Schools and hospitals are missing out on £890m of subsidies for producing heat through renewables. This is serious money but public bodies must move faster to take advantage
My wife Em and I like sausages but to a varying degree. She can only eat two to three at a time, whereas I can easily chomp down four. This invariably leaves us with single lonely sausage in the fridge, which always goes out of date and gets thrown away. As a result we buy more sausages than we need.
This suggests there is a gap in the market for the provision of sausages in smaller odd-numbered packs. However, I think that the reason Wall’s don’t do this is that, whilst there is a gap in the market, there is no money to be made as a result ie you cannot make as much money per sausage selling three as you can eight.
Our metaphor of capitalism to date has been a constantly evolving organism that spots gaps in the market and mutates into them like a virus. Nature abhors a vacuum and so it is presumed does capitalism. But I think it generally behaves more like a series of steps ie eight sausages, family pack and catering size, with no packs in between. There are gaps in all sorts of markets but that doesn’t automatically create lots of new markets in the gaps.
Where this is relevant to the public sector is, amongst other areas, the provision of renewable power. We have been over this ground before but to reiterate the UK has to generate 15% of its base load power from renewable sources by 2020. We are currently at about 7%, just a little bit better than Malta. This is a huge chasm to bridge in a relatively short period of time. A typical micro generation project takes at least two years from inception to completion, so this means we are going to have build lots of projects very quickly.
Where the public sector comes in is because of its huge collection of land and buildings and the fact that, as a collective entity, it is the single largest consumer of energy in the UK. However, because of the dispersed nature of the estate, the potential scale of individual projects is quite small at £250k – £500k at most. This is our metaphorical single sausage; too small to be of much interest to the funding markets who will spend as much time on this deal as they will on a £50m project but make much more in fees on the latter.
In the same vein, the local headmaster or hospital manager has got bigger things to worry about than micro generation of renewable power so our single project will not get built and we will remain at the back of the European class when it comes to being green.
In order to try and change this, the government has been throwing money at the problem and its latest wheeze is the Renewable Heat Incentive (RHI). Put simply, this is a subsidy for every unit of heat that is produced from renewable power. The current budget is £890m but less than £500,000 has been paid out so far. This leaves a lot of money on the table and for a draughty old Victorian school or hospital, this subsidy can lead to some spectacular savings on heating of up to 30% after paying for the capital.
This is serious stuff and not to be sniffed at in times of austerity, particularly when energy prices are going up faster than a Russian pole-vaulter on steroids.
So from the public sector’s point of view, we have a situation where the single project does not make sense but lots of little projects across a portfolio of buildings benefits everybody. I think the answer is for the forward thinking councils to create an entity above the level of the individual school or hospital called an Energy Supply Company or Esco.
This works in four stages as follows: The Esco contracts with a bio mass boiler company to install lots of little bio mass plants. It then contracts with a pellet supplier to feed them with wood. Next, it approaches the funding market to say ‘I have lots of potential little projects that sum to say £10m and generate a chunky return on the investment’. Finally, it contracts with the single sausage consumers ie the schools and hospitals to sell them heat at a discount to the fossil fuel price. Hopefully this is a no brainer to the end user so you get to install lots of projects and, most importantly, the Esco gets to claim lots of RHI subsidy.
Despite the obvious attractiveness of this structure, take up by the public sector has been frustratingly slow. The RHI is paid to anybody who qualifies and other fleeted footed entities have been predictably quicker to act. Farmers, for example, have been one of the first out of the traps and are now claiming RHI in order to heat big sheds with renewable power. The fact that a couple of hundred thousand scrawny chickens scratch around in those sheds is all well and good but no longer really the point – the real cash is to be made in heating them.
So how can you catch up with our tweed wearing, Range Rover driving, honest tillers of the soil? The key to making this work is to limit the time spent making decisions by making the process generic. Every single project must look like every other one so you are not paying expensive lawyers to draft agreements from scratch every time you want to do a £250k install.
In my experience, the public sector is very bad at making decisions because it tends to want to involve everybody in the process. In reality, the Esco only has to decide upon about three things ie which boiler, which pellets and which funder, so get these decisions out of the way before you approach the individual heat user.
So in conclusion the public sector has the opportunity to create the market in the gap for micro generation. It has lots of cold buildings that our good friends at the Department for Energy and Climate Change have allocated hundreds of millions of pounds to subsidise the heating of. However, Decc are also blind and indifferent to whom the RHI is paid to so you will need to move fast before it is all frittered away on saunas for baby chickens.
By creating an Esco, you can bypass the process of every man and his dog having a say in what you do. This will make the decision a lot easier for your average headmaster grappling with Ofsted, pushy middle-class parents and Jamie’s school dinners campaigns. Your role is to do all the hard work up front then simply present your heat users with a binary proposition: ‘Do you want to buy heat from our council-owned Esco at a discount to the fossil fuel price, yes or no?’
Michael Ware is corporate finance partner at BDO