​Contracts for Difference: what changes lie ahead?

As we await confirmation from the Government on the timing of the next Contracts for Difference (CfD) allocation round (which may be influenced by the leave outcome of the EU referendum) and the outcome of the two consultations currently being conducted by the Department of Energy and Climate Change (DECC), we look at some of the key issues that will shape the future of the CfD scheme.

What you need to know

• Changes to the CfD contract: the DECC is currently consulting on proposals to amend the standard form CfD contract to prevent the cumulation of state aid, clarify the application of the change in law provisions to planning challenges and make a number of further "minor and technical changes". These amendments will not only apply to future CfDs that are awarded, but could also apply to existing CfDs.
• Non-Delivery Disincentive (NDD): DECC is also currently consulting on proposals to amend the Contracts for Difference (Allocation) Regulations 2014 (the CfD Allocation Regulations) to widen the Non-Delivery Disincentive exclusion.
• Future CfD auctions: the Government has confirmed that it will auction £730m of CfDs this Parliament for offshore wind and other less established renewables. We understand that an announcement on the timetable for the next auction of £290m - which is scheduled to take place towards the end of 2016 or early 2017 - may be imminent. The leave vote on the EU referendum could lead to such an announcement being delayed (or worse).

Following the cancellation of the second CfD allocation round in October 2015, the renewable energy industry was buoyed by the Government's announcement in its 2016 Budget that it would "auction Contracts for Difference up to £730 million this Parliament for up to 4 GigaWatts of offshore wind and other less established renewables, with a first auction of £290 million".
In an earlier speech on 18 November 2015, Amber Rudd, Secretary of State for Energy and Climate Change, confirmed that "if, and only if, the Government's conditions on cost reduction are met - we will make funding available for three auctions in this Parliament. We intend to hold the first of these auctions by the end of 2016".

We understand that an announcement on the timetable for the next auction may be imminent and, consistent with Ms Rudd's speech, the auction is likely to take place towards the end of 2016 or early 2017. There is an expectation that the auction will be for the 2021/22 and 2022/23 delivery years, and possibly even delivery year 2023/24, although this is yet to be confirmed by DECC. However, the vote to leave the EU could, at best, delay the timing of the announcement on the timetable for the next auction or, at worst, could put the brakes on the auction itself for an indefinite period of time.

As some existing CfD holders endeavour to get to grips with the complexity of the CfD and satisfy the challenging CfD conditions precedent and milestone requirements, the Government is looking to tighten the rules around state aid and restrict the availability of change in law protection for generators, while making it harder for applicants who fail to sign or lose a CfD to have another shot at developing a successful CfD-backed project.

While we await confirmation from the Government on the next allocation round and the outcome of the two consultations that DECC is currently running, we look at some of the key issues that will shape the future of the CfD scheme below.

What are the proposed changes to the CfD?

In its May consultation, DECC is proposing to make a number of changes to the CfD, the key changes being:

Cumulation of state aid

DECC is proposing a number of changes to the state aid provisions in the CfD, driven by a European Commission requirement to ensure that CfD payments made by the Low Carbon Contract Company (LCCC) (which have already been classified as state aid) are not cumulated with any other form of state aid such as loans, tax exemptions, grants or subsidies.

The proposed changes are extensive but in essence they require generators to repay any other form of state aid they have received (with interest) before they are entitled to receive CfD payments. Any repayment would need to be made to the relevant aid grantor or, where such person refuses or is unable to accept repayment, would be set off (again, with interest) from the relevant CfD payments. Until the other form of state aid is repaid or set off, CfD payments would be temporarily suspended without accruing any interest.

DECC's expectation is that each generator should be aware if they have received or benefited from any other form of state aid. Therefore, DECC is also proposing to expand the scope of the conditions precedent in the CfD and introduce new information provision obligations relating to the receipt of state aid by each generator.

Foreseeable changes in law

Under the CfD contract, generators are entitled to limited cost and revenue protection following the occurrence of certain types of change in law. One of the main exceptions to this protection is that it does not extend to changes in law which are deemed to be "foreseeable" at the date the CfD is signed. The existing definition of foreseeable is long and complex and captures a wide range of laws, regulations and guidance which generators knew about or should have known about on the date they signed the CfD.

ECC is proposing a number of amendments to the foreseeable change in law definition; most notably an amendment to clarify that judicial review proceedings brought against the grant of a planning permission, environmental permit or other consent for the relevant generating station are foreseeable, even where such proceedings are brought after the date the CfD contract is signed (provided that they are brought within the relevant time limits for challenge).

On the one hand, this proposal is consistent with the widely understood CfD eligibility requirement that prospective CfD applicants need to ensure that a planning permission is in place when applying for a CfD. However, on the other hand, applicants who are awarded a CfD only to face significant project delays due to a judicial review challenge to the award of their planning permission, could be terminated under the CfD for a failure to commission their facility by the longstop date (losing the significant development costs they have incurred up to the date the CfD is terminated), even where the judicial review challenge is ultimately unsuccessful.

Storage

DECC is proposing to amend the CfD to clarify the position in respect of electricity storage, including a proposal to require separate Balancing Mechanism Units (BM Units) to distinguish between electricity that is generated by a CfD facility (to which the CfD would apply at the time of generation) and electricity that is stored, whether such stored electricity is generated by the facility or imported from the grid.

Other amendments

Finally, DECC is proposing to make a number of further "minor and technical changes" which are set out in the consultation.

