Consultation response by Brodies LLP
Thank you for the opportunity to respond to the UK Government’s consultation on the proposed amendments to the CfD scheme including the proposal to include remote island wind projects in the next CfD auction for less established technologies.
Brodies LLP is a leading law firm based in Scotland with wide experience in the renewables sector, particularly in windfarms in the Scottish islands and in CfD projects, giving us insight to some of the issues raised in the consultation.
We are providing a response in respect of a number of the questions asked in the consultation where we believe our experience enables us to provide informative feedback.
The government welcomes views on whether the proposed approach is an effective means of supporting onshore wind on remote islands.
The Measure of Effectiveness
The measures of effectiveness are twofold. Will windfarms be built in the UK’s remote islands as result of the policy? And, second, will they provide value for money for the consumer? If no remote island wind (RIW) projects are built the policy could not be said to have been effective. Equally, if the price does not offer value for money, consumers will pay too much for their electricity.
The CfD contract is a proven means of supporting wind farms and many onshore wind farms are already in construction on the basis of the first CfD auction. A RIW CfD contract on appropriate terms can therefore be an effective means of supporting onshore wind on remote islands. The question is not so much the CfD mechanic as the ability of RIW generators to secure CfD contracts in a CfD auction in sufficient numbers to enable the connection to the island to be installed.
We anticipate three particular barriers to RIW generators securing CfD contracts. First, there appears to be a very significant disparity between the terms on which RIW projects can connect to the grid and the terms on which offshore wind (OW) projects can connect to the grid. Second, sufficient projects on each island must secure CfD contracts in order to enable the grid connection to be built. Third, OW generators are able phase their projects under the OW CfD contract.
Grid Connection Terms
There are a number of ways in which the grid connection terms expose RIW generators to risks to which OW generators are not exposed – namely the level of charges, grid security costs and the lack of control over the connection works.
The combination of the high cost of the island connectors and locational charging methodologies are anticipated to translate into high transmission network use of system charges. We understand will be very much higher than those incurred by offshore wind generators.
RIW operators have a limited opportunity to control or reduce the costs of building the island connector. The OFTO framework introduces competition which has the effect of reducing connection costs (£700m according to Ofgem ), whereas RIW generators must rely on the TN owners to price and build the island connectors. This means a large part of the cost base of an island wind project lies outside the control of RIW generators, making it more difficult for RIW generators to compete.
OW generators are not exposed to the requirement to post security under the OFTO framework, and this is a significant (and early) liability for RIW generators.
Finally, under the OFTO framework, OW generators build the connection and then hand it over to the OFTO operator, thereby taking control of the construction process and enabling OW generators to directly manage delay risk. This is not available to RIW generators who must bear the delay risk associated with the construction of the island connector. While the CfD contract contains provisions which extend the Target Commissioning Window if a grid connection delay occurs, it does not protect developers against additional costs resulting from the delay, and this risk must be priced into a CfD bid.
One way in which BEIS could address this issue is to implement a connection charges scheme under Section 185 of the Energy Act 2004. The Secretary of State has powers to introduce a statutory scheme outside the industry standard charging regime in respect of an area which has high potential to provide renewable generation and where the level of charges would hinder development. The remote islands fall within the scope of these powers. The TNUoS charges which RIW projects are anticipated to incur are significantly more than offshore wind, and this would be one way to help create a level playing field for a CfD auction.
CfD Contracts and Needs Case
The second barrier is that RIW projects will not be built unless a needs case for the construction of the TN connection can be made. If too few RIW projects on an island secure a CfD Ofgem will be unable to approve a needs case for construction of the TN connection for that island, which will result in no RIW projects being built. This would inevitably be seen as a failure of the policy. Addressing this barrier is complex, given that BEIS must operate within the parameters of the CfD auction framework. However, we believe the CfD auction process can be designed in a way to maximise the chances of a successful policy outcome.
BEIS has the powers to introduce minima and maxima for RIW projects in the 3rd CfD auction. We understand the Government’s reluctance to do so, but we believe the auction could be designed to ensure value for money for the consumer. This involves taking a holistic view over the 3rd and 4th auctions – only by taking this view, will it be possible to maximise the chances that any single island wins sufficient CfDs to support a needs case for the connection.
