How can corporate Ireland meet renewables targets and reduce energy costs?

Transcription

1 How can corporate Ireland meet renewables targets and reduce energy costs? Introduction Corporate Power Purchase Agreements or Corporate PPAs are currently a hot topic of discussion in the Irish energy sector, particularly due to: the need for renewable energy developers to find bankable revenue streams as the REFIT support schemes come to an end; and heightened focus upon the sources of the energy used by large consumers particularly those that wish to market environmental credentials alongside their core retail offering. This paper will seek to define Corporate PPAs and to explain how they work, both in general and in the specific context of the Irish energy sector, which at the moment is going through significant change, both with the introduction of ISEM (new arrangements in the wholesale electricity market) and with the end of the REFIT schemes. Having observed the development of Corporate PPAs internationally, we will also offer our views as to how their use is likely to develop in Ireland. It is important to note that we focus here on Corporate Renewable PPAs, and in particular on the challenges and solutions for Corporate PPAs that are used to support new renewable electricity projects.

2 What is a Corporate PPA? Surprisingly given how often the term appears in renewable energy discussions there is no industry-standard definition of a Corporate PPA. Its components do, however, provide some clues. The PPA label has, in project finance, traditionally been applied to the contract under which a generator sells, and is remunerated for, the electricity that it produces. This usage focuses on the quality of the buyer s covenant (i.e. its creditworthiness), and its ability to support the financing of the construction and operation of the project. The identity of the final consumer of the power or even the need to identify a final consumer is not always important in this type of arrangement. The initial buyer was often, in fact, a supply company that would on-sell the electricity to its broader customer base. The Corporate designation supplements the traditional PPA description by adding an identifiable final consumer to the structure. As the label suggests, this consumer is often a corporate entity, but its precise legal form is not material, so long as once again its credit rating (together with credit support, if necessary) is sufficient to support Additionality In an electrical system where all forms of electricity generation and demand are pooled together and delivered through a single electricity grid, it can be difficult to establish just how close is the relationship between a single electricity consumer and a single electricity generator. There is no single way of establishing or measuring the quality of this relationship, and different organisations use different methods. However, a common and serviceable method is to identify additionality i.e. to ask whether a particular renewable energy project would have been built but for the commercial arrangements that comprise the Corporate PPA? Where the answer is no, the Corporate PPA Consumer has a relatively strong claim to be directly associated with the renewable output from the relevant project. the financing of the construction and operation of the project. We propose that there are therefore three key elements of a Corporate PPA structure: i. an identifiable electricity consumer agrees to purchase electricity direct from an electricity generator this contract would typically involve a pre-agreed price or pricing formula, and a minimum duration; and ii. the purchased electricity can be credibly attributed to the output of that generator; and iii. the consumer s promise to purchase and (more importantly) pay for electricity contributes materially to the financing of the construction and operation of the generator. Once these elements are present, there is considerable flexibility and consequent diversity as to how a Corporate PPA might be structured. For most of the history of the Irish renewable electricity sector, the typical PPA used to support the financing of generation projects has featured, as its off-taker, a household name electricity supply company. More recently, developers have incorporated their own licensed supply company off-takers known as supplier lite structures in order to retain control over both wholesale market revenues and revenues from the REFIT support scheme. Neither structure places any importance on the identity of the final consumer. This is because most Irish renewable electricity projects have, for at least part of their life, been the beneficiary under one of the Irish government s successive support schemes the AER series, and then the REFIT series. Although a PPA is central to the design of each of these support schemes, the identification of a particular final consumer is not required under any of these schemes. Developers have therefore not been motivated to graft a corporate consumer into the structure of the supported project. However, in the meantime, Corporate PPAs have been offered, and banked, in a number of other jurisdictions. The practice originated in jurisdictions where a support scheme existed that left the developer with flexibility in the design of its power sales arrangements (e.g. the US with Production Tax Credit (PTC)/Investment Tax Credit (ITC) support or the UK with Renewable Obligation Certificate (ROC) subsidies), and with the ability to attract additional revenue streams. More recently, the practice has taken hold in jurisdictions where there is no renewable energy support scheme (including where a previous scheme has lapsed). By the end of 2016, the following jurisdictions had corporate PPAs in place in relation to the following generation capacity: USA and Mexico: c.14gw UK: c.700mw Europe, Middle East and Africa: c.2gw Asia-Pacific: c.1.3gw Of this c.18gw figure, it is noteworthy that approximately 13GW of these corporate PPAs were entered into between 2014 and 2016¹. The commercial benefits of a Corporate PPA include: for developers: a secure revenue stream, which can unlock the availability of finance. Crucially, in most jurisdictions, the attractiveness of this revenue stream will also depend very much on whether support scheme funding is available alongside any Corporate PPA revenues. This is particularly important in Ireland as we find ourselves positioned between the end of the REFIT schemes and the establishment, at some future time, of the Renewable Energy Support Scheme (RESS); and for corporate electricity consumers: verifiable and brand-enhancing leadership in the decarbonisation of electricity generation and progress towards corporate and national renewables targets. Note that the attractiveness of this procurement option may depend upon how much value the customer places upon environmental issues particularly if the per-unit price sought by the developer includes a premium over and above the market prices that apply to current brown electricity supply. When compared with medium to long term future electricity price curves, this initial price premium is expected to be displaced by a price saving for the corporate relative to a business-as-usual scenario, as market prices are forecast to rise. 2 ¹ Source: Bloomberg New Energy Finance.

