On the same day as the Energy White Paper, the Department for Business, Energy and Industrial Strategy (BEIS) published a Call for Evidence titled Enabling a High Renewable, Net Zero Electricity System. It got somewhat lost in the noise of the White Paper and then the end of the Brexit implementation period but it is open until 22 February so there is still plenty of time to respond.
There's lots of food for thought in this Call for Evidence and it could eventually lead to a fundamental redesign of the Contract for Difference (CfD), which is the main scheme for supporting renewable energy projects. It won't affect the upcoming fourth Allocation Round due later this year (for more information on this see our article) but it is likely to mean changes to the CfD after that.
The Call for Evidence asks for evidence on how BEIS' policies can achieve three objectives:
- Maintaining growth in renewable deployment to meet net zero targets – BEIS are looking to understand more about how projects will derive revenue and the security of that revenue, what the impacts of increasing amounts of low marginal cost generation will be and how these will change over time;
- Ensuring overall system costs are minimised for electricity consumers – exploring how to minimise the whole system costs of renewable deployment, particularly looking at the balance between price stability and exposure to demand signals, as well as locational signals and the role of renewables in providing system services; and
- Supporting and adapting to innovative technologies and business models – to learn more about the new types of project coming forward, such as those utilising multiple technologies, extensions of old projects or international projects that work across national borders.
The CfD is now the main scheme for supporting renewable energy projects in GB. It works by guaranteeing a set price for the electricity that a renewable power plant produces. Generators bid their proposed prices in a CfD auction and contracts are awarded based on the lowest prices bid (it's more complicated than that, but that's the basic premise). The CfD is a contract to pay the "difference" between the market reference price (which is based on wholesale prices, so effectively the price the generator would get from selling their electricity on the market) and the (higher) bid price ("strike price"). So generators end up being paid a guaranteed strike price no matter what the wholesale price does, although worth noting that if the market reference price goes above the strike price the generator pays back the difference, and if the market reference price goes negative (i.e. there is so much electricity on the system that consumers get paid to use it) then generators don't get paid anything.
The CfD scheme has been very successful since it was first introduced in 2015, especially for offshore wind projects where the prices awarded in the latest allocation round were a third of those awarded in the first round. But it needs to continue being successful as now the UK has a legally-binding target to bring all greenhouse gas emissions to net zero by 2050, which will need even more renewable power: the 10 Point Plan sets out the ambition to have 40GW of offshore wind by 2030.
The problem with all this intermittent offshore wind on our electricity system is that it makes it much more difficult to balance supply and demand. We don't have a large-scale storage solution yet that can store excess energy and release it later, so when the wind blows at night or other times when demand is low, then wind farms are either paid to switch off (curtailment) or the wholesale prices go very low or even negative. The energy industry are working on ways to solve this, including changing our demand habits so we spread out our energy use more across the day, or are prompted to use more energy when it is windy, but there is some way to go still.
So this Call for Evidence looks at whether the CfD in its current form can still deal with these issues, particularly as contracts are for 15 years, so we need to be looking ahead. BEIS are also looking more widely at how their policies should evolve throughout the next decade, focussing on three areas as listed above which we will now look at in more detail.
MAINTAINING GROWTH IN RENEWABLE DEPLOYMENT TO MEET NET ZERO TARGETS
HOW PROJECTS EARN REVENUE
The main issue here is whether we still need a CfD to encourage more renewable projects. More and more are deploying on a merchant basis, without government support. BEIS are interested to know how projects will earn revenue – how will they trade on wholesale and balancing markets and can revenue from these support merchant deployment? What about Capacity Market revenues? Flexibility services? Whether companies responding to this Call for Evidence are prepared to provide this level of commercial detail remains to be seen, but it will be interesting to get a better picture of how projects are earning revenue.
The other major issue is price cannibalisation. This is where the wholesale electricity price is driven down at times of high output from intermittent, weather-driven generation such as solar, onshore and offshore wind. This will become more of a problem as more low-marginal cost generation deploys, making it more difficult to make a business case based primarily on wholesale revenue. BEIS are interesting in knowing how post-CfD revenues are valued when projects are deciding on what strike price to bid.
Price cannibalisation also has implications for the CfD scheme itself. If prices in the applicable reference price market become lower/more volatile, the amount of top-up to the strike price is greater and overall levy payments increase. This impacts the supplier obligation that funds the CfD: electricity suppliers (and ultimately all of us as bill payers) end up having to pay more.
