A discussion on decarbonization and electric vehicles in the UK

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Never has there been such a global consensus on the need to reduce greenhouse gas (GHG) emissions. There is rarely a single day without the media reporting the current climatic consequences due to global warming. To eliminate the UK’s contribution to global warming, the UK has set itself an extremely ambitious target of reaching net zero by 2050.

In 2019, transport was the main contributor to UK domestic GHG emissions (27%). In November 2020, the UK government announced a further acceleration of its timetable for phasing out internal combustion engine (ICE) vehicles, with sales of new petrol and diesel cars and vans now due to end by 2030 and all new cars and vans to be zero tailpipe emissions by 2035.

The government has also launched consultations on the phasing out of new ICE heavy goods vehicles and ending the sale of new ICE buses in England. There are 40,000 buses in the UK (and almost 900,000 buses in Europe) so there is a lot of work to be done given that only 2% of England’s bus fleet is fully zero emissions from 2021.

Some passenger operators have set themselves even more ambitious targets. For example, FirstGroup has committed to no longer purchase new ICE buses after December 2022, as well as a commitment to operate a zero-emission bus fleet by 2035.

One of the key elements of the government’s 10-point plan for the “green industrial revolution” is the inclusion of electric vehicles (EVs). An EV runs, in part or in whole, on electricity, whether it is stored on board the vehicle in batteries or produced from hydrogen. The battery is about 40-50% of the value of an electric vehicle battery, with the other components of the electric powertrain responsible for an additional 20%. It is estimated that by 2040 the UK battery market alone will be in the order of £ 9bn per year.

It is a theme common to all electric vehicles that there is a mismatch between the operational life of the battery and the operational life of the vehicle itself (the “Husk”). Most commercial electric vehicle batteries currently have an expected operational lifespan of around five to eight years, while the operational lifespan of a Husk (properly operated and maintained) will be considerably longer. For example, a diesel passenger bus is currently expected to have an operational lifespan of around 16 years, with an equivalent Husk EV potentially extending that lifespan slightly.

The inadequate operational lifespan of EV components presents a funding challenge for both EV operators and financiers. Funding arrangements at the start of any purchase should cover significant deferred costs with respect to replacement batteries while also mitigating risks and unforeseeable costs. For these reasons, an attractive option may be to have separate financing solutions for hulls and batteries.

Commercial electric vehicle operators have encountered some resistance in funding Husks passenger buses for terms of more than eight years, as diesel buses have typically been limited to a maximum funding term of eight years, even though their term operational life is often much greater than this. However, there are now a number of financiers who are comfortable with funding Husks passenger buses over the longer term. Husks financing can therefore use traditional financing structures that are familiar to all parties, but with some additional considerations regarding remarketing and access to batteries.

It’s all about BaaS – Commercial Electric Vehicle Financing

Financing batteries for commercial electric vehicles is proving more complex and there are many emerging models. One of these funding models is Battery Provision as a Service (BaaS). Under BaaS, the battery is leased from a specialist battery financier (for example, on a per kWh, per km or per month basis) and is provided as an ongoing service to the EV operator by the BaaS provider . The BaaS provider will also often install, manage and maintain the associated charging infrastructure, which can include co-located energy storage capacity that facilitates rapid charging of multiple vehicles without the costs of upgrading the grid connection to meet on demand for peak load power, as well as making it easier to purchase power overnight when prices are lowest.

The main advantages for the BaaS EV operator are:

  • all costs of purchasing, maintaining, replacing and disposing of batteries are covered by the BaaS supplier to provide cost certainty to the EV operator from the start;

  • the operator’s initial investment costs are lower, as they only cover the costs of purchasing Husk and the corresponding project costs. Although not directly related to BaaS, these initial investment costs can also be reduced further through the use of available government grants and incentives;

  • removing battery costs from the overall purchase price of the vehicle converts it to an operating expense, which may be more “user friendly” depending on accounting approval;

  • As the BaaS provider may take some (if not all) of the residual value (RV) risk with respect to the batteries, the BaaS provider is encouraged to exercise prudent battery management to mitigate the RV risk and extend the life of the battery. useful life of each battery;

  • all issues regarding the battery supplier (for example, battery warranty claims) are handled by the BaaS supplier; and

  • the BaaS provider should be well placed to assess the risks / benefits of operating both the charging infrastructure and the battery assets (both on vehicles and co-located with the charging infrastructure) in order to generate additional income, possibly on a profit-sharing basis. These additional revenues may include B2G (battery to grid) where the charging infrastructure includes co-located energy storage capacity and making the charging infrastructure available to other users when it is not. not otherwise required. V2G (vehicle-to-grid) may also be an option for electric vehicles, but this option is not particularly suitable for buses due to the schedules at which most buses in a fleet will provide service to passengers.

The main advantages for the BaaS provider are as follows:

  • battery rental produces a predictable long-term revenue stream over the term of the contract (likely corresponding to the expected operational life of the EV). In order to protect any erosion of the revenue stream, the BaaS provider will need to ensure that unforeseen costs are minimized either by

(i) careful negotiation of battery warranties with the original equipment manufacturer (OEM), or

(ii) ensure that he fully understands the underlying technology and that he can manage certain risks himself.

  • the BaaS supplier may be able to take advantage of its commercial position to obtain an extended warranty and agree on battery replacement costs in advance. OEMs may be reluctant to extend warranty terms or offer replacement batteries for less than the current market value of the equivalent battery. This is despite the general view that the operational lifespan of batteries will far exceed the warranty periods currently offered and that battery costs will significantly reduce in the years to come. With due diligence, there may be opportunities for BaaS vendors and others in the industry to improve overall returns by assuming some level of risk relative to the likely reduction in battery replacement and replacement costs. the operational life of the batteries beyond the warranty period. . It can also be an opportunity to encourage EV operators by setting up a risk sharing model directly linked to maximizing the operational lifespan of the batteries;

  • many electric vehicle operators will seek a simple one-stop-shop for electric vehicle financing that includes hulls, batteries and charging infrastructure. Being able to provide BaaS will be advantageous when bidding for other elements of EV purchases. The installation of the charging infrastructure by the BaaS provider allows for greater flexibility in the rental structure, as it allows additional options to quantify the rental amounts due under the lease. It also reduces the risk that the EV operator will switch to another BaaS or battery technology vendor when the contract term expires, as the costs associated with replacing the charging infrastructure can make this unsuccessful. viable;

  • assuming the BaaS provider installs the charging infrastructure, it is possible to generate additional revenue by sharing the charging infrastructure with other EV users and selling the electricity back to the grid (whether B2G or V2G); and

  • there may be a secondary market for batteries that are no longer suitable for use with electric vehicles. For example, batteries could be reused in static battery arrays collocated with the charging infrastructure.

BaaS is an emerging market with few active BaaS providers in the UK. However, this is an area that arouses great interest from operators and financiers, driven by an expanding market with solid ESG credentials. This, combined with the extremely competitive investment market, means that there is substantial interest in every VE asset acquisition. Financiers with no previous experience in VE or BaaS asset investment and who wish to enter this market will, however, need to carefully select their business partners and advisory teams to avoid exposing themselves to unnecessary risk.

© 2021 Greenberg Traurig, LLP. All rights reserved. Revue nationale de droit, volume XI, number 257


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