Some newsbytes stick with you when you read them. They make an impact. This can be due to intense personal interest. Or perhaps it’s a game changing event which has happened. Sometimes, its because a number of events described are so at odds with each other it makes one pause and think ‘Really’??
That happened to me at the end of last year. On one hand there was news of renewable generation overtaking fossil fuel generation for the first time. Yet, perversely some would say, we also saw UK clean energy investment fall by 46% in Q3 2018. Government policy along with Brexit concerns were attributed to this.
The achievement in driving up renewables deployment in the UK is laudable. However, since 2015 there has been a steady erosion of policy support with energy efficiency spending being cut, the cheapest form of renewable energy deliberately frozen out of CfD auctions and support for small scale renewables being slashed. However, the effects of this have been largely invisible due to the pipeline of projects developed under the coalition coming online.
So, how does renewables generally, and onshore wind specifically, in the UK progress. It has been touted that ‘subsidy free’ is the future. Evidence that this concept is gaining traction can be seen with Energiekontor constructing their first subsidy free onshore wind farm and others following suit.
So, as be begin the move towards subsidy free onshore wind, what questions begin to spring to mind?
What does subsidy free mean?
At the risk of being a pedant, it is necessary to examine what’s meant by ‘subsidy free’ as it means different things to different actors in the sector.
Strictly speaking, subsidy free means that the project is deployed without any government mandated support such as a FiT or CfD.
However, Government support can come in other forms which don’t involve state subsidies for price stabilisation or long-term contracts to ensure predictable and secure income. Take Vattenfalls Dutch offshore wind farm. No state subsidies. No price stabilisation. No CfD.
However, the Dutch government are funding the grid connection. This approach has also been adopted by the German Government. However, in Germany, the developer can build in pre-defined sites so it negates the planning risk – something which is significant in the UK especially around onshore wind.
So, are these projects really subsidy free, or are there hidden subsidies? Many of the costs to providing a stable electricity system around the clock and throughout the year are socialised. By that, I mean that the costs are spread between consumers, producers and the government in some way. The system in place is not perfect at being cost reflective and 100% transparent. So, some costs are passed to those who don’t create them and there are costs which are incurred which don’t get passed on. One obvious example is environmental goods which are not accounted for.
Also, there are other payments made which aren’t termed ‘subsidy’. However, they surely are – think about capacity market contracts.
How can they get off the ground?
Some senior figures in industry have stated that the value in subsidies was not in the payments per se, but rather in the certainty of revenue – whatever that revenue was. Investors now have to get comfortable with risk and with the volatility of the power market.
One way to mitigate this is through long term Power Purchase Agreements (PPA’s). Many PPA’s run for five or seven years which isn’t long enough to provide the security investors are looking for.
This market is fairly shallow right now. It may exist at the level required in a number of years but right now, its not there. There are encouraging signs – many large companies are now signing PPA’s for 100% renewable energy supply. The will is there – its the length of the PPA which needs to expand.
Another way to give security on investment is for onshore wind to be able to bid into a range of other markets which can then add to their income from selling wholesale electricity. This is known as revenue stacking and one example would be to use onshore wind farms for frequency response services. Another option would be to allow onshore wind to bid into the UK’s capacity market.
What are the risks?
One risk is in subsidy free schemes not actually getting built. Finance loves certainty and the two greatest sources of uncertainty in onshore wind are planning risk and – with no price stabilisation mechanism – income or merchant risk. Following the German model of greater certainty in planning would go a long way towards mitigating this risk.
Merchant risk is the other key risk. This is the risk posed by onshore wind being at the mercy of the wholesale electricity market. This is the key risk to onshore wind subsidy free deployment right now. This is the key reason CfDs were introduced. With a CfD, a project becomes bankable. To obtain funding in the face of merchant risk, lenders will want a higher return to compensate. When this higher return is factored into financial models and debt is accounted for, it makes project finance very challenging.
Some concluding thoughts:
· Renewable energy has made significant strides forward as a result of previous Governments policies and actions;
· The current Government’s policy stance against renewables has seen investment fall significantly;
· One way forward is to move renewables – including onshore wind – to being considered ‘subsidy free’;
· Subsidies exist in all generation, usually as a price stabilisation mechanism;
· Investors value certainty of long terms revenue which ‘subsidy free’ doesn’t provide;
· There are other ways in which Government could intervene and still maintain a subsidy free stance. This includes funding grid connections, giving planning certainty without the current high levels of preconstruction investment required, allowing onshore wind to provide frequency response services and allowing onshore wind to compete in the capacity market;