UK Government proposes significant changes to Contracts for Difference regime for renewables

The UK Government is consulting on changes to the Contracts for Difference (CfD) regime, which are intended to apply to CfDs issued in the fourth CfD allocation round (AR4), which is scheduled to take place in 2021. Perhaps most significantly, the Government has proposed that onshore wind, solar PV and energy from waste (EfW) with CHP projects will once again be eligible to take part in the allocation round, but the consultation encompasses other noteworthy changes. In this briefing we discuss the key consultation proposals and their implications for the renewable energy industry.

Background

The CfD regime has been the main source of support for new-build renewable energy projects since 2014, when the first CfD allocation round was launched. Recently, the Capacity Market mechanism has been opened to renewable energy providers, but the CfD regime remains the most viable route to achieving bankability for new-build large-scale (i.e. above 5 MW) renewables.

The third, most recent allocation round (discussed in an earlier briefing), which took place in 2019, was hailed a success in terms of securing offshore wind capacity at a strike price which is less than the wholesale electricity price. However, that success was not shared by technologies that could not compete with offshore wind on price (such as tidal stream) or technologies that were not eligible to take part (such as onshore wind, solar PV and EfW with CHP).

Impetus for the Government making changes to the CfD regime has come from both internal and external sources. In 2019, the Government adopted a new statutory target of net zero carbon by 2050 and in doing so reignited debate about the role that onshore wind and solar PV, as proven and cost-efficient technologies, could/should play in achieving that target. The Climate Change Committee noted in May 2019 that "it is unlikely that this generation will come forward at scale without Government backed contracts, which de-risk investments and reduce project costs". Another development, which should not be overlooked, was the launch of a judicial review challenge by renewables developer Banks Renewables, against the legality of the Government's decision to exclude onshore wind projects from the third CfD allocation round.

Reintroducing "Pot 1 - established technologies"

Heeding the warnings about the challenges associated with developing "merchant" renewable energy projects (i.e. projects without Government subsidy support) in certain technology sectors, the Government is proposing to reintroduce the "Pot 1" technologies category, for so-called established renewable energy technologies, which featured in the first CfD allocation round. Pot 1 technologies comprise onshore wind (>5MW), solar PV (>5MW), EfW with CHP, hydro (>5MW and <50MW), landfill gas, and sewage gas. This is very welcome news for onshore wind and solar PV projects in particular. While there has been significant discourse around the future of "subsidy free" renewables in some sectors, the reality is that in the absence of clear Government support, it has been challenging for such projects to establish robust investment cases. This is even more so the case since the raft of changes to network charges being implemented by the regulator Ofgem (for a more detailed discussion of these, see our Ofgem TCR briefing), which have resulted in the removal of many benefits previously available to smaller-scale "embedded" generators connected to the distribution network.

From subsidising to stabilising

However, it is clear that the nature of the CfD regime is changing, moving from a subsidy support mechanism to a revenue stabilising mechanism. This is brought into sharp focus by the Government's statement that it expects that these Pot 1 technologies will secure CfDs "at strike prices below the average expected wholesale price for electricity, and so over the course of a contract may pay back as much, or more, than they receive in CfD top-up payments (based on current market forecasts)".

The current structure of the payment mechanism under the CfD regime is such that generators receive a payment based on the difference between the reference price (which is intended to reflect the wholesale electricity price) and the strike price awarded to them under their individual CfD. Importantly, it is a two-way payment mechanism, meaning that if the reference price is higher than the strike price then the generator is required to pay the difference back to the CfD counterparty.

While the Government has not proposed changes to the structure of the payment mechanism under CfDs, the fact that it is anticipated that much lower strike prices will be achieved through the CfD auction process (something already seen in the last allocation round) means that the nature of the CfD will change if payments primarily flow from generators to the CfD counterparty. For those Pot 1 technologies that have demonstrated in the last five years that neither subsidising nor stabilising support is required for a development project to be "bankable" – including in the EfW sector which has continued to be highly active – the key question will therefore be, is there any benefit in locking in a CfD price below the wholesale electricity price, in turn giving away to the CfD counterparty and electricity consumers the (highly likely) upside that would otherwise be received where the wholesale electricity price is above the CfD price?

