Environmental Audit CommitteeWritten evidence submitted by Pure Leapfrog

Summary1

The term “community energy” refers to the ownership of renewable energy and energy efficiency assets by legal entities owned and operated for community benefit.

Frequently, community energy groups choose an Industrial & Provident Society (IPS) legal structure, incorporating as either a Community Benefit Society or a Co-operative. Other organisation structures, either for the entities that own the assets or that provide support to the sector, are charities or Community Interest Companies (CICs).

An IPS structure has become increasingly popular due to the increasing reliance on community share issues as the main source of funding. This particular legal form has the following benefits:

They can have charitable status, enabling community benefit to be built into their corporate structure.

They incur low regulatory costs when raising money from the public.

They offer social investment opportunities for private investors with sound returns (usually 5–7%, often supplemented by EIS tax relief).

There are approximately 400 community energy groups established with a focus on renewable energy, with around a half of have either completed projects or are in the feasibility and development stages.

There is currently 58.9MW of total operational community energy capacity in the UK, made up of 146 installations.30

Scaling up Community Energy in the UK

Since 2003, UK community energy capacity has undergone a fourteen fold increase from 4.1MW in 2003 to 58.9MW in 2013. This is over three times the growth rate of the UK’s total renewable energy capacity which has grown from 3.5GW to 17.6GW in the same period.2

This growth has occurred alongside the introduction of various renewable specific incentives. The Renewables Obligation (RO) in 2002, the Feed-in-Tariff (FiT) and Renewable Heat Premium Payment (RHPP) in 2010 and the non-domestic Renewable Heat Incentive (RHI) in 2011.

Community energy is still, however, just a tiny fraction of its potential size. According to latest figures from Ofgem, it accounts for a mere 1% of feed-in tariff generation capacity. By contrast, in Germany 50% of renewable energy is owned by citizens and communities—more than twice the UK’s total renewable energy capacity.3

We are committed to supporting a significant expansion of the field of community energy, with all of the social, financial and environmental benefits this will bring to communities across the UK.

Community Energy Group Formation and Eevolution

Community Energy groups tend to originate from the following sources: a Transition Town group, a local sustainability group, a local authority initiative or a response to a call for funding proposals.

The early groups working with renewables tended to arise in more wealthy areas of the UK and this is a trend that has continued. Having said this, the integration of climate change and fuel poverty incentives into policy along with the genuine desire of wealthy groups to help poorer neighbours is beginning to redress this balance. There is a growing trend for successful groups to look for new projects in the areas where they can make the biggest impact.

Barriers to Community Energy Projects

Below is a list of barriers faced by community energy groups.4 The list is not intended to be exhaustive, and inevitably each community group will encounter its own particular challenges:

Community Experience and Availability

Lack of widely available information and advice, and limited mechanisms for knowledge sharing between communities.

Limited awareness of the opportunities for or benefits of community energy.

Challenges in establishing appropriate community group structures, and navigating complex legal structures.

Regulatory Hurdles

Complex regulatory environment in the UK.

Management of tariff risks requires advanced sector knowledge.

Expense and management of the planning process.

Technical Complexities

Renewable energy projects are often technically complex and require expert knowledge.

Ability to negotiate with and manage appropriate counterparties.

Challenges of selling electricity generated.

Funding Issues

Funding for set up costs and working capital.

Managing costs on a one-off project basis.

Administering revenue streams.

Navigating complex and varied funding sources (debt/equity/grant funding).

Inherent difficulties of an immature banking market.

Please see Appendix A for a more detailed analysis of the specific challenges faced by community energy groups seeking finance. This highlights a number of issues which community groups must address to secure appropriate funding.

The Need for Aggregation

One of the primary barriers to the expansion of community energy to the levels achieved in Germany is the difficulty that these projects have in accessing conventional finance while retaining community ownership.

Most debt providers are unwilling to finance community energy projects, and even those who have a commitment to community energy are reluctant to provide funding for projects below the £2–5 million level.

