.

If the current market conditions prevail as predicted, this could have an impact on the flow of equity and the UK may begin to see other finance structures emerging. For now, the more traditional format looks likely to continue.

The UK biomass market is growing, with financial structures development to accommodate increased confidence in fuel supplies, technologies and offtake prices. Newer technologies are likely to continue to develop in both portfolio structures and larger projects.

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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