Investors have questioned a review of subsidies for renewable heat generation, warning it could destabilise confidence in the sector and disrupt anaerobic digestion (AD) projects under development.
The Department for Energy and Climate Change (DECC) has conducted a consultation on amending the renewable heat incentive (RHI) for biogas-to-grid energy produced by anaerobic digestion (AD) plants.
DECC said it wants to adjust what is currently a single level of tariff for gas production to banding or tiering, a process known as “degression”. This is to avoid overcompensating larger plants, which might benefit from economies of scale. It’s argued they could generate returns higher than what would represent value for money for taxpayers.
However, some investors have said this could be interpreted as a lack of long-term stability in subsidy decisions and could give a negative signal to the market.
“It’s never ideal when the Government changes the goalposts around previously announced incentive levels”
“It’s never ideal when the Government changes the goalposts around previously announced incentive levels by attempting to introduce modifications such as tariff tiering because they are concerned about over-incentivising equity return from renewable and waste infrastructure,” James Barrett-Miles, renewable energy corporate finance director at Ernst & Young, told MRW.
“Unexpected incentive changes also destabilise the confidence of investors in its commitment to the sector, and increase the perception of risk related in spending development money to get planning permission for infrastructure with a long development and construction lead time.”
He added that was particularly relevant for the AD sector given that incentives are locked down at commissioning rather than at financial close.
Barrett-Miles questioned the need for degression: larger plants might benefit from economies of scale, but were potentially riskier projects, he noted.
“Investors [in such large projects] are exposed to higher equity risk, for example around procuring feedstock and taking on a higher capital costs,” he said.
“Investors [in such large projects] are exposed to higher equity risk, for example around procuring feedstock and taking on a higher capital costs”
Alon Laniado, director at Eternity Capital, which recently invested £9.6m in a gas and electricity to grid AD plant in Fraddon, Cornwall, is also concerned about the message such decision could send to the market.
He urged the Government to review the evidence-base used in the consultation, so to ensure the fear of overcompensation was backed by substantial market information.
In particular, he questioned the figure of £25 to £41 per tonne that the Government used as an estimate of the gate fee AD plants can impose.
“This might reflect local authority contracts, but very few plants get such levels of get fees,” he said.
He pointed out that many merchant facilities ended up with a gate fee closer to zero as a result of competition, haulage costs, and the need to mix food waste with crops to balance the risk of low level of supply.
Laniado said some larger plants could balance lower gate fees with economies of scale, but the size of those facility was well above the 2MW threshold indicated by DECC.
In the consultation document, DECC acknowledged it still had uncertainty around gate fees and capital costs and said it would “refine the options” after considering industry responses.
Impacts on plants under construction
Laniado pointed out that DECC intended to implement the changes in Autumn 2014, and this would impact plants under construction, which have not yet secured the tariff. He described the move as “not retrospective by law, but retrospective by spirit”.
Barrett-Miles said that the proposed amendments would not necessarily stunt the growth of the industry, as many of the plants in the development pipeline are configured to produce power and would receive electricity subsidies alongside the renewable heat incentive.
But he said the Government should take into account that regulatory incentives are only locked down at commissioning and AD project development in the UK is a “long lead item” because of the nature of the local/national planning regime.
“Given these two factors, the Government should therefore refrain from implementing changes to established regulatory support regimes that are key to encouraging equity to take development risk to deliver critical and incremental waste and renewable infrastructure in the UK,” he said.
Mark Wilson, partner at Catalyst Corporate Finance, acknowledged that the change in the RHI could be destabilising in the short term, but said investors operating in the waste sector should be prepared for policy amendments designed to promote longer term market stability – like degression.
“The degression mechanism has been established to bring stability into the market. The biggest challenge for Government is that there is a limited amount of money to subsidise this industry. If the tariff is set too high with no banding or means to adjust, then you get an overabundance of players in the market, which will distort it,” he said.
“The Government has to be careful not to generate super profits for anyone”
“The Government has to be careful not to generate super profits for anyone, and that’s what they are trying to do. The degression approach should create a much more stable framework for investors and operators,” he added.
A stable regulatory regime
Besides the technical aspects of the review, Laniado also questioned the brief nature of the consultation, which closed on 27 June, four weeks after its launch. Industry members had diverted a lot of resources to respond it on time, he said.
DECC told MRW a shorter consultation would minimise uncertainty in the market and mitigate the risk of overcompensation. It added it would be working closely with industry on the matter.
Laniado warned that a failure to address investors’ concerns and reduce uncertainly in long term government planning, would compromise investors’ confidence in supporting projects subjected to Government subsidies, other than AD. It could also potentially impact on the appetite for investments in the UK waste sector.
“Investor committees will no longer see the UK as a premium [investment market]”
“Investor committees will no longer see the UK as a premium [investment market] rather than, for example, Eastern Europe.There we could get potentially better returns, but the reason we don’t do it is because we believe in the UK microenvironment – which includes the Government’s commitment to stick to its decisions.”
Barrett-Miles said that DECC’s proposals might disappoint investors as they would obtain lower than expected equity returns, but the UK would still be looked at as a good place to do business.
“The UK has a good sovereign credit rating, and there are few other countries, if any, that have the kind of AD and RHI tariffs at a reasonably high level.”
He also said the UK had “a fairly developed and increasingly more sophisticated” waste management structure, which has and will continue to stimulate a maturing feedstock supply chain. This was a “critical enabler” for the development of AD and energy-from-waste projects.
A DECC spokesperson said: “While the existing biomethane tariff helped kick start the market we must ensure tariff levels are set appropriately. It is important that the RHI continues to deliver value for money for the taxpayer and secures a sustainable future for the biomethane industry.”