Article by Malcolm Dowden and Simon Ewing
Originally published in New Law Journal, 24 September 2010
Malcolm Dowden & Simon Ewing discuss issues affecting the coalition government's energy objectives.
IN BRIEF
- Renewable energy schemes promise additional income.
- Financial projections do not address property issues.
- Benefits depend on accurate financial models and "end of life" issues.
The Coalition government published its first Annual Energy Statement in July 2010. It observes that the rationale for action is economic as well as environmental. With its own oil and gas resources declining, failure to act now would make the UK more vulnerable to high, and volatile, oil and gas prices. It confirmed the government's mission "to support the transition to a secure, safe, low-carbon, affordable energy system in the UK, and to mobilise commitment to ambitious action on climate change internationally".
The statement sets out 32 actions intended to promote those objectives. They range from measures designed to remove barriers to investment in energy efficiency, to the promotion of a range of renewable energy technologies and an increase in the EU's greenhouse gas reduction target from 20%–30%.
It is, necessarily, a complex area. Increasingly, responses to government consultations are highlighting the scope for conflict between policies and objectives, and the risk of challenge or litigation should policies be amended or withdrawn once parties or industry sectors have relied on them to structure transactions or projects. The risk, inevitably, is at its greatest for early adopters.
Feed-In Tariffs-Opportunities and Hurdles
Since their introduction in April 2010 feed-in tariffs have received significant attention as the driver for new commercial-scale renewable energy projects in the UK (excluding Northern Ireland). They provide incentivising payments for small scale generation (up to 5MW) using anaerobic digestion, hydro, wind, micro combined heat and power or solar photovoltaic.
For commercial scale solar projects, tariffs payable over 25 years mean that project developers will receive payment from an energy supplier for each KWh generated, plus a further payment for any electricity exported to the grid.
The provisions create opportunities for energy project developers to install microgeneration technology, such as solar pv panels, on rooftops or on open land, such as agricultural land or urban sites. In each case, the payments available through feed-in tariffs represent a potential income stream for commercial landowners, with rental income based on a share of payments to the project developer.
Social housing providers and commercial landlords are also likely to be attracted by the possibility of providing cheaper energy to tenants, and by the potential for reputational gain in commercial sectors subject to mandatory environmental and sustainability reporting requirements.
The feed-in tariffs regime favours early adopters. Tariffs for the initial years of the scheme are set at a higher level, with "degression" or tapering taking effect in 2013, after which tariffs will reduce annually by 7.5%.
Structuring Issues
Many of the operators promoting schemes in the UK market have gained their experience in other jurisdictions, including Germany and Italy. Schemes are often based on financial projections developed in those jurisdictions, and make a range of assumptions that sit uneasily in the context of property, property tax and planning law in England and Wales.
The schemes fall into two broad categories.
- The first type require a property owner to pay for equipment and its installation at the outset, recovering that investment over the term of the contract through the income stream produced by feed-in tariffs.
- The second type requires no initial capital investment, but requires the property owner to provide a secure right to occupy roofspace or land for the period required to ensure a sufficient return.
In each case, optimistic financial projections must be tested against legal issues that might detract from them.
Owning the Apparatus
In many ways, owning the generating equipment is the more straightforward approach. However, before committing to that structure, a property owner must consider the practicalities of installation, and possible impacts on their relationship with tenants.
For solar pv installations, projections tend to assume that the equipment will be in place and in use for 25 years to secure a return on investment of 5%–7%. Where equipment is to be installed on a rooftop, the probable need for repair or renewal during that period must be factored in. Those works may be planned or triggered by an emergency. There is to cater for emergency works. However, where there is a planned maintenance schedule it is worth checking whether its implementation would require temporary removal and decommissioning of the generating equipment. If so, the impact of any downtime on financial projections must be taken into account at the outset.
