Memorandum submitted by the Combined Heat
and Power Association
OVERVIEW OF
THE COMBINED
HEAT AND
POWER ASSOCIATION
1. The CHPA is a long-established not-for-profit
trade association that acts as a focus for the combined heat and
power (CHP) and community heating industry in the UK, providing
support across our membership and working to establish and maintain
the strong and stable market conditions necessary to grow the
application of these technologies. The CHPA has over 90 members
and represents a significant proportion of the total CHP capacity
within the UK. Our membership comprises of CHP developers (small
and community scale, large scale industrial and utility companies),
end users, suppliers, public sector bodies and professional services
providers.
WHAT IS
CHP?
2. Combined Heat and Power (CHP) is a highly
efficient process of energy conversion, which maximises the value
of the energy that can be provided from a given quantity of fuel.
The efficiency of the CHP or "cogeneration" process
means that the technology has the potential to deliver major benefits
through savings in fuel consumption and reduction in carbon emissions.
BACKGROUND TO
THIS RESPONSE
3. The CHPA welcomes the Environmental Audit
Committee's (EAC) inquiry. As the Committee has rightly noted,
the Chancellor's 2008 Pre-Budget Report was set against a backdrop
of a crowded policy agenda, a worsening fiscal outlook and competing
calls from both the private and public sectors for assistance
in addressing the consequences of the economic downturn. Within
this context it is critical that the Government maintains and
strengthens its commitment to improving the competitiveness in
UK manufacturing, whilst mitigating climate change. HMG and in
particular, HM Treasury, should demonstrate this by prioritising
measures that are aimed at stimulating economic recovery but simultaneously
provide the confidence for the private sector to invest in sustainable
energy infrastructure which in turn facilitates "green collar
jobs".
4. The Government has a target to achieve
an installed capacity of 10 GWe of CHP capacity by 2010. Current
installed capacity is 5.47 GWe and there is now no prospect of
securing this capacity target in the proposed timeframe. However,
the Government's own analysis[36]
indicates that there is significant potential for further investment
in new CHP capacity over the period top 2015, over which timeframe
there is urgent need for investment in new UK power generating
capacity.
5. The Government has previously established
a package of measures that historically has provided a stimulus
to CHP investment, under sympathetic market conditions. As the
CHPA has previously highlighted to the Committee,[37]
a major proportion of the value of this package accrues from an
exemption from the Climate Change Levy for power exported from
a qualifying CHP plant, a benefit which is subject to a European
Commission State Aid approval which expires in March 2013. The
value of this incentive as a stimulus to investment requires a
clear an unequivocal commitment from the Government that it intends
to retain this benefit in the period post-2013. Similarly, the
benefit of Enhanced Capital Allowances is not currently available
to Utilities, owing to State Aid constraints. This discriminatory
arrangement undermines prospects for investment in CHP by preventing
a major class of investor from accessing the benefit.
6. Since both incentives described are subject
to the Finance Act, the Budget and Pre-Budget Reports provide
an appropriate opportunity for the Chancellor to signal a commitment
to address the uncertainty that is presently blighting investment
prospects for large and industrial CHP. While this uncertainty
persists, the prospects for growth in the CHP supply chain are
likely to remain compromised. The UK retains significant capacity
in the design and manufacture of industrial gas turbines, a major
component of larger CHP plants, in both Lincoln and Newton Abbott.
The uncertainty will also undermine the commercial opportunity
to exploit CHP as a means of managing ongoing energy costs in
the UK manufacturing sector. CHP is an important means of delivering
energy savings in industries such as papermaking, refining and
petrochemicals and food and drink.
7. In his Pre-Budget Report, the Chancellor
delayed a decision on fiscal incentives until the forthcoming
heat and energy saving consultation.[38]
The CHPA considers that this move presents further delay in an
aspect of energy, climate and economic policy that demands prompt
resolution.
