Decommissioning:

a necessary evil?

Decommissioning: a necessary evil?

Introduction – increased generation from wind and solar around the globeThe latest official statistics published by the UK government show that during the second quarter of 2018 a record 31.7% of electricity generation came from renewable sources, a three percentage point increase from the same period last year.¹Bloomberg New Energy Finance (BNEF) data in August 2018 showed the world has attained the landmark figure of 1TW of wind and solar generation capacity installed with 1,013GW of wind and solar PV generating capacity installed worldwide as of June 30, 2018. The total is finely balanced between wind (54%) and solar (46%)².BNEF estimate that the second terawatt of wind and solar will arrive by mid-2023 and cost 46% less than the first.Wind and solar are not the only technologies grabbing the headlines; battery storage is quickly becoming an important component in the renewable energy mix and in South Australia it made news with Elon Musk’s Tesla company installing a 100MW battery and already providing energy security and savings to the State.

Return on investment planningReturn on Investment (ROI) planning and reaching financial close on any new renewable energy deal relies on a myriad of factors, including the above mentioned technologies, their performance, the weather (enough sun and wind) and of course the period of time that the technology will be operating for. This period in turn is determined by the licence to operate, the permit to operate or indeed the rental agreement with the landowner. This naturally varies by territory and technology.Typically, the period of the lease is 20 -25 years, again depending on the technology, onshore or offshore and the country. The earliest windfarms in the UK called Brocklock Rig 1, Dumfries and Galloway, Scotland and which became fully operational in November 1996 consisting of 36 Nordtank wind turbines each of 600 kilowatts (kW), providing a maximum power of 21.6 megawatts (MW), is nearing its original lease date.

Decommissioning or repowering?Planning permissions for onshore wind farms in the UK generally require decommissioning and restoration after 25 years. Decommissioning means the removal of turbines and other infrastructure and includes the restoration of the site where required.The alternative to decommissioning is repowering. This is the process of replacing the original turbines with new ones, and reconfiguring the layout. It may mean fewer, but larger or more efficient turbines. Delabole was the first commercial wind farm in the U.K; it opened in 1991 with 10 turbines of 400kw each. In 2011, those turbines were replaced with four turbines totalling 10MW.
UK decommissioning obligations

Sections 105 to 114 of the Energy Act 2004 introduce a decommissioning scheme for offshore wind and marine energy installations. Under the terms of the Act, the Secretary of State may require a person who is responsible for one of these installations to submit (and eventually carry out) a decommissioning programme for the installation. They should also be responsible for meeting the costs of decommissioning – the ‘polluter pays’ principle.What does decommissioning cost?

The cost of decommissioning will clearly vary by the technology (wind, solar of battery storage, hydro and whether onshore or offshore). For wind, the key components could include turbines, turbines base, transformers, buildings, substation and cables. A recent estimate from Scottish examples suggested that the decommissioning cost is approximately £80k per megawatt. Offshore costs will undoubtedly be higher because the CAPEX is always significantly more than onshore; indeed, a recent study by OFGEM has suggested decommissioning could be at least 5% of the total investment³.

Initial summary - and some key questions for the developer!

For any developer or partnership reviewing new onshore or offshore opportunities in any major renewable energy territory, the financial model will need to anticipate that, in 20-25 years’ time, the project will need to fund decommissioning. It may be asked to demonstrate by the authorities it has the funds and the plans on how to implement this. This cost impacts the financial viability and profitability of a project and for Offshore bids can be a critical cost and determine winning of losing a bid.

So there are some key questions for the developer to answer:

What security needs to be shown by the developer that they will decommission in 20 years to 25 years’ time?
Does all of this amount need to be set aside?
How does the landowner know the developer really will decommission?
What happens if the developer becomes insolvent or is sold?

Clearly there needs to be certainty for the landowner, the Council, the Crown Estate or the Department for Business Energy & Industrial Strategy.

For any developer or partnership reviewing new onshore or offshore opportunities in any major renewable energy territory, the financial model will need to anticipate that in 20-25 years’ time the project will need to fund decommissioning.

Financial securities, bonds, guarantees and parental guarantees
Typical financial security instruments have taken the form of bonds which the developer is obliged to purchase and evidence to the authority, landowner or Crown Estate. Banks and insurance companies will typically provide these types of securities; they might be typically valid for 3-5 years but annually renewable.
Cash Escrow

The developer is required to place actual cash into an escrow account, with little or no investment interest added for the term of the lease. This cash is only released by the landlord when decommissioning takes place. While attractive to the public authority or landowner, this is not attractive to the developer as it would typically be funded through equity. The opportunity cost of not being able to use this cash during the term of the lease will be multiples of the original cash amount. An additional concern is that some territories have experienced negative interest rates which will reduce the escrow cash and therefore will need to be topped up.
Surety Bonds

These are “on demand” and are provided by insurance companies. They have a maximum term of up to 5 years, usually with the developer required to post collateral. The fees are usually payable annually. In the event that decommissioning is required and developer is insolvent, the public authority or landowner can call the bond and the surety will be obliged to settle the demand within the agreed time period, usually 5 days. The surety provider
will then seek reimbursement from the developer and/or its’ parent.
Bank Letter of Credit (“LoC”)

Similar to the Surety Bond, bank Letters of Credit (LoC) are “on demand”. The bank will always require collateral or security equal to the amount of the LoC. This reduces the available borrowings to develop the site, thereby increasing the amount of capital required resulting in a reduction in the project’s expected returns.

Parent Company Guarantees

These are provided by the parent company of the developer and guarantee the financial security obligation to the public authority and/or landowner. This is a more cost effective method to provide security for future obligations but in reality these are only open to large creditworthy organisations due to the long term nature of the leases and may impact the parent company’s ability to raise debt.An alternative solution – Decommissioning & Reinstatement Insurance
Is there an alternative to the current range of financial securities? Can the developer’s long term cost be reduced? Major risk intermediaries are working with the insurance market to provide more efficient tools and a more effective mechanism.Working closely with the insurance markets, an alternative insurance market solution - Decommissioning & Reinstatement Insurance - has been developed, which may result in long-term savings being achieved. The following is a summary of the solution and its benefits:

The policy protects the landlord and/or public authority against the risk that the Operator fails to fulfil its decommissioning obligations at the end of the lease term, usually as a result of default of the Operator.

The limit of indemnity is agreed and fixed at the outset; accommodation is made for inflation at this time. Revisions can be made during the term but it is usually better for all parties to fix this at the outset.

The Operator is required to enter into an escrow agreement with the landlord/public authority and the Insurer. The escrow account builds slowly over the life of the field until it equals the required financial security amount (usually 2 to 5 years before abandonment).

The insured is the landlord/public authority. The Operator pays into the escrow account.

Product benefits

The policy is not cancellable by the Insurer.

There is no renewal; it is a long-term policy (maximum period of insurance of 30 years).

It provides certainty to the landlord/public authority over the term of the lease with a combination of cash escrow and a strong AA rated Insurer.

It provides a significant saving to the Operator of the cost of the financing of the financial security when considered over the life of the project - approximately 80%.

It frees up capital, as the policy not a liability on Operator/partners’ balance sheet.

Significant capacity is available.

Evidence that long term savings are available by using an alternative insurance solution is provided by Fig 3 on the previous page. In this example:

the blue bars represent the opportunity cost of utilising cash from day one

the purple bars represent the opportunity cost of using the alternative solution

Conclusion – towards a more efficient solution

As concluded by Enercon, tens of thousands of turbines will be reaching the end of their useful life between now and 2030⁴. Local planners, law makers and authorities are waking up to the costs and logistics of addressing the decommissioning issue. More focus is being given to the security requirements of developers to guarantee projects will be effectively decommissioned, or repowered at the end of the lease period. New projects are therefore also being challenged to detail their decommissioning plans and demonstrate financial security. The cost of decommissioning can impact the viability and profitability of a project long term over 25 years. Any savings on this core cost can mean the difference in a ‘go’ or ‘no go’ on a project and or a successful bid.Risk intermediaries such as Willis Towers Watson have led the way in educating developers and landlords alike to how this more efficient solution will deliver long term benefits to all parties. This solution can be used for both onshore and offshore projects; to estimate the extent of the savings potential, intermediaries will need to agree the assumptions, understand the full risk profile of the project and the decommissioning requirements and timings. This process is risk free and will quickly demonstrate that by reducing the long term cost of the decommissioning bill, the overall profitability of the project will be enhanced.

Adam Piper is an Executive Director in Willis Towers Watson’s Renewable Energy team in London.

¹https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/743757/Press_Notice_September_2018.pdf
²https://about.bnef.com/blog/world-reaches-1000gw-wind-solar-keeps-going/
³https://www.ofgem.gov.uk/system/files/docs/2017/08/new_donagh_report.pdf
⁴https://www.enercon.de/en/home/