UK Contracts for Difference: The third allocation round

The third Contracts for Difference (CfD) allocation round (CfD AR3) to provide support for renewable energy projects in Great Britain was launched on 1 May 2019 and is currently underway. This article considers the details of CfD AR3, together with various changes to the CfD regime consulted on by the Government, which apply to CfD AR3, and the likely implications for the renewables industry.

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Background: the story so far

The first CfD allocation round took place in 2014. Originally it was intended that allocation rounds would take place on an annual basis, but the second allocation round did not commence until April 2017. For a full analysis of the results of the second CfD allocation round, see our earlier briefing "The UK: Offshore wind all the way". There were some key differences between the first CfD allocation round and the second CfD allocation. One key difference was that a more narrow range of technologies was eligible to take part in the second allocation round: only so-called "less established technologies", comprising offshore wind, advanced conversion technologies (ACT) (with or without CHP), anaerobic digestion (with or without CHP), dedicated biomass with CHP, wave, tidal stream and geothermal technologies. What was also significant was that the second CfD allocation round resulted in much lower strike prices being awarded to the successful projects - a trend, which, as discussed in more detail below, will almost inevitably be repeated.

In the Clean Growth Strategy, published in October 2017, the Government said that it would make "up to" £557 million available for further CfD auctions, with the intention that these further CfD allocation rounds will be held every two years.

The scope of CfD AR3

The budget

The Department for Business, Energy and Industrial Strategy (BEIS) has confirmed that £65 million (at 2011/12 prices) is being made available in CfD AR3. This budget will be made available to eligible projects with delivery years of 2023/24 and 2024/25. While larger than the £60 million draft budget published in November 2018, this is still a much smaller budget than that offered in the second allocation round, which was £295 million. Moreover, as discussed in more detail below, BEIS has indicated that it expects the subsidy levels resulting from CfD AR3 to be even lower than that awarded in the second allocation round.

A new capacity cap

What is interesting is that, for the first time, a capacity cap is being imposed as well as a budgetary cap. The cap that the Government has decided to apply is 6GW. This means that even if the full budget of £65 million is not spent, the total capacity of all the projects awarded CfDs in CfD AR3 cannot exceed 6GW. It is to be assumed that the capacity cap is being imposed to allow less than £65 million to be spent if the target capacity is procured at sufficiently low strike prices.

The use of an overall capacity cap for CfD AR3 was subject to state aid approval from the European Commission, which has now been granted.

Eligible technologies

Once again, only "less established technologies" are eligible to compete. However, as discussed in more detail below, onshore "remote island wind" (RIW) has been added to the less established category. Therefore, the technologies that are eligible to compete for CfDs in CfD AR3 are: offshore wind, RIW, Advanced Conversion Technologies (ACT) (with or without CHP), anaerobic digestion (AD) (with or without CHP), dedicated biomass with CHP, wave, tidal stream and geothermal technologies.

The budget notice also set out the administrative strike prices (which represent a cap on the strike price that may be awarded to a project) that apply to the difference technologies in CfD AR3, as set out in figure 1. The "methodology" published by BEIS in December 2018, setting out how the prices were set, states that for CfD AR3 the Government has set administrative strike prices at a level whereby projects representing the 25 per cent of the lowest cost capacity of each eligible technology should be able to participate in the round. What is particularly notable is the low administrative strike prices set for offshore wind, which, probably not surprisingly, have been set at a level below the strike prices awarded to two of the three offshore wind projects that were successful in the second allocation round. There is a very clear expectation that the cost of delivering offshore wind projects should be reduced further. In January 2019 the Secretary of State stated that "the cost of renewable technologies such as offshore wind has fallen dramatically, to the point where they now require very little public subsidy and will soon require none". It has been reported that on the basis of the Government's own modelling of the future reference price, as set out the draft Allocation Framework for CfD AR3, for offshore wind projects commissioning in 2024/25 the level of subsidy may be as low as £2/MWh.¹

Figure 1: CfD Administrative Strike Prices for CfD AR3 (£2/MWh, in 2012 prices)

Remote island wind

While the Government's policy is that conventional onshore wind projects should no longer be eligible for support under the CfD regime, the Government has decided, following consultation on this issue, that onshore wind projects located on remote islands (referred to as remote island wind or RIW), such as the Scottish islands of Shetland and Orkney, should be eligible for CfD support as less established technologies. The changes have been implemented pursuant to the Contracts for Difference (Miscellaneous Amendments) Regulations 2018. State aid approval from the European Commission for the separate treatment of RIW was received in January 2018.

