Feed-in tariffs for the UK
In April 2010 feed in tariffs were introduced into the UK renewable energy sector for the first time. There was not a great deal of fanfare. A press release was issued from the government’s Energy and Climate Change department, some of the larger UK power entities posted explanatory notes on their websites explaining how feed-in-tariffs were a premium rate paid for electricity generated from a renewable source, but not much more.
A quick look across the channel and eastward to Germany and greater reason to take note of the new UK energy legislation may have been found. Germany had introduced a niche feed-in-tariff in 1990 and subsequently, in 2000, re-introduced the feed-in-tariff in a more recognizable form with a much wider remit. The reaction to the updated legislation had been nothing less than sensational. Taking stock five years later in 2005 figures showed that 10% of all power production in Germany now derived from renewable sources.
Fast forward to February 2011 in the UK and the precedent set by Germany had been matched in willingness and magnitude. None more than in the solar photovoltaic (“PV”) sector where 19,000 installations had been recorded (source: Ofgem), thousands of jobs had been created and tones of carbon emissions had been commensurately cut. Further, larger investors had begun to enter the sector in earnest, long term guaranteed revenues representing an attractive proposition especially in the wake of the credit crunch.
All was not well though. Rumours were rife that the government had taken a different view on what to all ends appeared a successful piece of legislation and on 7th February 2011 the fears of the solar PV sector were confirmed when Energy Secretary Chris Huhne announced a comprehensive review of feed in tariffs, claiming that
‘…this review will provide long term certainty’
Something of a misnomer given this was surely the intention of the original legislation and that his announcement immediately created short term un-certainty. Huhne, continued to present reasoning for the immediate review ‘Large scale solar installations weren’t anticipated under the FiTs scheme we inherited and I’m concerned this could mean that money meant for people who want to produce their own green electricity has the potential to be directed towards large scale commercial solar projects.’
Political maneuvering at its best of worst?
Inherited or not the ultimate aim of the feed in tariff was to accelerate the UK from a low base speedily towards the targets of 15 per cent of energy from renewable sources by 2020. Meeting this target without the aid of mid to large scale investors is highly unrealistic. Huhne repeatedly chastised the previous government for allowing the UK to rank third from bottom of 27 EU countries for renewable energy generation (2008), but now appeared happy to jeopardise the momentum of ten months of accelerating growth. It’s hard not to imagine that low prioritization of renewable energy in the governments broader budget deficit strategy might have something to do with this. But perhaps I am just being a cynic.
Uncertainty comes at a price
Whatever the reason, the price review had its obvious initial implications. Uncertainty is the bane of investments in the slow but steady infrastructure space and so unsurprisingly the vast majority of mid to large scale solar PV projects ground immediately to a halt and entered a holding pattern. Understandably, the solar community acted with barely controlled fury and then gathered themselves gainfully into lobbying and petitioning groups. The government responded by accelerating the review process and appeared to actively avoid entering into a meaningful dialogue with the experienced heads and minds of the solar sector.
The national administration was duly accused of avoiding their responsibility to engage and also of fundamentally misunderstanding the issues at play. Huhne promptly referred in an interview to 50kW installations as ‘huge’ at the ‘size of two tennis courts’ which compounded the sector fears that the Energy Sector had already sketched a very low line in the sand, over which, feed in tariffs would be cancelled or greatly discounted.
It’s all in the numbers
A little over a month from the initial review announcement, Minister of State Greg Barker had news and the misgivings of the sector were confirmed. Previous, comparable, feed in tariffs had ranged from 31.4 to 29.3 (pence per kW), now for installations of between 50kW and 150kW (or two to six ‘tennis courts’ in Huhne’s parlance) only a return of 19p has been afforded. From there up to 250kW installations the tariff had been halved from its previous position to 15p and at the top end, the real show stopper, was a 8p feed in tariff for installations ranging from 250kW to 5MW – almost a quarter of the previous price.
Of course, this confirmation will encourage a lot of questions. In the long-run is micro or macro driven growth better for the sector? What position do targets for renewable generation really have in the government’s gallery of priorities? Is this backdoor support for the traditional energy monoliths?
Worthy investigations, but the reality remains that heavily discounted feed in tariffs are here to stay, at least until the budget deficit is significantly ameliorated – no time soon – or the current administration is pushed by public vote from office – earliest 2015.
From my perspective having been involved in a number of large scale solar projects, the situation beggars instead two present and more relevant questions.
- Can a pipeline of large scale solar projects be kept alive?
- What legal recourse do active projects have for this sudden and crippling change of terms?
In solar scale plays an important role, when we model a 5MW UK solar project using the previous feed in tariff rates we calculate an internal rate of return (“IRR”) of 11% to 16% depending on the negotiated capital expenditure, leveraging and operating expenditures. Stress testing returns from this starting position shows that the IRR will be at zero or below as the tariffs tend towards half the previous rate.
In layman terms, projects barely wash their faces at a tariff of 15p and this with the economics of scale playing a favourable role here too. Hence, at 8p per kWh, the new rates effectively kill projects running under the current economics in the solar sector.
Bar for hoping blithely that a technological revolution in PV panel production will suddenly ignite, there only remain a few solutions for large investors under the current rules however the complicated nature and departure from ‘traditional’ investing practices may make them unpalatable for many investors.
There is some credence that a secondary market could take root if the recently skilled solar sector has the allure to retain its labour force. If smaller players can find a margin to develop mid-size sites where feed in tariffs are not entirely prohibitive then in time larger investors may also find the opportunity to return to market with the aim of building large portfolios of multiple 250kW sites, which managed with a strict cost basis and leveraged at the portfolio level may provide a reasonable, if not sexy return.
Irrespective of tariff positions, solar and other renewable energy solutions remain inviting investments for local councils. The reasons include
- Energy security
- Reduction of energy bills
- Job creation
- Meeting energy targets under the CRC Energy Efficiency Scheme
Councils taking this broader view inclusive of indirect financial and social benefits of instigating solar projects may allow ‘viability’ for larger scale developments. The tactical move for the specialised financial investor could therefore be in development and/or management of these assets.
Recourse for Market Disruption
If legal recourse is generally directed by precedent then the UK solar investor can take some heart. A little more then a month ago a syndicate of fifteen major project finance solar investors and energy companies lodged a claim under the Energy Charter Treaty against the Spanish government.
Their grievance? The Spanish government had just slashed their ‘guaranteed’ feed in tariffs. A claim of this type has only once before being brought to an EU member state, but Vattenfall’s victory in that case and receipt of compensation from the German government does not augur well for the Spanish administration nor now the UK.