OUTER HEBRIDES ENERGY SUPPLY COMPANY

SCOPING STUDY CARRIED OUT FOR COMHAIRLE NAN EILEAN SIAR

A substantial new company from the Outer Hebrides could enter the UK electricity market in 2017-2018 retailing clean, green Hebridean electricity to local and export markets. Substantial numbers of skilled staff could be employed in the Hebrides focused on renewable electricity generation, retailing and marketing, customer support, billing, market trading and engineering.

This study indicates that the Outer Hebrides Energy Supply Company appears to be a viable proposition and presents a route map to enable the company to be formed.

NEIL FINLAYSON

DONALD MACRITCHIE GREENSPACELIVE LTD

NIGEL WALKER WILLIAM ALLAN SWEETT (UK) LTD

MAY 2013

AUTHORS & REVIEWERS

This report has been produced by GreenspaceLive Ltd. in association with Sweett (UK) Ltd. and Comhairle nan Eilean Siar.

GreenspaceLive Ltd

Neil Finlayson, Donald Macritchie. Intern support: Seumas Finlayson

Sweett Group

Nigel Walker, William Allan

Comhairle nan Eilean Siar

Anne Murray, John Cunningham, Calum Iain Maciver

A full list of consultation respondents has been included in Appendix A and GreenspaceLive Ltd is grateful for the level of support and expertise that has been afforded during the course of the study.

SUMMARY

1. This report describes the findings of a Scoping Study carried out to examine the viability of an Outer Hebrides Energy Supply Company (‘the ESCO’) and presents a route map to achieve this.

2. Retail of electricity by Local Authorities became possible in 2011 when the regulations associated with the Energy Act were relaxed, and there is now scope for Local Authorities to generate and retail electricity to their local market.

3. There is potential for the Outer Hebrides community to purchase a proportion of generation from one of the recently consented Wind Farms and the recently concluded ISLEPACT project identified this as the leading ‘Bankable Project’ for the Outer Hebrides. The ultimate objective would be to create a community owned Energy Supply Company (ESCO) which can retail the electricity generated from this share.

4. The ESCO’s primary activities are likely to be:

• sourcing of wholesale electricity from Hebridean wind farms and other renewable generators;

• retail of electricity supply to island and UK mainland customers;

• other energy services offered by the ESCO may address renewable heat, energy efficiency and low carbon transport.

5. The study identifies the relative flexibility of the ESCO model and three case studies in particular are presented, all of which offer varying good practice examples for the Outer Hebrides context:

o Gotland, a Baltic Sea island which is seen as offering a model for Hebridean energy developments including local government involvement in electricity supply and innovative approaches to handling island renewable energy network problems;

o UK public-sector energy services companies such as Woking and Aberdeen Combined Heat & Power;

o A mid-sized electricity independent, Good Energy, one of the new renewable energy suppliers in the UK market.

6. The report concludes that an Outer Hebrides ESCO is a viable concept which could have significant economic development and environmental benefits for the Outer Hebrides.

7. It recommends that a Joint Venture with an existing electricity supply company be explored in the first instance, with scope for an independent local energy retailer to emerge out of this partnership in the medium to long term.

8. Our main conclusion is that a substantial new company from the Outer Hebrides could enter the UK electricity/energy services market in 2017-2018 retailing clean, green Hebridean electricity to local and export markets. Substantial numbers of skilled staff could be employed in the Hebrides focused on renewable electricity generation, retailing and marketing, customer support, billing, market trading and engineering. As the company matures, a wider range of services including renewable heating and energy efficiency services could be offered.

9. Finally, the study presents a route map to enable the company to be formed.

1 INTRODUCTION

AIMS AND OBJECTIVES 1.1 The key aim of this study is to provide a comprehensive overview of the viability or otherwise of establishing an Outer Hebrides Energy Supply Company and to provide best practice recommendations in terms of establishing and operating the company.

1.2 The objectives of the study are to:

• examine in detail the potential viability of establishing an Energy Supply Company for the Outer Hebrides; • fully explore the business case for an Outer Hebrides Energy Supply Company; including the optimal trading arrangements for the successful operation of the venture; • recommend in detail the optimum governance, legal, ownership and operational structure of an Outer Hebrides Energy Supply Company; • identify the opportunities and challenges facing the operation of an Energy Supply Company in the unique context of the Outer Hebrides; • explore methodologies for delivering generated electricity to the local community, including a Cost Benefit Analysis of the use of existing Grid infrastructure; • develop a detailed Risk Assessment, with mitigation measures, for an Outer Hebrides Energy Supply Company; and, • assuming an Outer Hebrides Energy Supply Company is a viable proposition, develop a detailed Route Map for its establishment.

METHODOLOGY 1.3 A Project Group involving representatives from GreenspaceLive Ltd, Sweett Group plc and Comhairle nan Eilean Siar was established to undertake the Scoping Study and develop the Outer Hebrides Energy Supply Company Proposal.

1.4 The methodology undertaken to perform the Scoping Study incorporated the following key elements:

• Identification of stakeholders • Stakeholder surveys and meetings • Identification of relevant energy supply and service models as case study examples. • A workshop with stakeholders • Desk-based research identifying issues in relation to potential financial and organisational models, impact of grid constraints and transmission charges.

2 BACKGROUND AND CONTEXT

OUTER HEBRIDES ENERGY SUPPLY COMPANY 2.1 When the UK electricity industry was privatised in the 1980’s, Local Authorities were prohibited from selling electricity to ensure that the entire industry went into private ownership. In 2010, the UK Government relaxed this restriction and Local Authorities are now free to generate and retail electricity, and to invest in such schemes (DECC, 2010).

2.2 Demand for renewable energy is growing rapidly and will continue to do so over the next decade. The Scottish Government is committed that 100% of electricity will be generated from renewable sources by 2020.

2.3 There is a substantial opportunity therefore for Comhairle nan Eilean Siar to invest in one or more local community generation schemes in order to retail a proportionate share of the generated electricity. Comhairle nan Eilean Siar is actively exploring the viability of investment in community or commercial onshore wind projects in order to secure a return for the community.

2.4 In pursuit of this objective, Comhairle nan Eilean Siar developed a Sustainable Energy Action Plan (Comhairle nan Eilean Siar, 2011) in the context of the EU ISLE-PACT project. ISLE-PACT seeks to reduce carbon emissions by at least 20% by 2020 in 11 participating island groups. Comhairle nan Eilean Siar was coordinating Authority for the project.

2.5 The ISLE-PACT process required partners to identify and develop Bankable Projects to be rolled out over the period 2013 to 2020 in order to meet the 20% by 2020 objective. A proposal to establish an Outer Hebrides Energy Supply Company emerged as the key ‘bankable’ project arising from Comhairle nan Eilean Siar’s participation (IslePact, 2011).

2.6 The core product to be offered by the ESCO is seen as clean, green electricity sourced from Hebridean wind-farms and other renewable energy projects to be retailed to island consumers and to the wider UK market. The underlying motivation for examining an ESCO of this nature is to address the high levels of fuel poverty in the Outer Hebrides.

2.7 The 2011 White Paper ‘Planning our electric future: a White Paper for secure, affordable and low carbon electricity’ (DECC, 2011) provides important guidance on reform of the UK electricity market, with potentially significant impacts on the viability and long-term prospects of an Outer Hebrides Energy Supply Company.

2.8 High barriers exist to market entry, construction costs for new facilities and networks are high and there is considerable market illiquidity. Small independent players risk not being able to find long-term buyers for their electricity. The carbon price is volatile and hard to predict, there is an uncertain appetite for investment and there are insufficiently strong signals to invest. Most of these problems represent significant obstacles to energy investment in the Outer Hebrides.

2.9 The UK Government’s strategy is to foster reliable contracts, including long-term contracts for both low-carbon energy and capacity, institutional arrangements to support this contracting approach, delivery arrangements trusted by investors, grandfathering so that there will be no

retrospective change to low-carbon policy incentives and a liquid market that allows new entrants to compete.

2.10 Solutions include a huge investment in renewables and the UK transmission network. The White Paper focuses on creating the right conditions for investment through a reduction of risks and provision of a clear and stable framework.

2.11 In summary, the White Paper identifies that in order to meet demand for electricity, there is a need to invest in renewables and also support new entrants to an electricity market currently dominated by six big firms.

HEBRIDEAN CONTEXT 2.12 The Outer Hebrides is a chain of islands off the west coast of Scotland, stretching from Lewis in the North, through Harris, North Uist, Benbecula and South Uist, to Barra in the South. The population of the Outer Hebrides is just over 26,000, with a large proportion of that population centred round the main town of Stornoway in Lewis.

2.13 The Outer Hebrides economy in general has a number of weaknesses including lower than average earnings, high % of employment within the public sector, lack of employment opportunities and higher costs (particularly associated with energy and transport). However, growth is evident in a number of key sectors, with textiles, aquaculture and tourism remaining significant employers. It is believed that renewable energy will be a leading driver for the local economy in coming years.

2.14 The Outer Hebrides are home to the strongest and most consistent wind and wave regimes in Europe making the area ideal for the generation of electricity from renewable energy, for local use and for export.

2.15 The second National Planning Framework for Scotland (NPF2) identifies new sub-sea cable links for the Outer Hebrides as a strategic grid reinforcement priority (Scottish Government, 2009):

“These strategic grid reinforcements are essential to provide the transmission capacity necessary to realise the potential of Scotland’s renewable energy resources, maintain long-term security of electricity supply and support sustainable economic development.”

2.16 Poor grid infrastructure with no export capability has constrained the development of this sector in the islands but the commissioning of a new 450MW HVDC Radial Connector between the main UK network and the Outer Hebrides is imminent. This Connector, scheduled for completion in 2017 and generation in 2018, and upgradeable to 900MW, will drive rapid growth in the onshore wind and marine renewable energy sectors.

2.17 International Power, owners of the Beinn Mhor project have agreed to underwrite one third of the Radial Connector costs, with Stornoway Wind Farm, Pentland Road Wind Farm and the Marine Renewable Energy developers underwriting the remaining Connector capacity.

2.18 There is a high level of activity within the Hebridean community renewable energy sector. Many community facilities have their own ground source heat pump or wind turbine to reduce carbon dependency. Seven communities have gone a stage further and have developed schemes for grid-

connected wind turbines with installations ranging from 900kW to 9MW. Most of these schemes are consented and awaiting connection to the distribution system.

ENERGY AND CARBON DEMAND 2.19 Energy demand for the Outer Hebrides is circa 680GWh (Comhairle nan Eilean Siar, 2011). Residential consumption, at 280GWh, makes up 40% of regional energy consumption with energy consumed by 26,180 people living in 12,335 households. 85% of the burning oil supplied to the islands is used for domestic purposes. The primary sector consumes 52.9GWh with this total largely shared equally by fishing and agriculture with a small amount for quarrying.

2.20 Electricity is sourced mainly from gas oil generation, followed by hydro, onshore wind and, to a very small extent, biogas CHP. 90% of the electricity consumed in the islands comes from two interconnectors. In 2009 / 10, this amounted to 161.5GWh drawn from the National Grid through these interconnectors. 6.5% of annual demand, or 11.6GWh, is provided by back-up diesel generation at Battery Point (Stornoway), Arnish Point (Stornoway), Lochcarnan (South Uist) and Ardveenish (Barra). In 2009 / 10, 15.2GWh was exported to the local distribution network.

2.21 DECC estimates for Carbon emissions state that the Outer Hebrides emit 305,600 tonnes of CO2 (2008 figures), equating to 11.7 tonnes per capita. Emissions directly related to energy are estimated at 188,100 tonnes or 7.2 tonnes per capita. Local assessment suggests that these figures could be 25% higher at 229,400 tonnes of CO2 per annum across all sectors. Electricity accounts for 42% of emissions, Gas for 18% and DERV / Petrol for 19%.

RENEWABLE ENERGY GENERATION 2.22 A total of 480MW is already operational (distribution connected), consented, in planning or in advanced development, so the islands look set to become a major UK centre of renewable energy generation.

2.23 Comhairle nan Eilean Siar is committed to development of a renewable energy industry in the Outer Hebrides which will supply green electricity to local and export markets, secure significant socioeconomic benefits for the islands in terms of fabrication (Arnish Yard), research (UHI Lews Castle College) and investment in the wider supply chain.

2.24 Installed renewable electricity generation capacity of 60MW would be sufficient to meet the current annual electricity demand of the Outer Hebrides. Assuming a conservative 33% capacity factor and 95% availability, 60MW installed capacity would be expected to generate approximately 165GWh per annum. Comhairle nan Eilean Siar’s aspiration is for Outer Hebrides to become zero carbon in terms of electricity demand.

ENERGY EFFICIENCY, FUEL POVERTY, AND ENERGY STORAGE 2.25 The ESCO will contribute towards ‘zero carbon’ Hebrides aspirations, and to help tackle fuel poverty. The Outer Hebrides has the highest rate of Fuel Poverty in the UK (currently 50%), with a prevalence of 'hard to treat' properties and an aggressive climate.

2.26 Attempts to address energy usage and fuel poverty are hampered by a high proportion of ‘hard to treat’ homes in the Outer Hebrides – 1930’s ‘Department’ houses with stone wall construction or

their 1950’s counterparts with poured concrete walls. Due to the solid walls, these properties defy conventional insulation techniques.

2.27 Energy storage projects are of ongoing interest in the islands. These projects increase the reliability and productivity of renewable electricity production generation, buffering excess production, and thereby ease the demands on distribution and transmission networks.

3 CASE STUDIES

BACKGROUND – EMERGENCE OF DISTRIBUTED ENERGY NETWORKS 3.1 Next-generation UK and EU energy markets will be characterised by increasing volumes of distributed energy where electricity generation is directly connected to a local distribution network, or exported to transmission networks (DECC, 2011). New entrants and novel products and services are expected to emerge in these markets, including Local Authorities and community owned suppliers.

3.2 Distributed networks often involve the simultaneous generation of useable heat. At domestic scale micro wind and solar photovoltaic systems generate electricity for local consumption with export of excess electricity to the distribution network. Heat generation includes heat pumps and Combined Heat and Power (CHP). These require electricity and gas respectively to operate but are more efficient than traditional electricity and gas heating.

3.3 Growing pressure for demand reduction will occur, involving close interaction between suppliers and customers and SmartGrid technologies. Community or district-scale systems will emerge based on local electricity networks and district heating schemes. Viability of these schemes are often dependent on the density of demand or the proximity of low-level demand to ‘anchor loads’ like data-centres, hospitals or commercial/industrial users. Economies of scale and efficiencies of larger installations for commercial and industrial purposes will lead to larger wind-farms, Combined Heat and Power schemes and Waste-to-Energy plants characterised by high upfront capital costs. Larger organisations are able to consider longer pay-back periods than individual consumers.

3.4 In order to inform the ESCO business model options, three different emerging distributed energy models in the EU and the UK are presented in the following sections. (i) EU Gotland - a Baltic Sea island similar to and yet significantly different from the Outer Hebrides (ii) UK Public-sector Energy Services Supplier Model and (iii) UK Electricity Supplier Model.

EU CASE STUDY - GOTLAND 3.5 The Swedish island of Gotland (Gotland, 2012) is seen as a potential model for energy developments in the Outer Hebrides. There are some striking similarities between the two island regions and yet significant differences. Gotland is the largest Baltic Sea island with 57,200 residents located around 100km from both the Swedish mainland and the Baltic countries.

3.6 Gotland aims to have a fully climate-neutral energy supply by 2025, based on local, renewable resources with the highest possible efficiency and economy. The overall goal for CO2 emission reduction is a 45% absolute reduction of the fossil

CO2 emissions from non-ETS (not including industries covered in the CO2 emission trade scheme) activities from 1990–2020.

3.7 In 2011 there were 175 wind turbines on the island providing an installed capacity of 181 MW. Annual wind power production was around 340 GWh equating to 38 % of Gotland’s consumption. Additional new turbines were installed in 2012. An impending switch to 2nd generation wind-farm technology will almost halve the number of turbines whilst tripling the area’s power production.

