As a central part of the UK Government’s Net Zero Agenda, the Contracts for Difference (the “CfD”) scheme, has been instrumental in helping to reduce the unit price of low carbon energy. CfDs are awarded through a competitive auction process to bidders with effectively the lowest price per unit of energy contributed to the electricity grid network.
On 17 April 2023, the Government launched a Call for Evidence in respect of its proposal to introduce non-price factors such as capacity, sustainability, innovation and system flexibility as part of the assessment criteria for the CfD scheme auction process. The deadline for responding to this Call for Evidence is set to close on 22 May 2023. If implemented, these reforms would constitute a significant shift from the current price-only award criteria.
The proposed reforms come against a backdrop of ever reducing subsidies, supply chain pressures and increasing costs (resulting from surging global demand for renewables and limited manufacturing capacity for key components as well as wider macro-economic factors), which are causing unpredictability in the market and creating challenges for generators and investors alike.
Principles, proposed “non-price” factors and challenges
The Government has outlined that any potential non-price factors will adhere to certain principles being:
(i) maximising impact on sustainability, skills and innovation, reduced barriers to integration with future electricity systems, and perceived lags in investment to support increased renewable deployment;
(ii) ensuring non-price factors are quantifiable, can be objectively measured, are feasible to implement and are compliant with the UK’s international obligations; and
(iii) limiting the number of such factors to reduce administrative burdens and limit overall costs. The Call for Evidence has identified a non-exhaustive list of non-price factors that would address these overall principles such as developing the supply chain, promoting small and medium enterprises, funding industry initiatives, investment in infrastructure, promoting sustainable procurement and decommissioning, promoting decarbonising, investment in R&D and using new technologies.
The Government recognises that the introduction of such non-price criteria into the CfD auction could increase deployment costs and consequently costs for consumers and add complexity and potentially some subjectivity into the CfD auction process. Through the Call for Evidence it is therefore seeking views on appropriate mechanisms for implementation that would ensure value for money such as subsidy control principles, barriers to deployment and limiting unintended consequences as well as the best timing for its implementation.
The Government is currently considering three models for the introduction of non-price factors into the CfD:
- “Top-up” to the CfD strike price: the auction and bidding process would remain the same. The projects that have been successful in the auction and have submitted high-scoring non-price factors would receive a top-up to their strike price for a certain number of years of their CfD contract. The amount of the “top-up”, whether this is paid on a sliding scale and the number of years for which the top-up would be paid, are each potential areas for further consideration. Projects that do not score highly on the non-price criteria may still be awarded CfDs, but would not receive such a top-up payment.
- Bid re-ranking: Under the current CfD “bid-stack” ranking methodology, the relevant projects in each allocation round are ranked in ascending order of bid price until the budget or capacity cap, as applicable, is reached and thereafter, no further CfDs are awarded. In the proposed bid re-ranking model, the scores in respect of the non-price factors would have a direct impact on the ranking methodology such that a project with a higher bid price which scores highly on non-price factors could be ranked ahead of another project with a lower bid price which scores poorly on non-price factors. The Government is considering further sub-models within this model.
- Amending valuation formula: In this model, the valuation formula used to determine the annual budget impact of a project bidding in a CfD allocation round would be amended such that projects scoring more highly on non-price factors would be determined to have a proportionately lower estimated budget impact (and vice versa). It is intended that the cumulative impact of this model would enable additional projects to come in within the budget and successfully be awarded a CfD while increasing the strike price for all successful bidders, ultimately maximising the impact of non-price factors on the likely success of a project’s bid into the CfD auction.
The Government has asked for views on any alternative mechanisms that ought to be considered (with evidence supporting such views), which may be outside the CfD mechanisms. It is also seeking views on which projects should be subject to such mechanisms (including the current 300MW threshold to which the supply chain plan requirements are applied as well as whether the introduction of these alternative models is appropriate for all eligible technologies). Any reforms would need to comply with subsidy control rules.
We will continue to monitor developments in this respect and will provide updates in due course. In the meanwhile, please get in touch if you would like more detail on the legislative and regulatory regimes underpinning the UK CfD scheme generally.