Given that many of the current schemes aim to encourage early adoption, they tend to assume that installations will be in place before "degression" takes effect. That in turn assumes that schemes will generally qualify, for planning purposes, as "permitted development". For both domestic and commercial installations there are doubts about the scope of permitted development rights, and anecdotal evidence suggests marked differences in practice between local planning authorities. If permitted development rights are not available then the need to obtain full planning consent might add a significant period to the project timeline – perhaps up to 18 months if the scheme attracts objections – so that installation occurs once "degression" has begun.
Early adopters also face a technology risk. Solar pv technology is in transition from crystalline silicon modules to newer "thin film" technology. Projected advances in technology suggest that solar pv cells may well be built into roof panels and cladding, potentially reducing visual impact and maintenance issues.
Tenants may also challenge the landlord's deal if it involves the landlord electing to receive income derived from feed-in tariffs in circumstances where the CRC Energy Efficiency Scheme (CRC) applies. CRC is a new "cap and trade" scheme for energy use that requires larger commercial and most public sector organisations to buy allowances for surrender against energy use. It aims to incentivise energy efficiency by allowing organisations whose energy use is within their allowance to sell surplus allowances on a secondary market to organisations that have exceeded their limits.
CRC also seeks to incentivise renewable energy generation and use by providing a "generating credit" which discounts energy produced through qualifying microgeneration. However, CRC and the feed-in tariffs regime are mutually exclusive, so that if a landlord elects to receive feed-in tariff payments the energy to which they relate cannot be discounted for CRC purposes. Allowances must be purchased and surrendered against that energy. Consequently, where the cost of CRC allowances is passed on to tenants there is a significant risk of challenge if the landlord receives and retains income derived from feed-in tariffs. In effect, the landlord's election to receive that income will have imposed at least a cashflow penalty on the tenant for the period between paying the cost of allowances and recovering that outlay through CRC "revenue recycling" payments. At worst, where energy use across the landlord's portfolio exceeds its allowances, CRC may become an irrecoverable cost to tenants.
Providing Space for Operators
Structures that do not require an upfront capital payment usually involve the operator retaining ownership of the equipment and receiving the benefit of feed-in tariffs. The income payable to the property owner is a rent derived from those payments.
For operators, feed-in tariff payments form only part of the financial model. The viability of schemes frequently depend on the availability of capital allowances which, in turn, means that deals are likely to be structured using familiar real estate documentation, including option agreements and leases of roofspace or open land. Licences to occupy are unlikely to be acceptable and, in any event, relocation of apparatus is unlikely to be practicable.
Potential pitfalls stemming from the use of "traditional" property documentation stem from the stamp duty land tax regime. They include administrative complexity and possible additional liability where part of the benefit to the landowner includes free or cheap electricity. The provision of electricity as part of the "consideration" for the right to install and retain apparatus on a rooftop would have to be taken into account for stamp duty land tax purposes. At the outset, a reasonable estimate would be required, followed by a further return once the full consideration for the first five years of the term is known.
Commercial landlords would also be likely to face challenge from tenants under the UK's service charge code of best practice unless the benefits of free or cheap electricity were passed on in full to the occupiers of a building served by a relevant project.
End of Life Issues
Whether apparatus is owned by the operator or the property owner, it is important to factor in the costs of disposal at the end of its useful life. Increasingly tight rules covering waste disposal mean that the cost of handling toxic or potentially hazardous waste and waste electrical equipment is set to rise. However attractive the headline financial projections might be, such end of life costs can radically affect the benefits of a scheme.
The legislation governing the feedin tariff regime was rushed through Parliament, and there is a pressing need for practical guidance from the government and from HM Revenue & Customs to ensure that projects receive the tax and tariff treatment expected.
Nonetheless, the potential for developing and funding renewable energy projects is receiving close attention in the real estate sector. Renewable energy projects could benefit both urban and rural estates, replacing diminishing sources of income such as telecommunications sites, now being decommissioned due to network consolidation. There are potentially complex property, planning and (ultimately) environmental issues to take into account. However, they are issues to be factored in to ensure that financial projections are realistic. They are not insurmountable, and should not be dealbreakers.
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