UK: Contracts For Difference –Sufficient Certainty And Stability For The Renewable Energy Sector?

Summary and implications

In order to encourage investment in low-carbon technologies and reduce the UK's carbon emissions, the Government is aware of the need to provide predictable revenue streams to investors. Contracts for Difference (CfDs) are the Government's chosen mechanism to support this guaranteed income, by improving electricity price certainty and by providing the backing of a long-term contract.

A detailed draft of the standard form contract was published on 7 August 2013 by the Department for Energy and Climate Change (DECC) as part of the package of reforms to be introduced by the Energy Bill which is due to be enacted as primary legislation later this year. Given recent uncertainty over the form of renewable and low-carbon energy support, it is key to investors, developers and generators alike, that the CfD actually delivers a stable market with sufficient incentives.

CfD overview

The CfD, which will replace the Renewables Obligation, will be a private law bilateral contract between an eligible generator and the CfD counterparty, a Government-owned limited liability company. Generators will receive revenue from selling their electricity into the market as usual, but will also, under CfDs, receive a "top-up" from the CfD counterparty of the difference between a standardised electricity market reference price and a contractually set "strike price" (which is a measure of the cost of investing in a particular low-carbon technology, and which will be indexed to the Consumer Price Index). Conversely, if the electricity market reference price is higher than the strike price then generators will be obliged under CfDs to pay the difference to the CfD counterparty, which it is hoped will reduce unnecessary costs to consumers when electricity prices are high.

Certainty as to term?

The standard terms offer price support to generators for a set period of 15 years. However, this period will be reduced if specific conditions are not fulfilled or delay is caused. The Secretary of State will also retain some flexibility to allocate CfDs directly, with potentially varying contract lengths.

Termination rights

The CfD counterparty has the right to terminate a CfD when there is failure by the generator to fulfil the initial conditions precedent within a limited period, where a qualifying change in law prevents completion of construction or permanently prevents generation, or if there are breaches of specified key provisions of the CfD, such as insolvency, fraud and non-payment. However, previous suggestions of immediate termination occurring simply by non-payment have been eliminated and the published draft CfD terms include a "cure period", which will give investors some comfort.

On the other hand, there are no circumstances in which the generator can request early termination and, given the circumstances in which termination is permitted, any compensation on termination is invariably from the generator to the CfD counterparty (however the change in law regime does provide for compensation to the generator where a qualifying change in law leads to the generator being unable to complete construction of the facility or being permanently unable to operate it).

Contract flexibility

Whilst generators will want certainty from the Government, they will also be interested to see if the standard form CfD provides them with any flexibility. Under the draft CfD terms, generators can adjust their installed eligible capacity estimate, but only within certain parameters and by a certain date. The draft terms also allow for generators to install a lower amount of capacity than the estimate stated in their CfD Application. This means that they are entitled to receive payments under the CfD despite the fact they have not met the full installed capacity. However, this flexibility comes at a cost. DECC has indicated (although there is not yet drafting to this effect) that where the installed eligible capacity estimate is not met, the strike price will be reduced. The draft terms also allow for the strike price to be adjusted if there is an unforeseeable change in law. Therefore, "predictable" income streams may not be quite so predictable as initially thought.

Market Reference Price

As the generator is paid the difference if the strike price is higher than the market reference price, it is clear that the market reference price is a key element of the CfD. DECC is opposed to the market reference price being based on a day-ahead index, and it will instead be calculated from a forward season index. This forward season index will be selected using "objective criteria" to be set out in the contract (i.e. there will be two reference prices each year – one set every six months). However, there is still not any clarity on what the objective criteria will be as DECC are still developing the criteria and, therefore, they are not included in the draft terms.

In the long term, the market reference price will be based on year-ahead prices rather than season-ahead prices. Perhaps certainty is too much to ask at this stage?

It remains to be seen whether the CfD will give the renewables industry the market certainty needed. DECC are seeking views on the mechanics and operation of the terms only – not the underlying policy, and any commentary must be submitted by 2 September 2013.

The full documents published by the Government and the press release are available on GOV.UK The final contract terms are expected to be published in December 2013.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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