The export and sale of excess power generated on-site either by CHP or from renewable sources (or both) can be a crucial part of the economic case for a project. However, deregulation in the UK electricity market has led to volatility, meaning high risks for independent generators. Tim Foster explains how risk can be managed so that the benefits of on-site generation outweigh the danger.
Small and large businesses alike are increasingly opting to generate their own energy needs driven by a number of factors; energy cost management, security of supply issues (as highlighted by the recent interruption to gas supplies from Russia) and various subsidies for decentralized generation, are all helping to make investment in on-site power an appealing option.
Energy-from-waste – one technology used in the UK where some of the electrical power generated is exported off-site
Combined heat and power (CHP) has proved particularly popular, being a means of generating electricity and heat simultaneously that boasts huge efficiencies compared to traditional, centralized power production and boiler plant. Originally, CHP took off following the ‘dash for gas’ with the development of the North Sea gas fields during the late 1980s/early 1990s. Businesses began to construct their own gas-powered cogeneration plants, taking advantage of the cheaper, cleaner fuel to produce heat, power and sometimes cooling for their business processes.
More recently, on-site generation has seen a shift to renewable energy production. This shift is being propelled by legislation aimed at encouraging sustainable energy production as well as increasing pressure from stakeholders who want to see the carbon footprint of businesses slashed. Moreover, certain industries lend themselves to this type of power production due to the availability of renewable feedstocks. For example, we are seeing a number of farmers deploy anaerobic digestion-based cogeneration on their farms as a way to simultaneously manage organic waste and produce power and heat for on-farm operations.
EXCESS POWER TO THE GRID
One of the main benefits of on-site generation is any excess electricity production can be sold to the local grid as an additional revenue stream for the business. Arguably, it is the income from exporting this additional electricity which makes on-site power production a viable option for businesses, helping to counteract the initial outlay cost of constructing the plant. However, a number of factors contribute to making the selling of surplus electricity a complicated and potentially a risky business – the risks can be so great that they can force a generator out of the market altogether.
These risks largely stem from deregulation of the UK energy markets. Successive market liberalization, culminating in the British Electricity Trading and Transmission Arrangements (BETTA) was designed to deliver more competitive trading arrangements – treating electricity more like a commodity which has its value more reflective of market drivers. However market liberalization has ultimately benefited independent generators, allowing them to enter into power purchase agreements (PPA) with any party of their choosing. Delivery is the key feature of BETTA, where a generator is expected to deliver on a nominated half-hourly contract position, where any under or over delivery of MWhs is taken care of by the system operator, often at a detrimental cost.
An anaerobic digestion plant, again excess power can be sold off-site.
Independent generators face a choice; selling their energy to end user consumers or to a licensed electricity supplier. Getting access directly to electricity end users is complicated and costly. Generators must incur the cost and obligations of signing up to the balancing and settlement code and having to interface with so many parties, including the end user of the electricity, makes the whole process slow, complex and potentially risky from a credit exposure and cash flow management point of view. Because of this, most independent generators will sign a PPA with an electricity supplier who will then sell on the electricity for them. Finding the right partner is key to the whole process and there are a number of factors which generators should consider while making their choice.
Any PPA must be tailored to the individual generator’s needs and their attitude to market risk. CHP generators in particular are exposed to price fluctuations in both the gas and power markets, making long-term planning very difficult. Both markets are ultimately affected by the price of oil, which, in turn, is affected by a number of wide-ranging socio-political factors beyond the control of individual businesses. Then of course there is ‘sentiment’, the often used excuse to explain blips or movements in the gas/electricity market prices that defy the logical interpretation of the fundamental factors such as global supply/demand, conflict and terrorism, etc. What is clear is that the rules of the game have changed since the ‘dash for gas’ and energy hedging – input fuel and export electricity – is crucial for large and small generators alike.
IMPORTANCE OF RISK
In a market where the price of energy is falling, it is tempting to fix the power selling price at a high level over the long term and buy in gas in a series of short-term (e.g. monthly) contracts, to maximize the difference between incoming revenues and outgoing costs (the ‘spark spread’). However, this approach of locking in the price of power while floating the gas price is an extremely risky strategy. Energy prices could rise sharply in the short term, or more gradually, but still significantly, over the long term, causing margins to be squeezed while the generator has no flexibility to change the price they get for their power.
As such, it may be more appropriate for risk-adverse CHP generators to adopt a strategy that locks in the gas import price with the power export price over the same contract periods. This way, while the generator may not make as large a profit from short-lived favorable price fluctuations, financial planning and cash flow management will be much easier as they know the amounts they can expect to receive for the duration of the contract and there will be no nasty surprises.
Alternatively, businesses which have a number of generation facilities on various company sites may choose to vary contracts for different sites as a way of spreading their risk. For example, British Sugar, the UK’s largest sugar manufacturer has installed a CHP plant on each its four processing sites to meet its energy requirements. The plants run on a range of fuels and produce steam and electricity. The steam is used in the process of refining sugar from sugar beet, with a proportion of the electricity consumed on-site. Operating four plants at once means the company can operate under different contract arrangements, with the smaller sites operating under fixed price certainty, whilst the larger sites take advantage of their inherent flexibility with more market facing arrangements.
Wind turbines and have no import fuel costs and therefore users do not need to factor the price of fuel into the equation.
