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Energy Bill update

FiT CfDs – will there be devil in the detail?

Despite delivering reliable and affordable power, the electricity market will not in DECC's view deliver the huge investment necessary to provide the diverse generation portfolio needed over the next few years to meet the UK's 2020 commitments and to keep the lights on.  The Feed-in Tariff: Contract for Difference is the new mechanism identified in the EMR White Paper last year to support investment in new low carbon generation.

The CfD works by stabilising revenues for generators at a fixed price level known as the 'strike price'.  Generators will receive revenue from selling their electricity into the market as usual.  However, when the market reference price is below the strike price they will also receive a top-up payment from suppliers for the additional amount.  Conversely if the reference price is above the strike price, the generator must pay back the difference.

Overarching Framework

The draft Energy Bill sets out the overarching framework for the CfDs.  However much of the detail is to be contained in secondary legislation and changes to codes and licences which have not been published and indeed much of the detail (including some significant points) is still under development. 

Draft CfD Operational Framework

The Government published a draft CfD Operational Framework alongside the Energy Bill for discussion with industry and other interested parties.  This document sets out the emerging position on the detail of how the Government envisages the CfD system will operate, structured around four core elements:

  • The process for determining CfD strike price
  • The system for allocating CfDs
  • The key terms of CfDs including length, reference price source and others
  • The institutional and legal framework underpinning the CfD, and the payment model for enabling financial flows between suppliers and generators.

The key features of the CfDs as Government currently envisage them are summarised in the table below.f

Feature

Description

Emerging proposal

Price setting and allocation

Administrative price setting

How strike prices will be set for different technologies.

Renewables: similar to RO banding review process.

CCS: initially through the CCS Commercialisation Programme competition in conjunction with the FID Enabling process.

Nuclear: initially on a project by project basis, through the FID Enabling process.

Competitive price setting

When and how strike prices will be set using a competitive process.

Move to competition as soon as market conditions allow; this could be 2017 for certain renewable technologies.

Eligibility

Which technologies will be eligible for support under the CfD regime.

Minded that new low-carbon technology plants that are not eligible for the small-scale FIT will be eligible for a CfD.

Allocation

How developers can apply for a CfD before the move to a fully competitive process.

Renewables: through allocation rounds run every six months.

CCS: initially through the CCS Commercialisation Programme or the FID Enabling process.

Nuclear: initially through the FID Enabling process.

Managing financial exposure

Ensuring costs of CfDs remain affordable.

Minded to instruct the System Operator to remain within an agreed budget when issuing CfDs.

Considering whether further controls are required for particular technologies.

CfD terms

Pre-commissioning

The arrangements for monitoring the development of plant after CfD award.

Minded to place obligations on developers to build within agreed timescales, with proportionate penalties to incentivise compliance.

Reference Price

The market price for electricity that is referenced in the CfD for the purpose of calculating CfD payments.

Intermittent: Hourly Day Ahead Auction Price for the GB Zone (as established under North West European Market Coupling).

Baseload: Year Ahead, price source to be determined.

CfD Volume

The definition of the volume of electricity for the purpose of calculating CfD payments, and the resulting metering requirements.

Minded to pay the CfD on the basis of metered output unless the price in the reference market is negative, in which case to pay on a measure of availability.

Allocation of supplier payments

How suppliers’ payment obligations / entitlements are calculated.

Minded to base suppliers’ payment obligations on market share (as defined by ‘supplier cap take’).

Settlement

Process and timing for invoicing and administering CfD payments.

Minded to base processes on Balancing and Settlement Code processes.

Minded that settlement periods will be monthly or possibly shorter.

CfD Length

The length of the CfD from the payment start date as defined in section C.

Initial view that CfD length for renewables should be 15 years.

10 years (subject to negotiations) for early stage CCS project(s) supported under CCS Commercialisation Programme.

Nuclear and long-term CCS-equipped plant to be determined.

Inflation indexation

Arrangements for adjusting the CfD strike price in line with inflation.

Minded to choose CPI as a standardised and established inflation measure that is familiar to international institutional investors.

Fuel Price indexation

Arrangements for adjusting the CfD in order that payments reflect a generator’s input fuel costs.

Minded not to link the CfD strike price to fuel costs for biomass.

For the first CCS project(s), minded that the CfD should provide indexation needed to hedge against long term fuel price variability.

Credit and Collateral

The requirements on generators and suppliers to provide credit / collateral.

Minded to place a collateral requirement based on an estimate of likely settlement amounts due in a given trading (settlement) period.

Amendment of the reference price and other CfD parameters

The arrangements for amending CfD parameters in response to changes which might impact the validity of the indices used.

Minded to include an ‘independent expert’ role in the CfD framework to manage any review of CfD parameters and determine any amendments required.

Change in Law

Arrangements for adjusting the CfD in response to relevant changes (e.g. regulatory) that materially affect the value of the CfD to either party.

Minded in principle that the CfD should contain change in law provisions, the form and scope of which remain to be determined. Further detail will be set out in the autumn.

Dispute Resolution

Procedures for resolving any disputes arising under the CfD.

The Government will seek further legal advice in this area before engaging with stakeholders later in the year.

Legal Framework and Payment Model

Legal status of the CfD

The arrangements for promoting investor certainty.

The draft Energy Bill outlines that the CfD will be an instrument created by statute that sets out obligations on suppliers and generators.

However, Government is considering industry concerns around whether a conventional contractual model would be preferable.

Route to market and liquidity

Route to market

Independent generators are often reliant on Power Purchase Agreements to secure project financing.

The Government plans to issue a call for evidence in June 2012 to set out understanding of the issues, the evidence that is needed to move forward, and to outline initial options that may address market concerns.

Liquidity

A liquid electricity market is an important factor underpinning the operation of the CfD.

Government welcomes recent positive developments in the markets, but believes further measures are necessary and will work with industry and Ofgem to ensure liquidity strengthens.

Room to move?

Interestingly, the Draft CfD Operational Framework is stated to set out Government's current preferred option. Recognition has been given to strong industry concerns about the model and the use of single counterparty as well as possible alternatives industry has suggested.  Further detailed consideration is to be given to these questions with a final decision on the framework and payment model being made by the autumn. 

The question therefore has to be asked whether the single counter-party approach will be maintained and what other changes might come about between now and the publication of the revised draft Energy Bill and CfD Operational Framework in the autumn?

Return to our Energy Bill update.