The current Contracts for Difference (CfD) scheme has been extremely successful in lowering the costs of renewables generation. However, by under-valuing other important factors, such as supply chain development and the use of innovative technologies, the UK is in danger of losing out on significant system benefits.
Regen has been talking about the need for the CfD to value wider non-price benefits for a while – our recent report, ‘Could the government be about to gamble away the UK’s leadership in offshore wind?’, highlights that reducing strike prices coupled with rising commodity costs are causing major supply chain squeezes and preventing development. Our flagship Go West! paper demonstrates that focusing purely on cost disregards the benefits that a low carbon generation mix brings to the whole energy system, whether that be a geographical or technological mix.
The proposed reforms in a nutshell
The Call for Evidence proposed three new mechanisms to update the CfD and capture the wider benefits of renewable energy projects:
- CfD “Top-Up” – a financial top-up is given for high-scoring non-price commitments
- Bid re-ranking – sealed bids are ranked first on price and then again based on non-price commitments
- Amending valuation formula – projects with high-scoring non-price commitments occupy less of the assigned budget of an auction
The Call for Evidence also suggested several non-price factors that CfD reform could address, including the development of the supply chain, skills provision and advances in innovation and sustainability.
All in all, this Call for Evidence is welcomed. However, our response has raised several matters that need to be addressed before any changes to the existing CfD mechanism are made.
Should non-price factors also be considered at earlier stages?
Securing a CfD is the last major hurdle for new low carbon projects before they make a Final Investment Decision (FID) to green-light the development. FID needs to be made within 18 months of winning a CfD which piles on the pressure, with project developers needing to procure major equipment and service orders in a tight timeframe. This leaves little room to commit to any non-price commitments made during the CfD allocation and may result in little measurable impact.
That being said, putting in a financial clause within the CfD rightly rewards projects (and incentivises continual investment) on their commitment to wider system benefits. As such, CfD reform may be best positioned to help reinforce the need to deliver on earlier commitments, like supply chain plans.
Incentivising certain non-price factors at earlier stages of project development (e.g., during leasing rounds and CfD pre-qualification stages) would provide greater timeframes for developers to target investment and would stimulate their thinking on how these factors should be addressed at an earlier stage. This is crucial for supply chain development, which needs long lead-in times to ensure the necessary size and scale of renewable deployment can be supported. However, earlier commitments to non-price factors will inherently be more speculative and high-level, as projects’ timings and technologies are not yet finalised, and so continual updates should be required as developments become clearer.
Ultimately, there needs to be a trade-off. Some non-price factors will benefit from more staged commitment across the whole project development process. Commitments should be made at the leasing stage, refined at the CfD pre-qualification stage and then reinforced through the CfD mechanism – with the ability to penalise developers if factors are not delivered.
The ins and outs of successful reform
Any significant alteration to the CfD will require balance. The government must ensure that the new process is transparent and objective – to avoid any risk of legal challenge – without it becoming too complicated and tedious for developers to bid, which could reduce competition and risk the investment attractiveness of the UK. It must achieve this while ensuring that wider system benefits are met and new renewable energy is deployed to meet our net zero goals, at a fair price to the consumer.
There is consensus among those in the industry that non-price factors need to be valued in some way, but there remains some discussion about which mechanism should be used and how it may be applied.
Each of the three mechanisms presents its own challenges in terms of deployment, compliance and appropriateness for incentivising non-price factors, and there remains uncertainty on how non-price commitments will be quantified and assessed between technologies – i.e., how can the non-price commitments of a 1 GW solar project be compared to those of a 1 MW tidal stream project? Would there need to be separate pots for each technology? Is the CfD the right mechanism to stimulate investment in all of the proposed non-price factors – innovation, sustainability, community benefits? These factors may be better considered within the context of supply chain development, or introduced at pre-qualification stage.
When should these reforms be made?
The government is currently suggesting a two-year ‘facilitation period’ prior to each allocation round in which non-price criteria would be published.
If the proposed reforms were enacted immediately, this would mean that non-price factors could be introduced as early as 2025 in Allocation Round (AR) 7. This is a positive first step towards progressing non-price factors as soon as possible, but long lead-in times are essential for introducing these factors, to give projects certainty on what they will be expected to offer when applying for a CfD.
A reform will provide a period of uncertainty for both project developers and their supply chains and so the government needs to be realistic about the length of time it takes for projects to put mechanisms in place to support any policy changes – like the currently in progress Review of Energy Market Arrangements (REMA).
A second REMA consultation is expected in Autumn 2023, which could to result in major reforms of the CfD – aligning the timelines of the two reforms is therefore paramount. Project developers and investors rely heavily on clarity and consistency, and it would be irresponsible to rush through reforms to value non-price factors in the next few rounds, only for them to be superseded by more radical reforms once REMA has concluded. Instead, the government must clearly communicate how non-price reforms may sit within the wider REMA engagement and all reforms must be consistent.
Is a more strategic approach needed?
All this discussion about system reform can’t help but force the question: how can the CfD support strategic development at scale?
Historically, low carbon generation in the UK has been developed as individual and independent projects. But given the urgency for action, the UK is shifting towards a more strategic net zero delivery plan where projects are becoming more dependent on co-investment in shared infrastructure, supply chain and skills.
In areas like the Celtic Sea – where four floating offshore wind projects (4 GW in total) are expected to connect by 2035 – the co-dependency of shared on- and off-shore infrastructure, supply chains and development in ports will act as a catalyst for investment and underpin the pipeline of tangible projects.
In these scenarios, CfDs could risk delaying and becoming a blocker to projects that share such co-dependencies because if one project out of a collective failed to secure a CfD then the whole development could fail. Even from the perspective of a single project, securing a CfD at such a late stage in the development process – as is the current system – can disincentivise significant investment in wider system factors like the supply chain and grid infrastructure prior to FID.
As the UK moves towards the strategic planning required to deliver net zero, the CfD approach will need to change for projects that are co-dependent. There needs to be a system where a CfD can be awarded as of right and where projects that are co-dependent can win a CfD collectively – whether that be through automatic allocation if requirements are met or through more negotiated and coordinated allocation rounds, as mentioned in the Offshore Wind Champion report. Offering greater route-to-market certainty reduces the pressure on projects that are concerned about working under risk and gives them the certainty to collaborate and invest in some of the wider system benefits the UK needs for net zero.
Key takeaways
Reform is in the air and it is great to see the government grappling with this. Another CfD consultation could be expected following this Call to Evidence later in the year, with the government already engaging with industry working groups on the best way forward, and REMA is still ongoing with a second consultation expected in Autumn 2023.
This Call for Evidence has raised important questions about how renewable developments are valued, how projects should be deployed in the right way and how the UK moves forward with delivering a strategic net zero.
As an industry, we now need to keep the conversation going and push for system improvements. CfDs are a critical piece of the puzzle to build the renewable capacity that is needed to reach the 2035 decarbonisation target and ultimately, that is what the UK is working to achieve.
View the full response below: