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.
It is hoped that CfDs will make it cheaper to deliver low-carbon generation by lowering the cost of financing projects; reductions that may not be achieved through existing policy instruments, such as the Renewables Obligation (RO) or carbon pricing.
On the 4 December 2013, the Department for Energy and Climate Change (DECC) published a key decision document that sets out the strike prices for renewable technologies for the period 2014/15–2018/19 (as set out in the table below). The decision document also provides an update on the key contract terms for the CfD. It is hoped that the publication by DECC of this major milestone will provide investor and industry certainty and will maintain the UK's position as one of the most attractive for low-carbon energy developers.
CfD overview
The CfD 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, generators will be obliged under the CfDs to pay the difference to the CfD counterparty, which it is hoped will reduce unnecessary costs to consumers when electricity prices are high. Strike prices
The updated strike prices set out in the table below will enable the UK to generate at least 30 per cent of its electricity from renewable sources by 2020 and to provide a solid basis for further decarbonisation in the 2020s while keeping costs to consumers down.
Support under the new CfD regime will fall further over time, as reflected by the strike prices set out in the table below, to take into account the expected cost reductions as renewable technologies become more established. Where demand for contracts exceeds available budget, competition will be used to select the best value projects.
Notes:
- The strike prices in the table above show the strike price for projects commissioning in the year stated in the column.
- These prices are in all cases maximum strike prices. In the case that constrained allocation applies earlier, the actual strike price will be the outcome of the constrained allocation process if that is a lower value.
- While strike prices have been set out for 14/15 in order to ensure comparability, the Electricity Market Reform consultation on proposals for implementation discussed a start date for CfD payments of April 2015.
CfD contract terms
Following responses to the key CfD documents published in August 2013, the Government has consulted with a wide range of stakeholders to develop its policy position on the CfD contract terms. The CfD contract will still be a 15-year contract for renewable technologies, with payments indexed to inflation (CPI), and obligations to deliver the contracted capacity in a timely manner but the following changes have been made that support the ability of developers to bring forward investment at lower cost to consumers:
- Flexibility to reduce capacity – developers will be able to reduce the capacity of their proposed project by up to 25 per cent (without financial penalty) between the date of allocation and the date of "Substantive Financial Commitment". This allows developers to refine their plans post-signature before confirming their commitment to build.
- Protection against unexpected events – in addition to force majeure protections, relief will be provided against delays caused by electricity connections.
- A targeted approach to generator collateral – the approach to collateral has been changed so that generators that make payments in a timely manner will not be required to post collateral. Instead, collateral requirements will only apply if generators fail to comply with the payment obligations set out in the contract.
- Protection against changing circumstances – protection from changes in law will be extended to include revenue adjustments should the generator be prevented from generating without receiving reasonable compensation; and strike price adjustments to compensate for changes in charges covering transmission losses and balancing services costs.
- Greater certainty over the reference price – baseload generators will have the option, but not an obligation, to switch to a year-ahead reference price when this is introduced.
- Phased offshore wind projects – all phases of offshore wind projects will receive the same strike price and this price will be determined by the target commissioning date of the first phase. Furthermore, it has been decided to reduce the minimum capacity required in this first phase to 25 per cent of the total project capacity.
Looking ahead
Whilst it remains to be seen whether the CfD will encourage the growth of the UK's renewables industry, the recent publication of the strike prices will give the investment community comfort around market certainty up to 2019.
It should also be noted that the RO remains open for business for new renewables projects until the end of 2017 so project developers have the choice of two support mechanisms, CfDs or RO, during a transitional phase from 2014 (the first year of CfD operation) until the end of 2017.
Finally, it is worth noting that the RO has been in existence since 2002 and is tested and trusted, whereas the CfD regime is new and untested in the UK. This may provide an opportunity for astute investors and project developers who can arbitrage between support rates under each instrument and consider the very different development risk profile associated with each before choosing the appropriate instrument to develop their project.
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.