As a nascent industry, commercial renewable energy has largely been dependent upon subsidies for a number of years. Intended as part of government policy to stimulate the sector, a drop in the level of subsidies was always anticipated as the technologies matured but the degression rates seen have been swift due to a mixture of the level of uptake, a shift in policy focus and the economic climate.
An economic model for renewable energy developments which is viable without subsidies limits the impact of ever-changing policy, improves investor confidence in terms of returns and is seen as one of the milestones of a maturing renewable energy industry.
One aspect of such a model is the concept of grid parity which is being spoken of more frequently as the costs associated with renewable technologies decrease. Grid parity is considered to be the point at which the site will produce power for the same cost as the electricity available to consumers from the Grid.
A 2014 study by Deutsche Bank Markets Research indicated that by January 2014, 19 countries around the world had already achieved grid parity for solar PV without subsidies (Germany for example achieved this for ground mount solar PV in 2011 and for roof mount in 2012) and more countries were anticipated to reach the same position in the three years following the research.
Similar research has also demonstrated grid party was achieved for wind in parts of the USA and some parts of Europe in the mid 2000’s – see Vattenfall’s successful tender to build out Kriegers Flak, a 600MW off-shore wind farm, at €49.9/MWh (roughly £42.50/MWh at exchange rates current to 28th November) and Good Energy’s plan’s for their subsidy-free 38.5MWp Big Field Wind Farm within the UK.
Renewable technologies in the UK have not reached grid parity yet and are still, to a greater or lesser degree, reliant on subsidies to be viable. The UK therefore lags behind a lot of Europe here but note the price at which generation is considered to have achieved grid parity differs by location as a number of factors are involved including the cost of power locally, transmission distance and whether the figure is calculated from a utility or a retail consumer’s perspective. Achieving grid parity for renewable technologies in the UK will therefore become easier as power prices rise generally, but it also hinges on specific reductions in the cost of asset ownership.
The average unit cost of electricity that a generating asset has to receive in order to actually make money over its lifetime is considered by reference to its levelised cost of electricity (‘LCOE’). The LCOE compares the cost of generation across different technologies on an equivalent basis and is calculated by aggregating the estimated costs per year of an asset over its lifetime (e.g. capital expenditure, financing costs and O&M costs – plus fuel costs for AD or biomass projects), discounting this to present values and then dividing this by the anticipated lifetime generation of the site generation (in MWh). This produces a levelised price in £/MWh.
The Mott MacDonald study released by DECC in June 2010 and the Arup study for DECC in 2011 provided UK estimates for LCOE in £/MWh across renewable technologies. With hindsight, these figures can be seen to have been conservative in estimating the significant cost reductions associated with a number of renewable technologies. In the context of solar PV for example, compare the LCOE cost range given some 6-7 years ago of £125-£180/MWh with the successful strike price in the last Contracts for Difference round for certain solar projects (e.g. the ones that are actually likely to proceed) of c.£80/MWh.
A more recent study by Bloomberg New Energy Finance in 2015 indicated the LCOE for onshore wind in the UK came in on average at around £55/MWh (Q2, 2015) but only once carbon costs were taken into account as well. An individual wind developer may find their LCOE differs here.
A number of factors are likely to impact both positively and negatively on LCOEs for renewable technology in the short to medium term:
1. The LCOE of solar PV is anticipated to drop further as a result of a reduction in panel costs brought about by process improvements and significantly boosted production resulting in a global module overcapacity. The increasing number of Chinese solar panel manufacturers that are withdrawing from the European Union’s Minimum Import Price agreement will drive down capex costs and EPC costs here even further.
2. The LCOE of both on and off-shore wind is anticipated to decrease due to improvements in wind turbine technology with longer, lighter blades and increased efficiencies in power generation and turbine performance.
3. The increasing availability and prevalence of battery storage systems and the ability to use these systems to stack additional revenue streams is likely to drive down lifetime costs of asset ownership across technologies. See our article on Battery Storage here.
4. Anticipated changes to embedded benefits by BEIS/Ofgem. Statistically, generation by renewable technology more commonly connects to the grid via the distribution system rather than directly to the transmission system. Certain costs can be avoided by the generator as a result and these are referred to as embedded benefits. National Grid’s consultation and Ofgem’s open letter on the issue indicates their view is that this distorts the market and provides a significant unintentional subsidy to embedded generation. Whilst consultation is still in progress, the current position is unlikely to remain and generators can expect to shoulder an additional burden at some point.
5. Dwindling grid capacity in certain areas of the UK and the inability of National Grid to upgrade the network in anticipation will mean any export capacity a developer may be able to obtain is going to come at increasingly higher premiums
Grid parity sites that are not reliant on government subsidies will also be free of a number of the regulatory restrictions imposed by the subsidy legislation such as the aggregation of separate sites that share grid connections, restrictions on the capacity and size of the site in order to qualify and requirements to commission by a certain date to ensure financial viability (which is important in light of the complete absence of effective force majeure provisions within the FiT legislation).
We’re already seeing developers land banking option sites with a view to development once grid parity has been achieved. The absence of extra efforts required to satisfy policy driven decisions will also be a breath of fresh air and with that in mind, economies of scale come into play so developers can anticipate further lowering their asset LCOE by utilising much larger sites assuming they can obtain the requisite grid export capacity or procure substantial PPA’s with private wire arrangements.
Larger sites should assist in pushing down the associated EPC & O&M costs. Stephens Scown has Chambers recognised construction specialists who can review a project’s EPC as well as the O&M contract.
The converse to a lack of subsidy is that the asset’s PPA becomes paramount and we will be publishing a further article on the changing environment of PPA’s shortly. In brief, robust PPAs are taking on increasing importance as the countdown towards a subsidy free environment progresses and the secondary market in sites flourishes. We have experience in reviewing PPA’s for both developers and funders across a range of technologies to ensure they are water tight and fundable.
When renewable energy reaches grid parity without subsidies, the argument that it is an expensive luxury compared to energy generated by fossil fuels becomes obsolete. When combined with the increasing prominence of the environmental impact of fossil fuels, the fossil fuel lobby has fewer and fewer legs to stand on and the transition to fully green generation has one less hurdle to overcome and the additional certainty this will generate will benefit agile developers and funders alike.
Stephens Scown have been at the forefront of renewables for a long time – we acted on the first commercial solar park in the UK at Wheal Jane and the first wind farm that exported to the grid at Delabole, both in Cornwall. We have the largest dedicated renewables team outside of London and have clients interested in both building projects out and others interested in outright asset acquisition.
For further advice and information on this topic please contact our Renewables Team on 01392 210700 or email firstname.lastname@example.org