The UK Government is currently consulting on the ‘grandfathering’ of bio energy projects under the ROC regime and has indicated that it is minded to grandfather anaerobic digestion plants. Grandfathering is important to the development of the sector as, without grandfathering, there is a risk that the level of support for a project could be changed midway through the project. (Grandfathering is the term given to exempting regulated entities from changes in regulation, in this case, changes in ROC regime.) Note, by contrast, the feed in tariff regime effectively creates grandfathered rights.
Investors have been lobbying for the change for some time to give them the certainty that, if they build an AD plant, a change in the ROC support mechanism will not leave it financially unviable. The introduction of grandfathering plus the completion of the first project financed AD plant has the potential to unlock funding in the sector, and enable many more developments across the UK.
The key variable for the funding of any AD plant is now the fuel supply arrangements. With wind, solar and hydro projects, the ‘fuel’ is free and, although it is variable, it can be measured and is predictable over the longer term. (In wind, investors use a P50 model and lenders a P90 model. P50 means that there is an evens chance of the forecast being correct. P90 means that there is a 90% chance that the forecast will be bettered.)
In AD plants, the fuel supply is dependent upon the ability of suppliers to make available the ‘fuel’ at the right price, and is therefore subject to market factors, transport and storage constraints. In order to mitigate these risks, project finance banks require long term, price certain contracts and revenue loss insurances. Investors will seek to retain as much flexibility as possible in order to try to maximise shareholder return and I expect the next couple of years to see some interesting negotiations.
In wind and hydro projects, the fuel is free and, although it is variable, it can measured and is predictable over the longer term. In AD plants, the fuel supply is subject to availability, and it is subject to constraints such as crop failure, transport interruptions and storage (given that crops are grown in season and plants operate 365 days a year there is a significant storage requirement). In order to mitigate these risks project finance banks look for long term supply and price stability obligations from suppliers. Investors, on the other hand, may look to take more market risk and buy supplies on a shorter term basis in order to try to maximise the upside. The next few years should see interesting negotiations in this sector.
On December 1, 2010