Jacqui O’Keeffe, MCIWM and solicitor at Virtual Law, looks at the growing interest from large companies in sourcing power directly from the energy generators.
Published in the CIWM Journal September 2013
Numerous articles are published warning of the increased costs for electricity following the closure of older nuclear, gas and coal-fired power stations and whether replacement power stations will be built in time. In anticipation of this, large energy business users are looking at what they can do to hedge against the anticipated price increases. Whilst some companies in the waste industry are large energy users and companies are keen to hedge against increased costs, there are an increasing number of facilities generating power, which is exported onto the grid. The purpose of this article is to describe growing interest in large energy users to contract directly with independent generators.
Businesses adopt several methods to reduce their energy costs, from entering into a supply agreement with a licensed energy supplier to supply all of their needs, wherever the location of their premises in the UK; to producing their own renewable energy on site, which they can use for their own purposes and to export surplus capacity.
However, not all energy users (customers) have spare land that can be used to generate electricity on site (by itself or a generator) and many have started to consider the purchase of renewable electricity direct from a generator. Although the cost of renewable energy may be higher in the short-term, the expectation is that the cost of non-renewable electricity will increase at an ultimately quicker rate. A number of large energy users, such as central government, government bodies, retail outlets, supermarkets, distributors with several depots and warehouses, airports, utility companies and waste management companies have entered into arrangements, or are at least actively looking into this. It is an alternative to signing up to a green tariff with their electricity supplier as they may be able to fix the price, or agree indexed increases over a five to 25-year period. Whereas the supply contracts agreed with the electricity supplier and customer normally last for a shorter period (just one or two years), and so their ability to increase electricity prices is greater. The other option is for a generator to sell the electricity to a licensed electricity supplier, which will sell it onto their customers (licensed electricity suppliers are required by law to source an increasing percentage of their electricity from renewable sources).
Go Direct
Some generators prefer entering into arrangements direct with the customer rather than signing up to a licenced supplier who then sells on the renewable electricity to its customer, as the payment for electricity from a customer may be higher. As many of these projects are project financed, the generator and its funder will want to be sure that the payment it receives for the sale of electricity not only pays the loan but also provides sufficient profit to enable it to operate. The credit rating of the customer will also be important as the generator will want to be satisfied that there is no likelihood of the customer getting into financial difficulty during the contracted supply period. This is achieved by the generator and customer entering into a power purchase agreement (PPA) in addition to the customer’s supply contract with the licensed supplier. What happens in reality is that the customer purchases the electricity and renewable benefits from the generator and sells this onto the supplier (because the electricity has to be transported through the system) who in turn credits this amount of electricity and deducts it from the amount to be supplied under the customer’s supply contract. This process is called “sleeving”.
Whether or not this is appropriate in every case will of course depend upon the circumstances of each customer. There are costs in setting up this arrangement because it is most likely that the existing supply contract with the licensed supplier will have to be amended to enable the new arrangements to be put in place and the customer’s electricity needs will have to be sufficiently high to make this cost effective. As the supply contract is for a shorter period than the PPA, negotiations for a new replacement supply contract will need to take account the existence of the PPA. A typical sleeving structure is illustrated in Figure 1.
What the customer is doing is in effect passing through the electricity and costs from the generator to the licensed supplier. It has to enter into a “back to back” PPA with the licensed supplier. There are risks in this arrangement as the customer is effectively underwriting the generator’s performance and this risk has to be balanced against the benefits ie more control over its electricity costs. As the market has developed different arrangements are currently being negotiated, for example tripartite arrangements are being agreed between the customer, generator and licensed supplier to govern the relationship between them where they all enter into the same PPA.
Licensed suppliers are also being more flexible and willing to consider different arrangements. Deals have been agreed where the customer has entered into a Price Guarantee Agreement with the generator which contains a price guarantee mechanism ensuring that the generator receives a fixed price and is not concerned about the vagaries of fluctuations in the wholesale price of electricity throughout the term of the contract. This arrangement is obviously appropriate where the price payable for electricity in the PPA is not fixed but fluctuates in accordance with an index or reflects the variation in the wholesale market prices. Under this proposal the generator and licensed supplier enter into a PPA. The customer’s supply contract with the licensed supplier will acknowledge this arrangement. Subject to drafting in the documents, this arrangement will mean that the customer is not underwriting/wrapping the generator’s performance. One example of this arrangement is shown in Figure 2.
What does this mean for the waste industry? Generators of renewable energy are now faced with lots of opportunities and this may demand a new skill set in house or appointing advisors who can assist with evaluating the best option for each company. Energy costs are an important aspect in the overall costs of running a business and they are being monitored more closely.
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