Don't you just love being in control?
Like the incumbents in any regulated sector, England & Wales' 10 Water and Sewerage Companies (WaSCs) have had their fair share of market change. For example, the Ofwat-instigated Office of Fair Trading market study into the market for treatment of organic waste, which in theory could pave the way for deregulation of certain aspects of the treatment of sewage sludge and break the WaSCs' traditional monopoly. Defra also has competition on its mind, and the industry awaits with bated breath both the post-Cave Report Water White Paper (due in late 2011) and the results of the ongoing consultation on proposed new regulations that would require certain water and sewerage infrastructure projects to be put out to competitive tender by WaSCs.
However, if there is one Government department still very much on the WaSCs' Christmas card list, it might just be the Department of Energy and Climate Change (DECC), whose Renewable Heat Incentive (RHI) scheme was announced on 10 March 2011. The RHI scheme is intended to stand alongside the Renewables Obligation Certificates and Feed in Tariffs schemes "to send a strong signal of support to the renewables sector". What will interest the WaSCs most, however, is how the focus of the RHI tariffs differs from that of ROCs and FITs.
Doing the right thing
The existing ROCs regime does not attach much premium to the use of anaerobic digestion (AD) in wastewater treatment to generate renewable energy - DECC's reasoning being that WaSCs have been using AD in wastewater stabilisation for over 100 years (that's even before the Coalition Government made AD topical). An estimated 66% of all the UK's sewage sludge is already processed in AD plants, and installing combined heat and power engines in existing plants to turn the resultant biogas into heat and energy does not involve extra capital expenditure at anything like the level of new-build food waste plants.
In this respect, RHI is a complete game-changer. From July 2011, Phase One of the RHI scheme will specifically target the industrial, commercial and public sectors. Crucially for the WaSCs, the definition of "biogas" in section 100(3) of the Energy Act 2008 is to be amended, so that the RHI scheme will support biogas produced by a range of technologies including not just waste AD, but also biogas from sewage gas.
England v Germany
Limited to generation of under 250kWth, the RHI scheme is unlikely to encourage further industrial-scale biogas combustion. (And, actually, it’s a bit stingy compared to FITs- could that be because central government, rather than licensed electricity suppliers, will be picking up the tab?). The real stimulus should be to biogas upgrading - "cleaning up" the biogas generated by AD of sewage sludge by the removal of carbon dioxide and excess oxygen, to produce biomethane that can be injected directly into the gas grid. But is this science fiction - fine in the lab, but unworkable in a full-scale wastewater treatment works?
Not in Germany - the German government's goals for injection of biomethane into the natural gas grid are 6% of 2007 German natural gas consumption by 2020, and 10% by 2030. And not in the UK, since Thames Water, British Gas and Scotia Gas Networks' high-profile biogas upgrading project at Didcot Sewage Treatment Works became the first UK facility to inject renewable gas into the grid in October 2010. Didcot might only supply a modest 200 homes, but with other biomethane projects hot on its heels (including United Utilities' and National Grid's grid injection facility at Manchester's Davyhulme Wastewater Treatment Works), there is every reason to buy into British Gas' vision of biomethane as a significant contributor to the UK's renewable heat targets.
According to National Grid's baseline scenario, biomethane could account for at least five per cent of the total UK gas market by 2020. This rises to 18% in the stretch scenario, but even the baseline scenario seems ambitious under current conditions, because it assumes a significant volume of renewable gas production from feedstocks such as manure and agricultural waste. By definition, grid injection will only be cost-effective for AD developers where there is readily-available gas grid connection, which may rule out many rural AD projects. The fact remains however that RHIs should help to divert precious biogas from combustion in CHP engines, at what National Grid estimate to be efficiency levels of around 30%. As Matt Eastland, Commercial Manager, Renewable Gas at British Gas Technology & Innovation explains, "Unless you can use all the heat on site, we believe that power generation from gas engines should be a secondary consideration. Biomethane to grid offers the most efficient way to convert biogas."
Financing the biogrid
It is hardly surprising that National Grid and British Gas are backing biogas upgrading - they respectively own and have to price in a costly infrastructure asset in the gas grid. The grid depends on sustainable volumes of natural gas to remain economical, and as North Sea gas reserves deplete, they'll need something else to put in it. Imported LNG is today's solution, but does not sit too well with an energy-secure UK for tomorrow. And as Defra has pointed out, "Currently, biomethane is the only way to decarbonise the gas grid". But does it make economic sense for everyone else?
Private equity remains to be convinced by RHI and its return-based philosophy. Lydia Whyatt of FourWinds Capital Management, an investment business active in the AD area, comments: “The Government needs to reconsider its renewable incentives. To meet the carbon emission targets it set for itself, it needs to maximise the quantity of renewable energy produced in MWh for each £1 of subsidy, and it is not doing that at the moment. It looks like the regulators are trying to second-guess what return investors would make in each renewable case, and are then trying to level the incentives so that that returns are roughly the same across all renewable energy sources. This does not make any economic sense, as the Spanish example demonstrated. They need to look at risk/return balance if they would like to attract private capital into the sector”.
But for WaSCs, who already have the balance sheet strength to build a biomethane capability into their AD infrastructure, the RHI scheme should provide a genuine incentive to wean them off their addiction to CHP engines.
Considering the outlook for the WaSCs' investment in biogas upgrading brings us right back to where we started in this article, and the regulatory outlook for the WaSCs and their balance sheets. If Government concludes that more competition is desirable in the sludge treatment market, and that (to quote London Economics' report for Ofwat) "Given its potential of greatly increased energy production from [sewage] sludge, co-digestion is an obvious point of entry for new competitors (which might include large companies engaged in municipal waste management which would be able to match [the WaSCs' sewage treatment works] on economies of scale)", then those balance sheets might eventually come to look a bit smaller- but there might also be other, integrated waste players with the resources to generate large-scale renewable gas.