It could work something like this. The maxima in each of the 3rd and 4th auctions could be set at a level which ensures that there is more RIW capacity bidding into the auction than there is available for RIW CfDs, to competitive bids. The minima could be set at the same level as the maxima, earmarking a proportion of the CfD contracts for RIW generators. The level of maxima and minima for the 4th auction can be set in light of the outcome of the 3rd auction, and in light of the further capacity required to enable needs cases to be met. A further value for money safeguard could be to set the RIW administrative strike price in the 4th auction at the clearing price in the 3rd auction.
One further aspect of this approach should be addressed. If a RIW generator secures a CfD contract, but insufficient RIW generators on that island do so, that RIW generator could be faced with a decision as to whether to invest 10% of the capital costs of the project within 12 months in the hope that sufficient RIW generators from that island can secure CfDs in the 4th auction to enable the needs case to be me, or losing its CfD contract. In these circumstances, the RIW generators may conclude it is not worth bidding if the 3rd auction contracts are likely to be terminated. This creates something of a catch 22. We believe it could be addressed by linking the milestone requirement to the approval of the needs case – for example, RIW generators would be required to meet the milestone requirement say 6 months after the approval of the needs case.
BEIS could introduce phasing for RIW projects to put them on a level playing field with offshore wind. Offshore wind is able to build out its windfarms in phases, which allows them to deliver capacity later in later phases. In a market where prices are falling and yields are increasing, this potentially offers an advantage to offshore wind. BEIS should consider offering the same terms to RIW generators.
The government proposes to make these proposed clarifications but is consulting to allow respondents to highlight if they consider that they could lead to any unintended consequences which the government should properly take into account before making any such changes and/or which may impact the way proposals are drafted.
Clarification of the force majeure provisions is welcome. We do however make one comment on the proposed clarifications. Paragraph 92(b) of the consultation appears to preclude a generator seeking to claim Force Majeure relief in respect of the Milestone Requirement in condition 4.1(A) of the CfD standard terms unless the failure or delay in achieving the Milestone Requirement is directly attributable to the Force Majeure event.
This appears to mean that the Force Majeure event would have to directly prevent an investment in the generator in order to apply. We do not think that this is consistent with the force majeure protections which investors generally seek. Investors would generally take the view that, if a force majeure event affects the timetable for delivery of the project, the date for meeting the CfD milestone requirement should be delayed, especially if the event has an uncertain outcome. Otherwise investors are put in the position of choosing to lose the CfD contract or making a considerable investment at a time when there is no certainty that the project can be built.
The government welcomes views on these proposed amendments including, but not limited to, whether they could lead to any unintended consequences.
Paragraph 93 of the consultation paper states that the government is minded to amend the contract to stipulate that a Force Majeure event must not be the result of pre-existing factors of which the Generator was aware, or could reasonably be expected to be aware, on or prior to the Agreement Date. We understand the principle that Force Majeure relief should not be available on the basis that the event is pre-existing.
In principle, if the event occurs prior to a contract coming into force, force majeure protection will not be available under the contract. Our question on the proposed approach is one of the appropriateness of the solution. Trying to define pre-existing factors, and then interpret them in the context of real life events is likely to lead to less, not more, clarity. We consider there are better ways to address the issue which the government is seeking to address. In particular, the CfD could clarify that an event only qualifies for Force Majeure relief if it first occurs after the Agreement Date. It could also clarify that events which also constitute a breach of a warranty cannot qualify for Force Majeure relief.
Finally, the government proposes the Agreement Date as the reference date for events first arising. We consider that the date on which CfD bidders are first bound by their bids is a more appropriate date. Bidders who submit a bid and do not sign a CfD are subject to the Non-Delivery Disincentive and are therefore are committing to enter into a CfD as at the date on which the auction closes. This date would be a more appropriate reference date than the Agreement Date.
We welcome the government’s intention to consult again on specific draft amending text for the CfD contract prior to implementation. We also presume that the government will ultimately publish a RIW specific CfD agreement. We consider it is necessary for this to be published well in advance of the next auction to allow full consideration of its terms and any impacts and unintended consequences to be considered before the auction. It would be helpful if the government could confirm that this will be published on a consultation basis to permit representations to be made on any identified issues before the publication of the final draft before the auction.