3 Corporate PPAs as part of a renewable energy strategy Many large energy consumers are dedicating an increasing focus to environmentally friendly strategies, whilst also attempting to reduce energy costs. The aim to reduce carbon emissions is a result of more stringent regulation and policy, a more environmentally sophisticated customer base and more ethically-focused requirements from a segment of the investment community. This is evidenced by the substantial and increasing number of organisations that are including energy efficiency, carbon reduction and renewable energy targets in their annual reports and sustainability focused publications. While perhaps the most immediate means to reduce one s environmental footprint is to reduce energy consumption, this must be optimised against operational requirements and will also be subject to technology constraints. To supplement this behaviour, many large energy consumers will seek to switch their source of energy to renewable sources note for example high profile initiatives such as the RE100, a collaborative, global initiative of over 100 influential businesses committed to utilising 100% renewable electricity. RE100 was launched in At the time of writing (January 2018) 119 corporates have signed up to this commitment, with 32 signing up in 2017 alone. Strategic renewable electricity options vary from purchasing the power from a third party s project to investing directly in a generation asset to buying renewable certificates. As noted above, we are focusing in this report on a company purchasing electricity under a longterm renewable PPA i.e. from an off-site renewable electricity project via a PPA. Bankability Financing for the majority of new renewable electricity projects of scale is normally structured on a project finance basis. One of the key focuses for lenders (and investors) in determining whether a project is bankable or not is the nature of the project s long term cash flow. Revenue is comprised of two variables volume and price. Lenders will look to energy output forecasts with respect to volume, and to the relevant subsidy or PPA with respect to price. If a fixed price is not guaranteed then a floor price will normally be required. To finance a new build project, lenders will normally require that the duration of the PPA contract must at least cover the debt term of the project finance. Under REFIT, however, due to competition between lenders and the strength of the guaranteed off-take price, there was some movement by lenders to offer debt tenor beyond PPA expiry, subject to certain structuring conditions. This is less likely under a Corporate PPA structure given the expected lower off-take price of a Corporate PPA versus the REFIT support levels. For a PPA to be bankable, certain issues must also be addressed such as the credit strength of the off-taker/corporate entity, credit support (e.g. a parent company guarantee or letter of credit) and how the risk of any change in law is to be borne. Core elements of a Corporate PPA structure Given the flexibility inherent in our three key elements definition of Corporate PPAs, it would be counterproductive to attempt to identify all possible structures that meet the description. However, some governing principles can be identified. One such principle is that if a corporate Consumer imports its electricity from the grid (as opposed to generating it on-site, behind the meter ) then the electricity must be sourced from the wholesale electricity market (in Ireland, the Single Electricity Market) and supplied to the Consumer by a licensed electricity Supplier. Viewed from the perspective of the wholesale electricity market, the basic relationship, involving a Supplier that is a utility and is separate from both and Consumer, is depicted below: Irish Wholesale Pool Supplier Consumer Market Project output + green rights Top-up electricity from pool (residual fuel mix) 3

