Opinion:
Allocation Round 4 (AR4) of Contracts for Difference (CfD) opened for applications in December, with a target of 12GW of new renewable capacity. This is the largest CfD auction to date. In this round, Pot 1 of established technologies has been re-introduced (onshore wind and solar) for the first time since 2015. A separate Pot 3 for offshore wind and tidal stream technologies has also been added. A total of £285 million of funding will be available among the 3 Pots. The sealed-bid auction will start in May.
Interestingly, over the past few months, renewable energy assets operating under the Contracts for Difference scheme have been paying back to the Low Carbon Contracts Company (LCCC – the designated CfD Counterparty) and ultimately to energy suppliers and electricity consumers.
A subsidy scheme…?
Between November 2021 and January 2022, CfDs have paid back £114.4 million. In a world where the benefit-claiming party pays back to the system, are the CfDs still rightfully considered a subsidy scheme for renewables or is it now rather a support and risk-transferring mechanism?
Under the CfD mechanism, LCCC (the governing body) considers only the difference between the Intermittent Market Reference Price (IMRP) and the strike price agreed in the contract. Where the strike price is above the IMRP, LCCC will issue a top-up payment to the generators. Where the IMRP is above the strike price, the difference has to be paid back to LCCC. The IMRP is calculated as a volume-weighted average of the two day-ahead auctions: EPEX and N2EX.
Until a year ago, the wholesale price of power was lower than what a new renewable energy project would have needed to receive to make it a viable project to develop. Thus, schemes such as the Contracts for Difference, were making a real difference, enabling new renewable projects to be built and helping to reduce our reliance on fossil fuels.
While the strike price agreed in CfDs generally exceeded the IMRP over the first 5 years of the scheme, in 2021 wholesale power prices began to rise dramatically (see graph below) and the situation reversed. In previous auctions, the weighted-average CfD strike price across various technologies oscillated between £45 and £165/MWh1. Since November 2021, baseload wholesale power prices have remained above the £150/MWh mark. This meant that for the first time generators under CfDs needed to pay back to LCCC instead of receiving the CfD top-up. Between November 2021 and January 2022, CfDs have paid back £114.4 million.
Baseload wholesale power price development from July 2017 to March 2022. Source: Neon market reports by Marex.
CfD could now be seen as a no-subsidy option. The scheme has been successful in supporting renewables growth in the UK but it does not currently provide direct subsidy to generators. It does however transfer risk from generators to consumers who effectively underwrite the price risk.
AR4 – long-term commitment for price stability – is it worth it?
The CfD mechanism offers generators a stable and guaranteed revenue stream – no matter what happens on the power markets, they know what price they’ll achieve for their exported power.
However, at times when the price achieved on the power exchange can exceed financial requirements of a new build project, developers are faced with a difficult choice: between maximised short-term (1-5 year) revenues through high-value PPAs, and guaranteed long-term (15 year) revenue stability supported by CfDs.
Entering a CfD is a commitment. Evaluating the risks associated with trading power in the wholesale markets vs price stability mechanisms offered by the support scheme will be on top of the minds of many developers. And as the last 2 allocation rounds did not consider the established technologies (solar and onshore wind), there’s now a large pipeline of assets ready to be built that just need those financial guarantees to get off the ground. The competition will be fierce in AR4 in Pot 1 which has a capacity cap of 5GW.
We can expect to hear the results of this auction in the summer with target commissioning windows for successful applicants across 2023-2025. We’re excited to see the results and look forward to supporting projects with high-value PPAs to help them maximise revenues.
1 Forecast Average Strike Price and Market Price by Low Carbon Contracts Company, issued 15/04/2021.
