Wrong. Unless they include extra charges.
The Code for Sustainable Homes, upcoming changes to building regs, and national emissions targets are all driving the industry towards much wider use of on-site generation.
Reducing carbon with on-site generation (also called “distributed energy” or just “DE”) brings extra costs relative to the business-as-usual approach of individual gas boilers and grid electricity. Cyril Sweett and others put the additional cost of building a zero-regulated-emissions house at £10k – £13k per dwelling, and some recent projects at work have borne this out.
This £10k – £13k is a massive problem for developers and housing associations, in some cases making projects infeasible.
There’s a widespread misconception that ESCOs can make the problem disappear. Some of this misconception has been fostered by ESCOs keen to get deals on the books (I’ll come back to this in a minute), but I think most of the problem is down to a poor understanding of distributed energy and how ESCOs make money.
So how much capital cost can ESCOs take on? Here’s an example:
Imagine an ESCO is going to take on 1,000 homes per year from 2010 to 2025, all built to zero-regulated-emissions standard (equivalent to Code 5). I’m using this standard as it’s probably close to what the definition of zero carbon will require once it’s out of consultation.
In 2010, let’s assume our householders are spending £330 on heating and hot water and £420 on electricity (it’s tempting to get preoccupied with detail, but it’s the big picture I’m hoping to illustrate so bear with me).
To be conservative, let’s say it’s only costing an additional £10k per dwelling for biomass CHP and a heat network. These costs might come down as the market develops (say around 2% p.a.) while energy prices will rise (say 3% p.a.). For simplicity’s sake, I’m ignoring capital cost of plant replacement. Here’s how that looks over time:
It’s clear that taking a very conservative view, after 15 years or so, the revenues are roughly equal to the cumulative capital costs.
At this point you might think: great, the ESCO is making as much money as it costs to put the kit in in the first place. But we haven’t counted the ESCO’s cost of sales! Let’s assume that after all its costs the ESCO is making a profit margin of 10%, which is quite high. Keep in mind, this only includes costs related to energy sales and doesn’t yet include any contribution the ESCO might make toward the capital cost of plant.
The value of the ESCO can be estimated using a price to earnings (PE) multiple – let’s say for a business like this, it’s a PE of 12. That gives an idea of how much the energy sales business is worth in relation to the capital cost and is shown in the graph below.
It’s clear from the graph that the value of the energy sales business is dwarfed by the capital costs of putting the in low or zero carbon DE. If we include costs of replacing plant, the capital cost line is significantly higher.
Certainly ROCs or FiTs could help take some of the capital burden away. If you assume that the electricity for the homes is coming from a technology that is eligible for double ROCs (roughly equivalent to the FiT proposed for biomass CHP as well), that’s about 6 ROCs per year or around £270. Capitalised at 8% over 15 years, that equates to about £2.3k of the £10k in additional costs.
Clearly, there is a serious shortfall between the capital costs of low carbon DE and what ESCOs can pay – a shortfall that is unlikely to be made up even as ESCOs grow, technology costs drop, and energy costs rise to 2025.
But there are already ESCOs in the market claiming to offer “zero cost” solutions – with no additional cost to the developer or the customer relative to business as usual.
How are they doing it? Either it’s just not true (and developers are still having to stump up for heat networks) or they’re financing the additional capital through something like a standing charge (fixed £/yr), which is independent of the unit cost of energy.
Standing charges are a good and reasonable thing to have. After all, a house owner would have costs associated with maintaining and replacing their own plant (e.g. gas boiler), why shouldn’t they contribute towards communal plant?
But the mechanism isn’t immediately obvious to developers and customers and charges could theoretically be set at any level. For example, if you set the standing charge at £100 per month, suddenly the ESCO can take on the £10k burden for each house. Painful for the customer, but look, the problem just went away.
The point is: there are additional costs associated with low carbon that an ESCO can’t take away based on the value of the energy. Either the land vendor takes this off the land value, the developer stumps up the cash, or the customer pays higher charges.
carbon limited 
Excellent article! I agree completely.
However a massive saving can be made by simply super insulating the building and introducing MHRV systems . With these in place a much smaller heating system is required(less fuel) and solar panels can further reduce fuel bills and are relatively inexpensive .
I have lived in a house with these in stalled and you would not go back to conventional after experiencing the comfort of such a house.
Martin, maybe Im missing both points here, but a smaller heating system will still entail high capital infrastructure costs as far as DE is concerned, while reducing returns, wont it?
Jason,
that is the six millon dollar question and one that needs to be examined in terms of the best value for investment in long term carbon reductions.
So, what to do in the following hypothetical situation?
1. Super insulate the dwellings, use MVHR to reduce space heating and solar thermal for DHW. All this acheives an annual carbon reduction of x, but there is no money in the pot to contribute towards DE.
2. Dont go so far on the insulation, say 0.22 for walls, forget MVHR and solar thermal and invest the £5-£7K saved per dwelling in the DE network, which in turn can then be used to decarbonise the hard to treat homes… This achieves a carbon reductions of 2x.
We know there are diminishing returns on insulation but how far do we embrace the capitalist notion that the market will always find the lowest cost to acheive a goal? Now there’s a question for Mel?
Timely discussion.
IMHO only efficiency is future proof given building life but this means the heat load is too low for district heat to be economic. e.g. in Germany many Passivhaus developments do not want to connect to district heat. Also distributions losses can easily be greater than the legitimate demand. If the heat really is free and will continue to be free for life of development then thats less of an issue but . . . ??
However for many existing dwellings, retrofit to such a high standard may be impractical and in my mind this points to a heat supply solution for existing urban developments with sensible levels of efficiency to achieve comfort and match supply to demand.
For new detached developments I’d argue for spending the budget on efficiency rather than gambling on say biomass. or wasting renewable electric on heating just to satisfy the obsessive compulsive political objective of on site carbon neutrality.