8. This submission sets out the rationale
presented to the Government for a further extension, in terms
of time and scope, of existing fiscal incentives for CHP.
CONTRIBUTION OF
CHP TO THE
UNITED KINGDOM'S
ENERGY POLICY
PRIORITIE
9. CHP can achieve an overall efficiency
of 80% or higher compared to a centralised power station efficiency
of between 30-50%. In addition, CHP is located close to sites
of heat loads and demand for electricity, and therefore avoids
the bulk of the losses normally associated with the transmission
and distribution of electricity. CHP delivers a range of economic,
environmental and other benefits—some accruing to its users,
some to operators of the electricity grid and yet others to the
wider community:
(a) Reduced carbon emissions
CHP reduces carbon emissions, typically by up
to 20%. The Government's latest statistics show that every 1 MW
of CHP operating in the UK reduces carbon emissions by between
510 and 760 tonnes every year. Across the UK economy, Government
estimates indicate that CHP saved between 10.6 and 15.4 million
tonnes of CO2 in 2006. CHP thus represents one of the largest
single carbon reduction measures in the Government's Climate Change
Programme.
(b) Enhanced energy security
CHP reduces primary energy consumption, typically
by more than 10%. Conventional gas-fired power generation is set
to expand, with an estimated 15 GWe of new capacity to come on
line in the period to 2020. If this new capacity was developed
as CHP plants, heat supplies from conventional boiler plant could
be displaced thus reducing national fuel demand and improving
the security of natural gas supplies. Similarly, ambitious renewable
energy targets will place enormous stresses on scarce resources
of biomass, recovered fuels, and wastes. Under these conditions,
CHP has the potential to deliver more useful energy for the restricted
quantities of fuel inputs, increasing the likelihood of securing
renewable generation targets, reducing import dependency and mitigating
the impacts of exposure to global energy markets.
Making more efficient use of fuel reduces overall
energy consumption and with it the costs of energy. CHP plants
that are "Good Quality" under the government's CHPA
Quality Assurance programme save a minimum of 10% of the primary
fuel that would be required to provide energy under the alternative
boiler and grid electricity scenario. Economic analysis undertaken
by the Government in its Heat: Call for Evidence indicates
that the majority of CHP investments can be considered as a `no
regrets' measure for policy makers, since they present negative
costs.[39]
These cost benefits are manifested as carbon savings, enhanced
security of supply and reduced energy costs over the 20 year life
of the project.
The CHP industry is an established element of
the green economy. From Local Authority members involved in strategic
planning, energy and planning consultants, energy service companies,
legal and financial services and CHP manufactures and the majority
of the major energy utilities, the CHPA represent a substantial
part of the supply chain of low carbon development. CHP applications
at different scales require varied skill sets and abilities from
highly skilled engineering contractors to apprentices that help
install heat networks.
CURRENT STATUS
AND FUTURE
POTENTIAL OF
CHP IN THE
UK
10) The Government's analysis, presented in
DUKES 2008,[40]
indicates that:
(a) Installed CHP capacity at the end of 2007
stood at 5,474 MWe. This represents a net increase of 50 schemes
between 2006 and 2007, but a net decrease of 10 MWe in installed
capacity.
(b) The electricity generated by CHP schemes
in 2007 was 28,677 GWh. This represents a little over 7 per cent
of the total electricity generated in the UK.
(c) Across the commercial and industrial sectors
(including the fuel industries other than electricity generation)
electrical output from CHP accounted for around 12 per cent of
electricity consumption.
(d) CHP schemes in total supplied 53,050 GWh
of heat in 2007.
(e) In 2007, DEFRA produced a report setting
out the economic potential for developing CHP in the UK and the
benefits this could deliver. The results can be seen in Table
1 below.
OBSTACLES TO
EXPANSION OF
CHP
11. In spite of this considerable potential
for expansion of CHP within the UK, we have not seen the increase
in capacity of CHP necessary to realise the benefits described
above, and the evidence from the marketplace is that we are not
on track to meet the Government's target of 10GWe by 2010.
