The Economics of On-Farm Renewable Energy

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1 The Economics of On-Farm Renewable Energy

2 2 The introduction of Feed-in Tariffs (FITs) for small scale electricity generation in April 2010 has contributed to an explosion of interest in the installation of renewable generation technologies. The returns available through FITs can be very attractive, and provide a real incentive for farmers and landowners to make the necessary investment.

3 3 Mark Neath, Associate Director Why renewable energy? Renewable energy is the catch-all term used to describe electricity generated from continuously replaceable resources, as opposed to generation from finite resources, typically fossil fuels or nuclear. Renewable energy includes both energy generated from movement of wind or water; and from processes involving organic materials. an incentive. Until recently, there needed to be some element of green motive to want to invest in renewable generation, but the introduction of Feed-in Tariffs ( FITs ) from April 2010 creates a real financial incentive to invest in renewable generation regardless of your attitude to greenness or climate change. What is more, energy is becoming increasingly expensive, and market prices unpredictable. Investing in your own generating capacity not only cushions you from the vagaries of the market but potentially gives you energy independence. The Government is committed to increasing the percentage of UK generation from renewable sources to 15% by 2020, in order to meet carbon-reduction targets in the EU Renewable Energy Directive. It is easy to see the attraction of renewable energy to government and to the green lobby, but why should it be of interest to farmers and land owners? Agriculture has always been about managing resources, providing the nation s needs and good husbandry. In recent years, new resources and needs have emerged which the farmer can manage, in the form of renewable energy. But having the resources is not enough, investment of both time and money is required, so there needs to be Along with the resources to generate power, you will also need sufficient grid capacity. This is frequently a problem for farms which are often at the end of the line on low-capacity connections. It may therefore be necessary to upgrade your grid connection, the cost of which may be significant and will be borne by you, as the developer. Permission from the District Network Operator ( DNO ), which in our part of the country is Western Power Distribution, is needed to connect any generating equipment. Applications for connection must be made to the DNO who will then issue a grid offer, together with costings of any necessary upgrades and a timetable. The DNO is not permitted to charge for a grid offer, but may make a charge for preparing a report assessing your existing connection.

4 4 Feed-in Tariffs The Government introduced a new system of feed-in tariffs ( FITs ) from 1 April 2010 to provide a financial incentive to invest in small-scale renewable energy generation capacity. The generation tariffs from 1 August 2011 to 31 March 2012 are as follows: p/kwh FITs are available to generators using: > Wind; > Solar PV (photovoltaic); > Hydro; > Anaerobic digestion; > Domestic scale micro-chp (Combined Heat and Power) <2kW. FITs are set for 20 years (25 years for solar photovoltaic) and will be index linked to RPI (Retail Prices Index) to account for inflation. The FIT consists of two components: a Generation Tariff and an Export Tariff, both of which are paid to the generator and paid for by licensed electricity suppliers. The Generation Tariff is paid for every unit (kwh) of electricity generated regardless of whether the electricity is used onsite or exported to the grid. The rate of payment depends upon the technology used and the scale of the installation. CAPACITY The broad spread reflects the relative cost of capacity of each technology. Tariff levels were set to enable a return of 5-8% per annum, or if you prefer to think in terms of years to pay-back: years. The Generation Tariff for new installations is set at a lower level each year after 31 March 2012, degression, in order to encourage early adoption and reflect likely reduction in costs over time. Once installed, the tariff is locked in at the level for the year of installation and will not degress further. The Export Tariff is a fixed sales price payable for electricity exported to the national grid. The purpose of the Export Tariff is to remove the uncertainty of fluctuating wholesale power prices. The Export Tariff is initially set at 3p/kWh, which is not generous relative to the prevailing market price. Generators may however, opt out of the Export Tariff and sell power on the open market.

5 5 Funding Feed-in Tariffs provide an additional income stream over the life of the generating equipment, but the majority of the cost of an installation is in the initial purchase of the capital equipment. The up-front costs can be funded by a combination of grant support or conventional commercial funding. Grant support may take the form of capital grants or favourable loans, such as those offered by the Carbon Trust, which are interest-free over three years with the level based on CO2 saved. Grants for renewable installation have historically been targeted at households and community groups but some limited support has been available for rural businesses. In the case of farms, the main support is through the Rural Development Programme for England ( RDPE ), although there is only limited time left to run on this programme. There are two routes to funding: a resource management grant of 10,000 ( 20,000 for dairy farmers) or a diversification or rural micro business capital grant, which may be up to 40-50% of capital costs for qualifying projects. The EU s State Aid rules cap the level of support at 200,000 over a threeyear period and therefore eligibility for FITs may be affected by the receipt of grants. Conventional funding is increasingly available for project development particularly where commercially proven equipment is being installed, as project loans or equipment leasing. Certain banks and leasing companies have chosen to specialise in renewable energy and are more keen to lend than others. They also have specialist managers with more knowledge of technology and the business issues. Asset finance is available, and many installers have links to finance companies that can provide lease finance over the equipment. Alternatively, leasing models have become common where developers rent land or roof-space from the owners of land or buildings and retaining the PV equipment and FIT entitlement, possibly supplying power to the owner as part of the deal.

