The results of the first generic CfD auction were announced this morning (click here for auction results) and with them the allocation of £325m of support (£65m for established technologies and £260m for less established technologies) to mitigate wholesale electricity price risk for the successful renewable generators.
It's a big step forward from the original Electricity Market Reform policy announcement in December 2010, even if 58% (£16.6bn) of the Levy Control Framework budget for CfDs has already been committed through eight bespoke Investment Contracts awarded by DECC outside the auction process (although two of these (the Drax and Lynemouth biomass projects) are still awaiting state aid approval and there is a potential challenge to the Investment Contract for Hinkley Point C in the wings).
The winners have until 27 March to sign the generic CfD and a race to satisfy the Milestone Requirements in the next 12 months (spending >10% of total pre-commissioning costs or reaching FID and evidencing the financial resources to meet total project spend). Failure to do so will trigger a 13 month disqualification from future CfD auctions.
Unsuccessful generators will need to reassess their business plans in a world without the RO and evaluate their prospects of success in the next CfD auction due to begin in October 2015 (unless derailed post general election).
The auction results give non-participating developers a much clearer idea of the likely clearing strike price and successful technology mix per pot with which to refine their bid strategy for the coming auctions.
Those generators that bid into the auction to win 'at any cost' (relying on others to clear the auction at a sensible price) now know where they stand and can remodel. For those with target equity returns dependent on leverage (and largely untested finance assumptions) or looking to acquire or divest equity, the dash for cash begins and generators will start to discover on what basis funders are willing to bank the generic CfD.
With no flexibility to amend the CfD Agreement and Terms and Conditions, tenor, leverage, pricing and financing terms alongside supply chain and equity recourse become the key levers through which funders can manifest concerns and seek to address CfD risk. The clearing price may provide revenue headroom for some, but there remain key bankability risks in the CfD that will need to be addressed. The key questions include:
what leverage the generic CfD will be able to support in light of the clearing price, the borrower's forecast costs and funder thinking around debt tenor, margin and the key project cover ratios and whether this level of gearing is sufficient to achieve equity return expectations;
will funders require the generator to satisfy the Milestone Requirements as a condition precedent to drawdown;
whether funders will rely on delay and performance liquidated damages (set to restore revenue at the strike price per lost MWh) payable by the project's construction contractor to support the loss of electricity revenue and CfD support that results from either a delay in completion of construction or lower than forecast plant electricity generation (which only looks feasible if the contractor is a turnkey that has the necessary balance sheet strength) or will funders reduce upfront debt tenor/leverage, seek additional equity recourse, and/or require cash sweeps and mandatory prepayment to mitigate this risk;
the compensation on termination payable to the generator if the debt is drawn but the project fails to achieve the Start Date and the generator loses the CfD - funders have some ability to avoid termination of the CfD by exercising their Direct Agreement rights against the CfD counterparty (LCCC), but funders will need to see a clear path to being repaid in full on early termination scenarios for the CfD to be bankable and this may be difficult to achieve if termination risk is not supported by a turnkey contractor with adequate liability caps and covenant strength;
to what extent funders will require reserving or operator performance liquidated damages to be payable to meet a loss of electricity revenue and CfD support as a result of unplanned outages (and will the operator's covenant be sufficient to support these);
how funders will address the general regulatory risk of non-payment or loss mutualisation by LCCC under the CfD (due to supplier payment failures under the Supplier Obligations) and whether this will trigger an Event of Default and an upfront requirement for additional equity recourse and/or reserving/distribution lock-up;
how a PPA shorter than the CfD term, or loss of the project's PPA, will be covered and whether this can simply be cured by entry into the Offtaker of Last Resort PPA within a defined timeframe (if replacement PPA cannot be entered into before then) or whether the loss of 25bps per MWh will trigger wider consequences under the key cover ratios; and
how the risk of payment failure (where the market reference price exceeds the strike price and the generator owes monies to LCCC but does not pay) triggering onerous collateral requirements to be satisfied by the generator can be addressed and whether this requires reserving or additional equity recourse or PPA credit support (particularly to cover non-payment or late payment by the PPA counterparty) on top of the usual controls over project bank accounts?
Funders will be naturally conservative lending to the new CfD (although many have been involved in Investment Contract negotiations to date so will have some familiarity with its terms). That may well be offset by competition to be among the first to lend to the new market. Whether generators will have the time to run a funding competition and still satisfy the Milestone Requirements remains to be seen.