Today the long awaited Energy Bill was published. The bill outlines reforms to the electricity market and sets out the position for Contracts for Difference (CfDs).
We are encouraged that the Energy Bill has been finally issued and DECC appear to have taken on board a number of the comments that we and the industry have raised. Helpfully, DECC have also issued Heads of Terms setting out the key terms of the proposed CfD.
DECC is also introducing transitional frameworks to make the process a smoother path which we thoroughly approve of.
There are still a number of areas where further clarity is required or where DECC is reviewing, for example, the determination of the reference price and PPA liquidity. In the case of the reference price, DECC is seeking to ensure that it is reflective of the price levels that can be achieved by generators. As the market for CfD related PPAs has yet to be developed, it will be interesting to see how DECC ensures this especially given the concerns regarding PPA liquidity.
There are also some new issues which have arisen in DECC’s proposals, for example, the generator being required to provide a letter of credit.
CfDs will be 15 year contracts and will be broadly generic (with some variation for different technologies). They will be allocated initially on a first come first served basis.
Generators will be incentivised to ensure completion of build within agreed timescales. They will be required to provide evidence of substantial financial commitment and will have a target commissioning date and a long stop date for build. This approach has been utilised partly to enable contracts to be awarded early so that development and capital expenditure can be incurred assisting with bankability with some degree of certainty whilst providing the Government with the flexibility to review contracts in the event that they are not progressed as expected.
There will also be conditions precedent to the receipt of payments under the CfD. These will include standard provisions, such as planning and grid connection. However, it will also include confirmation that the installed capacity is not less than a set percentage of the contracted capacity, say 95%. This will remove flexibility in the case of wind farms where it is quite standard to have greater flexibility in case one or two turbines are not commissioned for some reason, such as a force majeure event or contractor default.
The Government has recognised that uncertainty during implementation changes under EMR could lead to delays in projects being brought forward pending implementation. Accordingly, it had already announced it would facilitate Final Investment Decision Enabling Projects under which the Secretary of State can enter into early CfDs with developers in advance of full implementation. These can be transferred to the CfD counterparty in due course. One of the issues with these contracts is that the payment terms will be conditional on enactment of the required legislation and state aid approval.
We have identified a few specific areas on which there has been focus in recent months:
The CfD counterparty will be a Government owned, limited liability company.
The Government has stated that it will seek to design and structure the company to ensure that it is as ‘insolvency remote’ as possible.
The CfD counterparty will only make payments when it has received them from suppliers i.e. ‘pay when paid’ principle. Whilst this protects the counterparty, it obviously creates an issue for the generator. To mitigate this it is proposed that collateral is lodged by suppliers and participating generators. Should a supplier go insolvent then the Supplier of Last Resort Regime will kick in. The Secretary of State also has powers to transfer CfDs to a new counterparty should the counterparty become insolvent, however, as this is discretionary, little comfort will be gained from this.
Participating generator collateral requirements
As indicated above, participating generators will be required to provide collateral. This will be in the form of a letter of credit and for an amount equivalent to anticipated payments under the contract over a given period. Generators’ banks currently provide letters of credit for the construction contractors and accordingly, whilst this is feasible, it does add an additional cost to the project.
Indexation of strike price
The Government is minded to use the consumer price index for indexation purposes. This will be a concern for biomass generators where a large cost base is the cost of the wood supply which will be more appropriately linked to stumpage and energy indices and for imports, foreign exchange rates.
To view DECC's press release and full details of the Energy Bill click here.
To read the full text of Ed Davey's speech click here.