3.8 Installation of new wind power plants are dependent on decisions outside the regional council’s direct control, but with supporting regional actions. Installed capacity of wind power will shortly reach the present grid limit of 195 MW. As a result, a new sea cable is to be put into operation in 2017 and the next major phase of wind power installation on Gotland is expected to take place in 2016– 2020.

3.9 Around 2,000 households on Gotland hold shares in wind turbines. Holdings were often initially in small, local cooperatives. In a single generation, they have transformed into holdings in major wind farms.

3.10 Vattenfall owns 75% of Gotlands Energi AB GEAB, the local energy company while the municipality owns 25%. The business operates through three companies, Gotland Energi AB, Gotland Energy Construction Ltd and Gotland Electricity Ltd., with around 150 employees. The work of the companies spans the entire energy spectrum from electricity grids, district heating business in the larger towns and electricity, broadband / fiber and contracting. They also provide an extensive range of energy services.

3.11 GEAB is the local grid operator. It has successfully integrated a large amount of locally produced wind power into the local power distribution grid. New, large, wind farms will require a new grid.

3.12 Wind power developers have expressed their interest in installing additional capacity during 2011–2025 on Gotland. In total there would be around 500 turbines mainly concentrated on 15–16 larger wind farms. On most of them development has already started.

3.13 A new sea cable is being laid between Gotland and the mainland, planned to be put into operation in 2017. It will then be possible to supply large amounts of power to the rest of Sweden and beyond. Consequently, the new cable is necessary for extended exploitation of Gotland’s full installed capacity.

3.14 Smart Grids Gotland is a joint project between Vattenfall AB, ABB, GEAB and other parties. The project aims to evaluate (a) customer preparedness to adapt electricity consumption to fluctuations from an intermittent power supply and (b)

technological effects of a high share of wind power in a full scale but distinctly defined island grid area. The project is similar in scope and objectives to the Shetland NINES project (Shetland News, 2012).

3.15 A technical paper authored by Gotland GEAB highlights some of the challenges associated with large scale wind power generation, grid management and electricity supply to local island customers and mainland export. Wind Power in the local Grid, Problems and solutions (Liljegren, 2001). Many new ways of handling island renewable energy network problems such as short circuit currents, flicker and power flows are described in the paper. A summary of the paper is given in Appendix B.

3.16 It is unlikely that the ESCO will engage in such technical activities at the outset. However, in the development of the ESCO, stakeholders should consider whether the ESCO would eventually carry out some or all of the type of technical activities described in Appendix B on the Outer Hebrides grid. It is likely that this would need to be in partnership with generators and/or the distribution and transmission network operator SSE/SHETL. It is believed that this level of technical engagement would be necessary to offer sufficient quality of service and maximise economic development opportunities. The further development of the ESCO should examine thse issues in more detail, including whether there is a precedence in the UK for electricity-generating Local Authorities to work in this way with the network operator.

3.17 Lessons for Outer Hebrides ESCO:

• GEAB is 25% owned by Gotland municipality, 75% owned by Vattenfall. • Scale of wind-farms and interconnector similar to Hebrides. • Gotland at least ten years ahead in wind-farm implementation. • Century-long history of electrical power management and supply on the island. • Cement industry is energy-intensive anchor customer. • Deep technical experience within GEAB. • An organisation capable of solving demanding local grid and interconnection problems. • GEAB is the grid owner, not the generator. • Partnerships, especially with large utilities are critical. • Related UK region/utility projects are underway that can also serve as model. • Outer Hebrides needs a steady stream of meaningful, substantial energy projects ranging from R&D to demonstrator projects to full-scale implementation to build knowhow, strong and lasting partnerships and the conditions for further investment.

UK CASE STUDY 1 – PUBLIC-SECTOR ENERGY-SERVICES SUPPLIER 3.18 In addition to renewable electricity, future energy services offered by the ESCO may address renewable heat, energy efficiency and low carbon transport challenges.

3.19 UK Green Deal Legislation will be a substantial driver for such activities and projects in UK cities are expected to be on a very large scale. For example the £100m Birmingham Energy Savers project run by Birmingham City Council is seeking Delivery Partners to manage:

• Thermal insulation work • Solar installation • Solar energy • Energy and related services • Energy-management services • Energy-efficiency consultancy services • Electricity • Solar panels • Heating equipment • Air-conditioning appliances • Cooling and ventilation equipment • Boiler installations • Heating materials • Insulation work • Heating, ventilation and air-conditioning installation work • Installation of doors and windows • Water heaters and heating for buildings; plumbing equipment. • Pumps • Thermal insulating material • Information technology services

3.20 We therefore include a review of UK energy service companies based primarily on Investigation of the options available for setting up an Energy Services Company (ESCO) prepared by AP Benson Management Consulting (McLaren, 2011).

3.21 Aberdeen Combined Heat and Power This project was initially developed to deliver heat and power to four multi-storey residential blocks. The company has been generating energy for 10 years. Their systems currently operate from mains gas supplies with a biomass facility planned.

3.22 The business structure adopted was to create a new commercial company separate from the local authority. The local authority has director-level control alongside senior management. The company employs individuals with expertise in the delivery of energy schemes and representatives of the community sit on the company board. Aberdeen Combined Heat and Power is limited by guarantee and operates on a not-for-profit model with the aim that any surpluses will be reinvested in further development.

3.23 The company is seen as having brought forward plans quickly which would have otherwise taken more than 10 years to implement. Political and local pressures driving the project include creation of new social housing and reduction of energy costs. The council has a strong commitment to renewable energy and reducing energy poverty, and has an in-house sustainable development team focused on reducing carbon emissions.

3.24 Southampton Geothermal Project Southampton City Council created the first geothermal and CHP scheme in the UK in 1986, in partnership with Utilicom. Utilicom own and run the company with support from the council. The Council provided the land, local resources and dealt with all property matters; applied to the European Union for financial assistance and provided a low rent guarantee to Utilicom as well as a guarantee to purchase part of the power generated.

3.25 While providing a secure local source of energy, savings have not been passed onto consumers in the form of cheaper fuel bills. The project is long running and successful, reduces carbon and provides funds to the council through a profit share agreement.

3.26 The council believes that “it must not only advocate sustainable development, but demonstrate its commitment” and the project provides tangible evidence of this.

3.27 Woking District Energy System In the 1990s Woking pioneered a district energy system which is often hailed as an exemplary UK model. Woking Borough Council formulated an energy efficiency policy whose aims included both the reduction of environmental damage and fuel poverty. Carbon emissions within the Council’s own buildings have been reduced by 77.4% and by 17% within the borough since the policy’s introduction.

3.28 To progress the district energy system, a separate company called Thameswey Limited (TW) was formed which in turn formed a company called Thameswey Energy Ltd (TEL) as a public/private joint venture ESCO with a Danish energy services company, ESCO International A/S. TEL has since become wholly owned by TW, due to Danish tax regulations but ESCO International A/S are still contracted to work on the project

3.29 The Woking system consisted of a combined heat and power unit fuelled by natural gas. The CHP creates electricity and heat which is transferred around the Woking area using a complex network of heat transfer pipes. The system also has its own private electricity network. The company supplies heat, water and electricity to hotels, conference centres, civic offices and other properties within Woking area. Electricity from the energy centre is also supplied to multi storey car parks in the town centre and local authority and residential customers outside the town centre.

3.30 The Woking CHP system is being extended to other buildings currently under construction and is supplemented by a large solar photovoltaic canopy.

3.31 Aberdeen Combined Heat and Power’s systems entail significantly higher capital costs therefore high risk investment for local authority. In Southampton, the private sector takes on much of the risk. The Woking ESCO is characterised by high initial capital cost, but much of the risk is defrayed to the private companies involved.

3.32 Lessons for Outer Hebrides ESCO:

§ Three well regarded UK ESCOs. § Local Authorities instrumental in their formation. § Risk partially or entirely transferred to the private sector. § Wider range of energy activities than currently envisaged for the Outer Hebrides ESCO. § Historically smaller in scale than is currently envisaged for the ESCO. § Very large projects e.g. Birmingham Energy Savers expected to emerge with Green Deal legislation. § Could UK ‘city-ESCOs’ be potential customers/partners for the Hebridean ESCO?

UK CASE STUDY 2 - MID-SIZED ELECTRICITY INDEPENDENT SUPPLIER 3.33 New firms have entered the UK Electricity Market in the last ten years to compete with the ‘Big Six’. Some of these firms are heavily focused on the provision of renewable energy. They often act as both electricity generators and aggregators, as the combination of such activities balances various risks.

3.34 An Outer Hebrides Energy Supply Company may well have a similar profile and business model to firms like Smartest and Good Energy. Strikingly, the ESCO may well have the capacity to be of near-equivalent size to these companies from a very early stage.

3.35 Good Energy - Here we look at the private firm Good Energy in some detail, based on their Admission Document to the London Alternative Investment Market (GoodEnergy, 2012).

3.36 The company was originally a subsidiary of Unit Energy Europe AG. Following a management buy-out in 2001, the company has since completed three public offers of its shares to raise funds. It currently has approximately 1,700 shareholders and 23% of the stock is owned by Directors and families.

Good Energy Company History

2001 • acquired by UK shareholders

2002 • raised £0.6 million

• purchase of Delabole wind farm

2004 • raised £1 million

• listing on OFEX

• achieved 10,000 electricity customers milestone

2006 • significant expansion

• brought all outsourced services in-house

• achieved 20,000 electricity customers milestone

2007 • raised £1.1 million

2008 • launch of Good Energy Gas

• Hot ROCs

2010 • Invested £11.8 million in repowering the Delabole wind farm

2010 • Planning submitted for a 4.6MW wind site in Aberdeenshire Onwards • achieved 30,000 electricity customer milestone

• achieved 38,500 FIT administration customer milestone

3.37 In 2011 Good Energy had a turnover of £21.6m, an EBITDA of £2.8m and a profit before tax of £1.06m.

3.38 The company was founded in May 2000 to lower UK carbon emissions by developing and distributing renewable electricity within the UK. The company is a vertically integrated utility supplying 100 per cent. renewable electricity to approximately 30,000 domestic and commercial customers and gas to approximately 6,700 domestic customers. It has over 75,000 gas, electric and generation customers in total.

3.39 The company is supported by a growing supply chain of approximately 38,500 independent green power generators across the UK. It has its own renewable electricity generation business which includes a 9.2MW operational wind farm in Cornwall, and a proposed 4.6MW wind farm in Aberdeenshire, currently in

planning.

3.40 The company is focused on three key business segments:

• the supply of electricity and gas • renewable power generation • FeedInTariff administration

3.41 The company strategy is to provide individuals and companies in the UK with a means by which they can reduce their contribution to the causes of climate change through selecting Good Energy to be their energy supplier.

3.42 The company has a highly qualified, motivated and experienced management team, with a deep knowledge of the renewable supply and generation sector and related policy. Good Energy has built proven and successful relationships with its customers and a scalable business model. It has demonstrated a proven ability in developing wind and heat projects.

3.43 Medium and Long-term Strategy. Good Energy is the only 100 per cent. renewable sourced electricity supplier in the UK and its medium and long term strategy is to continue to supply 100 percent renewable sourced electricity. The Group plans to generate around 50 percent ‘of its own electrons’. It has a medium term target of owning and operating 110MW of renewable generation assets and to maintain this percentage as the supply side of the business grows.

3.44 Its assets are onshore wind and large scale solar together with small scale hydro and bio-generation technologies. Longer term the company intends to acquire renewable assets in the heat sector. This renewable heat strategy will support carbon offsets required for the certification aspect of the electricity business.

3.45 The company seeks to be the preferred partner for smaller generators, a market which has expanded significantly since the advent of Feed-In Tariffs (FiT) to over 320,000 installations in the UK. The company identifies opportunities to provide services directly to generators and on an outsourced basis to utilities.

3.46 Good Energy has a 100% renewable energy fuel mix, sourcing its electricity from a community of around 500 renewable generators. It supplies over 30,000 homes and businesses across the UK and also supports a pioneering community of more than 40,000 renewable generators that use wind, small-scale hydro, solar power and sustainable biomass to generate heat and power. It now has over 6,700 gas customers.

3.47 Good Energy currently has around 15% of FIT customers making it one of the largest FIT administrators in the UK.

3.48 The company plans to grow its customer base and increase its rate of growth of electricity and gas customers from a combined 18 per cent annualised rate. It intends to achieve this through its pricing, marketing and sales strategy, development of new tariffs, particularly load shifting tariffs and local tariffs and is looking to support the management of variable and weather dependent generation. The company has identified opportunities in demand side management and trading.

3.49 The company’s key priorities for 2012 were to further develop the customer base for electricity, gas and FIT customers, to develop the generation business by identifying additional wind and solar, to look at small hydro and bio-generation opportunities, to launch a customer relations system to further enhance the Good Energy ‘experience’, to develop unique tariffs around the Group’s 100 per cent renewable electricity trading portfolio, to develop FIT administration services for other organisations and to finalise research and piloting of demand side and local community tariffs.

3.50 Planned use of new funds included £1.0 million for improved marketing and brand awareness, through development of new partnerships with national membership organizations and increase in local and national advertising; £1.0 million for development of the Group’s trading platform and credit lines to enable its trading team to improve trading margins across all technologies and £1.5 million for asset development for expansion of the Group’s portfolio including onshore wind and large scale solar projects.

3.51 Lessons for Outer Hebrides ESCO:

§ Mid-sized private firm operating across UK. § Solid and growing customer base. § Strong renewables products and brands. § Mix of electricity generation and aggregation reduces risk. § Experienced management and staff. § Knowledgeable on Power Purchase Agreements, FIT, trading and, perhaps crucially, marketing. § Existing relationships with local Hebridean generators. § GoodEnergy and similar companies are examples of candidate joint venture partners for the Hebridean ESCO.

4 CONSULTATION RESPONSES

CONSULTATION 4.1 A detailed consultation on the proposal for establishing an Outer Hebrides Energy Supply Company was carried out in March 2013. A fifty-two question survey was sent to forty-six contacts mostly drawn from the Outer Hebrides Renewables Group convened by Comhairle nan Eilean Siar. This list included a cross-section of interested local, national and European contacts. Eleven contacts responded to the survey as shown in Appendix A. Respondents were asked groups of questions regarding: • their organisations • energy services • potential ESCO customers and reasons to buy • current projects and revenue streams • markets and competition • energy procurement practices • ESCO products and services • contracts • transmission and distribution grids • business structure and operations • risk • strengths, weaknesses, opportunities and threats • viability • legislative environment and • funding.

RESPONSES 4.2 ORGANISATION Four respondents worked for small community owned energy companies in the Outer Hebrides and a fifth worked for Commnity Energy Scotland. One respondent worked for SSE, two for medium-sized renewable energy developers, one for a small energy consultancy company, one for a Norwegian energy research institute and one for a Swedish island’s local authority. Most of the respondents were managers in their organisations.

The respondents were generally actively involved in or highly knowledgeable about renewable energy projects. For example, Aquamarine Power are currently developing, “the largest consented marine energy project in the world” west of Lewis. Most respondents had direct involvement in projects in the Outer Hebrides or with Hebridean organisations. All the community owned companies had community regeneration as a primary focus.

A formal response was not received from Lewis Wind Power. The Stornoway

Trust did not respond to the survey but offered some responses in the course of a briefing meeting.

4.3 ENERGY SERVICES The distinction between energy supply and the broader term energy services was emphasised by respondents, and there was some confusion about the intended focus of the core ESCO offering, and the meaning of the term ESCO:

“Definition of ESCO isn’t clear – energy services company is different to energy supply company. Very few example of communities acting as energy suppliers to third parties”

Electricity, heat at residential and district scale and energy efficiency services were suggested. Project scales were thought to be on the order of hundreds of customers and costing £1m.

SSE have, “provided extensive technical and financial support to Community Interest Companies”, supplying energy services, including the Isle of Wight EcoIsland project.

4.4 POTENTIAL CUSTOMERS AND REASONS TO BUY

Some respondents identified Hebridean customers as the most likely target, focused on lower tariffs and alleviating fuel poverty in the area. Others envisaged a wider UK market. Reasons to buy included lower prices, green energy and community reinvestment. Customer segments including domestic/household, commercial/industrial voluntary/community and public sector were identified, all having different buying motivations and goals:

“A local company would be supported more than a multinational, especially if it had wider social aims for the Outer Hebrides.”