6 6 Wind Wind turbines range in size and output from small domestic units to large-scale 200 metre tall turbines. Wind turbines capture the energy from the wind, which turns the turbine s blades, either in a horizontal or vertical axis. The UK, particularly the western side, is ideally placed to take advantage of wind energy, being the windiest country in Europe. Despite this, wind is controversial and deployment has been restricted by planning disputes and protest groups blocking many proposed developments. One of the principal drawbacks of wind power is that turbines only generate when the wind is blowing with sufficient force. An exposed, hilly site without trees or buildings is ideal, and an average wind-speed on the site of at least 4.5 metres per second is necessary for a viable installation. The online wind speed database ( do/uk_supply/energy_mix/renewable/explained/wi nd/windsp_databas/windsp_databas.aspx) can provide a guide for potential sites and installing an anemometer (wind gauge) for a period of months can help to confirm a site s suitability. Turbines are designed to have a life of years but they do require maintenance and moving parts, particularly the gearbox, may need replacing over their life. Wind Feed-in Tariff Size FIT p/kwh < 1.5 kw kw kw kw kw 1.5 mw mw 5 mw 4.5

7 7 Solar PV (Photovoltaic) Photovoltaic cells convert the sun s energy directly into electricity. PV panels can be integrated into buildings or mounted as free-standing arrays on farm land. It is a common misconception that solar PV requires direct sunshine to operate, but this is not the case and electricity is still generated on cloudy days. The key requirements are a south facing roof or site without shade. The location of the site also affects performance due to the level of solar radiation available, in general terms, the further south and west the site, the better the performance. A PV estimator tool, developed by the European Commission can provides an estimate of output for your location: Solar PV panels are virtually maintenance free, bar cleaning. Panels should have a life of 25 years (over which period FITs are available), although performance does degrade over the life of the panel, depending on the design, may be in the region of 1% per annum. Inverters, which turn DC power into AC, as used in the mains, have a shorter life, and are likely to need replacing half-way through the life of the panels. Planning is often straightforward, and in the case of roof mounted panels, may be permitted development. Over the first year of the Feed-in Tariff, the Department for Energy and Climate Change ( DECC ) became concerned that large-scale field-based solar PV projects were liable to take a disproportionately large amount of the available FITs and an immediate review of take-up and rates was ordered. A consultation document was published in March 2011, which proposes a reduction in the FIT for larger solar PV installations connected after 1 August The original Solar PV Feed-in Tariff, together with the proposed post-august rates are as follows: Size Original FIT p/kwh From 1 August 2011 < 4 kw new build < 4 kw retrofit kw kw kw kw kw kw 5 mw Stand-alone system

8 8 Hydro Any property with a river or stream flowing through it may have the potential to generate hydro power from the water flow. Hydro power is generated by moving water driving a turbine, Archimedes screw or water wheel, which converts the rotational movement into power. The power generated depends on the fall of the river over the land and the volume of water flowing through it. Hydro has the advantage of being a continuous source of power, with high predictability although seasonal rainfall patterns impact the flow rate and generation over the course of the year. In addition to obtaining planning consent, approval of the scheme by the Environment Agency is likely to be required, and an environmental impact assessment may be necessary. Size FIT p/kwh < 15 kw kw kw 2 mw mw 5 mw 4.5 Hydro has the advantage of being a continuous source of power, with high predictability although seasonal rainfall patterns impact the flow rate and generation over the course of the year.

9 9 Anaerobic Digestion Anaerobic Digestion ( AD ) is an organic process, similar to composting, but which takes place in an oxygen deprived environment, whereby microbes digest organic material, the by-product of which is methane, which can then be used as a fuel to generate power. AD plants may be large scale centralised operations, bringing in feedstock from external sources, or smaller, farm-scale units, using feedstock from the farm. A wide range of feedstocks can be used, depending upon the design of the system, which will have varying biogas yields. Research on the yield of different feedstocks is available at Whichever feedstock is chosen, it is important to have security of supply. One of the key advantages of AD is that using selfgenerated waste streams can benefit the developer through waste-disposal costs reduced or avoided, and in the case of farms, to help meet requirements for nitrate vulnerable zones. Planning permission will be required for most AD installations, although small-scale units using only on-farm waste may be permitted development. If waste is to be imported from third parties then full planning permission and waste management licensing will be required. AD plants require filling with the feedstock and need maintenance. There is also a risk of digestion failure should conditions within the digester not stay within the parameters within which the microbes are able to survive. At the same time as the review of solar PV FITs was undertaken, DECC was also concerned that take-up rates for AD were lower than had been anticipated. The consultation published in March 2011 proposes the introduction of an additional banding and higher rates from 1 August The original Anaerobic Digestion Feed-in Tariff, together with the proposed post-august rates are as follows: Size Original FIT p/kwh From 1 August 2011 <250 kw kw 500 kw kw 5 mw

