Fast forward to a vision of Britain in the year 2020: 30% of the UK’s electricity demand will produce zero carbon; utilities will be settling balance sheets to the satisfaction of shareholders; investors will be counting a decent return on investment; government ministers will be celebrating the success of their policies; consumers will be paying reasonable rates to power and light their homes and businesses.
If a week is a long time in politics, eight years is a very short cycle in the energy industry and without an acceleration of government action, the UK is at risk of failing on its target of sourcing 15% of its demand from renewable sources. Every aspect of the dream scenario described above could be reversed.
“It’s a very challenging target and 2020 isn’t that far away, particularly for large offshore wind farms,” said John Wood, a consultant at Norton Rose law firm in London. “If you haven’t really kicked them off now they’re not going to be generating by 2020.”
The UK has a looming energy crisis which is full of opportunity for renewable companies. Bloomberg New Energy Finance estimates that 20 GW of generating capacity will be retired by 2016, and an additional 4 GW of the country’s coal fleet will be too dirty to run economically under the Industrial Emission Directive effective from 2020.
BNEF estimates that two-thirds of the 30 GW of replacement capacity due to come online by 2016 will be renewables. That is good news for the wind industry.
It could also be good news that the government estimates that this will require €200 billion in new investment – a great boost to an economy struggling through a double dip recession.
But the bad news is that the mechanism to attract capital to the energy industry may not be enough to help the government meet its 2020 target.
Over the past decade, incentives to invest in clean energy in the UK have focused on returns from the Renewable Obligation Certificate system. Projects have been financed largely by utility companies, but utility balance sheets cannot run to €200 billion.
“Essentially we still have a system where utilities are putting the cash up front, building the projects and then recycling the capital by selling down equity and bringing in project finance,” said Wood. “Proceeds of the refinancing of the sale of equity takes them onto the next project. But they can only turn that wheel so far and it’s a limiting factor in how quickly you can get these things done.”
The existing ROC subsidy model is about to be changed radically with the introduction of the Contract for Difference (CfDs) from 2014 as part of Britain’s Electricity Market Reform (EMR).
“EMR is not a reform of the electricity market but is a reform of the subsidy system,” said Wood.
Concerns that support for the industry had remained the same as technology and project development costs declined are at the heart of the reforms.
If the UK is to achieve its 2020 targets, wind companies need regulatory certainty and capital.
But the government has scrapped original plans to guarantee CfDs, which could have reduced the cost of borrowing capital to finance projects.
“It’s causing quite a lot of frustration,” said Wood. “There is a serious risk that investment will go elsewhere. Generally, the wind industry is an international industry that has opportunities to develop in German waters or elsewhere.
“There is a huge amount of concern particularly among the finance community about the robustness of the legal arrangement,” said Wood.
After heavy criticism from industry and members of parliament, the Department of Energy and Climate Change is busy reviewing the level of long-term commitments government is prepared to agree with utilities.
Getting the policy right on CfDs will be critical if the UK government has any chance of meeting its 2020 target, which is probably only realistic with an accelerated push towards offshore wind.
The government has few options available to give investors incentives to shoulder the burden of financial risk. Tax credits for investors, utilities and developers are a politically tricky issue in the UK. The Big Six utilities are largely owned by French, German and Spanish companies – a legacy of the privatization of the energy industry in the 1990s.
Asking the consumer to foot the bill for renewable projects under CfDs is an easier sell than asking the taxpayer to subsidize a company headquartered in a different country.
Banks Go For Offshore (Wind)
Wood said that some banks were starting to finance projects in the construction phase of offshore wind farms.
“We are seeing a maturing of the market [with] more confidence from lenders and investors to come in at an early stage,” he said.
Royal Bank of Scotland, in which the UK government holds an 82% stake, has been leading in two crucial areas of renewables. Last year, it loaned twice as much as any other bank to renewable energy projects in the UK and has become a majority purchaser of renewable energy. RBS bought 61% of their total electricity consumption, 634 GWh, from renewable sources, according to the Global Corporate Renewable Energy Index (CREX).
RBS is also making inroads overseas. In the US, RBS arranged and distributed $1.782 billion of debt capital in 2011, both directly to renewable energy companies and to finance assets that directly support renewable energy, according to CREX.
“The bank believes that loans for renewable energy provide a good return on investment and therefore aims to help its customers improve their environmental impacts through its products and services,” said the report, citing the launch of a £50 million clean energy fund for the agriculture sector and small business.
Private sector investment will be the cornerstone of the 2020 target, but green capital will only flow if the policy foundations are in place. Politicians will ignore industry’s pleas for urgency and long-term regulatory certainty at their peril.
This piece appears on Breaking Energy as part of the Energy Transparency series in partnership with Vestas.