The results of the first allocation round for Contracts for Difference (CfDs) were announced on 26 February 2015, with £315m of new contracts being offered to five renewable energy technologies under development in Great Britain.
Those projects that were unsuccessful will be considering their options; either participating in the second allocation round for CfDs (expected to be held in October 2015) or assessing the feasibility of accessing the existing support scheme for renewable energy, the Renewables Obligation (RO), prior to its closure.
Those that were successful will now need to sign a CfD and deliver their project in accordance with its terms. This briefing looks at the key questions which successful applicants and their funders will need to engage with over the next 12 months.
Now that the results have been announced, within 10 working days, successful applicants will receive an offer to enter into a CfD. They will have a further 10 working days to accept the offer and return a signed copy of the agreement. On the current timetable, offers are expected to be made on 12th March, meaning that the last day for signature and posting of the CfD Agreement is 27 March 2015.
Successful generators will then have a further 10 working days to fulfil the initial conditions precedent under the CfD. These include complying with “know your customer” requirements, the generator producing a legal opinion confirming that it is duly formed and existing and has the power to enter and perform under the CfD agreement and providing technical information about the facility.
Although these are not onerous, failure to comply could trigger termination of the CfD and the site could be banned from participating in a future allocation round for 13 months under DECC’s non-delivery disincentive policy.
Milestone delivery date to drive the timetable?
Satisfying the “milestone requirement” is likely to be the immediate challenge post CfD allocation. To meet the milestone requirement the generator must demonstrate a significant financial commitment to the project within one year of signing the CfD (known as the “milestone delivery date”). There are two paths for the generator to show compliance, either:
- provide evidence that it and its direct shareholders have spent at least 10% of “total project pre-commissioning costs”. A value for these costs has been estimated and assigned by DECC for each technology type; or
- provide evidence that the “project commitments” have been met. This requires the generator to produce (amongst other things) certification that the generator has or will have sufficient financial resources to meet the total project spend, evidence of a property interest over the site and information regarding consents and planning permissions, and that the generator has entered into contract(s) for the supply and/or installation of material equipment.
In practice, this is akin to requiring the generator to have secured finance or to have reached its financial investment decision within 12 months of being awarded the CfD. Failure to meet this milestone requirement could lead to the non-fault termination of the CfD. Although the 12 month period can be extended in certain circumstances, in practice it is likely to act as a hard deadline. This deadline may be challenging for larger facilities, such as offshore wind.
This milestone will be a key focus and will likely influence the decisions of developers and financiers. Where debt financing is required, developers will be looking for financiers with a track record for working pragmatically to meet deadlines. Similarly, financiers will look for projects that can be financed without significant issues. If there are issues, bridge financing structures (particularly equity based) may need to be considered in order to preserve a CfD while a longer term financing package is agreed.
Impact of pre-start date termination under the CfD
As seen above, failure to fulfil the initial conditions precedent or the operational conditions precedent within the relevant timeframe may lead to the termination of the CfD. Any pre-start date termination will not give rise to a termination payment from or to the generator. However, it may result in the project being unable to seek support under a new CfD (for a time limited period) under DECC’s non-delivery disincentive policy.
In addition, the generator will be unable to seek support under the RO. The right to do so is only available to facilities whose application for a CfD was rejected by the national system operation or by the Secretary of State.
Issues for investment and credit committees
Having engaged with CfDs since their inception, Norton Rose Fulbright is familiar with the issues which credit and investment committees will need address over the coming year. We consider here three headline issues: construction risk, counterparty credit risk and offtake risk.
Construction risk in relation to a CfD manifests itself in a number of ways:
- value erosion due to the contract start date occurring before the project is commissioned
- termination where the project is not commissioned by the longstop date
- termination due to failure to deliver sufficient MWs of capacity.
Some of these risks are mitigated through – sometimes generous – contractual protections such as extensions of time periods for force majeure type events, the ability to start the contract early if 80% of the capacity has been installed and adjustments of initial capacity estimates (within the permitted range).
Allocation of these risks between the project and its contractors will be at the forefront of the negotiations when seeking to secure financing. Lenders’ concerns may be alleviated via a careful technical due diligence and negotiated construction contracts, focusing on realistic work programmes and suitable remedies for delays. However a balance will have to be struck between the passing through of risks and the pricing of the agreement.
Counterparty credit-risk and risk of non-payment
The CfD terms include a number of provisions designed to make the CfD counterparty, LCCC, an insolvency remote vehicle. These include:
- no insolvency action – the generator undertakes that it will not take any action seeking the liquidation or similar of the CfD counterparty.
- limited recourse – the liability of the CfD counterparty is limited to the amounts it has received and holds from the supplier obligation. The CfD counterparty is only obliged to pay once it has received payment under the supplier obligation.
However, to ensure that sufficient funds are available to meet its payment obligations under the CfD, the Energy Act 2013 includes a strict obligation on the LCCC to collect sums due under CfDs from electricity suppliers. The LCCC’s payments to the generator will be funded by a levy set out in the Energy Act 2013 and secondary legislation, called the supplier obligation, which must be paid by all licenced suppliers in Great Britain. The supplier obligation is also a condition of a supplier’s licence. Failure by a supplier to make a payment or comply with its supplier obligation as required will be enforceable by Ofgem as a breach of a licence condition.
Under the CfD regime, generators still need to sell their power. Unless they have their own trading capability, generators will continue to require a route-to-market power purchase agreement with a credit worthy offtaker if they are to secure financing for their projects.
One challenge for the generator will be to find an offtaker that will offer a price that tracks as closely as possible the market reference price (and any changes to it).
Another challenge is managing imbalance risk. The CfD to some extent removes electricity market price risk by ensuring a fixed income for the generator but it does not insulate the generator from imbalance risk. Offtakers will manage this risk but for a price, which tends to increase with the length of the offtake contract term. It remains to be seen whether DECC’s “offtaker of last resort” solution will be an acceptable back-stop offtake solution to lenders.
Over the next 12 months, generators and their funders face a steep learning curve as they delve into the detail of CfDs.