UK Government Announces Key Changes To CFD Scheme To Boost Clean Energy.
The new UK Government has made reforming the sector to make Britain a clean energy superpower a key pillar of its early energy strategy. In just over four months since the general election, the Government has progressed plans for a state-owned clean energy company in the form of GB Energy, acquired the Electricity System Operator (now National Energy System Operator (“NESO”), and has proposed grid connection reform.
In a sign that the winds of change in the UK’s energy sector continue to blow, the Government has recently responded to a Consultation on the Contracts for Difference (“CfD”) scheme. The reforms outlined in the Government’s response will apply to Allocation Round 7 (“AR7”) onwards, subject to further revisions to the scheme in future. Changes to the CfD follow a roller coaster of preceding years for the scheme. AR5, which saw no offshore wind awarded, was labelled as ‘disastrous’ by now energy secretary Ed Miliband. AR6, on the other hand, was allocated the largest ever budget for a funding round (£1.5 billion) and awarded a record 131 clean energy projects with a combined total capacity of 9.6GW.
What exactly is the CfD scheme
CfDs are long term agreements (typically 15 years) between the government-owned Low Carbon Contracts Company (“LCCC”) and low carbon electricity generators. Under a CfD, the LCCC agrees to pay a low carbon electricity generator a fixed price per unit of electricity generated. This shields generators from fluctuating market prices and encourages investment in clean energy by derisking capital loss.
The price per unit of electricity under a CfD is referred to as the ‘strike price’. The strike price is set by auction (the aforementioned allocation rounds) and remains fixed for the duration of a CfD subject to annual index-linked adjustments. The strike price can be contrasted with the more volatile ‘market reference price’ which is set for each hour based on the results of auctions for power held the day before generation. The delta between the strike price and the market reference price is known as the ‘difference payment’. Where the market reference price is below the strike price, the LCCC pays the generator a sum to make up that difference. Conversely, where the strike price is below the market reference price, the generator pays into the scheme, which helps protect consumers from high prices.
The stated aims of the CfD scheme are to help the UK meet its decarbonisation goals, maintain security of supply and reduce the cost of energy to consumers.
Consultation for future rounds of the CfD Scheme
On 18 October 2024, the Department for Energy Security and Net Zero (DESNZ) published its response to the consultation regarding amendments to the CfD scheme. The Government settled on a few amendments due to take effect in next year’s auction and identified several areas where further thought and planning remained necessary.
CfD Phasing for Floating Offshore Wind
CfD phasing, which allows projects to be developed in multiple stages each having their own CfD, reduces risks associated with project delivery. This phased approach, which previously only applied to fixed-bottom offshore wind, will be extended to floating offshore wind (“FLOW”) projects from AR7 onwards.
FLOW allows for access to wind resources in deeper waters with typically higher and more consistent wind speeds. The Government expects that this emerging technology will rapidly expand throughout the 2030s, hence the extension of the phased approach.
At present, fixed-bottom offshore wind assets must comply with various rules and restrictions to qualify for phasing, including that the overall capacity of the project is capped at 1500 MW, that the project be built in no more than three phases and that 25% of the project capacity must first be constructed and commissioned. These same rules will initially apply to FLOW projects as well, with the Government intending on keeping the phasing policy continually under review to ensure its appropriateness.
Repowered Onshore Wind
Projects with full repowering models will, from AR7 onwards, be allowed to apply for a CfD. Full repowering models are those whereby a currently generating onshore windfarm is decommissioned and completely replaced with new wind turbines and new structures at the same site. This can be contrasted with partial repowering or life extension.
In order to minimise complexities in the CfD auction design, repowering projects will be on standard CfD terms and conditions (e.g. for a 15-year term).
The eligibility criteria applicable to repowering projects are:
- the relevant technologies must already be CfD eligible;
- projects must carry high upfront capital costs; and
- projects must have reached the end of operating life using power generation cost assumptions. For example, an onshore wind project will qualify for repowering support if it commenced commercial operation 25 years before the delivery years of the next allocation round. This 25 year period can include decommissioning and recommissioning of the new project on site.
The Consultation considered whether repowering projects would be required to ‘at least retain their current capacity over the term of the contract.’ Despite the fact that this requirement could maximise repowering capacity, the Government was confident that commercial incentives for increasing capacity were sufficient and that any reductions in capacity could likely be attributed to extraneous and unusual difficulties in managing a given repowering project.
