Renewable heat in the UK: entering phase one

The UK’s Renewable Heat Incentive (RHI) scheme – the first of its kind in the world – should drive a seven-fold increase in the production of renewable heat in the UK over the coming decade, if UK Government predictions hold true. There has been keen interest in the RHI scheme since it was first proposed because the existing renewable energy incentive schemes in the UK have focussed mainly on electricity and not heat.

The first phase of the scheme was introduced in late November 2011 (when the Renewable Heat Incentive Scheme Regulations 2011 (SI 2011/2860) came into force). By making it easier to deploy renewable heat technologies, it will give the UK a better chance of meeting targets set by the EU Renewable Energy Directive (RED).

Phase one is now under way, giving us some means of measuring its chances of success. Despite its infancy, the Government is considering interim measures to ensure that annual spending budgets set for the RHI are not exceeded. These measures are intended to apply until longer term measures are in force (see further below).

Renewables targets

The UK must ensure that at least 15 per cent of its gross final energy consumption (including heating, transport and electricity) is from renewable sources by 2020, in order to meet its RED target.

The UK Government‘s plan is that, by 2020 (and using the RHI scheme), 12 per cent of the UK’s heating will come from renewable sources. Heating currently accounts for around 47 per cent of UK final energy consumption and around 77 per cent of energy usage across all non-transport systems.

The RHI scheme applies in England, Wales and Scotland (not Northern Ireland) and will be implemented in phases. The regulatory body Ofgem will administer the scheme and make all payments to generators through its E-Serve division. The Government is funding the scheme from taxes rather than through a levy. It has committed to providing up to £864 million for the period from 2011 up to and including 2015; funding beyond 2015 has not yet been agreed.

Phase one

Phase one is aimed at the non-domestic sector. Long-term tariffs will be available for the industrial and commercial sectors, the public sector, not-for-profit organisations and communities.

The owner of an “installation” will receive a fixed price per kilowatt-hour thermal (kWhth) of eligible renewable heat generated for 20 years from the date of accreditation (or registration, for a producer of biomethane). The heat produced must be used for heating a space or for heating water or for carrying out a process. (The injection of biomethane into the national gas grid is not included in this definition.)

Phase two

Phase two will offer long-term tariff support for the domestic sector and will be introduced later in 2012, to coincide with the introduction of the Green Deal for Homes, which will require further regulations. The domestic sector will be supported by Renewable Heat Premium Payments; to date the Government has ring-fenced around £40 million to make payments to households which install renewable heating.

In practice

The incentive comes in the form of payments made over a 20-year period (based on expected operational lifetimes); the payments are calculated by multiplying the appropriate tariff by the “eligible heat use”. The eligible heat use is equivalent to the actual metered generation or use of heat (depending whether an installation is “simple” or “complex”).

Payments are made each quarter (following the submission of required information).

The Government funds the RHI directly and has set the annual budgets for the scheme.

The budgets are £56 million (m) for 2011/12, £133 m for 2012/13, £251 m for 2013/14 and £424 m for 2014/15. Beyond 2015, there are as yet no agreed budgets.

However, as spending through the RHI is funded from general taxation, its success will have a direct impact on government borrowing and debt. In order that spending on the scheme does not exceed the annual budget limits set by the Comprehensive Spending Review, the Government is consulting on a new interim cost control mechanism that would, once triggered, close off the RHI scheme to new applicants for a given period.

The proposals are set out in a consultation document entitled ‘The Renewable Heat Incentive: Consultation on Interim Cost Control’ which was published on 26 March 2012 (the Consultation) and will close on 23 April 2012. Publication of the Interim Cost Control Regulations is scheduled for July 2012.

Interim cost control

Under the Consultation proposals, once a certain percentage of its annual RHI spending budget is allocated to existing schemes and applicant schemes, the RHI scheme will be suspended with the result that no new applications for accreditation would be accepted from the date of suspension and for the remainder of the financial year. A budgetary trigger will therefore activate the temporary suspension of the RHI. DECC intend to frequently publish the data being used to monitor progress towards the trigger, in order to allow the market to make informed decisions about the likelihood of suspension.

The Government is consulting on whether to give some notice or no notice of its intention to suspend the RHI, depending on the proportion of budgeted spend that it decides to use as the trigger (the length of notice given necessarily impacts where the budgetary trigger is set). There are three potential combinations of trigger and notice period which set out in the table below.

Source: DECC Consultation on interim cost control

The proposals apply to new applications (including registrations for biomethane producers). The Government also intends that suspension will apply to additional capacity requests which would not be processed during the period of suspension.

Preliminary accreditation is available for medium and large biomass and energy from waste installations, biogas and deep geothermal. Installations that have been awarded preliminary accreditation prior to the date that the interim cost control regulations come into force may apply to Ofgem for their preliminary accreditation to be converted into full accreditation during the suspension period. Installations who applied for preliminary accreditation after the date of entry into force would not be able to convert to full accreditation during the suspension period.

The RHI scheme’s suspension would only remain in place for the financial year and the scheme would then re-open at the beginning of the next financial year.

These measures, once implemented, are only intended to apply until longer term measures - are in force (such as degression and review - see further below). The Government is currently considering how to implement a long term cost control measure, which it anticipates will be in force from February 2013.

Broadly, eligible technologies are technologies which the European Commission considers to be renewable under the EU Renewable Energy Directive and which are in commercial use in the UK.

The following technologies have all been recognised as eligible:

• solid biomass in plant designed and installed to use it as the only primary fuel source and solid biomass contained in municipal waste (including combined heat and power plants (CHP))
• ground and water source heat pumps with a coefficient of performance of at least 2.9
• geothermal from at least 500 metres below the surface (including CHP)
• solar thermal at capacities of less than 200 kilowatt thermal (kWth)
• biogas combustion (including CHP but not including landfill gas) at capacities of less than 200 kWth
• biomethane injection.

Participants will also need to meet other criteria. Installations are only eligible if they were completed and first commissioned on or after 15 July 2009; and support is only available if an installation has not received and will not receive any public grant funding. (If a grant was received before the RHI regulations came into force – on 28 November 2011 – then support will only be available if that funding has been repaid.) Also, solid biomass installations are not eligible for the RHI if they are or have been a qualifying CHP generating station accredited under the Renewables Obligation Order 2009 or the Renewables Obligation (Scotland) Order 2009.

We recommend that all applicants double-check eligibility as each new project comes up.

Ineligible technologies

Air source heat pumps, direct air heating, bioliquids and landfill gas are not eligible now but may become eligible once further Government investigations are completed.
Co-firing of biomass with fossil fuel, exhaust air heat pumps, transpired solar thermal panels, fossil fuel-fired CHP and waste heat from fossil fuels are all excluded from the scheme.

Tariff levels depend on the cost of technologies at different scales. They have been calculated to compensate for the extra cost of renewable technology over fossil fuel heating and to provide an incentive to overcome non-financial barriers to the development of renewable heat technologies.

They should also provide a return on the additional capital invested. The rate of return assumed is 12 per cent for all technologies and fuels, apart from solar thermal; at present, solar thermal is more costly per unit of energy than other technologies and therefore has a lower rate of return.

In November 2011, the European Commission gave State aid approval to the RHI scheme with the proviso that the tariff for large biomass schemes be reduced from 2.7p per kWhth to 1p per kWhth. (The Regulations were accordingly amended to take this into account.)

The tariff rates - set out below - reflect prices that apply in each year of the scheme. For each following year, commencing on 1 April, the rates will be adjusted automatically by a percentage increase (or decrease) in line with the UK retail price index for the previous calendar year (with rates rounded up to the tenth of a penny).

Tariff levels

Different methodologies are used to determine the level of support payments depending on whether an installation is in a simple or a complex heating system.

A simple system is one in which an installation:

• generates and supplies heat solely for one or more eligible purposes used in one building;
• does not deliver heat by steam; and
• is not a CHP system.

If any one of these criteria is not satisfied, the system is deemed to be complex.

The support payment for a simple system is calculated by multiplying the tariff rate by the heat generated in the relevant period. A generator in a simple system does not, as a result, take the risk of heat loss.

Where a system is complex, the support payment is calculated by multiplying the tariff rate by the total heat used by the heating system in the relevant period (for eligible purposes).

Where a number of generators supply one heating system, each generator is entitled to payment in proportion to the heat that it has generated compared to the heat generated by all generators supplying heat to the same system (in each case, in the relevant quarterly period).

Calculations differ again for generators of heat from the combustion of biogas.

Support levels are expected to fall over time for new projects, as the cost of renewable heat technologies comes down. The Government published (in March 2011) two methods for this reduction in support: reviews and degression. These are expected to work in tandem.

Degression

Degression will provide for automatic reductions in tariff levels when trigger points are reached (such as megawatt hours of generation or megawatts of installed capacity). This will provide an incentive for developers to get into the scheme early to benefit from the higher tariff levels at the start of the scheme. The rate of degression and triggers will be technology-specific.

Reviews

Scheduled reviews will take place every four years, starting in 2014 (for implementation in 2015). There may also be additional “early reviews” where specific circumstances arise. Any aspect of the scheme may be reviewed, not just the tariff levels. The UK Government will also reserve the power to initiate early reviews in specific circumstances (as with the Renewables Obligation).

These cost control measures are planned for phase two, so further details are due out later in 2012. The legislation does not provide any details at the moment.

The Government may base its final cost control measures on its earlier proposals, as set out above. It has reiterated its commitment to “grandfathering” support for existing installations; and the Regulations clearly state that tariff levels are fixed as at the date of accreditation by Ofgem. This commitment should provide certainty for investors.

Installations seeking to accredit on or around a scheduled review date may be delayed until tariff rates are confirmed.

To gain accreditation, applicants have to demonstrate compliance with all the eligibility criteria. All applications go to Ofgem, even in the case of solid biomass (other than that contained in municipal waste), solar thermal and ground or water source heat pump installations in each case of 45 kWth or less, which are subject to MCS certification.

Applicants can apply for preliminary accreditation (which should help to secure finance), but the tariff rate is set from the point at which full accreditation is granted.

Biomethane producers are treated differently.

Changes and additional capacity

If changes are made after accreditation (preliminary or full), Ofgem will have to be notified and provided with information to decide whether the installation still meets the eligibility criteria.

Where a number of units of the same technology are installed within a 12-month period, their combined capacity is considered when setting the level of tariff. The installation capacity will be the total installed peak heat output of the installation.

However, if there is a number of different technologies on a single site, each will be classed as separate and be subject to eligibility criteria and tariff levels.

If an owner wishes to add capacity to an installation (whether seeking support for the additional capacity or not), Ofgem must be informed and given updated information.

With the interim cost control consultation underway and more consultations due this year, the Regulations are likely to change again. In particular, the Government is keen to introduce more support for waste in the non-domestic sector, and to include eligibility for mixed waste and solid recovered fuel from waste streams.

It is also considering whether and how to introduce support for air-source heat pumps.

The Government is also developing guidance on the definition of “a building” under the scheme in relation to chemical plants, as this is currently unclear. These definitions will bring investors more clarity and are unlikely to change the tariff scheme.

The scheme’s success depends in the short term on whether alternative support is available (under the Renewables Obligation, for example) and on the returns available under any alternative scheme.

In the longer term, its success will depend on how tariff levels compare to the level of upfront capital costs and on the risk of stranded assets should heat demand decrease.