“Public-sector customers will be seeking cost effective and potentially tailored packages, with longer-term benefits and security included and may be interested in supporting wider/local objectives – procurement hurdles to overcome.”

“Follow the good example set by Ecoisland on the Isle of Wight. You should work with SSE’s regulated network business to provide security of supply to the island network.”

“Enables projects to show that having local energy schemes can directly impact on individual energy bills (as well as providing the other benefits for the wider community).”

4.5 CURRENT PROJECTS AND REVENUE STREAMS

Most organisations did not wish to provide revenue figures. Point and Sandwick Power are projecting, “annual revenue of £2.8m from 2014”, and Galson Energy are projecting annual revenues of around £0.5m. The Island of Gotland has made, “big savings especially in savings in heating and electricity in the regions buildings”. These savings are estimated to be 100m SEK (approx £10m) over a ten-year period.

Trends: Project costs are high and rising, “rising costs of developments, cost of generation and grid access”

“Project costs vary significantly and, in the case of wind energy, often increase significantly beyond the budget due to the pricing of risk and lack of competition amongst products/suppliers”

Simple payback time: “The trend of payback time generally, and in particular the Outer Hebrides, is dominated by changes in the ROC support mechanism.”

Operational and Maintenance savings: “O&M savings vary. Ground-source heat pumps have provided savings but an on-site wind turbine has been very unreliable and involved significant additional O&M expenditure.”

4.6 MARKETS AND COMPETITION

Competition would come from SSE and other licensed suppliers. The ESCO: “would compete with a variety of existing energy providers at different times, such as the ‘Big Six’ energy companies, PPA off-takers, oil/gas suppliers, accredited Green Deal providers, etc.”

Hebridean electricity is seen as having the potential to be a “strong brand and sell across UK.” Green, clean Hebridean energy was likely to be an attractive message in the market. Some respondents thought Hebridean electricity might have price advantages, “might be cheaper due to higher utilization from better wind conditions.”

Others disagreed, raising the important points of size of customer base and diversification:

“Difficult to see how pricing of a mainstream local energy product could be competitive ... operators require large customer bases to achieve the economies of scale needed to bring down costs and be able to offer attractive packages ... there may be cross-subsidisation occurring with other more lucrative sides of the business”

The local market is potentially resistant because of interference with competition:

“Curiously, widely available products perceived to be offered by public-sector

organisations are often viewed sceptically by local domestic customers as they are deemed to be interfering with the operation of the market i.e. reducing access to cheap deals.”

4.7 ENERGY PROCUREMENT

Procurement decision-making and criteria, “varies between staff, directors/boards and lenders/financiers depending on value, complexity and significance to business case….choice of products/suppliers are very limited and quality often is as important as high prices. Financiers very diligent in investigating quality issues given risks of failure and potential to limit income i.e. ability to repay loans.”

4.8 PRODUCTS AND SERVICES

These could include: electricity, renewable heat, District heating, SmartGrid, and broadband as per the Gotland model. One respondent also suggested:

“Bulk purchase of gas, oil and other key fuels where possible to reduce costs.”

Many of the respondents were involved in substantial generation projects that could result in them becoming electricity wholesale suppliers to the ESCO.

4.9 CONTRACTS

Respondents were very familiar with and experienced in negotiating Power Purchase Agreements:

“Each community energy scheme has (or will) gone out to tender for PPAs. These tend to be with the big 6 energy suppliers and others such as Co-op Energy, M&S and Smartest Energy.”

Many had also negotiated contracts with suppliers of services eg balance-of-plant and construction works and, “grid agreement with SSE, turbine supply and O&M with Enercon, technical support from Sgurr Energy”

4.10 TRANSMISSION AND DISTRIBUTION GRIDS

A decision not to proceed with the Hebrides-Scottish mainland transmission grid would have a devastating effect on projects:

“Not sure on what the effect on an Outer Hebrides Energy Supply company would be, but it would certainly mean a significant delay or cancellation of our development projects on Lewis”

Transmission network charging needed to be equitable to enable Hebridean

projects and new Hebridean electricity market entrants to reach their markets and be competitive:

“Level playing field required across the UK - the UK will benefit from such energy provision”

Transmission network charging could influence the company structure:

“High cost – less local competition – tougher main land competition. Low cost – higher local competition – easier to compete on the mainland. This could result in two different company structures the first one smaller with strong local anchorage and the second larger with dual focus.”

Significant investment is required in the local distribution grid:

“Existing distribution grid has very limited capacity in many areas and requires significant expenditure in order to realise the renewables development ambitions in the area.”

4.11 BUSINESS STRUCTURE AND OPERATIONS

Most community groups felt that community ownership was the preferred model. Others felt that a Joint Venture was preferable. One respondent thought that the ESCO should be a self-contained private firm, and another felt that the model should depend on gauging the level of reward and risk the community was willing to take on.

Business operations required of the ESCO would need to be quite extensive and could include (a) Energy Infrastructure (b) Billing (c) Sales and Marketing (d) Service Management (e) Maintenance and (f) Customer Support. In the opinion of the Island of Gotland respondent: “I THINK YOU NEED ALL OF THEM”

4.12 RISK AND BARRIERS

A large and diverse number of risks were identified including:

• Not finding the investments needed. • No cable for electricity transport. • Lack of quality market research. • Achieving economies of scale with such small market. • Potentially diluting impacts if services are out-sourced to organisations not sharing common aims/objectives. • Need to manage consumer demand to align with variable energy supplies.

These and other risks are considered further in Chapter 12.

Barriers identified included: (a) Lack of appropriate forms of finance, (b) Small size of projects and high transaction costs, (c) No compulsion on customers to join heat/ electricity networks.

4.13 STRENGTHS, WEAKNESSES, OPPORTUNITIES AND THREATS Table 4.2 lists strengths, weaknesses, opportunities and threats identified by the respondents:

Strengths Good people potential. Local knowledge. Potential opportunities for eliminating Fuel Poverty. Political support. Economic driver. Availability of resource. Full support of LA and other agencies. Good baseline data for energy challenges in area. Significant potential renewable developments in pipeline. Local agencies have shared/over-lapping ambitions and tend to work well together. Public is receptive to alternative solutions/change e.g. crisis is recognised. Local research/higher education base. Good volunteering appetite in area to support initiatives with community benefits.

Weaknesses Small world thinking and attitudes. Lack of knowhow and professionalism. Local rivalries. Lack of commitment and drive. Existing infrastructure. Victim mentality. Grid issues. Effective exemplars. UK Business models. Funding challenges. Inability to understand what an Outer Hebrides Energy Supply Company would mean to a renewable energy generator on the islands. It's not a concept that we are familiar with and as such do not understand what is being proposed. Small local market. Energy market is strongly price orientated. Route to market for local energy generators is very difficult. Existing operators may squeeze out new providers.

Opportunities The whole renewable package esp turbines. New companies. Tackle local challenges. Local input into climate change targets. Some significant local customers (prospective energy generators and purchasers of scale). Small local market provides visibility for good news/case studies. Unique and effective local products/solutions could be delivered.

Threats Interconnector not being developed. Buy in by all the energy producers. Small improvement schemes detracting from the big picture. Objectives are set too wide and become clouded by price issues. Success becomes derailed by unsupportive/cynical media. Procurement processes for corporates and public-sector organisations carry bias for national rather than local solutions. State aid interpretations aligned to any public funding can be fairly restrictive where new organisations are entering a competitive/commodity market with a significant level of existing suppliers.

Table 4.2: SWOT Table

4.14 VIABILITY When asked the question How much do you agree with the following statement, 'An Outer Hebrides Energy Supply Company is a viable and feasible proposition’, the majority either agreed or felt it was too early to state a view until more was known about the proposals.

4.15 LEGISLATIVE ENVIRONMENT The legislative environment affecting the ESCO would include: regulations / incentives on Electricity Generation, Electricity Distribution Carbon Reduction

Commitment, Energy Performance of Buildings Directive, Renewable Obligation Certificates (ROC) and Feed-in Tariffs.

4.16 FUNDING Possible funding mechanisms for the ESCO included: UK and Scottish funding streams, EU funds, the Low Carbon Infrastructure Fund, the Low Carbon Networks Fund and bank financing.

5 OWNERSHIP AND OPERATIONAL STRUCTURE

5.1 Traditionally ESCO’s are focused primarily on energy services rather than energy supply. However the Hebridean ESCO will be focused in the first instance on supply, with scope to diversify later into services. This section describes the different operational models of services/supply companies.

ELECTRICITY SUPPLY COMPANY STRUCTURE

5.2 The ESCO is predicated on retail of Hebridean electricity. The responsibilities of electricity retailers include buying the electricity customers need, arranging for it to be distributed to customers through networks, providing associated services such as metering and billing and promoting efficient use of energy (SSE, 2012). Electricity utility business models are typically diverse and can consist of electricity generation, wholesale energy trading and retail supply businesses.

5.3 Generation businesses sell coal and gas generation capacity and renewable energy to wholesale trading. Generation also receives the benefit of Renewable Obligation Certificates (ROCs) and Levy Exempt Certificates (LECs) from wind and qualifying hydro. Trading businesses buy capacity from Generation and other Joint Venture, associate or third party generators. They can also procure fuel (coal, gas, oil and biomass) for Generation, purchase carbon tickets, and buy power from contracts and over the counter trades. They also sell power in the wholesale trading markets, sell power and gas to supply companies and participate in the balancing market. Energy supply businesses procure electricity from wholesale trading for retail to customers.

5.4 A full range of electricity company business functions can include:

• Operation and maintenance of generation assets. • Responsibility for scheduling decisions. • Responsibility for interactions with the Balancing Market. • Responsibility for determining hedging policy. • Responsibility for implementing hedging policy. • Interaction with wider market participants to buy/sell energy. • Holding of un-hedged positions (either long or short). • Procurement of fuel for generation. • Procurement of allowances for generation. • Holding of volume risk on positions sold (either internal or external). • Matching of own generation with own supply. • Forecasting of total demand. • Forecasting of wholesale price. • Forecasting of customer demand. • Determination of retail pricing and marketing strategies.

• Bearing of shape risk after initial hedge until market allows full hedge. • Bearing of short term risk for variance between demand and forecast.

5.5 Clearly the ESCO will not engage in all such activities. Nonetheless it is clear from the detailed case-study analysis of substantially smaller players provided in the previous section that a significant subset of such activities are required to operate and prosper in the electricity and energy market.

ENERGY SERVICES COMPANY STRUCTURE 5.6 Energy service companies (ESCOs) are different from electricity supply companies although there are areas of overlap (McLaren, 2011). ESCOs often have diverse goals, from aiming to maximise use of renewable energy, promote energy efficiency and achieve cost savings. They can enable delivery of energy savings, energy efficiencies, low cost energy supply and provide associated planning and development services.

5.7 They will often assume all or most of commercial and other risks associated with energy services, and may be willing to provide a guarantee of costs and commercial risks associated with implementation. Risks may need to be shared with other stakeholders/partners.

5.8 ESCOs enhance the sustainable use of energy via promotion of efficiency and renewables. They can offer efficient and low cost supply through, for example, fuel purchases and joint venture arrangements with energy suppliers. Payment for ESCO energy services is based, either wholly or in part, on achievement of energy efficiency improvements and on meeting of other agreed performance criteria.

5.9 ESCO services may include design, build and operation of energy generation facilities such as wind farms and solar farms. The ESCO firm may also provide energy analysis and audits, monitoring and evaluation of energy savings and energy consultancy. ESCOs often engage in the completion of energy audits across an organisation’s facilities, recommendations and implementation of low cost, efficient energy services, contracting of more beneficial supply agreements with energy suppliers and sustainability support and environmental compliance services.

5.10 Energy management services may include specialist energy management services, development of bespoke solutions for an organisation’s facilities, design and delivery of more cost effective solutions for the provision of gas, water and electricity, bulk purchasing contracts with energy suppliers that are then sold on profitably to customers, provision of service level guarantees of service levels and energy efficiencies and management of risks associated with design and build.

5.11 Project design and implementation of alternative energy generation facilities is often involved together with acquisition, implementation, maintenance and operation of energy generation projects.

5.12 Based on AP Benson recommendations, the choice of ESCO model, technology and financing options will depend heavily on the organisation(s) that are setting up the project. The project must articulate its own drivers and goals. It is crucial that organisations set out a strategy for the success of the ESCO at the outset.

5.13 The ESCO should set out exactly what it is trying to achieve, e.g. energy savings, cost reductions, energy resilience. Previous projects must be examined in depth to learn from their success and problems. Local stakeholders must be engaged to ensure support for the scheme. Appropriate partners must be selected who can help to deliver strategic goals. An appropriate structure and technology for the ESCO must be chosen. Costs must be thoroughly understood as must legislative issues key risks must be understood and set out, and a sustainable financing model set out.

5.14 There are many factors to consider in setting up the ESCO. The AP Benson report recommends the following key considerations (McLaren, 2011):

Model A model should be chosen which delivers the easiest and most cost effective mechanisms. Political and local pressures Public bodies may be looking to cut costs under the government’s austerity budget. Government policy and legislation The research might point to a scheme which is including launch of feed in tariffs aimed at making use of the new government feed in tariffs, to reduce costs for the consumer. Timing and opportunity There may be strong time limitations on the project. Any scheme would therefore need to be simple to implement i.e.:

1. A private sector partner and funding should be easily available 2. The technology should be easily available on short lead times 3. Implementation should be quick 4. The project should be relatively low risk given the rapid “time to market” inherent in the plan Reducing energy poverty A real effort must be made to pass on any savings to the consumer, may result in using less private involvement so as to obviate the need for the JV company to make a commercial return allowing profits to be reinvested in the supply of energy. Energy security and resilience The project needs to be resilient. In the Woking model resilience comes from having many sources of energy from gas, solar and heat pipes.. Lack of internal funding Look for outside investment or grants from EST or government/EU. Maximising income generation and If possible, create a project which has a significant inward investment and capital growth infrastructure element which would create jobs to build and maintain. Risk Use a model which would share risk as much as possible

5.15 What is the optimal model for the ESCO and what are the organisation’s criteria? Reduction of energy poverty might be better achieved by using public sector

funding, whereas private sector funding requires an investment return and therefore looks to maximise prices charged for energy. Lack of private sector funding could impair the ability of the ESCO to attract inward investment. Risk reduction and lower administrative overheads can be promoted by sharing risk with private firms or other bodies. Comhairle nan Eilean Siar and its community partners may seek schemes which create jobs in the local area and attracts inward investment.

LEGISLATION 5.16 Licensable activities: The Electricity Act 1989 prohibits certain activities unless the person carrying on that activity is licensed, or is exempt from the requirement for a licence. An organisation which wishes to carry out any of the licensable activities and are neither exempt nor excepted must apply for a licence. Two licenses of potential relevance to the ESCO are: (a) Generation Licence: Allows the licensee to generate electricity for the purpose of giving a supply to any premises or enabling a supply to be given. (b) Supply Licence: Allows the licensee to supply electricity to premises.

5.17 Distribution network operators (DNOs) are companies licensed to distribute electricity by OFGEM. There are fourteen licensed geographically defined areas in the UK. The distribution network operator distributes electricity from the transmission grid to homes and businesses. Under the Utilities Act 2000 supply of electricity to consumers is done by an electricity supply company which makes use of the distribution network.

5.18 The Sale of Electricity by Local Authorities (Scotland) Regulations 2010 and similar regulations in England and Wales allows local authorities to sell electricity produced from the following sources: (a) wind, (b) solar, (c) aerothermal, (d) geothermal, (e) hydrothermal and ocean energy, (f) hydropower, (g) biomass, (h) landfill gas, (i) sewage treatment plant gas, and (k) biogases.

5.19 An interesting question immediately arises from these provisions. In order to manage risk and ensure security of supply, private sector electricity companies develop a generation mix based on fossil fuel and nuclear sources, as well as renewables. Will local authorities, being restricted to renewable energy developments, need to address risk in different ways from the private sector?

5.20 In its response to consultation on local authority power to sell electricity from renewables, the UK Government stated that it saw no reason to impose size limits on the scale of generation local authorities are allowed to take forward, and that larger generation projects will require a generation licence which will be strictly regulated by Ofgem.

5.21 Small suppliers, i.e. most site specific renewable generators, are authorised to generate, distribute and supply electricity under The Electricity (Class Exemptions from the Requirement for a Licence) Order 2001.

5.22 Other key national government factors include the Green Energy (Definition and Promotion) Act 2009, which sets out key impact indicators including total number of energy efficient solutions number of households in fuel poverty and the percentage of energy that has been generated from renewable sources.

CONTRACTS AND INCENTIVES 5.23 The Renewables Obligation (RO) is currently the main support mechanism for large-scale UK renewable electricity. Smaller scale generation is supported through the Feed-In Tariff scheme (FITs). The RO places an obligation on UK electricity suppliers to source an increasing proportion of electricity from renewable sources.

5.24 Operators of accredited renewable facilities are issued with Renewables Obligation Certificates (ROCs) for the renewable electricity they generate. ROCs are tradeable and are used by suppliers to demonstrate that they have met their obligation.

5.25 Suppliers must pay an equivalent amount into a ‘buy-out’ fund if they do not have sufficient number of ROCs to meet their obligation. The buy-out fund is used to cover administration cost of the scheme and the surplus is distributed back to suppliers in proportion to the number of ROCs they produced.

5.26 DECC and the Scottish Government have established the Scottish Islands Renewables Steering Group which is reviewing the commercial and economic case for island renewables. Specific Island ROCs are being considered for energy projects around Scotland’s islands.

5.27 The RO will close to new generators in March 2017. In its place the UK Government has introduced Feed-in Tariffs with Contracts for Difference (FiT CfD), a new system of long-term contracts intended to deliver clear, stable and predictable revenue streams to electricity generators. The Government has also introduced a Carbon Price Floor (CPF) - a fair price on carbon. CPF is intended to increase wholesale electricity prices (linked to cost of carbon) and revenue certainty whilst encouraging renewable energy investment.

5.28 FiT CfD and CPF ensure that the cost of capital required for new low-carbon generation capacity is lower and provides a framework for independent generators and new investors to invest in low-carbon generation. Ofgem is also taking action to improve liquidity which will assist new entrants to come to the electricity market. These are positive signals for the ESCO.

5.29 The FiT CfD long-term contract is set at a fixed level. Variable payments are made to top-up the level of payment to the generator to the agreed tariff. FiT payment is made in addition to the generator’s revenues from selling electricity in the market.

5.30 The FiT CfD provides low-carbon electricity generators with increased confidence in their revenues through agreement of a long-term contract, as shown in Fig 5.1. If the wholesale electricity price is below the price agreed in the contract, the generator will receive a top-up payment to make up the difference. If the wholesale price is above the contract price, the generator pays the surplus back.

Figure 5.1: FiTCfD operation (DECC, 2011)

5.31 The UK Government aspires to provide clear, long-term stability with this mechanism. However it should be noted that “Decisions on the overall size of the envelope for contracts will be taken at fiscal events ... in order to consider the cost of support in the round against other pressures on Government finances.” (DECC 2011) There is a risk for the ESCO here that FiT CfD renewable incentives may decrease in the face of such pressures.

5.32 Other forms of contract: Energy Performance Contracting (EPC) is a creative financing mechanism for capital improvement which allows the funding of energy efficiency upgrades from cost reductions. Guarantees are agreed upon in terms of costs and energy savings by all parties. The model targets specific energy or cost savings which are then shared by all participants. Any saving can be used to re- invest in the ESCO.

5.33 There are two main variations of this model; Shared Savings and Guaranteed Savings. In Shared Savings the ESCO or customer finances the project either through its own funds or by borrowing from a third party. The ESCO then takes on most of the risk including project risk and any risks associated with the customer’s credit rating. All cost savings are then shared between the members of the ESCO and the customer at a prearranged percentage for an agreed length of time, dependent upon project costs, project length and risk accountability. Shared saving contracts are beneficial when the customer does not have borrowing capacity.

5.34 In the Guaranteed Savings model an organisation would finance the creation of the project by borrowing funds from a third party such as bank or a leasing company. The ESCO then takes on all the risk of the project and benefits from the energy savings made. If the savings do not reach agreed minimums the ESCO covers the difference; if they are exceeded then the organisation agrees to share the savings with the ESCO. Therefore, the ESCO is providing a guarantee of performance to the organisation that financed the project.

5.35 The Build-Own-Operate-Transfer (BOOT) contract. This contract model is popular for financing Combined Heat & Power projects in Europe. The equipment eg a wind-farm is owned and operated by the energy services company. After the end of a long term supply contract with the organisation the infrastructure is transferred to the client eg the Local Authority at a rate that allows the ESCO to recover its investment. The benefit is that the ESCO takes the risk and also raises the initial investment managing the creation and implementation of the entire infrastructure and operation.

5.36 The energy supply contracting method has many of the same advantages of the performance contracting model but gives less incentive for the contractor to continually improve the energy performance experienced by the client. This is a low risk method with small margins. The suppliers’ business models will often focus on developing long term operation and maintenance contracts.

5.37 The Chauffage Contract contract is popular in the UK, especially in CHP projects. The end users are sold energy by the ESCO at an agreed rate. The ESCO has the freedom to change the way the energy is supplied, e.g. the ESCO could add more efficient methods to reduce operating costs. The ESCO will provide all maintenance and support throughout the project, which can last for 20 or 30

years.

5.38 An ESCO will finance the company through its own equity. This is often funded through debt, which allows the ESCO to run a number of projects at any time. Energy user/customer financing, where again the finance comes from internal resources of the client with the risk managed through the energy service guarantees. This may make sense if organisations have ‘ring fenced’ funds that could be invested in guaranteed energy projects. Third party financing from a bank or leasing company is the most commonly employed option in the UK.

5.39 Debt financing: Normally a customer will take on debt as it lowers the financing costs as the average customer’s cost of capital is lower than the average leasing company’s or ESCO’s. Most ESCO projects are financed by debt which the customer has borrowed from a bank or other lending institution. This debt will appear on the customer's balance sheet, which could reduce the customer’s ability to borrow for activities directly related to its business.

5.40 Leases: ESCOs can take out a capital lease, and at the end of this lease following regular payments, the customer will have the option to buy the equipment. The capital will also appear on the balance sheet as an asset or liability. An operating lease will generally cost more for the customer as the leasing company still owns the equipment and thus takes on the risk. The equipment does not appear on the balance sheets and at the end of the lease; the customer would have to pay the market value for any of the equipment. Low cost, government funded municipal leases are often used in school, hospital and other local government projects. They can be taken on as operating or capital leases if necessary.

OWNERSHIP AND OPERATIONAL STRUCTURE 5.41 The Scottish Futures Trust have prepared a detailed report for the Convention of Scottish Local Authorities, entitled Report on the Commercial Aspects of Local Authority Renewable Energy Production. (Scottish Futures Trust, 2011) which informs the present study. The report identifies three categories of commercial structure for Local Authorities engaged in energy services and supply:

• Category A – owner operator structures • Category B – JV and partnership structures • Category C –arm’s length structures

5.42 Table 5.1 summarising the risk-reward spectrum for different scenarios in each of these categories is shown below. The Stornoway Trust’s current relationship with Amec-EDF is broadly a mix of Scenarios C1 and B3. If the ESCO is established the working relationship is likely to move further up the risk-reward spectrum.

Spectrum Scenario

A1 Public-sector body self-designs an energy facility, procures its construction and then operates the facility itself.

A2 Public-sector body procures design and construction of an energy facility from a third party then operates the facility itself.

A3 Public-sector body procures design and construction of an energy facility from a third party and then lets successive short/medium term contracts for operation, maintenance & lifecycle replacement.

B1 Public-sector body sets up a company with a third-party investor or contractor to deliver energy infrastructure projects.

B2 Public-sector body procures DBO of energy facility from a third-party contractor, and finances facility itself.

B3 Public-sector body procures DBFO of energy facility from a third party contractor.

C1 Silent landlord – public-sector body

leases site to third party to design construct and operate an energy facility.

C2 Service concession

Table 5.1: Structural Models and Risk-Reward Spectrum

CATEGORY A - OWNER OPERATOR STRUCTURE 5.43 Owner operator structures are characterised by significant public sector involvement in the renewable facility, possibly including involvement in design, operation and maintenance.

5.44 Functional models include direct investment where an organisation such as a Local Authority could fund deployment of a renewable energy facility such as a large wind farm.

5.45 Smaller-scale owner-operator models involve formation of local community based organisations focused on small scale community based generation and funded by the organisation directly through grants payback based on cost savings and sale of excess supply to the Grid. Such a model is typical of community energy projects in the Hebrides.

CATEGORY B - JV/PARTNERSHIP STRUCTURE 5.46 JV/Partnership structures involve the public sector entering into partnership with the private sector to develop renewable projects, in the form of joint venture or more formal PPP type structures.

5.47 Funding for ventures could be provided from existing funds or funds could be raised through a joint venture company with interests in both private and public electricity sales. Such a Joint Venture could be owned through a spin out group partnership. There may be synergies with other parts of the organisation such as environmental waste services.

5.48 Other alternatives include formation of Joint Ventures with other Authorities and public sector bodies. Each authority would own a stake. The spin out company would act as a provider of energy supply and such a company could be opened up to other organisations to whom an equity stake could be sold. One could imagine a Scottish Islands Energy Supply Company for example set up jointly by Shetland, Orkney and the Western Isles.

CATEGORY C – ARM’S LENGTH STRUCTURE 5.49 Here the public sector makes no financial commitment to projects and has little risk exposure. Examples include land lease agreements and service concessions.

5.50 Direct investment from outside organisations can also be envisaged. Such a company would seek to attract funding from private investors or government grants, and be owned by private investors. The Local Authority and other clients could agree to enter into a contract for the purchase of energy supply in order to underpin the new company and to provide investors with support for the company’s income model.

6 OPPORTUNITIES AND CHALLENGES

OPPORTUNITIES – SUPPLIERS 6.1 There are a number of potential Hebridean suppliers of electricity on a wholesale basis to the ESCO.

6.2 The Stornoway Wind-Farm is a Lewis Wind Power project (Lewis Wind Power, 2013). Lewis Wind Power is a joint venture between AMEC and EDF Energy, working in partnership with the Stornoway Trust, the community owned trust, which owns the wind-farm site. The Stornoway Wind Farm is a 36 turbine development with a generating capacity of up to 129.6MW. Preliminary engineering has commenced and the wind farm is expected to be fully operational by 2017/18.

6.3 The community has an option to purchase 26MW of generation from the Stornoway Windfarm, which is currently in the planning phase. In addition, a Community Trust will receive approximately £4,000 per installed megawatt each year from the scheme, equating to about £520,000 per year for a 130MW scheme.

6.4 In 2012 International Power (70% owned by GDF SUEZ) acquired the rights to develop the Beinn Mhor wind farm (International Power, 2012). The 39 turbine wind farm will have an installed capacity of around 125MW and is expected to cost £215 million pounds.

6.5 A community ownership scheme similar to the Stornoway Wind Farm has been offered (Scottish Government, 2011). Beinn Mhor Power has contracted to pay 1% of its revenue to the Muaitheabhal Windfarm Community Trust. In addition, Beinn Mhor Power contracted to lease to the Trust, on a rent free basis, up to six turbine sites in the Windfarm, with that number being reached if the consented windfarm comprises a total of 53 turbines (Comhairle nan Eilean 2006).

6.6 Aquamarine Power have been granted a Crown Estate lease for 40MW of wave- power generation off the West of Lewis. Pelamis are in the application process for another 20MW lease in the same area. Statoil are scoping the North Minch for a site for a commercial floating offshore wind deployment amounting to hundreds of Megawatts.

6.7 Community generators make up 25MW of consented onshore generation. Seven deployments are currently planned, ranging from 900kW to 9MW.

6.8 Multi-MW solar power plants augmented by large batteries have been proposed for the Outer Hebrides. These plants may be operated ‘off-grid’ so that a private

electricity supply would be created for key customers, e.g. the Local Authority, hospitals, housing partnerships, Stornoway township and/or large industrial customers. This is essentially an ESCO model.

6.9 Many of the generators on this list will either have their own route to the retail market or will have signed contracts with other off-takers, e.g. in the form of power purchase agreements.

OPPORTUNITIES – CUSTOMERS 6.10 A detailed analysis of the UK Market opportunity is beyond the scope of this study and will have to be addressed in a full business plan for the venture. However, some general observations can be made.

6.11 As observed in the Gotland case study, local anchor customers with high electricity demands provide a significant stimulus to energy sector growth. Given heavy Highlands and Islands investment proposed in fibre broadband as well as energy, and the security, climate and clean energy advantages afforded by the Outer Hebrides, there may be opportunities to dovetail these investments productively in the form of renewable energy driven data centres.

6.12 Highlands and Islands Enterprise has announced a £126.4 million next generation fibre broadband project to be implemented by BT. The project includes subsea links to Lewis and the Uists and overland links through the Outer Hebrides (http://www.hie.co.uk/regional-information/digital-highlands-and-islands/next- generation-broadband/). This project will radically transform the Hebridean environment for further data-rich and indeed energy-rich investments.

6.13 Data centres can consume up to 100 to 200 times as much electricity as standard offices (National Renewable Energy Laboratory, 2011). In a typical data center, cooling systems and IT equipment loads account for a very large proportion of the entire facility’s energy use and ongoing operational costs.

6.14 BT, the BBC, Google, Carphone Warehouse, and Iomart are examples of companies with heavy data centre requirements. The BBC has a strong Stornoway media presence through BBC Alba. Google have invested heavily in renewable energy facilities and power purchase agreements (Google, 2011).

6.15 Carphone Warehouse has a large customer support facility in Stornoway, acquired from the leading UK cloud-computing company Iomart. Iomart has strong Hebridean connections and is one of the most successful companies on the AIM market and strongly emphasizes green hosting and cloud services.

6.16 Even if they chose not to locate strategic data centre facilities on the islands, companies such as these are likely to be excellent ESCO targets for entering into long-term power purchase agreements.

6.17 Other potential ‘anchor customers’ for the ESCO include Hebridean Housing Partnership, BiFab, BASF and the NHS. Hebridean Housing Partnership, for example, has undertaken energy efficiency studies on its housing stock as part of its drive to improving the thermal condition of the stock and reducing fuel poverty in the Western Isles.

CHALLENGES – COMPETITION AND BARRIERS TO ENTRY 6.18 Competition – the ESCO will face stiff competition. In the local market, SSE and other members of the ‘big six’ provide electricity to consumers, and mid-size renewable energy aggregators such as Good Energy, Smartest Energy and Co- operative Energy are busily signing long-term power purchase agreements with local generators. In the heating sector, Scottish Fuels dominate the local market.

6.19 A list of UK Domestic Electricity Suppliers is given in Table 6.1

Supplier % renewables Atlantic (SSE) 14.0 British Gas 7.9 Centrica (British Gas) 7.9 Co-operative Energy 100.0 Countrywide Energy (green energy uk) 32.0 e.on 5.2 East Midlands Electricity (e.on) 5.2 Eastern Electricity (e.on) 5.2 Ecotricity 64.3 EDF Energy 3.0 Equipower / EBICo (SSE) 14.0 First:Utility 5.1 Good Energy 100.0 Green Energy UK 32.0 LoCO2 Energy 45.0 London Energy (EDF Energy) 3.0 M&S Energy (SSE) 14.0 Midlands Electricity (npower) 12.0 Midlands Gas (e.on) 5.2 National Trust Green Energy (npower) 12.0 Northern (npower) 12.0 Norweb Energy (e.on) 5.2 npower 12.0 Npower Direct 12.0 OVO Energy 28.5 Sainsbury Energy (British Gas) 7.9 Scottish Gas (British Gas) 7.9 Scottish Hydro-Electric (SSE) 14.0 ScottishPower 13.5 Seeboard Energy (EDF Energy) 3.0 Southern Electric (SSE) 14.0 SSE 14.0 Sterling Gas (e.on) 5.2 SWALEC (SSE) 14.0 SWEB Energy (EDF Energy) 3.0 Telecom Plus (npower) 12.0

TXU Energi (e.on) 5.2 Utilita 0.8 Utility Warehouse (npower) 12.0 York Gas (npower) 12.0 Yorkshire (npower) 12.0 Table 6.1: Licensed UK electricity suppliers

6.20 Limited Route to Market for Scottish Island Generators and Suppliers – the absence of a large-scale grid interconnector to the Scottish mainland, together with onerous transmission charging is a severe barrier to entry for the ESCO in the wider UK market.