12. The principal constraints are market-related.
From a commercial perspective, CHP presents a relatively complex
and risky investment prospect, as plant owners must negotiate
contracts for fuel supply, power and heat sales. Interacting with
an electricity market designed to accommodate major, integrated
energy companies also brings additional cost and risk. Investors
demand additional returns to reflect these conditions and certainly
higher returns than a more straightforward investment,in a conventional
combined cycle gas turbine, which is the "default" investment
in today's electricity market. While current sparks spreads suggest
strong returns for CHP plant, future spark spreads are less attractive,
and investments are made on the basis of this view of the future
and not current prices. Therefore, establishing a policy framework
to deliver adequate returns and manage these risks is a necessary
step towards securing these important benefits of carbon savings.
13. The result is that while there is considerable
interest in acquiring existing CHP assets, current investment
in large scale CHP has stalled. The CHPA is aware of a number
of major projects which are at an early stage of development but
without greater certainty of adequate returns these are considered
unlikely to proceed, further compromising efforts to maintain
security of electricity supplies.
HISTORIC INCENTIVISATION
OF CHP
14. The Government has already seen fit
to incentivise CHP, and between 2000 and 2003 introduced a package
of measures designed to support the expansion of CHP capacity.
Plant commissioned under this regime included the 730MWe CHP plant
at Immingham, Europe's largest industrial CHP plant. These incentives
included:
(a) Climate Change Levy exemption on CCL for
fuel input and electricity output.
(b) Enhanced Capital Allowances (restricted to
non-Utility companies).
(c) Business rate relief.
IMPROVING THE
PROSPECTS FOR
CHP INVESTMENT
15. There are a number of actions that must
be taken to address the situation and improve prospects for the
deployment and operation of CHP:
(a) Extend the Climate Change Levy exemption
on all supplies of electricity from Good Quality CHP, including
power exported from a site. This important benefit is only available
until 2012; thereafter the Treasury has provided no guarantees
that the incentive will be retained. Investors cannot, therefore,
value the incentive when making new investment decisions. Providing
an unequivocal statement of the Government's commitment to retain
this CCL exemption for CHP until at least 2027 would thus provide
greater investment confidence.
(b) Make Enhanced Capital Allowances universally
availability to both Utility and non- Utility companies.
(c) Continue to provide Business Rate relief
on CHP plant.
16. Concern over the adequacy of investment
support measures have been reflected by major industrial CHP operators.
At the CHPA's Annual Conference in November 2008, Andy Duff, CEO
of RWE npower stated that his company was capable of making major
steps forward in CHP investment. He presented the case for a simple
and transparent investment framework to be put in place by the
Government:
"We need clear and unequivocal signals which
would include the extension of the exemptions from CCL until 2027,
universal availability of Enhanced Capital Allowances, exemption
from the new heat levy for Good Quality CHP and finally a genuinely
level playing field under the EU ETS, which would guarantee that
CHP will not be disadvantaged by the allocations regime".
17. The International Energy Agency (IEA)
is presently undertaking a major review of CHP and District Heating
and Cooling, which includes comparative analysis of the incentive
and policy framework for CHP in OECD member countries, using a
scorecard approach.[41]
Each scorecard provides a rating and issues recommendations to
that country. The IEA have scored the UK at 2.5 out of a possible
maximum of 5, and have made several notable recommendations. Amongst
these are the establishment of locational signal for CHP investment,
continued emphasis on the potential for efficient CHP for large
power station developments, and creation of a national CHP target
and strategy beyond 2010. Most notably, it calls for "further
investor confidence in support mechanism longevity and accessibility",
in reference to Climate Change Levy exemption for Good Quality
CHP.
18. Publication of the scorecard also provided
the opportunity to benchmark the UK's record on CHP against that
of other industrialised nations. It is notable that the UK lags
behind many competing economies in its adoption of CHP, see below.
