Contracts for Difference: AR5 and beyond – what does it mean for offshore wind in the UK?

1. Background

The UK electricity system operator National Grid (“NGESO”) has opened registration (see here) for contracts for differences (“CfDs”) for the upcoming fifth allocation round (“AR5”), which is set to launch for bidding in March 2023. This will be the first CfD auction round to run on an accelerated annual basis, as part of the UK Government’s ambitious net zero objectives (the timeline has now been published here). AR5 will see offshore wind competing against more established technologies, with floating offshore wind competing alongside other newer technologies.

In this article, we take a closer look at the changes to CfDs being proposed for AR5 (as compared to the current CfDs for the fourth allocation round). We also consider the Government’s proposals for future rounds of the CfD scheme and what this means for offshore wind in the UK.

Please get in touch if you would like more detail on the legislative and regulatory regimes underpinning AR5 or the UK CfD scheme generally.

2. At a glance - proposed changes for AR5

The UK Government has been consulting on a number of proposed changes to the CfD standard terms and conditions and private network agreement in advance of the AR5 allocation round opening (see here). The consultation has only just closed and responses from Government are expected later in the year. A short summary of some of the main changes are set out below:

• CfD start date: The Government is proposing to remove flexibility for a generator to nominate a start date to take advantage of high merchant power prices, whilst still allowing flexibility in choosing a start date for generators who face genuine delays in achieving commercial operations. This proposed change may well be considered by bidders to be the most material, many of whom have looked to structure a “merchant nose” by delaying the start date, primarily as a means of securing longer-dated debt (and allowing them to bid a lower strike price) rather than to take advantage of high merchant power prices.
• Unilateral commercial operations notice: The CfD counterparty, the Low Carbon Contracts Company (or LCCC), will have a new right to issue a unilateral commercial operations notice where it considers that commercial operations have commenced (even if the operational conditions precedent have not been satisfied), thereby triggering the generator’s liability to pay difference payments.
• Data provision: The consultation envisages simplifying the reporting requirements for generators.
• Private network agreement: Government intends to update certain definitions in the private network agreement, primarily to better align with the Contract for Difference (Allocation) Regulations 2014 (the “CfD Regulations”).
• Interest rate methodology: The consultation proposes the inclusion of a new interest rate methodology (used for calculating the repayment of cumulated subsidies), in place of the previous methodology which was based on the EU regulations which have now been revoked.

In addition to the changes being consulted upon as outlined above, the following two key changes are also expected to take effect for AR5.  These key changes are not subject to consultation:

• Supply chain requirements: As part of the bidding process, all floating offshore wind projects (irrespective of size) will need to demonstrate that they comply with the supply chain requirements, with a pass rate of 50%. For other projects, the supply chain requirements are triggered above 300MW and require a pass rate of 60% (see here).
• BSUoS charges: Following Ofgem’s decision in April 2022 to change the way in which Balancing Services Use of System (“BSUoS”) charges are collected, with the result that generators will no longer be liable for these charges from April 2023, certain changes are being made for the purposes of AR5 to remove the compensation mechanism for generators that was previously included in respect of these charges.

Following an amendment to the CfD Regulations in July 2022, a change to the non-delivery disincentive has also been made (i.e. where a bidder does not sign a CfD offer or a CfD is subsequently terminated for non-delivery), such that the bidder/generator will not be permitted to participate in the following two allocation rounds (rather than just the following one allocation round, as under the previous CfD Regulations). While this change does not form part of the AR5 consultation, it is worth noting here as the change is effective and in place for AR5 and future allocation rounds.

3. Looking ahead to the future of the UK CfD scheme

Whilst the AR5 process is already in progress, the UK Government is also looking ahead to the sixth allocation round (“AR6”) and beyond as well as consulting on its policy for future CfD rounds and the scheme more generally (see here). The Government continues to see the CfD scheme as fundamental to its Net Zero objectives and its goals of a fully decarbonised electricity system by 2035 and up to 50GW of offshore wind by 2030.

• Coordination: Following the Offshore Transmission Network Review, the Government is considering legislating, under the Energy Bill 2022, for the licensing of ‘hybrid’ or ‘multi-purpose’ interconnectors (“MPIs”), whereby an offshore windfarm would connect directly to an interconnector (an “MPI-OFW”), instead of using separate radial connections to the onshore electricity network. As part of the consultation on the CfD scheme, Government is requesting input on granting eligibility to an MPI-OFW to compete in CfD allocation rounds (currently, these types of assets would be ineligible as there is no provision to allow for a renewable generation asset that is connected to an interconnector to apply for a CfD). This is not expected for AR6 and will be considered as part of future CfD allocation rounds.
• Phasing: The Government is considering restricting or removing the phasing policy (which allows generators to build the projects in up to three phases) from future allocation rounds on the basis that this policy has achieved its original purpose (i.e. to mitigate the construction risk across multiple phases, which was critical when the sector was nascent). Government's view is that generators are now primarily using phasing as a bid optimisation strategy, rather than as a risk mitigation strategy.
• Definition of Floating Offshore Wind: The Government is considering if it would be useful to provide further clarity on the definition of “floating offshore wind” (specifically in respect of the type of foundations that would be deployed in deep waters) which would determine eligibility under the CfD Regulations alongside a guidance on eligible technology types. The main policy driver is to ensure that new and innovative technologies are not prevented from coming to market by ambiguity in eligibility. Any proposed changes will not impact AR6 and will be considered for future allocation rounds.
• Private wire arrangements: The Government is considering making electricity supplied over private wire arrangements to offshore oil and gas facilities ineligible for CfD payments. Projects would only receive CfD payments for electricity exported to the grid. This is likely to require legislative changes to the CfD Regulations as well as to the private network CfD agreement from AR6 onwards.

4. Next steps

In the consultation on future CfD rounds, the Government has reviewed and confirmed that the current level of exposure for generators to wholesale market prices achieved by the CfDs remains appropriate for AR6. It is likely that this will continue to be reviewed alongside the variations to the CfD that were consulted on by the Government as part of its Review of Electricity Market Arrangements (the response is expected to be published in due course in 2023).  

The consultation on AR5 and the consultation on future policy closed on 5th and 7th February 2023 respectively; the Government will publish its response in due course during 2023. If you would like to discuss further the changes proposed to CfDs in AR5 and beyond or any other aspects of the regulatory regime underpinning the development of offshore wind in the UK, our market-leading energy team would be happy to assist you.