The definition of RIW requires that, among other things:

• the remote island is located in offshore waters and the entirety of the coastline (measured from the mean low water mark) of it is situated not less than 10 kilometres from mainland Great Britain; and
• the project's connection to the GB transmission system involves "not less than 50 kilometres of cabling, not less than 50 kilometres of which is subsea cabling".

The structure of CfD auctions is such that all the less established technologies eligible to take part, including RIW projects, will be competing in the auction against each other for the same pot of money. When the Government consulted on the inclusion of RIW in the CfD scheme, some stakeholders argued that the Government should set a minimum budget and/or capacity for RIW in the third allocation round, to guarantee that at least some RIW projects are successful in gaining a CfD. Concern has been expressed that without such measures it may be difficult for RIW projects to compete against other technologies — in particular, offshore wind, the costs of which have fallen significantly, as indicated by the large strike price differential between CfD allocation rounds one and two. The Government, however, while acknowledging that a minimum for RIW or a maximum for offshore wind could "increase the likelihood that the next allocation round brings forward sufficient RIW capacity to justify one or more new transmission links to the remote islands", has decided not to introduce such measures on the basis that this would not achieve the lowest price, which is the Government's primary objective for the auction process. The same justification was used in the second CfD allocation round, when the Government decided not to apply a minima to wave and tidal stream on the basis that "reserving a proportion of the budget for these technologies — at the expense of other potentially less expensive technologies in Pot 2 [i.e. less established technologies] — does not represent good value for money for consumers.

It should be noted that developers on Scottish remote islands are committed to the Scottish Government Good Practice Principles for Community Benefits from Onshore Renewable Energy Developments, which recommends a minimum payment of £5000 per MW per annum in to a community benefit fund. However, the Government has decided, at this stage at least, not to make any changes to the CfD application process or to the CfD contract to mandate a particular form of community benefit.

A focus on offshore wind

The Government has made it clear that in the short to medium term at least, it will support the deployment of large-scale offshore wind projects as a means of reaching its renewable energy targets in a cost-effective way. In the Clean Growth Strategy published in October 2017, the Government pledged to work with the offshore wind industry to develop a “sector deal” for offshore wind, which, according to the Government “could result in 10 gigawatts of new capacity, with the opportunity for additional deployment if this is cost effective, built in the 2020s”. The Offshore Wind Sector Deal was finalised in March 2019, which, through various commitments by Government and industry, seeks to establish a pathway for the
delivery of up to 30 GW of offshore wind capacity by 2030.

Given the success of offshore wind in the second CfD allocation round, it seems likely that this success will be replicated in CfD AR3.

Changes to CHP requirements: dedicated biomass with CHP

The Government has decided that new efficiency requirements will apply to technologies that are only eligible for a CfD if deployed with CHP (i.e. dedicated biomass with CHP and energy from waste with CHP, although no funding has been provided for energy from waste with CHP to participate in CfD AR3).These new efficiency requirements are as follows:

• 70 per cent overall efficiency (net calorific value);
• primary energy saving of 10 per cent (gross calorific value); and
• 10 per cent heat efficiency (gross calorific value).

These new requirements will apply to all dedicated biomass with CHP projects irrespective of size, but will not apply retrospectively to projects that have already entered into a CfD.

To implement the new efficiency requirements, the CHP Qualify Assurance (CHPQA) Standard and the accompanying Guidance Note 44 has been amended and issued as versions 7, dated December 2018. Issue 7 of the CHPQA Standard applies to any CHP schemes in respect of which a CfD contract is entered into on or after the publication of Issue 7.

Changes to CHP requirements: "optional CHP" projects

ACT, anaerobic digestion and geothermal projects are described as "optional CHP" projects, because they can take part in CfD allocation rounds with or without CHP. The Government has decided to simplify the CHP requirements relating to such projects, where they do decide to proceed with CHP. In particular, going forward, such optional CHP projects will no longer be required to identify as being either "with CHP" or "without CHP" at the point of application for a CfD. This is designed to allow developers of optional CHP projects to make their own commercial judgements on whether to deploy CHP during the project lifetime. The Government has also decided to make some changes to the CfD contract terms, so that more similar contract terms will apply to developers of optional CHP projects irrespective of whether or not they deploy using CHP.