6.21 Generators need to be able to sell their electricity. There are normally two routes to market: (a) Power Purchase Agreement (PPA) with a supplier or aggregator who will manage key risks including offtake and balancing risks on behalf of the generator; and/or (b) sell power directly e.g. through brokered Over the Counter (OTC) contracts or on power exchanges.

6.22 FiT CfD provides long-term price certainty and mitigates some risks preventing generators from trading directly in the market. Independent renewable generators have raised concerns, however, that poor levels of liquidity could leave them with no choice but to enter into PPAs to secure finance for investment. In the absence of a supplier obligation, PPAs would only be available at a steep discount.

6.23 Regardless of market liquidity smaller generators may still prefer to pass the risk of managing trading and balancing risks on to bigger companies through PPAs not least because direct market participation can be complex and may require an in- house trading capacity. Will the ESCO take on management of trading and balancing risks and the complexity and skills required for such operations?

6.24 Firms that are able to manage balancing risks associated with intermittent renewables will still find opportunities in offering PPAs. As with the current Renewables Obligation (RO), market economics and competition will determine the discount that generators are exposed to.

6.25 New opportunities are emerging for companies such as the ESCO to offer aggregation services and enter the PPA market.

6.26 Cooperative fund structures and not-for-profit business models have proven to be successful options. These can support development of distributed generation projects that can increase diversity of supply, meet the needs of local people and support local fuel poverty objectives. Joint public/private sector action on such projects spreads risk across a number of players and leverage investment.

6.27 Transmission Network Charging is an issue which is central to the viability of the ESCO. Changes are imminent: ‘We have welcomed the review of the charging methodology by Ofgem in Project TransmiT, which concluded the status quo on

charging is no longer an option, and note their view that Government is best placed to determine a preference or subsidy for one form of generation or one area of the country over another. Working together with the Shetland, Orkney, Western Isles Councils and HIE, we are fully playing our part in the ongoing industry panel review of the findings of Project TransmiT. It is essential that this review delivers on the wider changes to the charging regime set out in TransmiT. It must also help to deliver a charging regime that levels the playing field creating conditions that are better able to deliver Scotland’s vast renewable energy potential and that reflect the realities of our future generation mix.We have called consistently for further action on islands charging, in addition to the ongoing industry panel review. On 11 October this year the Scottish Government and DECC announced the formation of an Islands Charging Group, which will undertake to identifying and undertaking a detailed assessment of options for addressing or mitigating the charges faced by renewable energy generators in the Scottish Islands.’ (Scottish Government, 2012)

6.28 Liquidity – Barriers to entry and growth in the UK’s electricity generation markets identified in the 2011 White Paper include liquidity. There are relatively low levels of liquidity in electricity forward trading markets, posing problems for smaller independents. Lack of liquidity in the electricity wholesale market makes it difficult for independent suppliers and generators to buy and sell energy at the volume and in the timescales they need to operate effectively, thus undermining investment signals.

6.29 Significant improvements in wholesale market liquidity are essential to ensure a competitive market to promote long-term security of supply, to enable Electricity Market Reform and to deliver efficient and cost-effective reforms. Ofgem is addressing liquidity issues through Retail Market Review. Independent generators, including new entrants, need viable routes to market to meet their commercial needs and allow them to achieve relevant reference prices to enable them to benefit from the Feed-in Tariff with Contract for Difference (FiT CfD).

6.30 Big-six dominance – Possible reasons for low liquidity include the role of vertically-integrated generators who have less need to trade and are able to hedge between their supply and generation activities.

7 COST BENEFIT ANALYSIS AND FINANCING

COST BENEFIT ANALYSIS 7.1 Lewis Wind Power, a joint venture between AMEC Project Investments and EDF Energy, is currently planning the design, construction and operation of a wind park of 150 MW in Stornoway on the Isle of Lewis. The development will be taken forward in partnership with The Stornoway Trust, the landowner. An Outer Hebrides Energy Supply Company would enable the community’s share of the electricity generated to be retailed to the local community and the wider UK market.

7.2 Formation of the ESCO will enable Local Authority investment on behalf of the community in the Stornoway Wind Farm in return for ownership of up to 26 MW of generation. The developer has presented the local community with an opportunity to purchase 20% of generation in the form of a floating share of generation rather than individual turbines.

7.3 The Stornoway Wind Farm development is located to the south-west of Stornoway with a site boundary covering approximately 1,700 hectares. Access to the site is via existing roads. A substation will house electrical infrastructure and 31 km of new and upgraded site roads will be constructed. Two 90 metre anemometer masts will be erected and turbines will be linked to each other and to the site substation by buried cable.

7.4 The island Grid is currently at capacity with a dated 22 MW Radial Connector oversubscribed, leading to local diesel generation to meet on-island demand in peak periods. A new 450 MW Radial Connector is proposed, with completion currently anticipated for 2017.

7.5 In the absence of detailed information on Stornoway Wind Farm economics, which remains confidential to the parties involved, an outline cost-plan for the ESCO was developed.

7.6 A Capital Payment of £39m to Amec/EDF for a 20% share in Wind Farm Development (assumed to be on pro rata basis) has been assumed, together with startup costs of approximately £1m.

7.7 Operating costs and revenues are modelled primarily on information presented in the following: Scottish Islands Renewable Project Final Report (Redpoint-Baringa- TNEI, 2013), Electricity Generation Costs (DECC, 2012) and published OFGEM reports.

Fig 7.1: Waterfall chart for levelised cost of electricity generation (Redpoint- Baringa-TNEI, 2013)

7.8 A Levelised Cost of Electricity Generation (LCOE) waterfall chart for the Western Isles presented in the Scottish Islands Renewable Project Final Report is shown in Figure 7.1 . The chart starts with a UK Central UK Onshore Wind >5MW cost of £84/MWh. Additional Western Isles specific cost differences for pre-development, Capex, and Opex are then added. Transmission Network Use of System (TNUoS) charges of £48/MWh are then added which reflect SHE-T estimates of over £700m for the transmission link. Finally, a wind yield cost reduction factor of £27/MWh is subtracted to arrive at a Western Isles specific LCOE of £130/MWh.

7.9 In our ESCO model we model wind yield as a revenue enhancement and therefore we include an expenditure value of £157/MWh as our central case. For the ESCO cost plan, three scenarios were modelled, utilising best, mid and worst case estimates of key variables shown in Table 7.1. The average operational cost estimates range from:

a) £80/MWh: the lowest on-shore wind mainland UK estimate by DECC (2012) b) £157/MWh: based on the Redpoint-Baringa-TNEI (2013) model c) £173/MWh: highest onshore wind mainland UK estimate from DECC (2012) of £110/MWh plus 57% additional cost due to new Transmission Grid link as per Beinn Mhor submission to OFGEM – Beinn Mhor Power (2010).

Scenario 1 – Scenario 2 – Mid- Scenario 3 –

Most range Least favourable favourable

Capacity Factor 38.50% 37.50% 36.50%

Average operational cost £80 £157 £172.70 estimate (per MWh)

Retail Value of electricity £160 £150 £140 (per MWh)

ROC Buyout Price (per £35.76 £36.99 £38.69

MWh)

Assumed recycled value per £18.61 £14.35 £3.58 ROC (per MWh)

Total ROC Value £54.37 £51.34 £42.27

Table 7.1: Key cost-plan variables.

7.10 Revenues and expenditures were estimated based on the existing ROC incentive mechanism and published Fraser of Allander methodology (Large wind-farm (Allan, 2008), as shown in Table 7.2.

Revenues

Sale of electricity

Rated capacity of windfarm (MW) Capacity factor Annual Energy Production (MWh) Retail Value of electricity (per MWh) Total annual revenues

Sale of Renewable Obligations Certificates (ROCs)

ROC Buyout Price (per MWh) PPA discounted ROC PPA discounted ROC value Revenue from ROC sales

Recycled value from ROC buyout fund

Assumed recycled value per ROC (per MWh)

Sale of Climate Change Levy Exemption Certificates

Rate for LECs (per MWh) Achieved rate Revenue from LECs

TOTAL REVENUES

Expenditures

Average operational cost estimate (per MWh)

Total annual operational expenditure

REVENUES LESS EXPENDITURES

Table 7.2 Table of Revenues and Expenditures

7.11 Revenues and expenditures were calculated for two values of Island ROC support mechanisms. The results of our calculations are summarised in Table 7.3. In the worst case scenario the ESCO is marginally profitable. Our mid-range scenario shows revenues of £17.2m and expenditures of £13.51m yielding a surplus of around £3.69m per annum. The same model indicates that a UK Central 26MW wind-farm would be a much better investment and would yield a surplus of nearly £7.8m per annum assuming a capacity factor of 30%. This clearly demonstrates that Western Isles onshore wind projects are significantly disadvantaged by large TNUoS charges and is consistent with the findings of the Redpoint-Baringa-TNEI (2013) model.

Revenues less Expenditures

Island ROC Scenario 1 – Most Scenario 2 – Mid- Scenario 3 – Multiplier favourable range Least favourable

1 £11.5m £3.69m £0.49m

cf. UK Central – 30 % Capacity Factor - £7.79m

2 £14.02m £6.03m £3.06m

Table 7.3: Revenues less expenditures for the three scenarios and two ROC multipliers.

7.12 If an island ROC multiplier of 2 is applied as postulated in the Redpoint-Baringa- TNEI (2013) report, the 26MW Hebridean wind-farm yields a significantly improved surplus of around £6m per annum. Although returns are still lower than UK Central, ESCO viability is demonstrated. In essence, if the Transmission Grid to the Hebrides is built and a stronger Scottish Islands Renewables incentive

mechanism emerges then the ESCO is an attractive financial proposition. Note that there are many assumptions in these figures that need to be challenged and developed in a more detailed financial model.

7.13 Summary cost-plan information for our mid-range scenario under the present ROC support mechanism is given in Table 7.4 Further detail on the Cost-Plan is presented in Appendix D.

SUMMARY

ESTIMATED EXPENDITURE AND START UP £40,000,000 COSTS

ESTIMATED REVENUES PER ANNUM £17,200,000

ESTIMATED OPERATING COSTS PER ANNUM £13,510,000

ESTIMATED PROFIT/LOSS PER ANNUM £3,690,000

Table 7.4 Cost-plan Summary

FINANCING 7.14 The Scottish Futures Trust (2011) indicates that structures can be financed through a range of different funding sources including direct Council funding, partner funding, commercial bank funding including EIB (European Investment Bank) and capital grants.

7.15 The Greater Manchester Waste PFI project provides an instructive example of public-private sector financing on very large-scale capital projects (New Civil Engineer, 2009).

7.16 The Manchester Waste £3.8bn project was a joint venture established between waste contractor Viridor and infrastructure investor John Laing to build and operate waste facilities across the Greater Manchester area for 25 years. The project was supported by the UK Treasury’s Infrastructure Finance Unit.

7.17 £529.5M of project funding came from public sources in either direct finance or loans. Project capital expenditure was estimated at £640M. £120M was provided by the Treasury’s unit as a loan, with £100M loaned by the European Investment Bank (EIB). £124.5M was provided in PFI credit. The Greater Manchester Waste Disposal Authority made a capital contribution of £68M and an additional loan amount of £35M. Private banks contributed an combined total of £245M.

7.18 The Viridor/Laing joint venture was thought to contribute £90M in equity for the venture. The EIB loaned an additional £82M to waste firm Ineos Runcorn TPS to build a Combined Heat and Power Plant to incinerate residual waste.

7.19 Direct Funding Councils are funding renewables schemes directly through either the UK Debt Management Office’s Public Works Loan Board or their wider capital budgets. Where funding is invested in an arm’s length company, Councils will need to comply with their Standing Orders and Local Government Regulations.

7.20 Partner Funding Many renewables schemes are self-funded by industry partners. Funding is often replaced post-construction with commercial debt, resulting in a lower cost of capital and an increase in the project’s IRR (internal rate of return).

7.21 Commercial Debt Provided by banks on normal commercial terms. Unlike project finance security is not necessarily ring-fenced to the specific project. Appropriate for projects below £15m.

7.22 Project Finance Requires that a separate company is established which ring- fences the cash flows of the project, against which project finance is secured.

Common model for PPP and unlikely to be suitable for projects below £20m. Contract periods often in excess of 15 years.

7.23 EIB Lending EIB lending for renewable energy reached EUR 6.2bn in 2010. Majority of lending is directed to wind and solar power generation. EIB has other financing means, such as equity and carbon funds. The Bank also provides technical assistance to develop projects.

7.24 European Energy Efficiency Fund Support energy efficiency projects and renewable energy sources, and is targeted at sustainable energy projects promoted by EU public authorities. Funds available are €205m.

7.25 Green Investment Bank availability of £18bn of capital to fund renewable projects for purposes of: (a) risk mitigation (b) refinancing commitments guaranteeing other funders an exit strategy; and (c) capital provision.

7.26 Low Carbon Networks (LCN) Fund established by Ofgem provides up to £500m support to low carbon economy projects sponsored by the distribution network operators (DNOs) to try out new technology, operating and commercial arrangements. Ofgem has also introduced Network Innovation Competitions (NICs) and the Network Innovation Allowance (NIA).

8 RISK ASSESSMENT

OVERVIEW 8.1 Larger players manage risk through diversity (DECC, 2011). They maintain a balanced portfolio of customers, generation technologies and energy contracts and power purchase agreements of varying lengths.

8.2 ’Hedging’ refers to making investments to reduce exposure to (short-term) price movements in an asset already held, normally by taking an offsetting position in a related asset. For an electricity generator the risk of electricity price movements can be hedged financially by selling electricity in the forward markets or entering into long-term contracts; or physically by integrating with an electricity supply business. Downward movement in prices resulting in a loss in revenues for the generation business is then offset by an increase in revenues for the supply business. Large players typically have a natural hedge between generation and supply activities.

8.3 Independents in the electricity markets identify concerns including large trade sizes, a limited range of products that do not meet their needs, difficulty in meeting hedging requirements. This makes risk management more challenging for independent generators and suppliers than for the large vertically-integrated power companies.

8.4 Risk is dependent on the ownership and operational model used for the ESCO and the mix of technologies used. Risks will vary according to the level of private involvement in the project, what the aims of the project are and the size of the project.

8.5 The AP Benson report recommends that risks should be identified and approaches to mitigating the risk by way of insurance, management, investment etc established (McLaren, 2011). Risks should also be costed into a financial model so that their impacts on a worst case basis can be assessed.

EXAMPLES - MARKET & TRADING RISKS 8.6 Weather risk: SSE’s Annual Report for 2012 highlights the strong infuence of weather risk on electricity supply. (SSE, 2012). Figure 8.1 shows the dramatic changes in average GB wind-speed over the last few years, including an 18% drop from 2008 to 2010.

8.7 The UK’s geographic location between the Atlantic Ocean and continental Europe means that small changes in wind direction can bring marked changes in the weather making long-term weather forecasting difficult. Cold spells in the UK lead to a surge in heat demand, while in warm weather demand can fall dramatically.

In southern England higher penetrations of air conditioning in buildings can cause electricity demand to increase at times of higher temperature.

Fig. 8.1: Average GB Wind Speed (SSE, 2012)

8.8 Residential and commercial buildings account for almost two thirds of non- transport energy consumed each year. 60% of residential energy is used for heating and cooling with a corresponding figure of 40% for commercial customers. Weather related fluctuations in energy use are substantial with a 1°C increase in average temperature decreasing space heating needs by 6-10%.

8.9 Spatial and temporal variations in weather are therefore important influences on how electricity supply companies – especially wind-based generators and suppliers – are managed.

