Contracts for Difference Scheme – Second Wind for Proven Technologies

Contracts for Difference Scheme - Second Wind for Proven Technologies

On 2 March 2020, the Department of Business Energy and Industrial Policy (BEIS) announced specifics of the next round of the Contracts for Difference Scheme (CFD), one of the last existing low-carbon power financial support systems. Details of the planned amendments to the scheme are laid out in a consultation paper, which welcomes comments from interested parties and stakeholders until 22 May 2020.

Press reporting focused on the consequences for the United Kingdom’s offshore wind market, which was in a time of decline after the 2015 election of the Conservative government and its subsequent strategy and policy program. The proposal essentially reverses the Government’s removal of financial funding for some forms of clean energy technologies. The renewables sector has widely welcomed the reforms stating that previously exempt “proven technologies” such as onshore wind and solar would be eligible to participate in the 2021 CFD rounds.

How CFD operates

Contracts for Difference - CFD's

CFD provides a fixed price for qualifying clean energy generators. These negotiated fixed prices are intended to boost generators by de-risking the high initial construction costs of low-carbon electricity infrastructure projects. The policy reforms would affect the fourth CFD allocation round (AR4) scheduled to take place in 2021.

The CFD Scheme

  • The government’s primary program to fund new projects in low-carbon power production. The goal is to promote renewable energy innovation by providing project developers with lower operating costs and long-term direct insurance against volatile wholesale prices.
  • Developers of qualifying projects can engage by private law contracts with the Low Carbon Contracts Company (LCCC), which administers the scheme on behalf of the Government.
  • Application to the CFD scheme is rendered by submitting a form called a ‘sealed bid.’ CFDs are distributed in an open auction process, and thus there is no guarantee of inclusion for qualifying technologies.
  • Allocation Rounds are held every two years where all forms of green energy (in the respective ‘Pots’) bid directly against each other for a contract with the LCCC.
  • Developers are given a minimum indexed rate for the energy they generate for a 15-year cycle, which is calculated by the product form, representing the investing costs (‘Strike Price’)
  • The generators are charged the difference between their Strike Price and the Reference Price (actual energy prices), where the reference price is lower than the Strike Price. But where the reverse is the case, the difference must be paid to LCCC to protect the consumers from the raised prices.

‘Proven’ and ‘Less Established’ Energy Pots

As set out below, different renewable energy technologies are classified as ‘pots,’ with more or less proven technologies competing against each other at auction in any given CFD round in their respective pots. Nonetheless, existing technologies have not been able to compete in CFD auctions since the first round in 2015, which explains why the plan to introduce a technology/Pot 1 auction in 2021 has made headlines. In defending its decision to fund these technologies again following a six-year break, the Government noted that running an allocation round in 2021, which includes existing technologies, would help provide a varied generation mix at low cost, as well as offer a better indication of the costs of these technologies, some years following the previous auction.

BEIS seeks to update, rather than amend, the Pot definitions:

  • The proposal discusses that offshore wind will be in its own third pot, representing variations in size and maintenance costs from other developments in either Bowl 2 (where offshore wind actually sits) or Pot 1. Offshore wind won 6 out of 11 contracts awarded in the third round of awards, leaving no space for competition for other technology, with fewer economies of scale and higher costs.
  • The paper also considers whether to identify floating offshore wind as a different technology category in Pot 2 with a distinct administrative strike price, a step intended to promote the production of this pre-commercial technology that could theoretically provide solutions where conventional fixed bottom offshore wind is not a viable alternative.
  • Coal-to-biomass transitions, sponsored as a temporary rather than long-term process, will be omitted from future rounds.

Present and Planned Technologies Pots

Pot 1, proven tech:

BEFORE: Onshore wind (> 5MW), solar photovoltaic (> 5MW), waste energy with CHP, hydro (> 5MW and < 50MW), landfill power, sewage gas, coal-to-biomass

AFTER: Coal-to-biomass, now part of Pot 1, will no longer be qualified.

Pot 2, less established tech:

BEFORE: advanced conversion technology (ACT), anaerobic digestion (AD) (> 5MW), CHP-dedicated biomass, geothermal, remote island wind (> 5MW), tidal stream, wave, offshore wind.

AFTER: Offshore wind, now part of Pot 2, may be shifted to a separate Pot 3. Floating offshore winds can be marked as different tech from other offshore winds.

Planning Challenges

For “shovel-ready” offshore wind projects that already have planning permits, future amendments to CFD may well provide the impetus they need to get construction underway. Nevertheless, major obstacles exist for proposals still to secure planning permission. The development policy implemented in 2015 is a de facto ban on onshore wind. In order to obtain planning permission, firstly, the proposed development site must be in an area identified as appropriate for the production of wind energy in the development plan, and secondly, it must be shown that the environmental implications identified by the impacted local community have been fully addressed and therefore the project is supported; in all other situations, the proposals should not be agreed to.

A Friends of the Earth report in May 2019 showed that more than half of a survey of 20 local proposals did not find any viable location for wind development. Even if planning does resolve this first hurdle, local residents still have a final vote, resulting in conflicts between developers and those locally impacted by the implementation of schemes that can lead to protests. The alleged wind production barriers are borne out by the Government’s Renewable Energy Planning Database, which reveals that nearly two-thirds of onshore wind schemes in England and Wales that join the strategy phase have not been operational, often due to inability to obtain planning consent either first or on appeal.

Recognizing the ongoing debate on community concerns (or, to a lesser extent, “NIMBYism”) disrupting the government’s route to net zero, the consultation paper addresses the need for projects to be followed by an adequate set of community benefits that should last the life of the initiative. The Government also recommends creating a registry of programs and community benefits to sharing best practices. The paper lists many inventions that exemplify good practice. The most recent of these, Brenig Wind Farm, included Chinese investor CGN’s contribution to a community benefit fund for 25 years with 4M GBP, which will be used for local projects such as urban transport or leisure. Combined with increasing awareness of climate change issues over the last five years since stringent policy measures came into effect, there is some optimism that these financial benefits will be adequate to combat municipal opposition.

The Verdict

The government’s proposals have mostly been received positively, hoping that they will encourage the resurgence of renewable energy projects and represent the cheapest new energy source in the UK – onshore wind – coming out of the cold. Although an increasing number of non-subsidy solar and other renewable energy projects are being deployed, this is not without risk. CFD may offer the projects the incentive they need to break ground.

It is also important that the government focuses on emerging technologies, such as floating offshore wind, where projects need to be de-risked in order to be feasible but still have a good potential to deliver returns. A global approach to technology can only help deliver a vibrant and competitive market for implementing renewable energy and the amount of renewable energy needed to meet the net-zero goal.