Duration is another aspect of any contract that will vary for different generating companies depending on their attitude to the markets and just importantly the financing requirements involved. For example, larger, profit-driven companies with strong balance sheets, are likely to opt for shorter-term deals, giving them the flexibility to take advantage of any favorable upturn in the market. Whereas the opposite may be the case for more budget-driven companies who are looking for the security of a long-term, predictable income in order to service any financing needs.
Of course, the power purchase agreement also needs to fit the type of generating technology. Generators operating renewable technologies such as anaerobic digestors or wind turbines have no considerable import fuel costs and therefore do not need to factor the price of fuel into the equation. Such renewable generators will be looking for a contract focused around maximizing the income from renewable generation subsidies. For example, under the Renewables Obligation (RO), the mandatory UK obligation on suppliers to source an increasing percentage of their electricity from renewables, generators of renewable electricity are eligible to receive 1-2 Renewable Obligation Certificates (ROCs) for every MWh of electricity they produce, depending on the type of generation technology . There is a strong market for ROCs as electricity suppliers can purchase the certificates towards meeting their own obligation.
As the RO is a financial subsidy to encourage growth in renewable, ROCs are not proof of the physical renewable electricity (like a Renewable Energy Guarantee of Origin certificate), and can be sold separately from the electricity to which they relate.
As such, it is important to ensure that generators have an arrangement in place that allows them to gain maximum value from their ROCs. As a partner, an electricity supplier will purchase ROCs from independent generators to cover their own obligation and some electricity buyers can also purchase ROCs to sell onto other market participants. It is important to get the contract for the ROCs right because it is often the case that without this subsidy mechanism in place, on-site generation of renewable electricity would not be financially viable.
The specific type of renewable technology is important here; following recent revisions to the Renewables Obligation Order, a banding system has been introduced to encourage the growth of less established technologies. For example, certain renewable generators such as those operating anaerobic digestors will receive 2 ROCs per MWh of power they generate.
Biogen, established in 2005, has built and operates a full scale 42,000 tonnes per annum anaerobic digestion (AD) plant at Milton Ernest, Bedfordshire. The scheme utilizes pig slurry, from its sister company Bedfordia Farms, and commercial organic waste to generate electricity from biogas. The plant delivers between 0.75–1 MW of electricity with the bio-fertilizer from the digestion process put directly onto the farm’s arable land. The Biogen model is being rolled out across the UK giving farmers the opportunity to dispose of slurry wastes and benefit from the bio-fertilizer, whilst giving food producers and retailers a disposal route for their waste.
SmartestEnergy buys the excess electricity from Biogen via a flexible power off-take agreement. This type of agreement guarantees an optimum price for the power, ROCs and embedded benefits, while protecting Biogen from fluctuations in the wholesale power price.
In some cases, businesses may use all the power they produce on-site, leaving little or no excess to export onto the grid. In such cases benefit is derived from ROC sales and also from avoidance of supplied energy charges (or in many cases from the certainty of a known energy price between the on-site generator and the consumer). For example, Eastman, the global chemicals, fibres and plastics manufacturer, has teamed up with wind farm developer Wind Direct to install two 2 MW wind turbines on Eastman’s Workington industrial complex. Work was completed in October 2006 and the two wind turbines generate more than 25% of the electricity required by the site, resulting in an annualized reduction of over 8000 tonnes of CO2 emissions.
DEMAND FOR GREEN POWER
Whichever power purchase partner is chosen, contract design is irrelevant if there is no demand for your power. Another advantage of selling to an electricity supplier is that, in certain cases, they can encourage demand for your power. Demand for renewable electricity is increasing in the UK with businesses, households and the public sector requiring more and more of their energy to come from ‘green’ sources. In particular, the market for renewable power from businesses is propelled by strong financial incentives – renewable and CHP power comes with Levy Exemption Certificates (LECs) which exempt large businesses from paying a Climate Change Levy (a tax on energy delivered to non-domestic users in the UK). As an end-user of the electricity, a business customer will be allocated one LEC per MW of electricity they purchase.
Here at SmartestEnergy we provide a ‘source-to-supply’ style retail service for business customers in recognition of this demand. The retail service provides companies with renewable and good quality CHP electricity and the associated LECs at prices competitive with traditional forms of power and customers can identify the exact technology they would like their electricity to come from and even the specific producer. This approach is a way of supporting independent generators by putting them at the heart of the market for renewable generation.
The importance of independent generators in helping the UK meet its energy targets must not be underestimated. Indeed, the government recognized the importance of this sector in its Renewable Energy Strategy which detailed plans for the introduction of a feed-in tariff regime to incentivize smaller-scale distributed generation, primarily in the domestic and small commercial sectors. With the right partner and contract in place, on-site generation can be an effective way for businesses to lower their power bills at the same time as carbon footprint, as well as potentially providing an additional revenue stream from energy exported from site. Power purchase contracts must be tailored to meet the needs of independents and must take into account fuel prices, technology type, size of plant and the risk appetite of the company involved.
The time is right for on-site generation, demand for renewable and good quality CHP is soaring and independent generators can fulfill this demand – the choice of partner will determine just how effectively this is done.
Tim Foster is Head of Business Development at SmartestEnergy, a purchaser and supplier of electricity from the independent generation sector, based in London, UK. Website: www.smartestenergy.com
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