Community benefits

One of the key reasons why the Government previously decided to withdraw CfD support for onshore wind and solar PV was local community opposition from some quarters (to onshore wind farms in particular). Therefore, in reinstating support for these technologies, the Government is also proposing to augment the framework for so-called "community benefits" associated with such projects. Importantly, it is intended that this framework should apply to all CfD eligible technologies. In particular, the Government is proposing to:

• update the existing community benefits and engagement guidance for onshore wind, jointly with developers and local communities. The consultation states that the Government wants to "ensure local communities are appropriately involved in decision-making on such projects"; and
• create a register of renewable energy developments in England that lists relevant projects and community benefits.

While it is important for such projects to have local community buy-in and for communities to directly benefit from renewable energy projects being deployed "in their backyard", so to speak, it is, nonetheless, crucial that Government policy does not allow for minority opposition to derail projects that not only satisfy local planning requirements but also contribute to the UK's net zero carbon goals.

Technology pot structure – a separate pot for offshore wind?

The consultation proposes that the "pot" structure adopted when the CfD regime was first introduced – that is, having separate budget "pots" for different groups of technologies – should still be retained. Therefore, for AR4, it is proposed that, as mentioned above, there will be Pot 1 for "established technologies" and Pot 2 for "less established technologies". A key question considered by the consultation is in which pot offshore wind should be included. While the third allocation round demonstrated the extent to which the cost of offshore wind has fallen, it is not proposed that offshore wind should be included in Pot 1, as the consultation acknowledges that the costs of offshore wind are still higher than those of other Pot 1 technologies.

However, the consultation also recognises that offshore wind projects are much larger and cheaper than the other technologies currently included in Pot 2, and suggests that an alternative option would be to create a new Pot 3 just for offshore wind. This is a development that would no doubt be welcomed by the developers of the other Pot 2 technologies – ACT, AD (>5MW), dedicated biomass with CHP, floating offshore wind (see commentary below), geothermal, remote island wind (>5MW), tidal stream, and wave – who have struggled to compete with offshore wind in previous allocation rounds.

Floating offshore wind

The consultation notes that while floating offshore wind is currently eligible to compete in allocation rounds as offshore wind, its cost means that it does not currently have "a clear UK route to market".

The Government is therefore proposing to define floating offshore wind to separate this technology from conventional, fixed-bottom projects for the purposes of the CfD regime and provide the technology with a distinct administrative strike price.

As discussed in the consultation, floating offshore wind has the potential for deployment in deeper water sites, where fixed-bottom offshore wind is either not technically feasible or uneconomic, and where wind speed can be higher. However, this is still a nascent technology and as such it is anticipated that the commercial roll-out of floating offshore wind will not start until the 2030s.

A continuing commitment to offshore wind

An important point to note is that while the Government is once again broadening the categories of technologies that are eligible to apply for a CfD and appears to be committed to facilitating a more diverse mix of technologies being awarded a CfD in AR4 and beyond, it is clear that offshore wind is still seen as being key in delivering the UK's carbon reduction ambitions. As noted in the consultation, in March 2019 the Government, working with industry, set a target of 30GW of offshore wind by 2030, but this has recently been revised upwards to 40GW by 2030. In an update on the work done since the launch of the Offshore Wind Sector Deal, the Government states that "meeting net zero is likely to require higher volumes of offshore wind deployment than previously envisaged, to meet greater levels of electrification across the economy".

Extending the delivery years

Currently, the CfD statutory framework allows the Government to allocate CfDs with a delivery year (i.e. the year in which the project is commissioned) of up to 31 March 2026. To allow allocation rounds to take place every two years beyond the next 2021 allocation round, the Government is proposing to amend the legislation to extend the delivery years to 31 March 2030.

If the Government later decides that CfDs have a continuing role to play in facilitating the roll-out of developing renewable technologies (such as floating offshore wind, in the 2030s), then the delivery year timeframe will need to be further extended.

Supply chain plans

Currently, CfD applications relating to projects of 300MW or more are required to be accompanied by a statement from the Secretary of State approving their supply chain plan (SCP).

