Government has released a draft of the terms for the Contracts for Differences (CfDs) that will be awarded to low carbon plants under its Electricity Market Reform proposals. The counterparty to the CfD will be a limited company, referred to as the CfD counterparty, which is expected to be owned by the Government. Alongside the draft terms, further details of the CfD allocation process for renewable generation and a policy update on the Supplier Obligation (a new levy on licensed electricity suppliers that will fund payments under the CfDs) were also released.

1. Allocation methodology for renewable generation

Further details of the allocation process for CfDs for renewable generation were released on 7 August 2013, including the eligibility criteria and how budget constraints will impact on the allocation process. For nuclear and CCS projects, Government has stated that it will allocate CfDs through a competitive project selection process "wherever practical and effective", but that bilateral negotiation will be used otherwise. Government has said that any CfD budget allocations can be shifted by it between technologies to foster inter-technology competition.

Eligibility criteria will be technology specific

The eligibility criteria will be technology specific, but each project must as a minimum have a valid planning permission and have accepted a grid connection offer for the generating station. Projects above a threshold size (yet to be determined) will also be required to obtain certification from the Government that it has prepared a suitable supply chain plan (as recently confirmed in the Offshore Wind Industrial Sector Strategy).

Two allocation rounds to be held per year

The allocation process will be managed by National Grid as the Delivery Body, and will initially be allocated on a first come, first served basis. The Delivery Body will be required to stop the initial allocation once half of the Government's CfD budget has been allocated, in line with the Levy Control Framework Budget. A decision will be made on whether there is sufficient budget to allow allocation to continue on a first come, first served basis, failing which allocation rounds will be used for all future allocations. Two allocation rounds are expected to be held per year, with the option to provide a sealed bid setting out the strike price that the bidder would be prepared to accept in the event of an oversubscribed allocation round. In this event, the lowest priced projects would be awarded CfDs, with all CfDs of the particular technology type being paid a clearing price (set by the most expensive project to fill the allocation), which may not exceed an administratively set strike price for the technology in question. Government has indicated that it may use the information contained in the sealed bids to inform its setting of the strike price for subsequent allocation rounds.

Appeals against allocation and eligibility decisions still under consideration

A statutory appeals process is expected to be introduced, allowing appeals to Ofgem against the Delivery Body's decisions on both eligibility and allocation. A further right to appeal to the Courts is still under consideration, although Government has indicated that in the event that Ofgem's determination of an appeal were subject to a judicial review, the relevant project would be likely to lose its place in the allocation round due to the time constraints for finalising the round.

Funding will be reallocated if CfD not finalised

Once a CfD has been allocated, the CfD counterparty will provide the contract to the developer for signature. If the signed CfD is not returned within a set time frame, the developer will lose the right to enter into the CfD and the funding will be released to be allocated to alternative projects.

2. Incentives for delivery under the CfD

Government has included 3 mechanisms in the CfD to try to ensure that projects are built and generating within expected timeframes – an issue which led to lower than expected renewable generation under the 5 Non-Fossil Fuel Obligation (NFFO) rounds held in the 1990s, under which several hundred 15 year power purchase agreements and CfDs were allocated.

The CfD will contain:

  • a "substantial financial commitment milestone", to be met within one year of signature, requiring a certain percentage of overall costs to be spent by the milestone date, or evidence of signed contracts committing significant expenditure against the delivery of the agreed capacity by the Target Commissioning Date; failure to meet the milestone gives the CfD counterparty the right to terminate the CfD;
  • a Target Commissioning Window, within which the developer should be able to build and commission the facility; following the expiry of the window, the contract term (during which payments will be made under the CfD) will begin to reduce;
  • a Longstop Date for commissioning and satisfying all remaining conditions precedent, following which the CfD counterparty may terminate the CfD.

Government has indicated that the percentage spend for the Substantial Financial Commitment, the length of the Target Commissioning Window and the length of time allowed prior to the Longstop Date will be technology (rather than project) specific. There is a wide concept of force majeure in the CfD, which will (where applicable) operate to give relief from compliance with deadlines.

