July 31st, 2018
What can be done to boost new deployment of subsidy free wind and solar in the UK?
Eunomia’s recent report ‘How Data Can Inform the Deployment of Renewable Electricity Generating Capacity’ shows that since 2015 there has been a major downturn in the number of projects of these two leading forms of renewable electricity generation entering planning. Just 29 large scale renewable energy projects became operational in the first half of 2018, which is less than 15% of the figure for the same period in 2017, while the generating capacity entering service fell by two thirds to 1GW.
This is not wholly surprising. Onshore wind projects have been hampered by the more onerous planning requirements now in place in England. Large scale deployment of both onshore wind and solar PV has also been affected by changes to, or expiry of, eligibility for subsidy schemes. This reduces the total revenue (and importantly the certain revenues) they receive for their electricity.
The Eunomia report also explains the difficulty and cost that developers can face in securing access to the grid: in many parts of the country the local distribution network is stretched, constraining how much new generating capacity it can accept. Developers are required to foot the bill for any additional capacity their projects necessitate.
The use of ‘private wire’ connections, in which a generator supplies electricity directly to a customer over a licence-exempt connection, is a potential way to overcome the twin barriers of reduced income and difficult grid access. Numerous private wire arrangements are in place, but it can be challenging to secure competitively priced finance to deliver projects where the underpinning revenue stream is a private wire power purchase agreement (PPA).
In this article we investigate the potential of private wire: can these projects boost the on-shore renewables sector in a post subsidy world; and can some of its potential pitfalls be overcome?
Routed to the spot
Typically, renewable energy generators connect to the grid and sell the energy they generate to offtakers – usually licensed electricity suppliers, who in turn sell via the grid to their customers. This gives the generator the “route to market” for its electricity. Being connected to the grid means that in theory the generator is not limited to a single offtaker or ultimate customer – via a licensed supplier, its power can be sold to any grid customer.
The export PPA between generator and offtaker specifies the price the offtaker will pay the generator. This is typically a variable price reflecting an agreed market index, although many will now offer fixed price options. PPAs can also vary in duration from a few months to many years, depending on the generator’s trading strategy and its (and its funder’s) appetite for risk. Some will favour short term PPAs so they are not locked in to pricing arrangements and can change offtaker, while others prefer the certainty of a long term deal.
A private wire PPA, by contrast, is a direct contractual relationship covering the supply of electricity over a direct physical connection, between a generator and a customer. These tend to be longer term agreements, reflecting the investment made in constructing the generating station and the connection.
The main incentive to implement private wire electricity supplies is financial – specifically to avoid non-commodity costs. These are charges, other than for the electricity actually consumed, that form part of energy bills. The principal ones are grid usage charges and Government energy policy costs. In total they account for about 50% of energy bills, expected to rise to 60% by 2020.
Private wire electricity can avoid these charges and so generator and customer are free to reach commercial agreement on the price. Per KWh revenues for private wire projects can therefore be materially higher than for grid export. Pricing arrangements are bespoke, but commonly incorporate one or more of the following features.
|Pricing structure||Price per kWh features|
|Floating price||Supply priced by reference to an index or measure agreed by the parties|
|Fixed price||Price fixed at an absolute number for the duration of the agreement|
|Fixed price + indexation||As fixed price, but with an indexation factor applied (e.g. RPI or CPI)|
|Tiered or stepped||One or more of the above applying for defined periods over the duration of the agreement|
|Discount to market||Pricing based on what the customer would have paid had it purchased electricity from a licensed supplier (inclusive of non-commodity costs) – less a discount, based on an agreed formula)|
It is common for private wire customers to keep an import grid connection as a backup. Generators also commonly have an export connection to manage surplus electricity, a must unless there is a viable mitigation strategy. The cost will therefore need to be factored in to the overall project economics.
The grid connection may need to handle 100% of the generator’s output if the customer’s demand materially reduces – for example, if they relocate production, cease trading or sell their assets to a third party. In these circumstances, the generator’s revenue streams would evaporate unless they have a mitigation strategy such as:
- an alternative route to market on similar terms; and/or
- the ability to claim (and recover) such losses from the customer.
Both generator and funder need assurance that the contract protects them from the risk of lost income and stranded assets. Funders may seek to manage the risk by requiring the funding case to be formulated on the basis of revenues from a “grid export only” operation, rather than the higher revenues that resulting from the private wire arrangement. However, there are funders operating in the UK market that are prepared to contemplate projects that do not have a full export connection and to take a view on the long-term viability of the customer’s business.
Private wire suppliers need to make sure they attend to several practical and compliance hurdles. Generation, distribution and supply are all activities that require a license (or the benefit of an exemption) under section 6 of the Electricity Act 1989. Private wire arrangements can usually be structured so as to be exempt but there can be complications if the customer wishes to do anything unusual, such as reselling electricity to a third party (e.g. a tenant) or if a third party owns the private wire. The regulations governing exemptions are complex so it is important to get advice from someone familiar with the issues and able to provide practical solutions.
Custom and practice
In the end, the biggest challenges for private wire arrangements are practical and commercial. On the practical side, the closer the generator is to the customer, the lower the cost of the physical connection is likely to be. In addition to any planning and construction challenges associated with building the power plant, there may be a need to lay cable over third party land to connect the generator and the customer. This may necessitate payments to secure the necessary land rights, while the physical works necessary to install the cable are likely to require planning permission. Whether the customer or the generator meets the initial cost of the connection (and how those costs are recouped over the contract lifespan, or refunded in the event of early termination) is a matter for discussion.
On the commercial side, private wire is only likely to be suitable for customers with a strong balance sheet (or access to credit support) and a large, relatively stable demand for electricity – ideally one that is well-matched to the output profile of the renewable energy facility. We have detailed a number of commercial considerations affecting private wire arrangements here.
Further, because the financial case for private wire relies on avoiding non-commodity costs, it is susceptible to regulatory action. Ofgem is in the process of reviewing charges that electricity network users pay for using the public networks. While it says it has no concerns with private wire developments per se, it is examining how to ensure that all network users make an appropriate contribution to grid maintenance costs. Currently, charging is based on metered consumption from the grid, so electricity which is generated and consumed “behind the meter” is not taken into account, even if the private network users rely on the grid to ensure continuity of supply – potential demand that the grid must accommodate. If Ofgem changes the charging basis, the commercial case for private wire projects could suffer.
To date, few of the developers that Eunomia speaks with to obtain data for BEIS’s Renewable Energy Planning Database are mentioning private wire as a route to market. However, in the absence of subsidy and facing increasing non-commodity costs, corporates are increasingly interested in behind the meter solutions as part of their long-term energy procurement strategy, and developers need to be positioned to respond.
In Burges Salmon’s experience, corporate PPAs between generators and customers, which fix a price but utilise the grid for transmission, are also worth considering, but can be contractually more complex. Also, while a corporate PPA structure can provide long term price certainty, the customer still bears the non-commodity costs of using the grid.
It seems that private wire’s role has the potential to grow, especially where already-operational renewable energy projects can connect to a nearby customer so as to secure greater income. However, key to unlocking the full potential will be:
- Greater funder willingness to accept the risks inherent in private wire structures; and
- Potential customers taking time to consider how they can use their buying power, balance sheet and detailed understanding of their own energy needs to work with generators to develop fundable private wire structures.
While private wire is unlikely to allow the levels of deployment achieved when subsidies were available, plentiful examples show that, if the project is right, subsidy free wind and solar is viable.
Nick Churchward is a Partner at Burges Salmon LLP.