In December 2022, the Department for Business, Energy & Industrial Strategy (BEIS) initiated a consultation regarding the considerations for future Contracts for Difference (CfD) rounds.
This consultation is aimed at seeking feedback to the potential changes that may be made to the upcoming allocation round (AR6) due to open in 2024, as well as providing policy updates. The consultation closes on 7 February 2023.
What is a Contract for Difference?
A CfD is a contract between a low carbon electricity generator and the Low Carbon Contracts Company (LCCC), a BEIS owned private company. Despite one party being a government owned entity, the contract is governed by private law.
The CfD scheme is the government's primary mechanism for supporting the generation of low carbon electricity. Renewable generators located in the United Kingdom, if eligible, can apply for a CfD by submitting a 'sealed bid'. After an auction, successful bidders are paid a flat (indexed) rate for the electricity produced over 15 years, which is the difference between the "strike price" (the price of electricity that reflects the cost of investment in that particular low carbon technology) and the "reference price" (a measure of the average market price of electricity in the market).
CfDs are attractive instruments since selected developers of projects receive direct protection from volatile wholesale electricity prices, which is valuable in a sector that envisages high upfront costs and price fluctuation during the lifetime of the project.
Four auctions or allocation rounds have already taken place, with the fifth one underway. National Grid ESO is responsible for conducting these allocation rounds.
The Consultation Regarding AR6
The Consultation has been initiated in the context of the government's twin goals of achieving net zero emissions and ensuring energy security for the UK; and pursuant to the recognition that by 2030, the majority of the country's power would likely come from low-carbon energy generators operating under CfD contracts. The consultation focuses on short-medium term considerations, with longer term changes to the market being considered by the government as a part of the Review of Electricity Market Arrangements (REMA), which has been discussed here. The Consultation has been divided into three sections, which are addressed below.
1. Considerations for AR6
- The UK government will be reviewing the private network CfD agreements in the context of more developers applying for CfDs for the purpose of electrification of offshore oil and gas facilities. If not re-assessed or modulated accordingly, such arrangements may not only add a new cost to household energy bills, but also potentially defeat the objective of the scheme;
2. Considerations for future allocation rounds
- Clarifying the definition of floating offshore wind: Recognising the potential ambiguity in the current definition in the CfD (Allocation) Regulations 2014, the government is seeking stakeholder input to determine whether new and innovative foundation types should be considered eligible;
- Considering Offshore Coordination: The government would be seeking input on how the Offshore Transmission Network Review ("OTNR"), which aims at improving the coordination of the offshore electricity network, would impact the competitiveness of the CfD process. It aims to ensure that the risks faced by coordinated projects (including those that are being coordinated with interconnectors) are minimised;
- Discussion on the Phasing of Offshore Wind: Offshore wind projects that fall within the area of the same Crown Estate Lease are built in three phases, with each phase entering into a separate CfD. With the evolution of offshore wind including swift deployment of projects, it appears that the phasing policy is no longer serving a valid purpose, and is thus being reviewed for all future rounds;
- Adapting the Appeals System: At present, the CfD policy contains a two-tier appeal system, which can delay the start of the allocation rounds if triggered. As the allocation would now be conducted annually instead of once in two years, the appeals system would have to be reviewed and adapted accordingly; and
- Considering Repowered Assets: The government is seeking evidence on whether projects which focus on repowering existing projects should be considered within the CfD scheme, so as to balance the increasing capacity with value for consumers, and long-term considerations of these projects within the broader electricity system.
3. Policy Changes
The government is providing updates on several matters of policy. While it is not seeking stakeholder input on this at present, these indications are relevant as they provide governmental insight on future developments in the CfD scheme. The key updates are summarised below.
- Assessing the appropriate level of market exposure for CfD generators: As renewable energy becomes a larger part of our future energy mix, the government will have to ensure that risk reduction via the CfD scheme does not create perverse economic incentives that cause inefficient operating behaviour. Resultantly, in a bid to balance efficient operating behaviour with revenue confidence and consumer value, the government reviewed the level of price exposure for AR6. While it concluded that the present exposure was appropriate for developers, this exposure to wholesale market prices will be reviewed again for the future rounds.
- The interaction of the CfD scheme with REMA: The first REMA consultation considered the role of CfDs in future market arrangements given their potential, which included seeking views on the high level options for CfD variations as well as any possible benefits of increased market exposure. This consultation closed in October 2022 and the response will be published shortly.
- The interactions between the capacity market and the CfD: Due to the way the Capacity Market regulations are structured, capacity providers have been unable to effectively participate in CfD allocation rounds despite theoretically being eligible. Proposals to address this deficiency will be highlighted in a separate consultation, with a range of proposed potential amendments to the Electricity Capacity Regulations 2014. These changes will be in place for AR6.
- The potential to include non-price criteria in the CfD: The government is assessing whether it should be considering factors beyond price that may be a barrier to deployment during the allocation process. At present, it has prioritised ensuring that consumer cost is as low as possible, making a price-based CfD policy the most suitable system. In other countries, including a few across the EU, leasing rounds and tenders feature a number of "non-price criteria", where outcomes are not only determined on the basis of the financial value of a bid, but also on criteria such as sustainability, project resilience and system integration. The government aims to consider this as well, while also maintaining an eye on consumer value.
The relevant information in relation to this Consultation can be found here.
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.