Speakers: Damir Ahmovic and Latif Faiyaz, Alfaenergy
All Party Group on the Costs of Energy
Tuesday 10 March 2015
Smarter procurement: Renewables as an asset class, turning cost into revenue
Chair: Lord Haworth
Energy costs are rising, despite the recent vagaries of commodity markets. This talk will take a different approach to energy costs.
The constituent parts of fully delivered energy costs are:
- Commodity costs
- Network distribution charges
Industrial and commercial customers operate in an environment with legislative drivers that are difficult and complex (such as CRCs etc.), and create policy costs. These have been introduced to create a low carbon future. This is a good objective, but the costs of these measures have filtered into bills. Some companies are unable to pass on the rising energy costs to consumers. Increases have been absorbed by industry, but what happens next? Electricity Market Reform (EMR) is about to add £25/MWh. How do we as consumers respond?
- Lobby government
- Question how can we view energy costs in different ways: changing from being a liability to an asset?
Most customers are doing the right thing; focusing on risk management, driving efficiencies demand response etc.: which are measures that treat the cost as a liability. There is only so much can be done with energy efficiency.
A change of view sees energy as an asset not a liability. Since 2009, when policy makers introduced QE in to the West, we have seen that the best investment decisions are aligned with policies. Why are industrial and commercial customers resisting the direction of policy rather than adopting a different approach? In managing costs efficiently we have a number of options: create an income; cut reliance on the grid; or a combination of both.
Challenges are not seen as opportunities by most enterprises.
Our suggestion is to divert some capital into generating onsite.
What is the attractiveness of investing in renewables or on-site generation in comparison to other asset classes? Government bonds are offering negative yield. Cash is not returning much and the yield on commodities is low.
Investment in on-site generation, taking into account all the subsidies available, can generate a yield from 10%- 35%. There are no barriers to entry for the industrial users (it is a different situation for retail users).
Policy drivers are pushing certain opportunities to industry users and for best part, they are pushing back. The key is to start seeing how they can re-position.
What is the long-term attractiveness of investing in renewable/self-generation?
Studies suggest that in the next 20 years $40.2 trillion will be needed for new generating capacity. 40% of that will be needed to meet the rising demand, 59% will be needed to maintain production at today’s levels. Another $8 trillion is needed to invest in energy efficiency. No one knows where this $48 trillion is going to come from.
Electricity prices are about 40% below full cost recovery levels. Investment will only happen if there is a guarantee that energy prices will be much higher than now. This can be done in two ways: organically with higher commodity prices; or artificial increases, which mean subsidies and additional instruments.
On-site generation will reduce reliance on the grid and give a decent payback on the investment.
What does EMR represents in terms of costs?
The consumer bill breaks down into commodity, policy and network costs. Commodity costs used to be over 60%. Now, for larger users, commodity costs are 48% of the bill, with network and policy costs making up the remaining 52%.
Policy costs are increasing, with the renewable obligation (requiring purchase of energy from renewable suppliers), Feed-in tariffs, and the Climate Change Levy. Now we can expect EMR – including contracts of difference and capacity mechanisms. The strike price for Hinkley is £92.50, whilst in the markets the price is in the low forties; a significant margin to make up which increases costs.
EMR is expected to add between £13 -£25/MWh by 2020, CFDs £10/MWh, Capacity mechanisms £3-£15/MWh.
How to turn costs into profit? We look at different options.
Looking at the example of solar energy; prices are down by 57% and will reach grid parity perhaps in the next 2-3 years in the UK. As previously mentioned, the Feed-in tariff becomes revenue rather than cost.
Embedded generation is becoming very popular. It is more robust than solar, especially for larger users. It contributes to security of supply. It will reduce energy user costs by 24% with gas as the input fuel.
There is no problem with gas supply. European supplies have become more consolidated since the last Russian gas shut off. There is also a global glut of gas from Mexico, Mozambique and US shale.
It is difficult to judge the costs of biomass; it is heavily reliant on subsidies (which mean it is reliant on governments). The market for woodchips is difficult to judge. This is a difficult source of energy
Of all the alternative sources, tidal energy is the most logical source for this country; here we can see projects such as the one at Swansea.
Policy costs can be turned to revenue, if the investment is made.
Comments and discussion
Comments on policy costs
Policy costs are adding to the bill, according the Climate Change Committee the addition to the bill for large industrial users is 26% (2014) 59% by 2020 and 98% by 2030, as a result of government policy. Whilst Government has introduced compensation and exemptions, it is not for all users and not all will get 100% compensation. This might mean even higher cost increases for other consumers. The option of self-generation will be increasingly important for those who do not benefit from exemptions.
Comments on Solar energy
Solar power gets less than 2% of LCF subsidy, it is trying to get off subsidies (companies such as Light Source is involved in community schemes). Growth can be seen in the energy storage market. The utility market is currently watching how this will pan out. They agree that this is the best way of dealing with the trilemma of bills, decarbonisation and energy security.
It is notable that 94% of solar projects are rejected because of a lack of capacity on the grid.
Solar energy projects are working more with social housing.
Comment on energy poverty
There will be winners and losers. It is not sustainable to put all subsidies on the bit you take from the grid. There will be the haves and have nots paying the cost and increased energy poverty. This needs to be funded by taxation as in Australia.
Comment on energy efficiency
Energy efficiency is always discussed briefly. One of the big concerns in the policy environment, yet energy efficiency remains an afterthought. The cheapest unit of energy is the one not used. Subsidies support generation rather than energy efficiency. Energy efficiency returns are longer term and so less attractive. Projects are too small to finance. Cheaper funding is not available for smaller projects.
European legislation will make energy efficiency more relevant. Demand-side efficiency is coming to the fore, slowly.
Decision-making in the boardroom
Renewable investment is increasing, is the industry beginning to understand that costs are going to rise and common sense coming into the boardroom?
Damir: There is more of a movement towards this. Energy security and strategic thinking about it are moving into boardrooms as companies seek to protect their businesses.
Capacity mechanism auction
Prices were lower than expected. Surprisingly lots of new plant got contracts; a lot of existing plant did not. This was caused by embedded benefits and avoided the policy costs. Is investing in embedded plant going to fall foul of the market in a few years’ time?
Damir: Not an expert in what is sustainable or not. There is a great need for the investment, to perpetuate industry growth. Logically payback is needed in order to stimulate the needed investment. This has to be paid for in bills. There are no simple solutions, in any country.
What can companies be advised on in terms of certainly on policy, capacity of networks and the planning regime?
Engagement of energy market professionals: financial and engineering team cohesion results in projects that work. The tide is slowly turning; pension plans etc. now want to know about future plans. There is a glimpse of change happening. Every investment has to pass the internal rate of return test within companies.
The meeting was brought to a close.