4 Due to the intermittency of the renewable resource, there will inevitably be trading periods during which the will not be able to export enough electricity to satisfy the Consumer s demand. During these periods the Supplier will play a balancing role, sourcing and selling to the Consumer additional, top-up electricity from the wholesale market. The two sources of electricity are depicted by the arrows in the diagram on the previous page. The converse situation where the exports more electricity than is necessary in order to satisfy the Consumer s instantaneous demand also requires commercial consideration. The key point here is how any difference, between the Corporate PPA price and the price at which the can spill the excess into the wholesale market, is treated. The Corporate PPA arrangement needs to involve all three parties, due to the interdependence of the services and products that they provide to one another. These services and products are depicted below: Consumer Payment for renewable electricity Renewable electricity and possibly green benefits (e.g. guarantees of origin) Strength of covenant supports project financing Credible claim to additionality Payment for balancing electricity Balancing electricity Locked-in forward prices for renewable electricity Balancing services support the Corporate PPA arrangement Electricity export data in order to allow calculation of quantity of balancing electricity Supplier In describing the situation in Great Britain, this tripartite relationship is generally described either as: a sleeved Corporate PPA where the Supplier wraps the s output in a sleeve comprising the additional top-up electricity; or a virtual Corporate PPA where the commercial position of each of the three parties is achieved through the use of a financial instrument (e.g. contract-for-difference between and Consumer) rather than arrangements for the physical sale, purchase and delivery of electricity. In Ireland, due to the requirement that the electricity be sold through the wholesale electricity market and supplied to the Consumer by a licensed electricity Supplier, we consider that it will be necessary to adopt a variant of what GB commentators would call a virtual Corporate PPA. The more active Corporate PPA Consumer In the event that it wishes to take a more active role in the Corporate PPA structure than that of a passive consumer, in Ireland it is open to a corporate Consumer to extend its role by (for example) incorporating its own Supply entity. This allows the Consumer to capture the trading profits that might otherwise have been lost to an independent Supplier. The role carries with it an administrative and regulatory compliance burden, although there are currently commercial service providers in the Irish market that offer to carry out the necessary functions. A structure of this type is depicted below: Affiliated entities Irish Wholesale Pool Supplier Consumer Market Project output + green rights Top-up electricity from pool (residual fuel mix) 4

5 Perhaps more significantly, it is also possible for an intermediary entity to purchase the s output and on-sell it into the wholesale market. In Ireland, this structure has frequently been used as part of a supplier lite model in order to allow a to capture both wholesale market revenues and REFIT support revenues. In such a structure it is the that incorporates the intermediary entity. However, in a Corporate PPA structure, it might make more sense for the Consumer to incorporate the intermediary, particularly so that the Consumer can claim to be taking ownership of the renewable output of the before it is intermingled with balancing electricity from the wholesale market. A structure of this type is depicted below: Affiliated entities Supplier Irish Wholesale Pool Market Supplier Consumer Project output + green rights Top-up electricity from pool (residual fuel mix) We emphasise that these permutations do not affect the number of roles that are present in a Corporate PPA structure. They do, however, offer flexibility in relation to who performs each of the roles, which in turn allows each party to fine-tune the extent of its investment, and involvement, in the structure. Corporate PPAs in ISEM The Single Electricity Market is currently undergoing a significant process of market change known as I-SEM (i.e. Integrated Single Electricity Market), which is scheduled to go live on 23 May In the context of Corporate PPAs, and relative to the basic structure depicted above, the impact of I-SEM implementation is to complicate the structure s interaction with the wholesale electricity market. The Single Electricity Market currently generates a single ex-ante price for electricity in each trading period. By contrast, following I-SEM go-live, a market participant s net commercial position, in respect of each trading period, will depend on its trading position in up to four temporal markets (forwards, day-ahead, intraday and balancing). Participation in the balancing market will be compulsory, while participation in the other markets will be voluntary. The impact of I-SEM on the basic Corporate PPA structure is depicted below: Irish Wholesale Pool Market: Forwards Day-Ahead Intraday Balancing Supplier Consumer Project output + green rights Top-up electricity from pool (residual fuel mix) 5

