Contracts for Difference - the new support regime for low carbon generation

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1 Contracts for Difference - the new support regime for low carbon generation James Taylor Raj Bavishi 11 November 2014

2 UK Incentive Regimes Small scale Feed in Tariffs and the Renewables Obligations have made the UK an attractive destination for renewable energy developers. The Renewable Heat Incentive is doing the same for heat The supported technologies are varied and include wind, solar, geothermal, energy from waste, biomass and hydro. Target is 30% renewables generation by But Legislation and traditional banding can t keep up with market forces Falling costs of deployment meant excess profit at the expense of unsustainable energy bills Highly politicised Discipline now imposed in the form of the Levy Control Framework (LCF ) Contracts for Differences CfDs will replace the Renewables Obligation as the main way of supporting renewables projects ROC RUSH 2 / L_LIVE_EMEA1: v1

3 The solution - Electricity Market Reform After three years of debate the Energy Bill, legislating for the Government s Electricity market reform (EMR), finally became the Energy Act in December 2013 EMR will deliver savings to consumers of around 5bn to 2030, relative to the current RO regime Feed-in tariffs with Contracts for Difference (FiT CfDs), are a core part of EMR. CfDs will become the main incentive regime for renewable projects not supported by the existing small scale feed-in tariff regime ( 5MW). The first CfDs are due to be awarded by the end of this year and with the RO being closed to new projects from 1 April / L_LIVE_EMEA1: v1

4 The Levy Control Framework, a reminder Levy-funded expenditure is considered to be Government spending even though it is funded through electricity bills In 2011, DECC and the Treasury established the LCF cap The LCF requires early action to keep costs within the caps The LCF includes small scale FiT, the RO, FiT CfD and the Warm Homes Discount. (Not the RHI) As CfD is included in the LCF this means that there is a defined pot of money out of which the CfDs may be funded. The LCF rises to 7.6B by 2020/21 (please note this is expressed in prices) 4 / L_LIVE_EMEA1: v1

5 What is a CfD? A financial instrument that guarantees a fixed price for generators supplying energy, called a reference price or a strike price (based on wholesale rates). The generators will then sell energy to suppliers, and the cost at which they sell this energy may be the same as the strike price; below it; or slightly above it. If the sales of energy by the generators are the same as the strike price, then there is no further action. If the price is below the strike price, it will trigger top up payments by the counterparty. If the sales by the generators are at a higher price, it will result in generators paying back the difference. 5 / L_LIVE_EMEA1: v1

6 What is a CfD? 15 year contract between an eligible generator and the Low Carbon Contracts Company Funded through a charge on suppliers Not a Power Purchase Agreement Issues in development: Generator credit support Necessary and minor changes Cure period for breach Milestone delivery dates Capacity adjustment Status of CfD counterparty Private wire arrangements 6 / L_LIVE_EMEA1: v1

7 RO vs CfD Advantages of CfD Removes wholesale price exposure No ROC price volatility No ROC Rush to hit banding or grace periods Faster settlement (daily billing with 28 day payment) Standard contract Disadvantages of CfD No certainty as to availability Uncertainty until after planning ACT qualification Auction strategies Frequency of allocation rounds 15 years and not 20 Robust counterparty CPI linked prices Virtual floor price 7 / L_LIVE_EMEA1: v1 Use of market reference as opposed to PPA creates a gap Unfamiliar Slightly lower price than RO to account for lower risk

8 Qualification criteria The project must use a qualifying form of low carbon generation plus tidal range, nuclear and carbon capture and storage (CCS). Waste projects can be ACT or AD (with or without CHP) or EfW with CHP. Planning permission or development consent (as applicable) has been secured, normally evidenced by a Decision Notice. A grid connection offer has been accepted. The applicant is validly incorporated under the laws of the relevant jurisdiction in which it is incorporated (for example, for a UK-based limited liability company, this could be evidenced through the provision of a valid VAT number and company number);. For projects above 300 MW, evidence (in the form of a certificate from the Government) that a company has a valid supply chain plan. Supporting evidence that enables the CfD to be drafted, such as the geographic location of the project, its estimated installed capacity and its target commissioning date. 8 / L_LIVE_EMEA1: v1

9 Strike Prices Some technologies will no longer receive benefit support under FiT CfD in comparison to the RO. These are: dedicated biomass plants without CHP; biomass co-firing; standard bioliquids; and geopressure (which generates electricity by using the pressure in the gas network). Very large capital intensive projects such as nuclear, tidal range and large hydro >50MW will have individually negotiated project specific strike prices and this has used up much of the LCF budget. Further down the line, Hinkley Point C will be 92.50/MWh 9 / L_LIVE_EMEA1: v1