This would leave private equity as the only other conventional financing route for smaller projects. This cuts out community ownership and means that financial benefits do not accrue for community benefit.

This explains why smaller-scale community energy projects to date have been funded exclusively through a combination of local equity and social finance, ie grants, debt or equity on preferential terms.

Pure Leapfrog aims to overcome this barrier by acting as an “aggregator” of smaller projects, bundling them up into portfolios of sufficient size and with the right risk/return profile for conventional finance.

Success in aggregation can unlock hundreds of millions of pounds of capital to fund community energy, transforming the demand for community-based renewables and making a major impact on the UK social investment market.

Components of a Successful Aggregation Strategy

In order to get to a situation where individual projects, with different owners, technologies and locations can be aggregated effectively for commercial investment, there are a number of hurdles to overcome:

1.Reduce origination and transaction costs

Origination and transaction costs for community energy projects are too high to make conventional debt provision viable because the projects are small and they often move at a slow and erratic pace.

2.Develop risk management techniques appropriate for community energy

Funders often do not know how to (cost effectively) evaluate the credit-worthiness of community based organisations, which may lack a balance sheet or trading history, but are underpinned by community support. Conventional techniques for reducing risk, eg expensive due diligence and insurance, are not appropriate for community-based projects.

3.Collaborating with, and providing support to, community energy groups

In order to accelerate the growth of community energy, time and expertise needs to be invested into community energy groups to build capacity of groups to engage their communities, manage project development and raise funding, both in the form of community shares and debt.

About Pure Leapfrog

Pure Leapfrog is the UK’s leading social investment provider in community energy. We are a business led charity (charity no. 1112249) which works in partnership with government, investors and communities. 

We bring together affordable finance and accessible expertise. Finance is secured through a credit facility from Big Society Capital. Expertise is provided by our professional partner network. We have funded close to 50 projects through loans or grants and our network of lawyers, accountants and professional service providers have advised 30 community energy projects on a pro bono or discounted basis.

Our mission is to ensure that community energy becomes a significant part of the sustainable energy mix in the UK. 

Pure Leapfrog has been at the forefront of the community energy movement as a founder member of the Community Energy Coalition which includes national organisations with a combined membership of 15 million such as The National Trust and The Church of England. It campaigns to enable communities to own, generate and save energy for the benefit of all.

Pure Leapfrog has built a loan portfolio of close to 20 community energy projects, primarily using solar PV, but also biomass boilers, LEDs and solar thermal.

Pure Leapfrog’s funding has genuine triple bottom line benefits, ie financial, environmental and social returns. The first £610,000 of loans that we have issued to 17 projects will have the following returns:

Financial: Average yield on the current portfolio is 4.22%, with a loan-to-value of 46%.

Environmental: Lifetime carbon emission reductions of 9,500 tonnes.

Social: Net financial benefit to communities, primarily in deprived communities, of over £3.4 million (over £5.50 for each £1 loaned out) composed of:

£3.1 million of financial surpluses for schools, charities and social enterprises.

£0.3 million of fuel poverty reductions

We are currently exploring with a range of social and conventional investors how we can scale up our financing facilities so that we can start to aggregate community energy at scale.

Appendix A: Analysis of funding challenges for community energy from a traditional senior debt funding perspective.

This analysis makes reference to the often used “CAMPARI” canons of lending, a traditional approach to senior debt funding. It exposes a number of issues which community groups must address to secure appropriate funding.5