3. Phased commissioning

Donec Government seems to anticipate phased commissioning only for offshore wind projects, and has imposed a number of criteria that will apply for phased support:

  • the total capacity of the project must not exceed 1500MW;
  • all phases must be within the same Crown Estate lease area;
  • at least 35% of the capacity must be registered in the first phase;
  • the Target Commissioning Date for the first phase must be no later than 31 March 2019 and for the last phase must be no later than the earlier of two years after the Target Commissioning Date for the first phase, or 31 March 2021.

Only the first phase will be subject to a Longstop Date which could lead to contract termination, but all phases will have separate Target Commissioning Windows. The strike price applicable to all phases will be the price applicable at the Target Commissioning Date of the first phase.lobortis.

4. Capacity adjustments

Government had originally proposed that unless at least 95% of the planned capacity for a project was commissioned by the Longstop Date, the CfD would be terminated. Government will now allow downwards only capacity adjustments of up to 30%. A 5% downwards adjustment can be made at the Substantial Financial Commitment Milestone, and a further 5% up to the Longstop Date, without triggering any strike price adjustment. Government has indicated that reductions beyond this, up to the 30% limit, would result in a reduction to the strike price.

Government is still considering whether it requires a termination right for projects delivering below 70% of the agreed capacity by the Longstop Date, or whether it could rely on further strike price adjustments. Capacity adjustments may also be permissible due to an unforeseeable geological issue impacting on the project.

5. The Supplier Obligation

Government released a policy update on the Supplier Obligation alongside the allocation methodology and draft CfD terms on 7 August 2013. Payments under the CfDs, and the CfD counterparty's operational costs, are to be funded from monies collected from licenced suppliers via the Supplier Obligation which will be implemented under powers contained in the Energy Bill. The Supplier Obligation will operate as a levy on electricity supplied, and Government's current thinking is that it will be a fixed rate levy (resulting in a £/MWh charge), rather than a levy that would be varied each month to match the CfD counterparty's payment obligations. Further detail on the levy and how, for example, the CfD Counterparty will be able to correct material shortfalls resulting from underestimation of the necessary levy, remains to be clarified when draft secondary legislation is available.

Protections will be included against supplier default

Certainty of fund flow is critical to the operation of the CfDs, and Government intends to include protections against supplier default by way of a requirement for credit support and a mutualisation arrangement (as is the case in relation to the buy-out fund under the Renewables Obligation), to be enacted in regulations to be made under the Energy Bill. There may also be an insolvency reserve fund. These will sit alongside the existing Supplier of Last Resort and Energy Supply Company Administration schemes that provide some protection for customers in the event that a supplier becomes insolvent or is otherwise unable to continue to operate its licensed business. To reduce the risk of supplier default, and lower the amount of credit support required, daily settlement is now proposed for sums payable under the Supplier Obligation, albeit with a 7 working day time lag to allow for the collection of supply data and enable invoices to be issued, and a 5 working day payment window for suppliers. Government is still considering how reconciliation payments (resulting from the level of the levy not matching the CfD counterparty's outgoings) will be dealt with.

Partial exemption likely for energy intensive industries

Government is currently consulting on a partial exemption from the levy for electricity supplied to certain energy intensive industries. Eligibility for the exemption is likely to be based on the same criteria as eligibility for compensation from the impact of the EU Emissions Trading System and the Carbon Price Support (in each case, subject to State aid clearances). The consultation on the exemption closes on 30 August 2013.

6. Summary of key provisions of the draft CfD

Government has developed the 70 page heads of terms released in November 2012 into a 170 page draft CfD. The overview document released with the draft provides an update on the current policy position in a number of areas (yet to be reflected in the drafting) and also highlights areas where Government is looking for further detailed input from industry.

The table below sets out a brief commentary on the key terms of the draft CfD.

Click here to view table.

7. Timetable for next steps

  • Summer 2013: engagement with stakeholders to develop the allocation methodology and processes.
  • 2 September 2013: Closing date for feedback on certain aspects of the allocation process or the draft CfD terms.
  • September 2013: CCS and nuclear stakeholder workshop on options for allocation.
  • Autumn 2013: Consultation on secondary legislation, and consultation on detailed policy proposals for the Supplier Obligation.
  • December 2013: Updated position on CCS and nuclear allocation and publication of the final Delivery Plan (including the final renewables strike prices).
  • Summer 2014: Implementation of the CfD mechanism (subject to the passing of the Energy Bill and required secondary legislation).