10 10 Taxation of income from renewable energy installations is taxable Income is taxable In general terms, renewable energy installations are a trade and therefore taxed as any other business. This means income from electricity sales, Feed In Tariffs and the saving from power which you use yourself will all be taxable, either through personal income tax if you own the installation personally or in a partnership, or corporation tax, if it is owned and operated by a limited company. Domestic exemption There is however, an exemption for householders with a domestic installation. What precisely qualifies for this exemption is set out in section 782 of Income Tax (Taxation of Other Income) Act 2005: There is no liability to income tax arising to an individual if: a) micro-generation equipment is installed at, or near, domestic premises; and b) the power generated does not significantly exceed the amount of electricity consumed at those premises. The key points to note are that the equipment must be owned by an individual, not a business, be installed at a residential dwelling house, or in the immediate curtilage and its output must broadly match what is used in the house. Does not significantly exceed is not defined and is likely to be decided by future case law, but you should look for the household demand to represent the majority of the generation. Certainly, use of the word micro-generation puts an absolute cap at 50kW (Energy Act 2004), although few households would use anything like that much power (4kW 10kW is more normal). Leasing or rental arrangements If, instead of investing in an installation yourself you have decided to rent a roof or some land to a developer, then the rental income and any lease payments are taxable in the same way as any other rental arrangement. Capital expenditure If the installation is owned by a business, be that sole trade, partnership or limited company, then this business should be able to claim capital allowances for the cost of renewable energy generating equipment, just as for any other capital expenditure. For tax year 2011/12, the first 100,000 of expenditure is eligible for 100% write-down against profits of that year (Annual Investment Allowance). Any excess expenditure on qualifying assets will attract an annual write-down of 20%.

11 11 From April 2012 onwards however, the amount available for 100% Annual Investment Allowance is to be reduced to 25,000 and the annual write-down for other expenditure is to fall to 18%. Neither the Annual Investment Allowance nor Writing Down Allowance is available to individuals relying on the domestic exemption from income tax. VAT Sales of power by a business are subject to VAT at the standard rate. Feed In Tariff payments are outside of the scope of VAT. Power both generated and used by the business, rather than sold, is an internal supply and does not figure in the VAT calculations. The capital cost of buying the equipment will be standard rated but most businesses should be able to reclaim this VAT, as for other input VAT. whilst those used in farming will attract either BPR or agricultural property relief (APR). The effect of BPR or APR is to take 50%-100% (depending on ownership) of the value out of your estate for the calculation of inheritance tax. If you own and operate a renewable energy installation as a business, then this should qualify for BPR. A domestic installation is not a treated as a business, and therefore will not attract this relief. If an installation is made at a farm building or on farm land, this has the potential to move the building or land from the APR regime to the BPR category. This may not be an issue as BPR can be more valuable than APR. However, where you are not the owner of the installation and are instead renting a roof or land to a developer, then this would be a property investment activity, which does not qualify for either APR or BPR. Individuals are not able to reclaim VAT. There is therefore a reduced rate of VAT of 5% applicable to the supply and fit of energy materials and equipment to a domestic premises. Inheritance tax The ownership of the project may be significant for inheritance tax. Generally speaking, land or assets used in a business will attract business property relief (BPR), Many solar farm projects are set up to permit the land owner to continue grazing beneath the panels, which is helpful in managing the grass. It is also believed, although untested with HM Revenue and Customs, that grazing is sufficient for the land to be deemed still to be farmed, and therefore preserve APR on the property. It should be noted however, that this will only cover the agricultural value of the land as pasture, whilst the uplift in value from a lease, which may be substantial, will not be so protected. Choices The technology you choose, if any, should be one that closely matches your resources, your needs and those of the farm or business. Ask yourself: Do you want to be an energy self-sufficient farm or a power station operator? Is the project in keeping with the setting and landscape? Can the project be matched to the natural resources on-farm or will you become dependent on others for supply of feedstock? Do you have a suitable grid connection? If not, there is no point in producing far more power than you need unless you are willing to bear the cost of upgrading the connection. Could the project also help to manage your waste / NVZ problems? this is a particular benefit of AD over other technologies. Investing in renewables may require significant capital investment and exposure to a new set of risks. Are you willing to take this on and divert cash and time away from the core business? Old Mill are ideally placed to support you through the process. We can not only help you through feasibility, forecasting and funding or grant applications; we have worked with a number of renewable technology companies, on their business plans and funding applications, which gives us a detailed understanding of how the technology works.

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