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HARNESSING SCOTLAND'S MARINE ENERGY POTENTIAL

ANNEX C
MARINE ENERGY - THE CASE FOR GOVERNMENT SUPPORT

1. Marine energy technology is still at an early stage of development and, as with any new technology, there will always be some irresolvable uncertainty over future costs and the effect of future innovations. It is likely that the cost of different technologies will converge on those projected from the actual costs experienced by the devices currently at the most advanced stages of development. The current high capital costs will only come down with further prototyping and commercial manufacture. Although the technology has the potential to become cost-competitive with other renewable energy options such as offshore wind in future, if it does not receive support in the interim period it is very unlikely that it will be able to reduce its costs to competitive levels.

2. In order to establish whether there is a case for Government funding the wave and tidal industry has, for the purpose of this economic appraisal, been treated as if it were a single firm applying for Regional Selective Assistance (RSA). The question posed therefore is: does the case presented by the industry for Government support, as articulated by MEG, pass the various tests as per the RSA selection process?

3. Marine energy technology is still exploring a wide range of possible technologies and because these technologies are at a very early stage of development costs are somewhat uncertain. Consequently a number of scenarios of the likely capital and operating costs need to be considered. These are tested by sensitivity analysis here but will be explored in greater detail in a complementary study commissioned by the Scottish Executive. ¹

4. The following assumptions have been used in this appraisal:

• An appraisal period of 15 years has been chosen with the project starting in 2005 and running to 2020. The sensitivity of the results to project life has been tested.
• The industry in Scotland is assumed to be 100 per cent UK owned.
• The 'without project' scenario is that the project would not go ahead at all or, if it did, it would go ahead elsewhere, for example in Portugal.
• As with all new technologies their will be a technology learning curve and the costs of building wave and tidal machines will fall as the number of machines and installed capacity increases. (see paragraphs 53-55 in the main report).
• The capital expenditure costs (CAPEX) are the number of machines built times the cost of a machine plus an additional 30% to cover other capital expenditure costs other than those associated with building the actual marine devices.
• For machines build in 2005 and 2006 operating costs are assumed to be 6% of total CAPEX for the first 5 years and 4% for years 6 to 15.
  For machines build in 2007 and 2008 operating costs are assumed to be 5% of total CAPEX for the first 5 years and 4% for years 6 to 15.
  For machines built after 2008 operating costs are assumed to be 4% of total CAPEX throughout the 15 year life of the machine.
• The capacity factor is 35% for all machines and the availability factor is 95% for machines built before 2008 and 97% for those built after 2008.
• The revenues from ROCs are 5 pence per kWh throughout the 15 years of the project. The revenues from exports are assumed to be similar to the Portuguese feed- in tariff of 23 eurocents per kWh or 15 ¹/ ₂ pence/kWh (converted at current rate of 1.5€ to 1). The revenues from any new UK revenue support mechanism are assumed to be 6 p/kWh for 6 years for domestic machines built before 2008 and 3 p/kWh for 6 years for machines built in 2009 and 2010. No UK revenue support is given for machines built after 2010.
• Capital grants are given to offset the costs of building domestic devices at the rate of 30% of CAPEX for machines built before 2008 and at 15% of CAPEX for machines built in 2009 and 2010. No capital grants are given for machines built after 2010.
• Production in the domestic market grows by a steady 100 MW of installed per year after 2010 while export markets grow by 25% per year after 2010.
• By 2020 domestic installed capacity is 1300MW which is equivalent to some 10% of forecast Scottish electricity generation.
• Turnover in the domestic market peaks at around 223 m in 2017 and then falls for a couple of years as the transitional feed-in tariff disappears before rising again after 2020. However revenues from the domestic market are dwarfed by export turnover which increases steadily to reach over 2000 m by 2020.
• 10 jobs are assumed to be created for every MW of installed domestic capacity and 7 jobs created for every MW of export capacity installed (based on ² ).
• Project capital expenditure builds up as the number of marine devices builds up and reaches a peak of over 1.3 billion by the end of the 15 year period in 2020, equivalent to the building of over 6400 marine devices. Operating capital rises in line with CAPEX to reach almost 300 m by 2020.

5. The principal tests in an RSA appraisal centre around:

• Additionality: What would happen in the absence of Government funding? There is the need to demonstrate that Government funding is necessary to enable the project to go ahead as planned. This may be to reduce the risks associated with the project, or to influence the choice of a mobile project's location.
• National and regional benefit: All projects should contribute positive benefits to both the regional and national economy. This is measured by the efficiency test.
• Jobs: The project must create or safeguard jobs. The jobs should last for at least 5 years and the project should not simply displace similar jobs elsewhere in the UK.

6. Additionality: Without Government funding there are two possibilities. Firstly there is a strong likelihood that the fledgling marine energy industry in the UK will go abroad, most probably to Portugal where a tariff of 23 eurocents per kWh (approximately 15.5 pence at the current exchange rate of 1.5 € = 1) is available. The other possibility is that the UK industry will simply not develop in any form either here or abroad.