6 I-SEM go-live will not affect the availability of the basic Corporate PPA structure or even the availability of a structure involving an intermediary that purchases from the before selling into the wholesale market. However, the increased flexibility with which each unit of exported electricity will be able to be traded into the wholesale market (following I-SEM go-live) will introduce a range of commercial opportunities and risks that have not previously been a feature of the Irish wholesale electricity market. It will be necessary for the parties to a Corporate PPA structure to agree which of them is to be responsible for trading the output into I-SEM, and whether any of the other parties are to be exposed to any financial upside or downside as a consequence of this trading activity. Regulation The key energy regulatory obligations that affect the Corporate PPA structure arise from the terms of standard Irish electricity licences. These obligations are: the s obligation to either sell its electrical output directly into the wholesale electricity market, or to sell it to an intermediary that in turn sells that electrical output directly into the wholesale market; the requirement that the Commission for Regulation of Utilities approves any proposed intermediary; the requirement that any electricity imported from the grid by the Consumer be registered against, and supplied by, a licensed electricity Supplier; and a licensed Supplier s obligation to purchase its electricity requirements from the wholesale electricity market. The parties to the Corporate PPA structure have considerable flexibility to design the remainder of the structure, provided that these basic regulatory obligations are addressed. Corporate PPAs in a Post-REFIT world As is well known, Ireland is currently pursuing a target of 40% electricity consumption from renewable sources by Since 2006, the main lever deployed by the Irish government in pursuit of this target has been successive tranches of the REFIT feed-in tariff support scheme. The last REFIT support schemes (REFIT 2 and REFIT 3) closed to new applications at the end of Successful projects had until the end of 2017 to obtain the planning permission and grid connection rights that are conditions precedent to the receipt of support. The Irish Department of Communications, Climate Action & Environment (DCCAE) published, in September 2017, what it described as the final consultation on the design and development of a new Renewable Electricity Support Scheme (RESS) for Ireland. It is clear that the RESS scheme is intended to be the support scheme that is the successor to the REFIT. The DCCAE consultation proposed that the main commercial thrust of the design of the RESS will be the use of pay-as-cleared auction mechanisms to allocate support, which will take the form of contracts for differences (CfDs). It has been suggested that it is not realistic to expect the first iteration of these auctions to occur before mid-2019 at the earliest, due in part to the fact that auctions of this type have not previously been run by the DCCAE. A high-level view of the expected near-term timetable is depicted below: REFIT December 2017: Planning and grid deadline under REFIT December 2019: Energisation deadline under REFIT December 2020: Ireland s RE target compliance assessed? September 2017: Latest RESS consulation Mid-2019: First RESS auction? RESS No Irish support scheme available. Corporate PPAs attractive to shovel-ready projects. Corporate PPA procurement can potentially proceed in parallel with RESS auction cycle. 6