8.10 Trading risk: In the forward markets, buying and selling of electricity for delivery in the month ahead and after may include trades in months, seasons and years ahead of delivery.

8.11 ‘Day-ahead’ trading refers to buying and selling for delivery of electricity on the day after trading takes place. Day-ahead markets tend to offer reasonably liquid trading.

8.12 BMReports provides data regarding wholesale UK electricity prices including the System Sell Price (SSP), System Buy Price (SBP) (both in £/MWh). These prices are used to settle the difference between contracted generation or consumption and the amount that was actually generated or consumed in each half-hour trading period.

8.13 SSP is paid to BSC Trading Parties who have a net surplus of imbalance energy. SBP is paid by BSC Trading Parties who have a net deficit of imbalance energy. An example of the substantial volatility and difference in these prices is given in Figure 8.2, pertaining to 48 half-hourly periods in 26th February 2013. At 5.30 pm BSC Trading Parties with a net deficit would have paid approximately £140/MWh while Parties with a net surplus at the same time would have been paid approximately £74/MWh.

Fig. 8.2: Variation of System Buy Price and System Sell Price in a 24-hour period.

8.14 A full list of Risks is presented in Table 8.1 and this, plus mitigation, should be considered in the further development of the project.

Risk Category Risk Mitigation

Construction & Lack of know-how and professionalism. Operational Local rivalries.

Small world thinking and attitudes.

Failure to achieve agreed energy/cost savings.

Potentially diluting impacts if services are out- sourced to organisations not sharing common aims/objectives.

Different technologies bring their own risks. Wind energy relies on the weather. Solar energy works better when there is less cloud cover. Key risks associated with technology include: Maintenance costs/ breakdown of the system; Inappropriate weather; Security issues; Vandalism of infrastructure.

Financial Not finding the investments needed. Investment risk.

Project exceeding initial capital cost estimates

Payback risk: project taking too long to deliver savings.

Credit risk: collateral and financing risks related to wholesale market trading

Lack of funds

Grid Resolution of grid issues

No cable for electricity transport. Risks associated with SHETL capital investment programme and placing of contracts.

Market & Offtake risks: The risk that generators, Trading particularly small, intermittent generators such as onshore wind will be unable to guarantee a buyer for their electricity impacting their ability to obtain finance.

Balancing risks - including the need to buy and sell power in the intra-day market and avoid exposure to the cash-out price. Cash-out is the process designed to target the cost of energy balancing incurred by the System Operator to the parties who created those costs (i.e. those parties who do not balance their inputs and outputs within the relevant balancing period)

Fragmentation between energy suppliers.

Lack of quality market research.

Difference between customer base buy-in to concept and actual purchase of products.

Price risks. FiT CfD proposals address the price risk for low-carbon generation, subject to achieving the reference price. To ensure that payments made under FiT CfD cannot be distorted, FiT CfD requires a robust reference price which is reflective of market fundamentals and cannot be manipulated. Distortions could leave consumers paying more than is necessary.

Basis risk - risk of deviation between the market price achieved by the generator and the reference price in, for example, FiT CfD contracts

Trading volumes: there is concern that there is Improving liquidity is currently insufficient market liquidity to thought to be essential support an effective FiT CfD. for supporting the operation of FiT CfDs.

Achieving economies of scale with such small market.

Weather risk: Need to manage consumer Accurate forecasting is demand to align with variable energy supplies required, as is knowledge of generation plant availability from other suppliers, customer demand and contractual arrangements with customers and suppliers. These permit assessment and management of exposure to weather fluctuations and wider market price risk.

Independent renewable electricity generators have raised concerns that poor levels of liquidity could leave them reliant on Power Purchase Agreements (PPAs) - an agreement to supply to another company - to secure finance for investment and that in the absence of a renewable obligation from 2017, PPAs would only be available at a steep discount.

Discontinuation of many fossil fuel generation plants that are more widely understood and perceived as more reliable

New variables will be introduced into consumer's energy planning that will cause confusion initially and take time to bed in.

Political & Lack of local community enthusiasm for the Regulatory project.

Perception of diverting funds from other key services.

Maintaining public interest in schemes.

Maintaining staff interest in schemes.

Impact of state aids if public funds are involved.

Future framework over the lifetime typically 30- 50 year perspective.

No permission to put up new energy plants.

Table 8.1: Risk table.

9 RECOMMENDATIONS AND CONCLUSIONS

VIABILITY 9.1 Energy Generation, Supply or Services? The study has demonstrated that there are important distinctions between energy generation, supply and service activities. The ESCO stakeholders must agree on the key goals of the venture at the outset.

9.2 The core aspiration is to retail electricity at attractive, clean-energy Hebridean tariffs to local and export customers and the company must be set up to deliver this service well. The ability to pass on energy savings to local people is a key goal.

9.3 In order to hedge trading risk, electricity suppliers typically diversify into generation.

9.4 Other energy services such as renewable heat and energy efficiency projects can be delivered in the longer term on the back of success with the core offering.

9.5 Owner-Operator, Joint-Venture or Arm’s Length? For the Outer Hebrides Energy Supply Company, a key question is where stakeholders such as the Local Authority, the Stornoway Trust and community energy groups would wish to see the ESCO situated on the risk-reward spectrum outlined by the Scottish Futures Trust. Category A – Owner-Operator, Category B Joint-Venture or Category C Arm’s Length?

9.6 The greatest reward and risk comes from becoming an Owner-Operator company. If Hebridean stakeholders are sufficiently entrepreneurial and determined and able to manage the risks, there is potential for creating a ground-breaking new Highlands and Islands venture of substantial size in the UK electricity market which would genuinely build on the natural resources of the area and foster long- term high-value economic development in the region.

9.7 The creation of an Arm’s Length organisation is the safest option. In this scenario all the risk is managed by large multinationals and a smallish amount of reliable income is generated through what would essentially be a large-scale power purchase agreement. Economic development opportunities are minimal in this scenario. We recommend rejection of this option: it would represent a once-in-a- generation missed opportunity for the Outer Hebrides.

9.8 There are two options we recommend for the ESCO, taking into account current uncertainty regarding the provision of the interconnector to the Scottish mainland.

9.9 OPTION A: Assuming that the radial interconnector to the Scottish mainland is constructed, and that TNUoS costs are appropriately supported, we recommend that the ESCO be created as a licensed electricity supplier in the UK market. In order to manage trading risk effectively, we also recommend that the ESCO become a licensed electricity generator.

9.10 Economic viability and stated appetites of stakeholders balanced against financial, generation, marketing and technical risks; lead us to recommend a Category B Joint Venture model as the most attractive approach for establishing the ESCO. It involves the generation and retail of high volumes of renewable energy, most of the risk is shared and investment requirements could result in inward investment, capital growth and sustainable job creation.

9.11 A Joint Venture with EDF, SSE or a smaller player like Good Energy would put a very sizeable and potentially profitable new player into the UK renewable electricity market with the potential for creating scores of high-value jobs in the Hebrides.

9.12 Once established in the renewable electricity sector, the JV could gradually take on more in the way of renewable heating and transport projects.

9.13 Such a venture constitutes a very exciting prospect for the islands, and indeed for the Highlands and Islands.

9.14 We recommend that a Joint Venture be conditional on a substantial commitment by the electricity industry partner to establish favourable Hebridean community tariffs, and a high-value skilled workforce operation in the Outer Hebrides capable of handling marketing, trading, customer relationship, engineering and research challenges. Over time, as experience increases, a move to Owner Operator status may become more attractive and achievable.

9.15 The question then becomes JV with which type of partner? A large-scale ‘Big 6’ supplier such as EDF or SSE? Or ambitious fast-growth mid-size players such as Good Energy, Smartest Energy or Coop Energy?

9.16 OPTION B: If the radial interconnector is postponed or cancelled, we recommend establishing the ESCO as a broad-based Energy Services company. Such a company would build on the plentiful energy resources of the Hebrides and provide a firm locus for future developments. Fuel poverty, energy efficiency and multi-megawatt off-grid electricity supply projects would form core operations.

ROUTE-MAP 9.17 Following the completion of the current ESCO feasibility study it is recommended that interested parties should develop an investment-ready business plan. Who are the customers; where are they and why will they buy? What will the detailed mix of products and services be, what prices will they be sold at and at what

volumes? What will operational structure and staffing profile look like? What will gross profits/losses be and when will break-even be achieved for the venture? A detailed business plan must be developed to answer such questions. The business plan will:

• Develop and cost the proposed strategy. • Develop a detailed financial model to project the expected revenues, profits and cash flows. • Provide a more detailed and accurate assessment of the return on investment.

9.18 A small operational Project Team should be formed from Local Authority, industry, academic and community stakeholders, and be tasked with overseeing the Business Plan process and bringing the ESCO venture to fruition within a prescribed timescale. The team should be funded through cash or in- kind/secondment contributions. It will be important to include or contract in a mix of expertise on this team including commercial/marketing, electricity trading and technical expertise.

9.19 Proposals should be developed targeting financing sources and instruments. Comhairle nan Eilean Siar’s new Capital Programme offers an opportunity to align Comhairle spending plans with the ESCO. Access to new and existing funding sources within Europe is currently being explored and these funds will be used to match any Comhairle allocations. The Comhairle is in discussions with local renewable energy developers to explore the possibility of investment funding. The Community Energy Scotland Innovation Fund is a possible funding mechanism for more detailed study.

9.20 The Project Team should initiate Joint Venture exploratory discussions with potential community and industry partners. The ultimate aim of this will be to enter into a partner agreement, and commence formation and staffing of the company vehicle on a small scale. It will be essential to recruit knowledgeable, effective leadership, which will form the nucleus for long-term company growth.

9.21 Concurrent with this, the Project Team should initiate a range of pilot projects and studies, e.g. market research, technical studies on hedging/weather risk/electricity trading, and strong engagement with small generation and supply projects in the Hebrides.

9.22 The Gotland example highlights the benefits of establishing a suite of meaningful Outer Hebrides energy projects to build learning and provide impetus for future developments. SmartGrid Gotland bears strong similarities to the £34m Shetland Northern Isles New Energy Solutions (NINES) project for example involving Shetland, Scottish Hydro Electric Power Distribution, Smarter Grid Solutions and the University of Strathclyde. The project is supported by the OFGEM Low Carbon Innovation Fund and features:

• modelling to better understand demand and supply on Shetland • a 1MW battery for energy storage • domestic demand side response • additional ‘flexible’ demand through a 130MWh thermal water store and 4MW electrical boiler forming part of a district heating scheme • connection of more renewable generation • Active Network Management (ANM) system • learning relating to customer behaviour

9.23 Identify and secure commitments from early suppliers and adopters – wind, wave and solar energy generators, Local Authority, NHS, large local companies and organisations, UK companies with strong sustainability commitments. Secure reliable revenue streams and projects as initial foundation.

9.24 The Route Map to establish the Outer Hebrides Energy Supply Company is summarised in Table 9.1, indicating the key tasks and outline programme to enable the company to be formed.

OUTER HEBRIDES ENERGY SUPPLY COMPANY (ESCO) KEY TASKS & OUTLINE PROGRAMME

Task Detail/Comment Timescale

Phase 1: July 2013-July 2014 Proposal Development

Establish Project § Set up Project Development Team (Comhairle/Stornoway Trust and other parties) July-December 2013 Development Team § Define role, responsibilities and outputs

Project Plan and Funding § Finalise Project Plan for Development Phase. July – December 2013 § Secure funding for Development Phase

Procure Consultancy § Procurement process for Phase 2 January- July 2014 Services § Consultancy support in place for Phase 2 by July 2014

Exploratory Discussions § Initial discussions with potential partners. January- July 2014 with Joint Venture Partners

Phase 2: July 2014 – December 2016 Business Planning

Initiate Business Planning § Project Manager: To be commissioned on flexible basis. July 2014-December 2015 Phase § Business Planning including Investment and Financial advisors: To develop Investment Ready Business Plan § Commercial and Legal Advisers: To support and inform competitive dialogue process and licensing process with Ofgem, other legal considerations. § Potentially Technical and Trading Studies to inform Business Plan: including

detailed study of electricity entrant market risks, network, operations, r&d studies. § Market Research: Customers, competition Investment Ready § Business Plan completed December 2015 Business Plan

Finalise Discussions with § Competitive Dialogue with 3 parties March 2016 Joint Venture Partners § Conclude competitive dialogue process by March 2015 § Draft Heads of Terms prepared Company Financing § Startup and capital funds in place - £3.6m plus capital costs (Green Investment Bank, October 2016 Secured HIE, EIB, HM Treasury as potential sources)

Supply and Generation § Ofgem December 2016 Licenses Secured

Phase 3 – 2017 Trading with JV Partner, Windfarm Build, Company Development

Company Premises § Outer Hebrides HQ March 2017 Secured

Chief Executive, Board of § Recruit Chief Executive and Core Staff March – July 2017 Directors and Core Staff § Board Members Appointed § Chief Executive and nucleus of operations team takes over from project team

Phase 4 – 2018 Sale of Hebridean Electricity in UK Market

Market Trial 1 – Local § Local Trial 2018

Early Adopter Power § Small number of large-scale anchor customers 2018 Purchase Agreements Secured

Market Trial 2 • Export Trial 2018

Full company launch into • Sale of Hebridean Electricity into UK Market 2018 market § UK Trading Commences § Energy Contracting Services • R&D Projects Table 9.1: Route-map showing key tasks.

REFERENCES

Allan (2008), Allan, G., Ault, G., McGregor, P. and Swales, K., The Importance of Revenue Sharing for the Local Economic Impacts of a Renewable Energy Project: A Social Accounting Matrix Approach, Strathclyde University Discussion Papers in Economics, http://www.strath.ac.uk/media/departments/economics/researchdiscussionpapers/2 008/08-11strathecon.pdf

Beinn Mhor Power (2010) Project TransmIT Submission To OFGEM, http://www.ofgem.gov.uk/Networks/Trans/PT/Documents1/Beinn_Mhor_Power.pdf

Comhairle nan Eilean Siar (2006), Muaitheabhal Windfarm Non Technical Summary, http://www.cne- siar.gov.uk/windpower/beinnmhorwindpower/documents/NTS_Text%20and%20Figu res%20FINAL.pdf

Comhairle nan Eilean Siar (2011), Island Sustainable Energy Action Plan – Outer Hebrides. Report for the ISLE-PACT Project, July 2011, http://www.islepact.eu/userfiles/ISEAPs/Report/hebrides/ISEAP%20Finalised%2025 jul11-corrFO.pdf

DECC (2010) Sale of Electricity by Local Authorities (Scotland) Regulations 2010

DECC (2011), Planning our electric future: a White Paper for secure, affordable and low‑ carbon electricity, July 2011, https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/481 29/2176-emr-white-paper.pdf

DECC (2012) Electricity Generation Costs, https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/657 13/6883-electricity-generation-costs.pdf

GoodEnergy (2012), AIM Admission Document, Good Energy Group, http://www.goodenergygroup.co.uk/media/BahbBlsHOgZmIh01MDBmY2JiZmNjOTMy NjAwMDIwMDA1N2U/GoodEnergyGroupAdmissionDocument.pdf?suffix=.pdf

Google (2011), Google’s Green PPAs: What, How, and Why, http://static.googleusercontent.com/external_content/untrusted_dlcp/www.google.co m/en/us/green/pdfs/renewable-energy.pdf

Gotland (2012), Sustainable Energy Action Plan for Gotland. Report for the ISLE-PACT Project, December 2012,

http://www.islepact.eu/userfiles/ISEAPs/Report/gotland/GOTLAND_SEAP_2020_eng.1 21218.pdf

IslePact (2011), Deliverable 6.4.1 Conclusions of Bankability analysis. http://www.islepact.eu/admin/files/Co- 1%20Community%20Investment%20in%20Onshore%20Wind.pdf

International Power (2012), http://www.iprplc-gdfsuez.com/news/press- releases/2012/02-04-2012.aspx

Lewis Wind Power (2013), Stornoway Wind-farm Project Website, http://www.stornowaywind.com/

Liljegren, C. (2001) Wind Power in the local Grid, Problems and solutions, CLEPS AB Report, Conference Wind Power on Island, Gotland Sweden September 2001 http://www.cleps.se/upload/Wind_Power_on_Islands_papper.pdf

