Background
Under the 2009 Energy Directive Ireland has committed to sourcing 12% of its heat demand from renewable sources by 2020. To date we have been slow to progress our obligations with the latest SEAI figures putting us somewhere around the 6.5% mark. Failure to achieve our obligations will result in heavy fines which will need to be funded by the taxpayer. Although very late in the day part of the solution to close the gap is the introduction of a Renewable Heat Incentive Scheme (RHI) which will pay participants a set price for producing heat from renewable sources (e.g. biomass, geothermal, etc)
A previous scheme to promote the production of electrical power from biomass (REFIT 3) didn’t gain much traction for a variety of reasons but ultimately it was down to the tariff. If there was a higher return available risks such as lack of long term fuel contracts, fuel quality and other operational risks could have been dealt with by providing a higher return to equity investors. Participants in this new proposed scheme will hope that some lessons were learned and the rates ultimately make sense from a commercial point of view. The risks inherent in the proposed RHI scheme are significantly less so it will be interesting to find out where the tariffs stand when the scheme is officially launched towards the back end of this year.
The Department of Communications Climate Action & Environment (DCCAE) issued a consultation document in January 2017 and asked a number of questions from participants in order to help frame the design – based on the indicators in this document we have attempted to opine on what the RHI scheme might look like. In this article, our focus is on biomass boiler installations which should comprise the majority of the uptake in the scheme.
So, what will the RHI ultimately look like from a financial perspective?
We ran a very typical 250 kW boiler installation project through our financial model and based it on 1,500 hours of operation p.a. Using industry standard construction and operation costs, a reasonable allowance for the write off of the incumbent system and reasonably conservative views on future fuel prices we estimate that to target a 13% IRR the project would require a blended RHI rate of c. 5 cent per kWh. In reality, it does appear as if the DCCAE are reluctant to incentivise this level of return and it is more probable that IRR’s in the region of 8 – 10% will materialise. This could reduce the potential blended RHI rate to c. 4.5 cent per kWh for this example. It is important to note that each participants situation will be different and it is expected that there will be a wide range of tariffs. It won’t and can’t be a one size fits all similar to previous REFIT schemes.
It is highly likely that the support will be for a 15-year period. Whilst it would be beneficial to participants to front end payments in order to service any associated shorter-term debt obligations it is likely to be spread evenly across the 15 years and linked to an appropriate inflation index. This would obviously help to protect and stabilise the indigenous supply of biomass material.
The scheme will almost certainly contain a tiering mechanism to control heat waste and to avoid repeating the reputational and financial damage caused by a similar scheme in Northern Ireland. The likely out-turn is the more you produce the less you earn. In practice, this should avoid the incorrect sizing of installed plant and also ensure that only the heat that is required will be produced. So take the example of our 250 kW biomass boiler above. Assume the operator runs the plant 24/7 and assume the rate remained constant at 4.5 cent per kWh. In this scenario the IRR on the investment could be stretched to over 70%! Applying the tiering mechanism would simply reduce this operator’s blended RHI payment to around 1 cent per kWh thereby negating any financial benefit from producing the additional heat. Given the tiering proposal it further follows that the scheme will most likely be based on metered heat rather than deemed heat.
How will projects be financed?
Some of the more established ways of financing projects would include: –
-On Balance Sheet using existing cash reserves
-On Balance Sheet using a mix of cash reserves and bank debt (typically up to 70% should be available)
-Energy Service Company (ESCo) – outsourcing the entire project to a third party who will own and operate the plant. Plant is installed on client premises and heat is provided to the client through a Heat Purchase Agreement. This is a particularly useful set-up if the price of heat is the key driver to system changes.
What are the Key Risks?
Undoubtedly the biggest risk, which outweighs any technology or operation & maintenance risk, is the robustness of the biomass supply chain and its ability to supply the quantity, quality and price of biomass that the market requires. The DCCAE has tasked Bord na Móna and Coillte through BioEnergy Ireland to solve this problem which is far from straightforward. It is not inconceivable to see a situation where operators up the value chain will spot an opportunity to increase prices in what is already a tight margin sector thereby driving up the price of wood chip and pellets. In the short to medium term biomass may even be required to be imported from other continents due a lack of indigenous supply which damages the green credentials and spirit of the scheme.
Ultimately the success or failure of the RHI will rest on how the DCCAE and advisers interpret the data available to them and how the overall scheme is framed. We await with bated breath…
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