Amendments to the definition of "waste"

The Government has decided to amend the definition of "waste" under the Contracts for Difference (Definition of Eligible Generator) Regulations 2014 to make it clear that the term "waste" excludes any substance that has been intentionally modified or contaminated to fall within the definition of waste in Article 3(1) of the Directive 2008/98/EC (the Waste Framework Directive).This is an anti-avoidance measure to ensure that, for example, feedstock such as wood cannot be contaminated to render it a waste product, as a means to avoid the sustainability requirements that would otherwise apply to the wood (if the wood is not waste).

Efficiency requirements for ACT projects

In a consultation document of December 2017, BEIS discussed the fact that although the majority of existing ACT plants produce a gas, there are some processes in development that either produce combustible liquids or mixtures of combustible liquids and gases. The Government has therefore proposed some new criteria to "more clearly demarcate the kinds of ACT technology the CfD scheme should support".

Two new criteria are therefore being introduced, as follows: ·

• a requirement to meet a 60 per cent conversion efficiency of energy in the biogenic content of the feedstock into energy in the biogenic content of the syngas/synliquid. The Government intends to require the developer to agree an appropriate methodology with the Low Carbon Contracts Company to determine the biogenic energy content of the syngas/ synliquid; and
• physical separation of the gasification/ liquefication and combustion units.

If there is non-compliance with the efficiency requirements, then payments under the CfD will be suspended during the period of non-compliance. If there are more than 26 periods of non-compliance in any consecutive 12 months (with an exclusion for the first year of operation) then this may result in termination of the CfD. Non-compliance with the physical separation requirements may also lead to termination.

Greenhouse gas criteria for solid and gaseous biomass

Technologies using solid and gaseous biomass feedstocks are required to meet sustainability criteria to be eligible for support under the CfD scheme. The sustainability criteria include greenhouse gas (GHG) emission, which are made up of a GHG threshold and a GHG ceiling. No changes are being made to the GHG ceiling, but the Government is setting a new lower GHG threshold value that will apply to any projects that are offered a CfD as a result of CfD AR3. A single GHG threshold of 29 kg CO2 equivalent/ MWh to apply across the five potential commissioning years of 2021/22 to 2025/26, and it will be fixed at the same level for the duration of the 15-year term of the CfD contract. There is no intention for the new GHG threshold to apply retrospectively. The new threshold represents a significant development, as it represents an 85 per cent reduction from the previous threshold of 200 kg CO2 equivalent/MWh).The GHG threshold looks across the entire supply cycle of a biomass plant including the origins of feedstock, transportation and plant operations.  The new, more stringent requirement will mean that some feedstocks, such as imported wood pellets, will not be able to be used by new plant, as they will not meet the GHG threshold.

Mitigating budgetary risk

An issue at the forefront of the Government's low-carbon energy policy has been the need to constrain the cost of support for low-carbon energy (which cost is ultimately passed down to consumers) and manage the risk of budget over-spend. One aspect of budgetary risk that the Government has recently reviewed is load factor uncertainty - that is, the uncertainty associated with the fact that CfD-supported projects might produce more power than expected, leading to higher costs of support under CfDs. To manage this risk, the Government has decided to introduce two new measures:

• the Government intends to use higher load factor assumptions that represent
  an upper portion of the expected distribution of load factors for each technology, rather than central load factor assumptions, in the valuation formula in the next CfD allocation round; and
• for successful CfD developers, a new requirement to submit additional information on the expected generation output of their project over the CfD contract term: The timing of submissions will be:
  
  – two months after the Agreement Date;
  
  – two months after the Milestone Delivery Date;
  
  – annually throughout the contract term by 31 January, starting from the 31 January immediately prior to the Start Date, or in the year after the year in which the Milestone Delivery Date falls, whichever is earlier;
  
  – as a new Operational Condition Precedent;
  
  – as soon as reasonably practicable and no later than 10 business days after a request from the Low Carbon Contracts Company; and
  
  – as soon as reasonably practicable and no later than 10 business days after the developer becomes aware of an event or circumstance which will, or is reasonably likely to, affect the generation output of the facility.