The Government is seeking views on the following issues:

• whether its SCP policy should be updated by increasing the quality of SCP commitments and the implementation of these through strengthened compliance processes;
• whether the 300MW threshold for submitting a SCP is set at the right level or if it should be lowered to capture smaller projects that are still large enough to make a material impact on the supply chain; and
• the carbon intensity within supply chains and how this could be measured and/or reported, and taken into account, as the UK transitions to a net zero economy.

Coal to biomass conversions

The Government is proposing to exclude new coal to biomass conversion projects from future CfD allocation rounds, including AR4. This is not a surprising development, given that currently all support for conversion projects is scheduled to end in 2027 anyway (resulting in a term shorter than the usual 15 year CfD term).

Decommissioning plans for offshore renewables

Currently, the Energy Act 2004 sets out the decommissioning regime for offshore wind and marine energy installations (wave, tidal flow and tidal range) and their related electricity cables. The Government is seeking views on how to strengthen the current regime as it applies to projects being supported under the CfD regime.
As more large-scale offshore wind projects are deployed, with a potentially high future decommissioning cost, this may be a timely opportunity to review how the decommissioning regime applies to CfD projects and decommissioning liabilities are dealt with, not just for the benefit of the Government and the taxpayer, but also for the benefit of developers and future investors in offshore wind.

Allocation round design

The consultation also invites views on improving the way the administrative strike prices are set, to better align the administrative strike price with the real cost of developing the relevant technology.

Non-delivery disincentive

The non-delivery disincentive mechanism under the CfD regime is intended to discourage developers from applying for a CfD without a definite intention to deliver the relevant project, by barring future applications relating to the same site for a set period of time.

The Government is considering extending the exclusion period for sites excluded in this way, possibly to 36 months or longer. Moreover, the Government is also seeking views on whether different forms of disincentive are needed for technologies at different levels of development and on what basis such differentiation might work most effectively. One option also being considered by the consultation is the introduction of a new requirement for a bid bond where applicants provide a deposit, either by cash payment, bank guarantee or letter of credit, which would then be forfeited upon non-delivery.

Storage

The consultation is also seeking views on what battery storage projects developers may wish to co-locate with their renewable energy installations and what changes to the CfD regime may be required to facilitate this.

Negative pricing

The Government is proposing to extend the existing negative pricing rule so that difference payments are not paid at all to CfD generators when the Intermittent Market Reference Price is negative. This is to remove any incentive for CfD generators to generate in ways which are "unhelpful" to the overall system at such times.

Phasing for offshore wind

Currently the CfD regime allows offshore wind projects that are allocated a CfD to be built in up to three phases, provided that all phases of a phased CfD offshore wind project are located within the same Crown Estate lease area. However, the size of phased projects is capped at 1500MW. Recognising the large scale of some of the offshore wind projects currently in the pipeline, the Government has considered increasing the cap on phased projects, but at present it is not inclined to do so. However, the consultation seeks views on whether there are any barriers to the development of a phased offshore wind project on a part-merchant basis.

Milestone Delivery Date (MDD)

The consultation notes that some generators find it challenging to meet the MDD, in particular in meeting the MDD through the 10% spend route. For this reason, the consultation is seeking views on the case for extending the MDD deadline. This is no doubt a positive development, given that going forward developers will be facing increasing pressures to reduce the costs of projects and doing this while meeting tight deadlines may be a difficult task. Energy UK (the industry body representing the GB electricity industry) noted in a report in May 2018 that while "to date it has been possible for projects to meet the current twelve month Milestone Delivery Date (MDD), this is sub-optimal and no longer appropriate for lean development projects in a competitive … environment".

Technical changes to future allocation rounds

Finally, there are certain technical changes that may be implemented in relation to the structure of future allocation rounds. In particular, the consultation discusses the possibility of removing the distinctions between different delivery years within the auction, meaning that in the auction process delivery years would not close independently but instead the whole auction would close, and there would be one clearing price across the different delivery years (subject to administrative strike prices and potential use of maxima).

Next steps

The consultation closes on 22 May 2020. In the meantime, the Government is scheduled to publish its overdue Energy White Paper later this month, and it may well be that the strategy set out in the Energy White Paper will have some bearing on the issues considered by the CfD consultation paper.

Authors: Anthony Johnson, Partner; Helen Raynsford, Associate; and Justyna Bremen, Senior Expertise Lawyer.