McLaren, A. (2011) Investigation of the options available for setting up an Energy Services Company (ESCO), AP Benson Management Consulting Report, http://www.apbenson.com/assets/Uploads/ESCO2.pdf

National Renewable Energy Laboratory (2011) Best Practices Guide for Energy-Efficient Data Center Design, U.S. Federal Energy Management Program Report, http://www1.eere.energy.gov/femp/pdfs/eedatacenterbestpractices.pdf

New Civil Engineer (2009) Greater Manchester Waste PFI Deal, http://www.nce.co.uk/greater-manchester-waste-pfi-deal-completed-with-treasury- cash/5200302.article

Redpoint-Baringa-TNEI (2013) Scottish Islands Renewable Project Final Report https://www.gov.uk/government/publications/scottish-islands-renewable-project- final-report

Scottish Government (2009) Second National Planning Framework for Scotland (NPF2), http://www.scotland.gov.uk/Resource/Doc/278232/0083591.pdf

Scottish Government (2011) Securing the Benefits of Scotland’s Next Energy Revolution: Consultation Response from Comhairle nan Eilean Siar, http://www.scotland.gov.uk/Resource/Doc/348977/0116539.pdf

Scottish Government (2012) 2020 Renewable Routemap for Scotland – Update, http://www.scotland.gov.uk/Resource/0040/00406958.pdf

Scottish Futures Trust (2011) Report on the Commercial Aspects of Local Authority Renewable Energy Production, http://www.scottishfuturestrust.org.uk/files/publications/Report_on_the_Commercial_ Aspects_of_Local_Authority_Renewable_Energy_Production.pdf

Shetland News (2012) NINES enters next phase, http://www.shetnews.co.uk/newsbites/5664-nines-enters-next-phase

SSE (2012), SSE Annual Report, http://www.sse.com/uploadedFiles/Controls/Lists/Reports_and_Results/SSE_AnnualR eport2012.pdf

APPENDIX A – CONSULTATION RESPONDENTS

Organisation Type

Tolsta CDL Community Owned Company

North Uist Development Company Community Owned Company

Point and Sandwick Power Community Owned Company

SSE Electricity Transmission and Distribution and Renewable Energy Developer

Sintef Research Institute

Gotland Local Government

GreenspaceLive Private sector firm

Aquamarine Power Renewable Energy Developer

2020 Renewables Renewable Energy Developer

Community Energy Scotland Community Owned Company – Community Energy Scotland is a charity regulated by a board and its members

UOG Galson Energy Community Owned Company

APPENDIX B – GEAB GOTLAND: TECHNICAL CHALLENGES OF LARGE WINDPOWER PRODUCTION ON AN ISLAND NETWORK B.1 A technical paper authored by GEAB Gotland highlights some of the challenges associated with large scale wind power generation, grid management and electricity supply to local island customers and mainland export.Wind Power in the local Grid, Problems and solutions (Liljegren, 2001).

B.2 An essential point is that Gotlands Energiverk AB (GEAB) is the owner of the network. Clear roles and responsibility are required in a deregulated market. In Sweden the owners of windmills are mostly independent producers.

B.3 The cement industry is the biggest consumer, an anchor customer for electricity consuming nearly 30% of the electrical energy on the island in 2001.

B.4 There is a long history of electrical power production on Gotland. In the early 20th- century a coal- and diesel-fuelled power plant was built. In the countryside small diesel generators were built for local consumption. In 1930 small power units to the system were connected with overhead lines. In 1954 the first HVDC link in the world was created between the mainland and Gotland. Rated power of this link was 15 MW, later upgraded to 30 MW. In 1970 consumers began to use electrical power for heating and the consumption increased considerably.

B.5 In 1983, the old HVDC link was taken out of operation and a new one replaced it with 150 MW rated power. A few years later a second HVDC link was built to ensure resilience and security of supply.

B.6 The island network consists of approx. 300 km 70 kV lines, 100 km 30 kV lines and 2.000 km 10 kV lines. Normally there is no local production other than wind power. The HVDC-Link transfers power from the mainland and regulates the frequency on the island. In order to keep voltage stability there are also synchronous generators that play an important role in the system.

B.7 Energy turnover in the system in 2001 was about 850 GWh, the peak load approx. 160 MW and the minimum load around 40 MW. About 36.000 customers were connected.

B.8 A large increase of wind power generation occurred from 3MW in 1984, 15 MW in 1994 and eventually 155 windmills in 2002 with total installed power of 80 MW producing about 180 GWh.

B.9 Existing infrastructure could not handle increasing production in the south of the Island. In the north a strong network built to feed the largest towns existed. A much weaker system in the south, designed to feed much smaller loads, became a ‘bottleneck’ for wind power generation. In the southern part of the island peak load was only about 17 MW, yet there was about 60 MW wind power capacity

installed. In the southernmost area where the peak load was less than 0.5 MW, approx. 40 of the 80 MW wind power capacity was installed. There was therefore a massive unbalance between load and production, making the system very difficult to manage from a technical point of view.

B.10 Short-circuit power was very low in relation to all connected equipment, compared with a normal distribution system. The system was rather unstable when the rotating mass in the system was very low, compared with a system fed from synchronous generators. Solutions to the island’s power transmission problems were met with installation of the first HVDC-Light plant.

B.11 The HVDC-Light system consisted of two converter stations connected by 70 km double + / - 80 kV DC cable. The converters were connected via reactors to the 80 kV AC bus which was fed from the 75 kV system. The transformers were equipped with tap changers to be able to reduce the voltage on the converter side to reduce no load and low load losses. This was an important feature, since wind power seldom operated at peak production levels, and sometimes did not produce at all.

B.12 It was found to be very important to keep the no load and low load losses as low as possible, as they had a much bigger influence on the electricity system economics than the peak load losses. HVDC Light was equipped with voltage source converters with pulse width modulation (PWM). With PWM just about any system phase angle or amplitude is possible by changing the PWM pattern, which can be done almost instantaneously. This allowed independent control of both the active and reactive power – a PWM voltage sourced converter being close to being the almost ideal transmission network component. From the system’s point of view it acts as a motor or generator without mass and is able to control active and reactive power almost instantaneously. This makes the operation characteristics more software than hardware dependent.

B.13 For a successful expansion of wind power, the electricity system must be adjusted to be able to regulate and keep an acceptable voltage quality. With increasing expansion of wind power production, GEAB co-operated with Vattenfall to ensure a safe supply with good voltage quality.

B.14 Many new ways of handling island network problems such as short circuit currents, flicker and power flows were developed. Essential aspects to study were:

B.15 Flicker - Perturbation of the human eye produced on lighting by voltage variations, often a consequence of variable electrical loads and generations. Conventional windmills exhibit several mechanisms for emission of flicker. ‘Slow’ flicker occurs due to wind gusts. Repeated starts and connections and disconnections of capacitors are a source of ‘fast’ flicker. Most of the flicker from wind turbines comes from the so-called 3P effect, which originates in power and voltage fluctuation at the blade-tower passing frequency, giving rise to power fluctuations around, typically, 1-2 Hz. Most typical frequencies of the voltage fluctuations generated by conventional wind turbines are around 1 and 8Hz, for

which the human eye is most sensitive. A number of standards and recommendations set limits for allowed flicker levels often obtained from statistics and assumptions. These do not guarantee disturbance free voltage.

B.16 GEAB had not used the IEC norm for flicker during planning for installations of wind power. Instead, the amplitude of power fluctuation for different frequencies and limits for different voltage fluctuation were used. This method was safer and gave more information than the statistical values that IEC used. Extensive simulation was work carried out to evaluate flicker levels before and after HVDC- light installation, and to develop a flicker controller that reduced the flicker in the range of 1-3 Hz. GEAB had noticed that several windmills would go into “synchronous” operation, during specific conditions that depend on the grid. The GEAB flicker controller caused these phenomena to disappear.

B.17 Transient phenomena – a very important aspect of wind farm operation is asynchronous generator behaviour during faults in the grid. Sub-transient current increases with more asynchronous generators. If the fault is longer than aprox. 200 ms, the generators take reactive power from the grid, the voltage dip in the coupling point gets bigger and the fault current becomes lower than without wind power. If the grid is protected with over current relays care must be taken about these phenomena. The sub-transient fault current must be calculated and also the fault current calculated in the longer term to have the right settings for relay protection. A quite complicated study was required to obtain the different fault conditions. GEAB, with help from Vattenfall, used computer models for dynamic studies. Studies and measurements showed that the normal synchronous generator controls the voltage too slowly to control these phenomena. Begins to be a problem when the installed asynchronous generators rated power in total is around 1/10 of the short circuit power in the coupling point.

B.18 This became the primary reason for GEAB to launch the HVDC-Light project. On Gotland it is more complicated to deal with transient phenomena due to the response from the HVDC-Link to the mainland which exhibits quite different behaviour from HVDC-Light and also a normal synchronous generator. This produces an impact on voltage dip during faults. Important that the voltage dip does not disturb the customer’s voltage, or at least not more than they can accept.

B.19 Validation – one goal for GEAB is to maintain voltage quality for the customer after a big expansion with wind power. Four fault cases were simulated in computer-models with whole system representation. These cases were compared with a system model without wind power. Steps involved included performing a real three-phase fault, by closing a 10 kV breaker to simulate a solid three-phase short circuit. Took voltage measurements in 10 different points. Close the breaker and let over current protection trip the breaker again. The fault time was not longer than 50 ms, but it showed the response from different equipment. Power responses from some windmills, the synchronous generators, HVDC link and, of course, from HVDC-Light, were measured.

B.20 Power flows Wind power production depends strongly on wind speed. On Gotland power variations around 50% in 10 minutes have been recorded. Variation produces voltage variations in the system that can affect the quality of the supply to the customer. Controlling the voltage by tap changers can be difficult and also affects maintenance costs for the transformers. Disconnecting lines carrying only wind power production when stability problems exist is not an optimal solution either. Capacitor on-off switching is possible, but affects voltage quality considerably. The most convenient method for solving voltage control problem with wind power is to use dynamic voltage control. This can be achieved by power electronics, such as SVC, together with intelligent controlling algorithms. Solution on Gotland has been HVDC-Light, which can optimise the power flow against low losses and voltage level. Algorithms were designed for real time calculation and management of reactive power. Time constants and gains for slow voltage control must be coordinated with tap changer controllers and synchronous machines voltage controllers, to avoid interaction and bad system performance. Interaction between dynamic voltage controllers in tap changer, synchronous machines, power electronics and other types of voltage control devices in a system with large wind power penetration is an aspect that must be carefully studied when setting control parameters since it determines system voltage stability.

B.21 Technical responsibility Ownership for wind power varies considerably. Some consist of shareholders and some is private. Big and small companies have invested in wind power. On Gotland, most are independently owned. GEAB as the grid operator has the responsibility for voltage quality to the customers, and even the producers are grid customers.

B.22 Even although wind power has such an impact on power quality, GEAB has to handle this responsibility without being the owner of the generating plants. Therefore GEAB sets up technical requirements for the connection points. These requirements are defined in terms of current or power. There are also some function requirements as protection and dynamic functions. Windmill owners have the responsibility to present correct data and also follow the requirements set in a contract for grid connection.

B.23 GEAB/Vattenfall innovation continues today with the large-scale SmartGrid Gotland project. ABB are also involved. Electricity networks need modernization to handle larger renewable generation, and many challenges are found in the distribution network. Involvement of the end user is vital to handle the balance between production and consumption. New technical solutions and new customer attitudes towards energy are required for building flexible, sustainable energy systems and promoting efficient energy use.

B.24 The project is also exploring new market models and a more sophisticated electricity production and distribution system to support an increased number of active players, including service providers, third party business aggregators and

RES producers. This R&D project is likely to become an international model for a long-term sustainable electricity power system.

B.25 The project includes the following features:

• new equipment and methods to facilitate increased renewable energy sources (RES) utilisation in the Gotland network. • new Smart Grid technology to provide improved system support for advancements in system control and monitoring of LowVoltage/MediumVoltage systems • demonstrate support for additional wind power generation by integration of : o a battery energy storage facility o a static VAR compensator (SVC) providing the possibility to control active and reactive power • energy storage is an important element in actively balancing local production, typically wind generation, and local loads • systems to support demand response where active consumers respond to a situation where production is low and price increases. • test possibilities for consumers to actively participate in demand respond activities to balance the intermittency of the RES generation • utilise the flexibility of consumer consumption and demand by providing o novel technology metering o energy management facilities o load control via aggregators o utilisation of advanced tariffs o charging of electric vehicles o improve in-house RES generation.

B.26 The financing plan for SmartGrid Gotland is as follows:

• Pre-study Financing: 25% Swedish Energy Agency, 75% Industrial Partners • Stage 1 R&D Financing; 25% Swedish Energy Agency, 75% Industrial Partners • Stage 2 Demonstration & Evaluation Financing; 50% NER 300, 50% Industrial Partners. • A legal agreement between the pre-study industrial partners has been produced, defining cooperation and obligations related to the pre-study. A letter of intent has been signed between the partners ABB, Vattenfall and GEAB regarding the NER300 financing plan.

APPENDIX C – UK ELECTRICITY MARKET REFORM

C.1 The 2011 White Paper ‘Planning our electric future: a White Paper for secure, affordable and low carbon electricity’ (DECC, 2011) provides important context for reform of the UK electricity market, with potentially significant impacts on the viability and long-term prospects of an Outer Hebrides Energy Supply Company.

C.2 In summary, the White Paper identifies that in order to meet demand for electricity, there is a need to invest in renewables and also support new entrants to an electricity market currently dominated by six big firms.

C.3 The current UK electricity market is organised as follows: Government makes policy and a range of delivery bodies (e.g. Ofgem E-Serve) deliver policy. The National Grid operates the GB transmission network. In Scotland the transmission system is owned by SP Transmission Limited and Scottish Hydro Electric Transmission Limited. Private generators produce the electricity and electricity is sold to consumers by suppliers. Ofgem is the economic regulator.

C.4 Problems with the UK electricity market are that a quarter of existing UK electricity capacity – mainly coal and nuclear power stations – will close in the next decade (around 20 GW). Keeping the lights on will mean raising a record amount of investment. Current market arrangements will not deliver investment at the scale and the pace required. Investment must build an electricity system fit for the future.

C.5 Traditional fossil fuels expose the UK to volatile prices, deepen dependence on imported energy and emit too much carbon.

C.6 Solutions include a huge investment in renewables, a new generation of nuclear stations and gas and coal plant that can capture harmful emissions.

C.7 The White Paper focuses on creating the right conditions for investment through a reduction of risks and provision of a clear and stable framework.

C.8 Drivers include threats to security of supply, the need for decarbonisation of electricity generation, rising demand for electricity and expected increases in electricity prices. These drivers are all very positive indicators for formation of the ESCO.

C.9 Investment of around £110 billion in electricity generation and transmission is required by 2020, which is more than double the current rate of investment.

C.10 Problems with current market arrangements are that the market price for electricity is driven by fossil plant with much lower fixed costs relative to operational costs compared with nuclear or offshore wind. Renewables are more volatile and provide uncertain returns compared with gas.

C.11 High barriers exist to market entry, construction costs are high and there is considerable market illiquidity. Small independent players risk not being able to find long-term buyers for their electricity. The carbon price is volatile and hard to predict, there is an uncertain appetite for investment and there are insufficiently strong signals to invest. Most of these problems represent significant obstacles to energy investment in the Outer Hebrides.

C.12 The Government’s strategy is to foster reliable contracts, including long-term contracts for both low-carbon energy and capacity, institutional arrangements to support this contracting approach, delivery arrangements trusted by investors, grandfathering so that there will be no retrospective change to low-carbon policy incentives and a liquid market that allows new entrants to compete.

C.13 In the electricity industry security of supply has several aspects: diversification of supply to ensure supply is not over-reliant on one source or technology; reduction of exposure to high and volatile fossil fuel prices; operational security to ensure that moment to moment, supply matches demand; and resource adequacy to secure sufficient reliable capacity to cover peak demand.