IMPACT OF
EXTENDING CHP BENEFITS
19. Impact on Investment and Operation of
CHP:
(a) Recognising the wider factors affecting today's
economy, it would be misleading to suggest that extending the
existing CHP benefits would have an immediate impact in delivering
an expansion in CHP capacity and outputs. However, it is possible
to demonstrate how the measures would affect the investment outlook
for a typical CHP projects. This will affect investment sentiment
and in turn the probability that new plant will be developed.
(b) The CHPA has undertaken analysis, in collaboration
with our members, to determine the returns made when investing
in CHP as an alternative to a conventional boiler and power purchase
arrangement that is typical in most industrial, commercial and
domestic applications. We estimate that if the existing package
of CCL exemptions is extended to 2027, then the Internal Rate
of Return (IRR) for the CHP project is extended by about 3-5%.
For an industrial site investing in its own CHP plant, this would
see the IRR increase to a point where it is likely to warrant
serious consideration. What constitutes an acceptable return will
vary between parties, however it is considered that the 5% increase
that can be demonstrated from this measure is material and is
likely to present a significant change in investor sentiment towards
CHP.
20. Impact on the Exchequer:
(c) The CCL exemption is, in effect, a tax credit
on the production of low-carbon energy. In stark contrast to measures
such as the Renewables Obligation, the CCL exemption programme
only presents a cost when the low-carbon energy is produced (the
RO imposes a cost on customers irrespective of whether any renewable
electricity plant is constructed or operated).
(d) It is therefore possible to determine a direct
relationship between the carbon saved and any tax revenue foregone.
The principal variable is the carbon content of the electricity
and heat that is displaced when a CHP plant is in operation. If
it is assumed that a CHP plant displaces natural gas in a conventional
boiler, and a "grid average" electricity supply, then
the cost of the carbon saved, in terms of lost revenue from CCL
exemption is equivalent to between £31 to £54 per tonne
of CO2 saved.
CONCLUSIONS
21. Under current market conditions, which
present a high degree of risk and uncertainty, it is unlikely
that new large-scale CHP investment will be forthcoming. This
is a direct consequence of commercial conditions, where the anticipated
returns that accrue to a CHP investment—based on the best
knowledge of future energy prices—are insufficient to support
this class of investment. The Government has previously established
a comprehensive package of measures that historically provide
a stimulus to CHP investment under appropriate prevailing market
conditions. Extension of these benefits, with extension of the
CCL exemptions to 2027 and universal availability of ECAs, presents
a "no-regrets" approach to incentivising new CHP investment.
ANSWERS TO
QUESTIONS:
The risks and opportunities of an economic downturn—and
of the policy response to it—for environmental taxation
and investment policy;
The current economic downturn coincides with
a period of necessary investment in energy infrastructure. There
is an opportunity to ensure that this investment meets both competitiveness
and environmental objectives. However, as is noted throughout
this response, this will not occur without the correct incentives.
The announcement of a forum on skills for a low
carbon economy
The CHPA welcome the announcement of a forum
on skills. The CHPA believe that without the appropriate skills
capacity, the politically attractive concept of green collar jobs
will never be fully realised.
January 2009
36 DEFRA: Analysis of the UK potential for Combined
Heat and Power, October 2007. Back
37
EAC: Reducing emissions from UK Businesses: The role of the Climate
Change Levy and Agreements, p 38, March 2008. Back
38
HM Treasury : Pre-Budget Report 2008, Facing global challenges:
supporting people through difficult times, November 2008. Back
39
BERR, 2008: Heat Call for Evidence. Back
40
BERR, 2008: Digest of UK Energy Statistics 2008. Back
41
International Energy Agency (IEA), Event Notice, International
Energy Agency Announces Release of UK CHP/DHC Scorecard, 19 November
2008. Back
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