7 Any Irish renewables project that: had REFIT support, but which lost this support by reason of missing the end-2017 deadline to obtain planning permission and connection rights; or achieved the end-2017 REFIT deadline but now knows that it will not meet the further deadline dates (31 December 2019 for project energisation, and 31 March 2020 for the requirement to have a PPA in place) may face a wait until at least mid-2019 before the next government-sponsored support scheme is available. Prior to the availability of RESS, and even alongside the RESS process once it is established, we consider that Corporate PPAs could be procured in Ireland through privately-run auctions. Auctions of this type are run in GB, typically by an advisor on behalf of an individual Consumer client. Corporate PPAs, procured in a systematic manner, can therefore provide a potential route to market for Irish renewable projects that does not depend upon centralised subsidy. Irish example: Microsoft/GE ² In October 2017, Microsoft announced that it had entered into a 15-year power purchase agreement (PPA) with GE to purchase 100 percent of the wind energy from its 37-megawatt Tullahennel wind farm in County Kerry, Ireland. As part of the deal, Microsoft also signed an agreement with an Irish trading company to provide energy trading services to Microsoft. In addition, each turbine will have an integrated battery; Microsoft and GE will test how these batteries can be used to store excess energy, and supply it back to the grid. Microsoft and GE formed a strategic partnership in 2016 and the PPA is said to build on that framework. ² From Irish Times and October 9th 2017 What will be the Market dynamic for Corporate PPAs in Ireland? We believe that GB is a good proxy when looking at how the market dynamic for Corporate PPAs will take shape in Ireland. There are some similarities - a centralised transmission grid network and the recent end of a long running government renewable support scheme. The ROC support regime has effectively been phased out since March 31st There are however some differences namely: In GB, onshore wind and solar PV projects have been excluded from CfD auctions, the replacement subsidy scheme post ROCs, so corporate PPAs have become the preferred route to market for such developers and; Historically Corporate PPAs complemented ROC support. For the last five years in GB, contracted corporate PPAs have been in the 100MWs per annum, although this is expected to increase now grid parity has been reached for corporate PPAs whereby PPA fixed prices are close to or even below average annual wholesale prices e.g. N2EX Day Ahead Auction prices. In terms of the market dynamic in GB, the balance of power that exists between the s and Corporate Consumer currently favours the Corporate Consumer. There are currently relatively few Consumers active in the PPA market, whereas there are many keen developers. So the Corporate Consumer is able to run competitive processes with numerous generators proposing prices and structures. As a starting point, it is reasonable to assume that the same market dynamic will exist in Ireland. However, Ireland may come to exhibit a different balance of power because: The more technology neutral are the RESS auctions, the more renewable developers will be eligible to participate, which may reduce the relative appeal of Corporate PPAs as a route to market; and relative to the GB situation, a large proportion of the renewable pipeline in Ireland is held by a small number of developers, which means that these developers will have a stronger hand when negotiating Corporate PPAs. Concluding Summary Corporate PPAs are a hot topic in the Irish energy sector at present given the need for renewable energy developers to find bankable revenue streams as the REFIT support scheme come to an end; and the heightened focus upon the sources of the energy used by large consumers. There are a number of different potential Corporate PPA structures, depending largely upon the consumer s required proximity to the generator, and their appetite for administrative activity - but each structure contains three key elements as detailed above. Prior to the start of RESS, Corporate PPAs could be procured by means of a privately run auction process that resembles the process that is to be adopted for RESS. And when RESS auctions eventually commence, Corporate PPA auctions could proceed in parallel in order to present a competing source of bankable revenues to projects unable to obtain RESS support. In GB, the balance of power currently favours the Corporate and it will be interesting to see how the market dynamic plays out here in Ireland. Will the fact that the majority of the renewable pipeline in Ireland is held by a limited number of developers tilt the leverage needle back toward the developers here? 7

8 Anthony Rourke Director, Government and Infrastructure Advisory, EY +353 (0) anthony.rourke@ie.ey.com Peter McLay Partner, Energy Practice, Mason Hayes & Curran +353 (0) pmclay@mhc.ie Phil Dominy Assistant Director, EY +44 (0) pdominy@uk.ey.com Eoin Cassidy Partner, Energy Practice, Mason Hayes & Curran +353 (0) ecassidy@mhc.ie Shane MacSweeney Partner, Government and Infrastructure Advisory, EY +353 (0) shane.macsweeney@ie.ey.com William Carmody Partner and Co-Head, Energy Practice, Mason Hayes & Curran +353 (0) wcarmody@mhc.ie EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organisation and may refer to one or more of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organisation, please visit ey.com Ernst & Young. Published in Ireland. All Rights Reserved indd 01/18. Artwork by the BSC (Ireland) ED None The Irish firm Ernst & Young is a member practice of Ernst & Young Global Limited. It is authorised by the Institute of Chartered Accountants in Ireland to carry on investment business in the Republic of Ireland. Ernst & Young, Harcourt Centre, Harcourt Street, Dublin 2, Ireland. Information in this publication is intended to provide only a general outline of the subjects covered. It should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of professional advice. Ernst & Young accepts no responsibility for any loss arising from any action taken or not taken by anyone using this material. ey.com The contents of this publication are to assist access to information and do not constitute legal or other advice. Readers should obtain their own legal and other advice as may be required. Copyright 2017 Mason Hayes & Curran.