C.14 These considerations translate into opportunities and challenges which have a direct impact on firms (including new entrants) in the electricity industry. For example, if wind-farm firms are unable to meet their ‘moment-to-moment’ supply obligations owing to an extended calm period in which the wind does not blow, the System Operator, National Grid (which is responsible for ensuring operational security) ensures resource adequacy through a Capacity Mechanism contractual framework.

C.15 The proportion of energy trading, or the number of buyer and sellers willing to trade, in the market is referred to as liquidity. Liquidity is of considerable importance to new electricity market entrants such as the Hebridean ESCO.

C.16 High levels of liquidity enable electricity companies to quickly buy or sell products. Low levels of liquidity mean that trades are difficult, potentially causing significant swings in price and incurring significant transaction costs.

C.17 In a liquid market market participants have confidence in traded prices. This in turn informs investment decisions and can help facilitate new entry. Liquidity is required to offer the means for independent generators of all sizes to compete effectively in the market.

C.18 The ability to buy or sell electricity quickly and without incurring significant costs is crucial to new investors unfamiliar with the market. GoodEnergy, Smartest Energy and other recent electricity market entrants have depended heavily on market liquidity for their growth. Liquidity gives confidence to generators that they can manage periods when they are short (or long) on electricity compared with their contractual requirements by trading electricity to manage their position. The ability to trade to balance a position is a particular issue for independent generators and therefore for potential new entrants.

C.19 Ofgem is responsible for improving overall liquidity, meeting the needs of independent generators and suppliers, and providing mechanisms for credible reference prices and credible routes to market.

C.20 Additional models of financing are required for generation and transmission projects. Debt is required to finance new energy projects and providers of debt need to be able to refinance their capital commitments in the public debt markets. The Government has created the Green Investment Bank (GIB) for this purpose.

C.21 The Carbon Price Floor and FeedIn Tariff Contract for Difference mechanisms are intended to rebalance investment choices in favour of low-carbon technologies and away from currently preferred fossil-fuel investments. The differences between these investment choices are summarised in the table below:

GAS-FIRED POWER STATIONS LOW-CARBON TECHNOLOGIES

• mature technology • typically high construction (capital) costs • low and predictable capital expenditure • low operating costs • quick to build • therefore low-carbon plants are • fuel costs are a large proportion of wholesale price-takers operating costs • difficult to make an investment case • gas (or sometimes coal) is typically the for them where wholesale electricity price-setting (or marginal) plant prices are predominantly set by the short-run marginal costs of unabated • fuel costs are therefore naturally gas and coal plant hedged because the price of electricity moves in line with the price of gas • even if the carbon price is high enough for their levelised costs to be • generation costs will tend to fall in line similar with any fall in revenues as electricity prices fall, preserving profitability

• able to run flexibly

• can easily respond to shifting demand

• costs of flexing a gas plant to respond to daily peaks in demand are relatively modest

• frequent stop/start and fast ramp-up operations do have a significant impact on maintenance costs

C.22 The CPF and FiT CfD combination provides two clear economic signals. The CPF provides a transparent and predictable carbon price which will gradually increase the wholesale electricity price, FiT CfD will provide low-carbon electricity generators with a guaranteed price throughout the period of the long-term contract. As the price of carbon increases and gradually raises the electricity price, the support needed for low-carbon generators through the FiT CfD is reduced.

C.23 These mechanisms provide a strong positive signal for the establishment and long-term viability of the ESCO. Further support for the ESCO concept comes from overall Government recognition of the benefits of decentralised supply and distributed generation and the need to deliver solutions that maximise local opportunities which will meet the need and demands of local people and their communities.

C.24 Both demand side and supply side measures are necessary. Energy efficiency saves power and reduces carbon emitted through electricity generation. Electricity consumers must be encouraged to contribute to overall improvements in energy efficiency. Heating and cooling accounts for a significant proportion of the UK’s total energy consumption, and an even greater proportion of the overall Hebridean energy demand. Decarbonising heat across all sectors is an essential component of reducing emissions.

C.25 Once the FiT CfD is introduced and until 31 March 2017 (the transition period) Government policy is to ensure no retrospective change for low carbon investments. This will ensure ongoing Renewables Obligation (RO) stability and existing accredited generation will continue to be supported under the RO.

C.26 RO is a mechanism which supports current Hebridean wind-farm projects and the impact of these reforms (and further proposed Scottish Island reforms) are still being explored.

C.27 New renewable generation will have a one-off choice between the RO and FiT CfD and the RO will close to new accreditations on 31 March 2017. No generation will be able to accredit under the RO from that date. From that point grandfather RO support will continue for all technologies at the rate applicable on 31 March 2017.

C.28 The ESCO and the electricity network in the Outer Hebrides is likely to be representative of a new era for the UK electricity network as a whole, as articulated in the UK 2030 Network Vision. In this vision, the UK becomes a significantly decarbonised economy on both the generation and demand side.

C.29 There will be widespread charging of electric vehicles and use of heat pumps and the UK will make the best use of available distributed energy resources. Information and communications technology will provide greater visibility of network flows. Networks will also be bigger to cope with increasing electrification and to connect up generation in new areas, both onshore and offshore.

C.30 Consumers will be engaged in how they consume electricity and they will have access to a range of tariffs and offers which will enable them to match their consumption to times when there is more generation available. This will enable them to reduce their overall energy bills in the process.

C.31 Demand will be more responsive to changes in the electricity price, shifting from times when prices are high to those times when prices are lower. Distributed energy, and distributed energy storage, will also interact with the network helping to manage local network constraints and balance supply and demand, thereby reducing the pressure on centralised generation.

C.32 At the transmission level the UK will be more integrated with other markets and there will be greater diversity in generation and demand across Europe.

APPENDIX D – COST PLAN

Outer Hebrides Energy Supply Company - Scoping Study

Cost Estimate No.03

Issue Date: May 2013 Issue Status: Status: Draft Final Issue Date: 28-May-13 Document Ref.: 130528.Cost Estimate 03

Checked and Verified: Name Date Initials Prepared By: Nigel Walker 28-May-13 NW Checked By: William Allan 28-May-13 WA OUTER HEBRIDES ENERGY SUPPLY COMPANY - SCOPING STUDY COST ESTIMATE No.03 1.0 Notes and Exclusions 1.01 This Cost Estimate has been prepared by the Sweett Group as part of the Outer Hebrides Energy Supply Company Scoping Study being undertaken by GreenspaceLive Ltd to provide a high level indication of the Start Up, Revenue and Operating Costs involved.

1.02 The Cost Estimates noted have all been based on published research documents however a number of assumptions have been made in developing the costs and further research and studies should be undertaken to refine the costs further. In conjunction with this further negotiation with Amec/EDF will be required to develop a Power Purchase Agreement (PPA) for the supply of the 20% share in the Stornoway Wind Farm development as this will fundamentally affect the start up and operating costs involved.

1.03 In addition to the high level costs a number of key issues which need to be considered and a list of reference documents have been noted below for information. 1.04 Published data suggests that the cost to design, procure and construct on shore wind generation equates to £1.5m per MW and this has been used to estimate the cost of the proposed 26MW wind farm development. Although it will be dependant on the details of the PPA it has been assumed for the purposes of this estimate that the ESCO's initial capital contribution will be calculated on a pro rata basis for the 20% share of the energy to be generated. In addition to the capital contribution a further £1m allowance has been included for other start up costs which will be incurred. For the purposes of this cost plan it has been assumed that these costs and the repayment of the initial capital contribution is reflected within the Levelised Cost of Electricity Generation (LCOE) amounts. 1.05 The Electricity sale and purchase costs have been based on data recently published by Ofgem with a capacity factor of 37.5% built in to reflect the periods when the wind farm will be operating at below capacity. 1.06 In calculating the Revenue Costs provision has been included for contributions to be secured for the sale of various Renewable Obligation Certificates and the like as it has been assumed that these are not already reflected within the LCoE calculations included as part of the estimated operating costs. 1.07 The Operating Costs have been assessed using the levelised cost of electricity generation (LCOE) methodology this being defined as the ratio of the net present value of total capital expenditure costs to the net present value of the net electricity generated over the life of its plant. Levelised costs are calculated by taking into account the Capex Costs (pre-deployment, construction and infrastructure costs), Opex Costs (fixed and variable operating costs, insurance, connection costs, decommissioning costs, fuel and carbon prices) and Expected Generation Data (capacity of plant, expected availability, efficiency and load factors) and a 40% uplift has been applied to the base costs to reflect the location factor.

Appendix D - Outer Hebrides Energy Supply Company - 130528.Cost Estimate 03 OUTER HEBRIDES ENERGY SUPPLY COMPANY - SCOPING STUDY COST ESTIMATE No.03 1.0 Notes and Exclusions 1.08 An assessment of the transmission charges has also been made based on costs outlined within the DECC/Scottish Government renewable project report for the Western Isles 1.09 EDF were given a number of opportunities to contribute and provide input into the cost estimate but they have to date declined to do so. Efforts to engage EDF in the process should continue however as they may have a better understanding with regard to the cost of constructing the wind farm and the preferred Power Purchase Agreements for the 20% share in the energy to be generated. 1.10 General exclusions from the estimate include - VAT - Inflation

Appendix D - Outer Hebrides Energy Supply Company - 130528.Cost Estimate 03 OUTER HEBRIDES ENERGY SUPPLY COMPANY - SCOPING STUDY COST ESTIMATE No.03

2.0 Key Issues

2.01 Need to formalise Power Purchase Agreement with Amec/EDF 2.02 Installation of the Radial Connector link between Stornoway, the Isle of Lewis and Beauly 2.03 Agreement of Transmission Network Usage Charges 2.04 Development of Start up Strategy - Appointment of Key Experienced Personnel 2.05 Option to Form Alliance with Another Established ESCO eg Good Energy 2.06 Identification of Risks 2.07 Strategy to Develop ESCO and the Intregation of Other Local Energy Producers and Renewable Technologies 2.08 Strategy to Develop Customer Base and Energy Markets both Locally and on the Mainland 2.09 Identification of Other Infrastructure Improvements Required 2.10 Explore Options for Energy Storage 2.11 Explore Options to maximise return from sale Renewable Obligation Certificates (ROCs) 2.12 Establishment of capacity factor for the proposed windfarm

Appendix D - Outer Hebrides Energy Supply Company - 130528.Cost Estimate 03 OUTER HEBRIDES ENERGY SUPPLY COMPANY - SCOPING STUDY COST ESTIMATE No.03 SUMMARY

ESTIMATED EXPENDITURE AND START UP COSTS £ 40,000,000

ESTIMATED REVENUES PER ANNUM £ 17,200,000

ESTIMATED OPERATING COSTS PER ANNUM £ 13,510,000

ESTIMATED PROFIT/LOSS PER ANNUM £ 3,690,000

Note : Based on current estimates relating to the levelised cost of energy generation for onshore wind developments in the Western Isles and for anticipated transmission charges it is currently estimated that the proposed wind farm development will return a profit for the proposed energy supply company.

This is based on a number of high level assumptions relating to capital costs, capacity factors and transmission charges and in order to make it more attractive for potential developers it would necessary for lower transmission charges to be secured or additional Government backed incentives to be introduced.

Further work should also be undertaken to establish whether lower transmission charges would apply to energy sold locally on the islands and not transferred to the mainland via the proposed new radial connector.

Appendix D - Outer Hebrides Energy Supply Company - 130528.Cost Estimate 03 OUTER HEBRIDES ENERGY SUPPLY COMPANY - SCOPING STUDY COST ESTIMATE No.03

ESTIMATED EXPENDITURE AND START UP COSTS

Estimated capital cost to design, procure and construct the 130 MW 1,500,000* £ 195,000,000 130MW Stornoway Wind Farm (Refer Notes Section)

Capital Payment to Amec/EDF for 20% share in Wind Farm 26 MW 1,500,000 39,000,000 Development (assumed to be on pro rata basis)

Community Benefit Charge (assumed to be annual charge and Sum 0 not a lump sum)

Initial Start up Costs Sum 1,000,000

Total £ 40,000,000 Say £ 40,000,000

* Rate based on estimates prepared for Beinn Mhor Power Repayment of capital costs assumed to be included within the LCoE rates noted below

Appendix D - Outer Hebrides Energy Supply Company - 130528.Cost Estimate 03 OUTER HEBRIDES ENERGY SUPPLY COMPANY - SCOPING STUDY COST ESTIMATE No.03

ESTIMATED REVENUES PER ANNUM

1.0 Electricity sales rated capacity of Stornoway windfarm (MW) 130.00 20% community floating share (MW) 26.00 37.5% capacity factor (MW) 9.75 Annual Energy Production (MWh) 85,410 MWh 150.00* 12,811,500

2.0 Sale of Renewable Obligation Certificates ROC buy out price (£ per MWh) 85,410 MWh 36.99 3,159,316

3.0 Recycled Value From ROC Buyout Fund Annual Energy Production (MWh) (from above) 85,410 MWh 14.35 1,225,634

Total £ 17,196,449 Say £ 17,200,000

* Rate based on Ofgem - 17 April 2013 overview of energy bills for standard tariffs Total ROC value noted above equates to £51.34 per MWh

Appendix D - Outer Hebrides Energy Supply Company - 130528.Cost Estimate 03 OUTER HEBRIDES ENERGY SUPPLY COMPANY - SCOPING STUDY COST ESTIMATE No.03

ESTIMATED OPERATING COSTS PER ANNUM

1.0 Estimate of Annual Energy Production Assuming 37.5% capacity factor rated capacity of Stornoway windfarm (MW) 130 20% community floating share (MW) 26 37.5% capacity factor (MW) 9.75 Annual Energy Production (MWh) 85,410 MWh

1.0 Levelised Cost for Onshore Wind Generation (LCoE)* UK Central Onshore Wind >5MW 84 £/MWh

2.0 Adjustment for Additional Western Isles Cost** pre development and construction 6 capex costs 9 opex costs 10 TNUoS*** 48 73 £/MWh

Estimated LCoE for the Western Isles 157 £/MWh 85,410 13,409,370

3.0 Community Benefit Charges assumed to be an apportioned annual charge Sum 104,000 ie £520,000 x 26/130

Total £ 13,513,370 Say £ 13,510,000

* Rate based on Department of Energy & Climate Change Electricity Generation Costs October 2012

Appendix D - Outer Hebrides Energy Supply Company - 130528.Cost Estimate 03 OUTER HEBRIDES ENERGY SUPPLY COMPANY - SCOPING STUDY COST ESTIMATE No.03

ESTIMATED OPERATING COSTS PER ANNUM

** Rate based on Scottish Islands Renewable Project Final Report *** TNUoS based on £125 per KW as per Beringa report ie £125,000 per MW x 130 MW = £16.25m Energy generated at 30% capacity = 341,640 MWh TNUoS cost per MWh generated = £16,250,000/341,640 = £47.6/MWh, say £48/MWh

Appendix D - Outer Hebrides Energy Supply Company - 130528.Cost Estimate 03 OUTER HEBRIDES ENERGY SUPPLY COMPANY - SCOPING STUDY COST ESTIMATE No.03

REFERENCE DOCUMENTS

1.0 Strathclyde Discussion Paper in Economics No.08-11 The Importance of Revenue Sharing for the Local Economic Impacts of a Renewable Energy Project : A Social Accounting Matrix Approach

2.0 Renewable UK A Community Commitment - The Benefits of Onshore Wind - February 2011

3.0 Ofgem Overview of Typical Customer Energy Bills, Costs and Indicative Net Margins - 17 April 2013

4.0 Parsons Brinckerhoff Powering the Nation Update Report 2010

5.0 Scottish and Southern Energy Western Isles Electricity Tranmission Link Update - 1 March 2013

6.0 Department of Energy and Climate Change Planning Our Electric Future: A White Paper for Secure, Affordable and Low-Carbon Electricity

7.0 Mott MacDonald UK Electricity Generation Costs Update - June 2010

8.0 Energy Generation Costs - October 2012 Department of Energy & Climate Change

9.0 Scottish Islands Renewable Project - Final Report DECC/Scottish Government - 14/05/2013

Appendix D - Outer Hebrides Energy Supply Company - 130528.Cost Estimate 03