We use cookies to make your experience of our website better. Some of these are set by third party Google Analytics to help us analyse website traffic. To comply with privacy regulations, we require your consent to set these cookies. If you continue to use the site without selecting an option we will assume you are happy for us to use cookies.

CfD - Now The Dust Has Settled

CfD - Now The Dust Has Settled

The dust has now settled on last Thursday’s Government announcement on which technologies and companies have won low carbon energy contracts in the new Contracts for Difference (CfD) auction for renewable energy. Taking time to reflect on the announcement, industry opinion seems to be mixed on the initial success of the auction, and its role in securing a stable and consistent framework for future investment in the UK’s energy industry.

The Good News

Firstly, as you will be aware, CfDs are the new support mechanism for nuclear, CCS and renewable energy introduced by the Government to replace the main support for large-scale renewables, the Renewables Obligation (RO). The auction round has successfully led to over £315m of new contracts being offered to five renewable technologies, including the more established technologies such as onshore wind and solar, and also less established technologies such as offshore wind.

The contracts being offered include two offshore wind farms, which could deliver over 1.1GW of new capacity, 15 onshore wind projects, 2 energy from waste projects (with CHP), and 5 solar projects. In total, over 2GW of new capacity could be built, and according to DECC, this will cost £110m per year less than it would have without competition.

The UK’s CfD regime is intended to deliver the lowest possible cost of energy to the consumer, and the competitive prices achieved during the first auction do highlight that the industry has been working hard to bring costs down, both onshore and offshore. It is a long touted ambition of the offshore industry that the magical figure of £100/MWh by 2020 has to be obtained, and the recent auction results provide a degree of optimism that such targets can be achieved given that the price has fallen from the CfDs awarded to a range of offshore developers last year.

In addition, the price of onshore wind has fallen by around 15% below the administrative strike price that was set for this auction round, and this is a true reflection of the need to bring down costs to ensure that onshore wind remains competitive with other technologies e.g. nuclear and gas fired power plants.

Scotland

Given the Scottish Government’s commitment to renewable energy, it is encouraging that two-thirds of the UK onshore wind projects awarded in this auction round will be located in Scotland, and 11 of the 27 renewables projects to receive a CfD are in Scotland. Both the Scottish Government and Scottish Renewables have been quick to point out that onshore wind is now considerably cheaper than new nuclear, and when these projects are constructed, it is anticipated that they could generate enough energy to power the equivalent of more than 600,000 homes in Scotland (or over one fifth).

Challenges

A criticism of the Government’s Electricity Market Reform (EMR) and the CfD system has been that there is a lack of long-term clarity over the budget and allocation rounds, and it is unclear to what extent EMR will be enough to attract investment in new technologies. Despite a recent increase to the budget for projects bidding for the CfD scheme, there is still concern that the funding available, particularly for future rounds, is insufficient to support the capacity required to meet the UK’s 2020 targets or achieve energy security.

Looking at the auction that has just been completed, the budget did not sufficiently meet the requirements of more than two offshore projects, and with offshore developers said to be spending in the region of £15-20m on their projects to simply get to the auction stage, a funding pot that does not provide the necessary levels of comfort or certainty is an unattractive and risky proposition.

With no indication of the size of the budget that will be available for future rounds, and competition for support set to increase (particularly from onshore wind) as the RO reaches its end date for new entrants, it is essential that DECC gives clarity on these issues as soon as possible. We are seeing an increased rush by developers and lenders to have projects commissioned prior to the expiry of the RO and investors are making short term business decisions to stick with what they are comfortable with in the RO. Some developers have not yet dived into the untested water of CfD, where there is no guarantee of success, and therefore it may become increasingly difficult for developers to sanction investment in new projects. It is important that any clarity provided by DECC allows developers, lenders, and indeed the supply chain looking to benefit from the work available in the renewable industry, the opportunity to plan ahead.

Solar

In terms of the technologies that benefitted from the recent auction, some developers in the solar industry have found the results disappointing. The UK utility solar industry remains comparatively young in comparison to other technologies, and solar developers have been at pains to point out that it is not yet ready to compete with technologies that have been established for over a decade, including onshore wind for example. There is therefore a considerable risk for a small or medium sized solar company to put in a bid for a CfD, and compete in the auction with large solar developers and onshore wind developers for the limited pot available.

For solar, the CfD results means that contracts enabling just 32MW of solar will be built in the next financial year (2015-2016) – this represents a considerable drop in the market compared to the current financial year (2014-2015) where 2-3GW of large-scale solar is estimated to be built. Solar farms above 5MW (about 30 acres) are particularly exposed, as the Government will close the current RO system to these solar projects alone (from 1 April 2015) – but leave it open to all other technologies until 2017.

General Election

The energy industry is also wary of what a change of government could mean for investing in new power projects. At this crucial time, the industry needs a stable policy framework for the coming years.
With the upcoming election, we expect a moratorium on energy policy and cross-party pledges on climate change. However, at this stage, there is little policy behind the rhetoric to convert this into concrete commitments post-election. As a result, the role of renewable energy in the UK’s long-term energy strategy needs to be reaffirmed in order to ensure investor and developer certainty as to their commitment to the UK renewable and construction industry. Depending on the make up of the next Government, the timing, and potential term of any such reaffirmation, is unclear.

Next steps

There are a number of next steps to be taken by the industry – there are the developers who now need to build their projects, there are the unsuccessful CfD participants who need to look at their projects again and contemplate future bids, and there is the Government who need to show commitment to the industry and provide the clarity and certainty that is required in respect of future CfD budgets and allocation rounds.

It is important to note that while the successful projects have all been offered contracts they have not yet accepted them. They have until 27 March to sign their CfD and then proceed with their project.
In proceeding with a project, the developer will be required to achieve a number of agreed project milestones as they go through the development process – these include providing evidence of substantial commitment to investment in the project by the ‘Milestone Delivery Date’ which is set one year following contract signature, and ultimately delivering their project within an agreed ‘Target Commissioning Window’. Failure to meet these milestones could result in contract termination and loss of support, and it will be interesting to see how this develops over the coming year, particularly if some developers run into issues with consents, supply chain or financing etc.

For the developers who were not successful in the CfD auction, or developers looking to enter future CfD rounds, the uncertainties around why bids were not successful, what the next allocation round will hold, how competitive is it likely to be, and what the budget will be set at, are all questions that need answers to allow parties to plan for the future. Although it is anticipated that the next round of allocation of CfDs will begin in October 2015, this will require the agreement of incoming ministers following the general election in May. It is also expected that the frequency of allocation rounds will be on at least an annual basis. However for ‘established technologies’ there are arguments in favour of running 6-monthly allocations.

It is estimated that a total budget of £1bn remains to be allocated between now and 2020/21, however the size of budget to be made available in each allocation round is unknown. DECC have committed (subject to incoming ministers) that if the next allocation runs to the same timetable as the recent round, then the draft  budget information for the next round will be available in July with the final  budget confirmed in October. Note however that the total value of contracts that can be made available is constrained by the ‘Levy Control Framework’ which currently extends to 2020 - therefore there is little certainty over what support will be available for the industry beyond this date, and that is a key area of focus for the industry in order to ensure the ultimate success of EMR and the CfD regime in securing a stable and consistent framework for future investment in the UK’s energy industry.

Peter Ward
Senior Associate

LChalmers