Consideration	Issues	Potential mitigants
Character - Is the customer trustworthy? - What is their track record?	Community energy projects are often developed and delivered by newly established community enterprises. These community enterprises will likely have a limited track record, making it difficult for a funder to assess their credit quality. There is a perception amongst the funding community that community groups may not “tied” to projects, therefore presenting a risk that management walk away from a project. There is, however, mixed evidence as to whether this is the case. In some instances community individuals (who have invested their own money/have persuaded friends and family to invest) find it much more difficult to walk away from a non viable project than professional developers. Whilst in other cases individuals (for whom community energy is not their job) find it easier abandon difficult projects.	Risk mitigants may include the appointment of appropriate professionals to act on behalf of the community group. Professional services to consider in this regard would include technical advisers/owners’ engineers, financial modelling specialists and legal advisers. The additional costs incurred by the appointment of professional advisers often prove prohibitive to community groups seeking to establish a “one off” renewables project. Costs will need to be carefully considered and modelled.
Ability - What key skills/potential weaknesses do management display?	Newly formed community enterprises typically include individuals with varying degrees of relevant experience and expertise. Often less advantaged areas which would benefit significantly from community energy projects, have the lowest concentration of experience/”human capital”.	Subject to the skills already represented within the group, communities may again consider the appointment of third party professional advisers. As a minimum, a funder would likely expect that a suitably experienced legal adviser is engaged and that a high quality delivery partner is selected to develop, install, operate and maintain any project.
Margin - Does the funder’s remuneration match the perceived level of risk?	The interest margin demanded by any funder will be calculated on a risk/reward system. Community projects are typically considered higher risk than professional developer projects and therefore will demand higher margins. This requirement for higher margins is opposed to the community group’s ability to repay. Community groups (and particularly those seeking to establish a “one off” project) will have higher set up costs than professional developers, and the additional funding cost will often be prohibitive.	To mitigate this issue, community groups should consider reducing the perceived levels of risk by employing experienced advisers and selecting high quality, proven technologies. Aggregation of projects will also allow for lower margins on later projects (when community groups have demonstrated a track record of successful operation and repayment).
Purpose - Does the purpose match the funder’s policy? - Is the risk appropriate?	Fundamentally the funder will need to be convinced that funding will be used for the described purpose. This ties back to the trustworthiness of borrowers, and can be mitigated by the Bank’s due diligence process. In addition, the project as described will need to present an appropriate level of risk. For example, a pilot project showcasing new technologies will likely not attract senior debt lending, and may only be attractive to equity funders with a greater appetite for risk.	Mitigation of this issue will require a shift in funders’ mind-sets. Senior debt lenders in particular need to be: - convinced of the scale of the opportunity; - offered education and training in the sector; and - supported by government policy,
Amount - Is the amount appropriate? - What is the debt/equity mix?	The amount of funding requested can pose difficulties both where it is relatively small (and therefore does not generate a sufficiently attractive return) and where it is relatively large (and therefore presents a too great a risk). Community groups must demonstrate a clear understanding of project costs and an ability to cover unforeseen cost overruns.	Senior debt lenders will often require equity funding to underpin the project, taking a first loss position in an event of default. Aggregation of community energy projects may develop a more attractive funding requirement.
Repayment - How will the debt be repaid? - Are repayments manageable?	Any community energy project must demonstrate its financial viability, ie the project must generate sufficient revenues (for example through the FiT or RHI) or sufficient cash savings (paid for by the end user) that it can afford to service its debt repayments. The funder will require a level of headroom such that cash flows more than cover repayments.	A financial model will be required for any project, demonstrating the availability of cash to meet repayment requirements. This model will likely be subject to audit during the funder’s due diligence process.
Insurance - What security is available to the funder?	Any funder will be mindful of its security position in an event of default, ie how will the funder recover its debt or equity in the event that a project does not perform as expected and modelled. In standard property loans, for example, the funder would take security over the property in question.	It is not appropriate that individuals involved in any community project should offer personal security to project. Instead a funder may look to take an option to step into any project that is underperforming. Aggregation of projects and cross-collateralisation allows a funder to take a portfolio approach to risk. Eg in a portfolio of 10 projects, 2 may be able to fail without senior debt repayments being impacted. The funder will likely require a full suite of due diligence (technical, financial, legal, insurance) to confirm project viability. Ideally, a central body may step in to cover a first loss position and protect senior lenders.

25 November 2013