Other changes to the CfD contract terms

The Government has decided to also make some other changes to the CfD contract terms, to address a number of issues, including some technical changes to drafting. The key amendments are as follows.

Force majeure relief 

In its December 2017 consultation, the Government stated that it felt that the force majeure provisions in the contract need to be amended to clarify the circumstances in which relief can be claimed. The Government has decided to proceed with amendments to the relevant provisions to clarify that force majeure relief can only be claimed:

• where a developer can demonstrate that the delivery of a contractual milestone has, or will, be affected by force majeure;
• where any failure or delay in performing a contractual obligation (including achieving a Longstop Date, Milestone Delivery Date or Target Commissioning Window) is caused by and directly attributable to a force majeure event;
• where condition 69 of the contract, dealing with notification, has been complied with (and which will now require notice as soon as reasonably practicable); and
• where the force majeure event or circumstance is a continuing one, is an event which remains beyond the reasonable control of the force majeure affected party or their representatives and remains one which they could not easily have avoided or overcome.

In addition, the force majeure provisions have been amended so that relief cannot be claimed where an event or circumstance has occurred prior to the CfD application date which the developer was aware of or, having made all due and careful enquiries and acting to a "reasonable and prudent standard", could be expected to have been aware of, and which impacts the developer's ability to meet their obligations under the CfD contract. Also, to avoid any doubt, the amended CfD terms state that non-availability of funds can never constitute force majeure. Finally, the provisions now provide that a generator must notify a force majeure if it has caused, is causing or will or is likely to cause, a failure or delay in performance and/or delay to the project.

Grid connection delay

An important feature of the CfD contract terms is the fact that developers are entitled to relief (in the form of extensions of time) for grid connection delay. However, to further tighten up the provisions of the CfD which are intended to ensure that a project is delivered on time, the Government has decided that developers will be required to provide notice of the delay occurring and to use reasonable endeavours to (a) act in a timely manner, enforce, and comply with the obligations in the relevant construction agreement, (b) avoid such failure and (c) to continue to mitigate the effects of such failure.

Definition of installed capacity

The definition of "installed capacity" is also to be amended, so that it is defined to be the capacity of the facility were it to be operated at optimal operating conditions at the facility on a continual basis for a sustained period, at the maximum capacity possible without causing damage to it and net of (a) all electrical loads required to operate the facility and/or deliver electricity, and (b) all electrical losses that would be incurred from the generating unit(s) to the metering equipment at the boundary point in so operating the facility and/or delivering electricity.

Description of facility

An amendment is also being made to the definition of "facility" to clarify, among other things, that the assets that fall within the generating facility are those identified in the description of the facility provided by the developer in accordance with schedule 1 of the CfD contract terms (which sets out the conditions precedent).

Bioliquids: sustainability requirements

To implement the requirements of EU Directive 2015/1513, the CfD contract terms will now impose new sustainability requirements for any plant using bioliquids.

Consequences of Brexit

Leaving aside the various indirect changes that Brexit may have on developers of low-carbon energy projects, the Government is addressing some of the changes flowing from Brexit that will have a direct impact on the CfD contract terms. For example, the definition of "Law" is being amended to include "retained EU Law" — that is, all EU law which has been incorporated into domestic law or which will be incorporated into domestic law as a result of the European Union (Withdrawal) Act 2018.

What next?

The commencement date of 29 May 2019 marked the opening of the Application Window for developers wishing to take part in CfD AR3, with the Application Window having been closed on 18 June 2019. Applicants were notified of the outcome of their qualification assessment on 9 July 2019 (the details of which are not publicly available), and by 8 October 2019 they will be notified if an auction is required (because the applications exceed the budget/capacity cap).

It is clear that the Government is banking on offshore wind projects, in particular, to deliver the Government's low-carbon generation targets, with the more expensive nuclear power projects falling away. However, while there is a clear expectation that new offshore wind projects can be delivered at ever decreasing cost, there is some concern by industry that the Government's ambitions have not taken into account the additional cost pressures that new projects may face as a result of Brexit and regulatory changes such as Ofgem's Targeted Charging Review (which is making changes to the way network costs are calculated and recovered).

1. Offshore Wind Journal, 31 January 2019: https://www.owjonline.com/news/view,exclusive-offshore-wind-subsidy-could-be-as-low-as-2mwh_56546.htm