Energy is often headline news with a such attention grabbing lines as the Total announcement that there is insufficient oil exploration meaning giving future shortages through to the Economist magazine headlines (Aug 8^th -14^th 2009) “How long till the lights go out?”. Its leading article talked about the potential for rolling blackouts in the UK as a result of a possible generation gap of 20GW (compared to a peak system demand of 59GW) by 2015. Whilst earlier in the August, Pöyry, a leading energy consultancy, published its long awaited Intermittency study looking at the impact of the forecast quantities of wind on the UK electricity market. That study showed a trend in increasingly volatile electricity prices.

We believe this should matter to any company developing low carbon buildings, and we explain why.

With tightening carbon targets for new houses, housing developers, social housing providers and councils are all focusing on installing low carbon energy for new buildings. Many of these schemes involve district heating networks, combined heat and power (CHP) plants as well as a mixture of renewables. Rather than a world where the developer installs individual gas boilers and then has no ongoing energy involvement once the development is completed, housing developers are forced to provide energy services on an ongoing basis, either by themselves or through the procurement of an energy services company (ESCO). Part of the process of procuring an ESCO is to understand the commercial viability of the energy sales and forecasting future electricity prices. This includes understanding the sites’ generation costs, likely customer tariffs, distribution costs, cost of additional electricity purchases and supply costs (e.g. cost of billing, meter reading etc). In this context, the cost of electricity in the wider market has a profound impact – not just in the feed through into competitor’s customer tariffs, but also into the cost of procuring additional energy on site. Poor understanding of electricity pricing can have a profound future impact on the viability of the energy side of a development. There are four key things you should know:

1. The difference between retail prices and profit

One common misconception we see in business plans for new developments, is that the retail price of electricity less the cost of generation equals profit. This is not true – supply margins are very small and generally the difference between the wholesale cost of electricity (the time average cost of generation on the system) and the retail tariff is the various costs of supplying electricity such as the fees for using the distribution network. Profit lines in business plans should be based on wholesale electricity prices not retail prices – wholesale prices may be (say) 4p/kWh versus 10p/kWh of retail price to the consumer. In this example, overall profit is more like 1.5p/kWh not 6.5p/kWh.

1. Not all electricity has the same value

Electricity value varies widely between day and night as well as between summer and winter. In winter, overnight electricity can be worth one third of electricity at the peak half hour. In fact, the Pöyry intermittency study suggests that the difference between night time electricity prices and day time prices could widen significantly with excess wind generation causing negative prices over night (i.e. generators will not get paid for their spill generation but will have to pay to generate overnight).

This matters for new housing developments because the general profile of these developments is a combination of continuous electricity output from a CHP and some intermittent output from renewables. The profile of the users on the site will follow the general consumption patterns for the electricity grid as a whole, with significant variations in demand over the day and during the year. To meet the carbon targets, on site energy assets do not have to match electricity demand on an instantaneous basis – but the electricity market matches on a half-hour settlement system. As a result, most developments will have excess generation at night and insufficient generation during the day time leaving them vulnerable to poor value from overnight electricity sales and exposure to high day time prices.

1. Getting the renewable energy value right

Renewable energy has value through the issuance of renewable obligation certificates (ROCs). These certificates are sold in the open market and potentially give significant additional value over and above the value of the energy generated. In addition, government is introducing a fixed payment called a feed-in tariff for small generation, which will be instead of the ROCs, and a renewable heat incentive for heat generated from renewable sources such as biomass. There is potentially a lot of additional value here for renewable assets installed in housing developments, but it should not be overvalued. For example, ROCs are likely to be limited to 20 years for any generation asset, so don’t extend the ROC payments to match the life of the asset. Some technologies like solar photovoltaics (PV) generate 2 ROCs per MWh of generation (instead of the standard 1 ROC per MWh), but government is likely to down grade the ROC allocation as PV generation becomes more prevalent – although government has traditionally allowed existing assets to continue to receive the higher ROC allocation when it has downgraded the ratings, there is no guarantee that they will do that in the future. Finally, feed in tariffs and renewable heat incentives also face similar regulatory risk and revenues should be forecast carefully.

1. How to supply customers on licensed distribution networks

One final issue to bear in mind is projects that plan to use an unlicensed electricity supplier over a licensed distribution network. Typically we see those for projects where there are more than 1,000 homes but less than 2,500 homes (where you can make use of the 2.5MW exemption for supply on licensed distribution networks) or for retrofit schemes where houses are already supplied on a licensed distribution network.

For retrofit schemes, you cannot force a customer to be supplied by the onsite energy (unlicensed) supplier – you will have to market to them and encourage them to switch over. Assuming 100% transfer over of properties within the scheme area is extremely unlikely, even if prices are heavily discounted. Around 40% of electricity customers switch supplier each year – so a 100% switch rate would be extraordinary – and retaining 100% of the customers to switch to you would also be unexpected.

Supplying customers over a licensed distribution network means that you will pay the full distribution charges to use the network including generation connection and use of system charges and full distribution customer charges. These costs must be explicitly included for business forecasting.

More than that, we are not aware of a single project that makes use of the right to be an unlicensed supplier on a licensed network. In fact, after speaking at length with Elexon, who operates the market rules, we have not yet found a way to comply with market rules and be unlicensed within the licensed network. Bear this in mind when reading rosy projections of revenue streams for projects.