Before the end of the year, the latest round of Contracts for Difference (CfD) auctions will have been completed. This will help new low-carbon projects to come on-line from 2021. There have been delays over the process, with more participants seeking entry, and the actual results of this long process will not be known until September. Regardless of what new generation secures support, the auctions will lead to an increase in consumer energy bills, so it is important to understand how we got to this point.
CfDs were introduced as part of the Government’s Energy Market Reform (EMR) package and are designed to provide support to new renewable capacity through a series of auctions. It was developed to replace the Renewables Obligation (RO) scheme, which officially closed to new entrants in 2017. The auctions provide successful applicants with a Strike Price.. The Strike Price is essentially the guaranteed price the generator will get for all of its output. The generator is still exposed to the wholesale market, but when wholesale prices are below the agreed Strike Price, the revenue it receives is ‘topped up’ to the value of the Strike Price. The Strike Price also rises with inflation, so the returns increase a little each year.
The cost of this top-up support is passed on to electricity suppliers, and then paid for by consumers through a levy on electricity bills.
CfD Basic Worked Example
The Windy Hills Wind Farm has a capacity of 30MW and secures a CfD contract with a Strike Price of £80/MWh:
- In Year 1 of the CfD contract, the prevailing electricity wholesale price is £50/MWh.
- This would generate a revenue from the regular electricity market of £4.6 million.
- However, the Strike Price is set at £80/MWh, so the guaranteed income the wind farm should get is £7.4 million.
- As such, the site will receive a top-up payment of £2.8 million for the year.
- This will have to be recovered from all energy consumers in the form of a levy on energy bills.
What is happening now?
The current CfD auction officially began at the start of April 2017, when the window for applications was opened. The actual auction itself will not take place until August at the earliest, which is much later than expected, as many seeking to take part are appealing a decision by National Grid to bar them entry. As such, the full results will not be made public until September.
A history of support
The current auction is only the second carried out. The first was concluded in 2015. However, there was also one earlier award of support, the Final Investment Decision Enabling for Renewables (FIDER). These subsidies were awarded without auction, as the Strike Prices were defined by the Government. However, the support offered via the FIDER scheme will still be collected under the normal CfD process of a levy on consumer electricity bills.
The CfD scheme has also generated the most controversial agreement, that with EDF Energy for the new Hinkley Point C nuclear reactor. Like the FIDER agreements, this was set without an auction and through negotiations between the UK Government and EDF Energy. The 3.2GW Hinkley Point C project has been beset with difficulties, costs rising and development delays.
From a start date of 2023, EDF Energy recently commented it was targeting a completion of between 2025 and 2027, although a later date is expected. As the struggle to build Hinkley Point C continues, there have already been pointed questions over allowing it to be funded under the CfD scheme, which was designed for generally ‘green’ energy projects. The costs of the project have also been a major bone of contention. Just last year, the National Audit Office (NA0) estimated the costs of Hinkley Point C alone to consumers through the CfD scheme would be nearly £30 billion, describing the deal as “high cost and risky.” The NAO cast doubts over the value for money of the scheme. Many – including Utilitywise – questioned if the money could be more effectively spent on other areas, such as energy demand management.
CfD consumer costs are already climbing
While FIDER contracts were awarded in 2014, and the first CfD auction was in 2015, consumers have only been seeing the costs fully reflected in bills in the last year. This is due to the sites being awarded contracts only starting to become operational since August 2016. As more generation comes online, the costs to consumers will rise. All the capacity which secured support under FIDER and the first auction is expected to be on-line before the end of this decade.
Indeed, one of the reasons why we have not had another auction up to this point has been the rising costs. The CfD scheme is part of the Levy Control Framework (LCF), which is meant to ensure the costs to consumers do not become unaffordable. However, the LCF – which currently is set to 2021 – is expected to be overshot. This is mostly due to the costs of the RO, but also as a result of the growing costs of the CfD. As such, no further auctions could be justified. The new auction, however, falls outside of the current LCF budget. Although, this is not to say it has no controls whatsoever.
Capping the costs of capacity
The next wave of CfD auctions has a set annual budget of £730 million. Regardless of how many auctions take place, the overall cost should not be allowed to exceed this budget. The Government has also set specific budgets for the capacity brought online in the first two delivery years of the new regime, 2021 and 2022. These are the focus of the current auction and the budget has been capped at £290 million.
With the first two years of the new CfD regime potentially able to secure aid of £290 million each, this could absorb over 80% of the overall budget for the new schemes. Much will depend, though on the actual Strike Prices secured in the auction. Indeed, on the former, recent schemes to support renewable technologies in other countries suggests aid could be provided at levels significantly below the previous UK auctions.
In the second section of this series of blogs, Utilitywise will assess the possibilities for this next wave of auctions, and what it might mean for energy subsidies.
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