Repowered projects will also be allowed to forward bid for the CfD. This will allow developers to apply for a CfD for a repowering project, without requiring the existing project on site to have first been decommissioned.
Appeals
The Government sought views on three potential options to improve the current CfD appeals process. The three options were:
- having a fixed timeline for appeals rather than five timeline scenarios;
- amending the ground of appeal to prevent appeals in relation to clerical errors and incomplete documentation; and
- introducing a pre-qualification process with appeals before formal application.
In light of responses received, the Government opted not to introduce a pre-qualification process nor to amend the grounds for appeal. Noting respondents’ preference for a fixed timeline, Government intends to implement a fixed timeline for appeals from 2026 onwards.
Reforms for future consideration
Hybrid Metering
The Government considered a hybrid metering approach to help facilitate CfD co-location with other assets. Under this approach, CfD generators would be able to measure their Metered Output used to calculate CfD difference payments at sub–Balancing Mechanism Unit level while co-located with other assets (e.g. merchant generation, battery storage or hydrogen).
NESO raised certain questions about how hybrid CfD assets would interact with the wider market, including the Balancing Mechanism, and noted that further consideration was required. NESO will first need to consider the value of making wider market changes to allow for hybrid metering solutions for all participants.
Issues were also raised about the interaction between hybrid metering and offshore wind (i.e. the fact the hybrid metering proposals may only work with onshore assets).
The Government opted not to implement hybrid metering in the CfD scheme for the next allocation round but will continue to consider its implementation in future.
Indexation of CfD Strike Prices
Strike prices are currently linked to the Consumer Price Index (“CPI”). Consultation respondents raised concerns about potential exposure during the time between bidding and reaching the final investment decision in light of recent commodity price volatility.
In light of the difficulties of design details for future reforms in this area, the Government has opted to hold its course and retain full CPI-linked CfD indexation for AR7.
Improved coordination of offshore transmission infrastructure
The Consultation considered solutions to improve the coordination of offshore transmission infrastructure to move away from the current point-to-point interconnectors and radial wind connections.
Bootstraps
The majority of respondents to the Consultation supported DESNZ’s view that offshore renewable generation projects that connect to a ‘bootstrap’ should be eligible to apply for a CfD.
However, the Government concluded that further work was necessary to clarify the costs of bootstrap-connected projects. Additionally, a decision will need to be made to determine what changes, if any, are needed to regulation, the allocation framework and the contract. Bootstrap connected projects will therefore not form part of AR7, but the Government will continue to consider its approach to bootstrap projects for future allocation rounds.
Multi-Purpose Interconnectors (“MPIs”)
The Consultation posed three questions in relation MPIs:
- views on the role of CfD in the Home Market (“HM”) and Offshore Bidding Zone (“OBZ”) models;
- evidence on the additional costs and benefits to consumers an Offshore Wind – Multi Purpose Interconnector (“OFW-MPI”) arrangement; and
- whether respondents could propose any other solutions to improve coordination of offshore transmission infrastructure.
The Government responded that it would, in principle, be possible to enable OFW-MPIs to be CfD eligible and that the standard CfD remains the most viable approach for an OFW-MPI in a HM scenario, but that greater clarity was needed on the MPI policy framework and the ongoing Review of Electricity Market Arrangements before Government could commit to CfD eligibility.
There will not be a CfD for MPIs in AR7 but the Government committed to complete a full assessment of the most viable CfD design option for MPIs once it has sufficient clarity on the policy framework within which a CfD could apply.
Conclusion
Reforms made to the CfD scheme ahead of AR7 continue to expand its scope. It is hoped that allowing repowered onshore wind projects to bid for CfDs and the introduction of phasing for FLOW will lead to an AR7 as successful as the previous allocation round.
Additionally, the ongoing review of hybrid metering and onshore transmission infrastructure in the context of the CfD and of the role of the CfD in supporting MPI and bootstrap infrastructure indicates that supporting the development of renewable energy generation in the UK is a key objective of Government.
Bird & Bird’s Commercial Energy team advises commercial and public sector organisations on a wide range of legal issues within the renewables sector including trading schemes, tariffs (such as the CfD), and protection and maximisation of intellectual property assets. We provide advice to clients working in onshore and offshore wind, solar, biomass, wave and tidal power, hydro power, energy from waste, transmission systems, and carbon capture and trading.
If you have any questions regarding the CfD scheme or the broader renewables sector, please contact Hadrien Espiard.
For further information, please contact:
Hadrien Espiard, Bird & Bird
hadrien.espiard@twobirds.com