10 Allocation Contracts will be allocated through allocation rounds. The Allocation Framework for the first allocation round divides the CfD budget into Groups including: Group 1 - a group of established technologies (Onshore Wind (>5 MW), Solar Photovoltaic (PV) (>5 MW), Energy from Waste with CHP, Hydro (>5 MW and <50 MW), Landfill Gas and Sewage Gas). Group 2 - a group of less established technologies (Offshore Wind, Wave, Tidal Stream, Advanced Conversion Technologies, Anaerobic Digestion, Dedicated Biomass with Combined Heat and Power and Geothermal). The size of the budget in the CfD allocation rounds for Group 1 technologies is deliberately short Group 2 technologies will not automatically move to competition and will not compete on price directly with Group 1 technologies. If all the projects seeking support within Group 2 can be accommodated within the allocated budget, they will receive support at the administrative strike price. 10 / L_LIVE_EMEA1: v1 m (2011/12 prices) Delivery Year (as defined in legislation) CFD Budget (2014 release) Pot 1 (established technologies) Pot 2 (less established technologies) 15/16 16/17 17/1 18/1 19/2 20/

11 Auction process Pot 1 is short and will go to sealed bids. Pot 2 is said to only support 1 offshore wind farm so also likely to go to sealed bids. Can ACT come in lower than offshore wind? A potential complication to the process is maxima and minima caps for specific technologies The allocation process will work as follows: all projects will be ranked by their sealed bid, representing the strike price they would be willing to accept working from the bottom of the ranked list upwards, projects that can offer the lowest bids would be allocated CfDs first once the entire allocated budget is used up, no further projects will be awarded CfDs all projects get the last accepted bid for the technology in that year 11 / L_LIVE_EMEA1: v1

12 Auction tactics Projects that are unlikely to accredit within the RO (March 2017 and March 2015 for solar) are likely to seek CfDs. (Note importance of Grace Periods) DECC advice is to calculate your costs, add your minimum acceptable margin, and bid the lowest possible strike price But much will depend upon data and tactics How quickly will the Pot 2 be used up and over what time period How will off-shore wind bid? What is everyone else doing? DECC is not binding future governments as to the size of future pots and whether actual CfD payments (as opposed to valuation estimates) could result in greater pots in the future All depends upon the LCF, 80% already allocated: in May 2014 DECC awarded eight renewable energy projects early CfDs (five offshore wind, two dedicated biomass and one biomass conversion) under the Final Investment Decision enabling for Renewables (FIDeR) scheme, worth a total of 16.6 billion 12 / L_LIVE_EMEA1: v1

13 The need for a PPA A renewable power station needs a CfD and a PPA. (Under the NETA and BETA electricity market reforms, CfDs were the PPAs under which power was sold - that is not true now) Reasons why a PPA is needed The purpose of the CfD is only to provide the generator with an extra payment if the electricity market price is below the level stated in the CfD. The generator still has to sell the actual electricity produced by the power station. In practice this means selling under a PPA, rather than selling on a spot basis through the balancing and settlement system. This is because: a PPA will be needed in order to provide a bankable long term purchase commitment. a PPA is also necessary in order to avoid the risk of very volatile system prices, and the risk of having to make imbalance payments that would arise when intermittent forms of renewable generation are not available as predicted. 13 / L_LIVE_EMEA1: v1

14 PPA issues Problems getting PPAs Government consultation suggests that it may continue to be hard for independent renewable projects to obtain PPAs This is because there is a limited number of creditworthy energy companies with large market portfolios that can absorb the volatility in the output of renewable power stations and they have relatively little incentive to buy the power Government is developing a voluntary code of practice and model PPAs to help develop a liquid market for PPAs Government is also planning to introduce an offtaker of last resort proposal that would offer PPAs to renewable projects if they cannot get one elsewhere. How would backstop last resort PPAs work: The backstop PPA would be at a discount to market prices. ( 25/MWh) The level of the discount is set to encourage direct PPAs Backstop PPAs would be available to holders of CfDs Some suppliers would be obliged to offer backstop PPAs. Others would offer them voluntarily They would also be available after a commercial PPA expires or is terminated They would last at least 6 months but could be renewed annually Fees charged by the offtakers would be determined by a competitive process and spread across all suppliers 14 / L_LIVE_EMEA1: v1

15 CfD Timetable Recently varied Application window now 16 October to 30 October 2014 Round closure now 15 April 2015 and not end of March 15 / L_LIVE_EMEA1: v1

16 simmons-simmons.com elexica.com This document is for general guidance only. It does not contain definitive advice. SIMMONS & SIMMONS and S&S are registered trade marks of Simmons & Simmons LLP. Simmons & Simmons is an international legal practice carried on by Simmons & Simmons LLP and its affiliated practices. Accordingly, references to Simmons & Simmons mean Simmons & Simmons LLP and the other partnerships and other entities or practices authorised to use the name Simmons & Simmons or one or more of those practices as the context requires. The word partner refers to a member of Simmons & Simmons LLP or an employee or consultant with equivalent standing and qualifications or to an individual with equivalent status in one of Simmons & Simmons LLP s affiliated practices. For further information on the international entities and practices, refer to simmonssimmons.com/legalresp. Simmons & Simmons LLP is a limited liability partnership registered in England & Wales with number OC and with its registered office at CityPoint, One Ropemaker Street, London EC2Y 9SS. It is authorised and regulated by the Solicitors Regulation Authority. A list of members and other partners together with their professional qualifications is available for inspection at the above address. 16 / L_LIVE_EMEA1: v1

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