The consultation also includes a call for evidence on options for potential changes to be made for allocation rounds beyond the next allocation round, noting that any significant changes would be subject to further consultation. The options, in summary, are as follows

Mitigating the risk of LCF overspend from load factor uncertainty

DECC has highlighted a concern that, due to faster-than-expected developments in certain technologies (such as offshore wind), load factors used in the valuation formula in the CfD allocation process have been underestimated, contributing significantly to the forecast Levy Control Framework (LCF) breach. DECC has therefore asked for views on what measures it can put in place to mitigate the risk of load factor underestimation.

Limiting the duration of force majeure protection

 As part of its aim to ensure that the LCF budget is not blocked by projects which are significantly delayed or may not proceed, DECC is considering whether there should be a time limit for the duration of force majeure events, after which a generator would not be entitled to relief from its CfD obligations or an extension to key CfD dates (such as the Milestone Delivery Date or Longstop Date). DECC is also considering whether a time limit should be applied on a blanket basis throughout the term of the CfD.

Budget-blocking

Finally, despite DECC acknowledging that the right balance has been achieved through the CfD framework to discourage budget blocking without adding undue cost, complexity or barriers to commissioning, DECC has asked for views and quantitative evidence about how the current budget-blocking measures might be refined without increasing the risk of speculative bids.

While, at first glance, this appears to be inconsistent with DECC's consultation on strengthening the NDD (discussed below), it does in fact hint at the difficulties that have been faced by certain successful CfD applicants with genuinely deliverable projects in satisfying the challenging (and in some cases, ambiguous) CfD conditions precedent and milestone requirements.

Could the above changes impact on existing signed CfDs?

The short answer to this question is "yes". Under the standard form CfD contract, the LCCC has the right to propose "Material Amendments" or "Technical Amendments" to existing CfDs as follows:

• "Material Amendments" are amendments that have a material adverse effect (a legal term which is not defined in the CfD, but which has been judicially considered in the UK) on the (i) revenues/costs of the generator which are not fully compensated by the LCCC or (ii) the overall balance of risks, benefits and liabilities of the generator. While the LCCC may propose a Material Amendment, the generator has the right to object to the amendment and if it so objects, the amendment will not be implemented unless the parties can agree to the amendment (having acted in good faith);
• "Technical Amendments" are amendments which are not Material Amendments and which are required to correct manifest errors. A sub-category of Technical Amendments are "General Amendments", which are Technical Amendments that apply to all CfDs or all CfDs of a particular category (in contrast to amendments which apply to a single CfD);
• finally, for Technical Amendments which are General Amendments, such amendments are binding on the generator unless 75 per cent of all affected CfD generators object to the amendment based on (i) its misclassification as a Technical Amendment or (ii) the amendment itself. If there is such an objection, the procedure in the above paragraph applies.

Clearly, the LCCC has greater control over the process of proposing and implementing Technical Amendments, provided that it can demonstrate that the relevant amendment is required to correct a manifest error, and has not be incorrectly classified as a Technical Amendment (rather than a Material Amendment).

DECC has stated that the changes on which it is currently consulting will be included in the CfD contract and legislation for the next allocation round. However, it has also highlighted the LCCC's powers to implement these changes into existing signed CfDs, which the LCCC would be entitled to do subject to the requirements set out above.

What are the proposed changes to the non-delivery disincentive?

The aim of the NDD is to incentivise projects which are awarded a CfD to both sign the CfD contract and then use their best efforts to satisfy the milestone requirement under the CfD.

The existing provisions of the CfD Allocation Regulations exclude the site of a project which is awarded a CfD from applying for a new CfD for 13 months, where the relevant CfD applicant either fails to sign the CfD or has its CfD terminated prior to or because of a failure to satisfy the milestone requirement.

Due to the cancellation of the 2015 CfD allocation round, DECC has expressed a concern that the 13-month exclusion period is not an effective disincentive based on the fact that the allocation rounds are taking place less frequently than every 13 months. Therefore, DECC is proposing to amend the CfD Allocation Regulations so that such exclusion applies to:

• any CfD allocation round that commences in the period up to 13 months from the date of the relevant CfD notification (as is the current position); and
• the first of any CfD allocation rounds that are held in the period between 13 months and 24 months after the CfD notification date.

Therefore, for example, if one CfD allocation round is held in month 12 after the CfD notification date and a further allocation round is held in month 18, the relevant site would be excluded from both allocation rounds. However, where no allocation rounds take place in the 24 months after the CfD notification date, the exclusion would lapse.

It is difficult to say in practice how effective these changes will be, or in fact how ineffective a disincentive the current 13-month exclusion has been. Of the 27 CfDs that were awarded in the first allocation round which ended in February 2015, we know that only 25 were signed, meaning that two sites were excluded until March 2016 (the sites for the Royston Solar Farm and Wick Farm Solar Park).

Equally, of the 25 CfDs and eight Investment Contracts remaining:

• the LCCC's register confirms that Mainstream Renewable Power is disputing the LCCC's decision to terminate its CfD for the Neart na Gaoithe offshore wind farm;
• the LCCC's register also confirms that the CfD for the Netley Landfill Solar Park terminated on 21 March 2016; and
• it is reported that the Triangle Farm Solar Park is seeking an extension to the Milestone Delivery Date (so, depending on the circumstances surrounding the request, could also be at risk of termination).

Therefore, these projects could be caught by the increased exclusion period which would deprive them of the opportunity to bid in the next auction assuming that it takes place towards the end of 2016.

Conclusion

Currently, the UK renewables industry is anxiously awaiting the announcement of the long overdue second CfD allocation round. Further detail around the second CfD allocation round - including for which delivery year(s) the budget will be made available - will hopefully provide greater clarity and confidence for industry.