7. Under the present ROC arrangements only onshore wind projects are entering the market, as they are currently the most cost competitive renewable generation source. Some parties have argued that the ROS is essentially providing excess profits to onshore wind farms, and that it is not providing an incentive to other renewables generation sources. Certainly on the basis of the current financial support for the marine energy industry, i.e. no tariffs and no capital grants, only ROC support at 5 p /kWh the industry would never make a profit. Running the status quo scenario produces the following benefits to the UK economy when discounted at the normal RSA rate of 10%. On this basis the additionally test is passed and without support the benefits the industry could bring to the UK economy would be lost. This concurs with views published by a number of Government agencies, trade associations and marine energy developers, concluding that marine energy requires additional targeted support in order to bridge the 'funding gap'.

Base Case Scenario (Status Quo - No Additional Funding)

8. National and regional benefit is measured by the efficiency test. The efficiency test attempts to measure the effect of the project on UK national income. For UK-owned companies, the benefit to the UK economy is equal to the benefit to the firm, discounted by the return to the average project in the UK. UK grant is treated as a transfer with no effect on UK national income. It has been assumed that all the firms involved in the marine energy industry in Scotland are 100% UK owned so in order to pass the test all that has to be demonstrated is that there will be benefit to the UK economy.

9. On the basis of the assumptions outlined in paragraph 4 the efficiency test is passed. The overall net benefit of the project going ahead to the UK economy is 1.5 billion after 15 years but even if we shorten the project life we still get a pass with the project showing positive after 6 years.

Domestic Export Market Scenario (See Paragraph 4 For Assumptions Used)

10. A strong home market is the base from which the industry can attack export markets. The capture of export markets is, however, the key to continued expansion as the domestic market is assumed to increase at a steady rate after 2010. Exports on the other hand are assumed to grow by 25% year on year after 2010. If we assume that there is no export break through then the economic case for support is very much weakened. Without any exports the benefits to the UK economy fall substantially.

Domestic Market Only (Export Markets Are Not Developed)

11. In line with emerging technologies throughout history it is highly unlikely that the capital and operating costs of marine energy devices will not fall as installed capacity increases. The Renewables Supply Chain Gap Analysis Study³ envisaged that the current costs for wave and tidal energy of 10-15 pence per kWk would fall to about 4-to 8 pence by 2020.

12. Jobs - MEG forecasts that by 2020 some 7000 jobs could be created by the marine energy industry in Scotland. On the basis of a total grant of 156 million, made up of 125 m in revenue support and 31 m in capital grants, this works out at around 20,750 per job. (The value of the grant after tax and discounted by the normal 10% rate is some 71 m). It is thought that the level of displacement would be very low since there are no competing firms at present, most of the output will be for export and there is idle labour resources from the fabrication industry associated with North Sea oil and gas.

13. One potential source of displacement could arise if the revenue support were to result in a large increase in electricity prices (similar to what has happened recently with water charges) for Scottish firms in general relative to firms south of the border. This might have two distinct effects; costs rise for existing Scottish firms making them less competitive and non-Scottish firms may be deterred from relocating here, both of which could potentially result in a loss of jobs to the Scottish economy. This however is not thought to be likely. Even if the full amount were passed on to electricity consumers this is a very small sum compared with the total cost of electricity consumed by Scottish firms in 2000. Indeed it represents only about 3_ % and this share will fall as energy prices are expected to increase in the coming years as a result of the introduction of carbon trading from next year and the expected increase in gas prices.

CONCLUSIONS

• The promotion of the marine energy industry in Scotland will not only help towards delivering the Executive's 40% renewable energy target by 2020 but will also contribute to the Executive's number one priority of growing the economy. A thriving marine energy sector has the potential to enhance Scotland's manufacturing capacity, to develop a new indigenous industry, particularly in rural areas, and to provide significant export opportunities. In the context of the Executive's 'green jobs' strategy it will also contribute towards another of the Executive's cross cutting priorities that of sustainable economic development.
• A "funding gap" currently exists between demonstration and commercial scale development in the marine energy sector. Under the current arrangements of limited R&D grants and the Renewables Obligations, the marine energy industry is simply too expensive to compete. The additionality test is therefore passed since under the present funding arrangements the marine energy industry is unlikely to develop in the UK.
• The development of marine energy industry in Scotland with Government support will bring benefits to both the UK and Scottish economies and so the efficiency test is passed. However based on the available evidence and on the assumptions used in the above appraisal it will be necessary to develop some kind of export market if these benefits are to be maximised.
• The prospect of over 7000 direct jobs in the industry by 2020, many of them in remote rural areas, is attainable. These will be additional jobs as the likely level of displacement will be extremely low.

July 2004

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