FREQUENCY OF AUCTION ROUNDS
Rather worryingly, the Call for Evidence says that although the government have set out their intention to hold further CfD auction rounds around every two years, they will keep this under review and would like views on whether there is a need for a government provided secured price, based on the wholesale market, in order for plants to secure low-cost financing and deploy at the levels required to meet net zero. BEIS asks whether the now mature renewable technologies can provide the low carbon power we need by deploying without further CfDs. Or will price support continue to be needed to achieve the necessary volumes?
BEIS also ask if there are advancements which could mean we won't need CfDs in future. Sector coupling (where one part of the energy system becomes linked to another, e.g. using electricity to produce hydrogen that can be stored and burned as fuel for industry, heating or other processes) could become a viable revenue source when electricity demand is low. We may develop long term storage so that power generated from variable renewables can better match demand; and consumers could change their behaviour, with things like time of use tariffs influencing how and when they use electricity.
ENSURING OVERALL SYSTEM COSTS ARE MINIMISED
OVERALL SYSTEM IMPACT
BEIS want a market structure that enables different technologies to realise both the value and the costs that each brings to the system. It needs to consider the overall system impact of each generating plant. For example, the costs of providing the network to export the electricity generated, the costs of balancing the system at times of imbalance, or the costs of procuring reserve capacity to cover times of expected and unexpected outages.
A fixed CfD strike price provides revenue certainty but prevents generators receiving signals to change behaviour based on the value of the power they are generating. According to BEIS analysis, by 2030, 65% of annual generation could be supported by the CfD, which is baking inflexibility into the system.
INCREASING MARKET EXPOSURE
BEIS are considering further steps they could take to remove some of the insulation from the wider electricity wholesale market that CfD-supported plant currently enjoys, including:
- Moving the reference price used for intermittent generators from the day-ahead hourly market to a more forward market such as the seasonal market price used for baseload plant.
- Moving from paying based on physical output to paying on deemed generation, thus reducing the incentive to export power to the grid in order to receive payments and presenting the opportunity to utilise other market opportunities such as co-located storage or sector coupling.
- Capping the amount of subsidy provided at times of low prices. This would have a similar effect to the negative pricing rule though would be expected to occur more often.
- Reducing CfD contract length from the current 15 years, thus allowing projects to capture, and respond to, merchant prices sooner.
- Moving to a price floor where generators would retain the ‘upside’ of high prices but be protected against low prices. Or combine with a cap so that generators are exposed to variable prices but are protected against very low prices and must payback an extra revenue earned at very high prices.
- Moving away from security based on power prices altogether and instead having a revenue guarantee scheme where overall revenue is secured to a minimum value; or based on a carbon price or carbon price trajectory, so generators are 'topped up' if carbon price is below an agreed level.
BEIS recognise the need for a balance between incentivising efficient behaviour and providing price security to help lower financing costs and it is likely that they will gradually increase exposure to the market over future CfD rounds: "we are not imminently embarking on a major restructure of our market framework" they reassure.
FLEXIBILITY AND BALANCING SERVICES
The Call for Evidence also asks if the CfD can be used to incentivise flexibility and balancing services and if there should there be minimum grid stability requirements for CfD plants, as they could also contribute to wider system stability, providing services such as inertia, frequency management and black start that have traditionally been provided by non-renewable generators.
LOCATION OF ASSETS
Finally BEIS ask whether CfD projects get the right incentives to locate in optimum locations, as the most plentiful wind and sun isn't always where the demand is. This links with Ofgem's Access and Forward-Looking Charges Review due to report this year, but BEIS ask if the government should be doing anything else to incentivise renewable assets to locate near demand.
SUPPORTING AND ADAPTING TO INNOVATIVE TECHNOLOGIES AND BUSINESS MODELS
MULTIPLE TECHNOLOGY PROJECTS
The CfD currently only supports projects of a single technology. The Call for Evidence asks whether it should also support sites with multiple technologies, such as solar plus battery storage, wind plus hydrogen. There is even a suggestion that VPPs (virtual power plants: multiple low-carbon technology types located in different places but connected through a VPP) could bid into an auction based on the overall amount of low-carbon generation supplied - so they could include flexible assets like storage. Allowing such projects to participate in the CfD would certainly be in the spirit of the Smart Systems and Flexibility Plan.
Referencing the offshore transmission network review, the Call for Evidence asks what changes to the CfD are needed to facilitate the coordination of offshore energy infrastructure. What about wind farms that connect to more than one national market? Should the CfD support projects outside GB that are providing clean power to GB customers?
BEIS ask if they should continue to allow part-built projects to compete for a CfD. The rationale seems to be that if these projects had started to be built anyway, they are clearly viable on a merchant basis without needing extra CfD support. BEIS want to understand if developers who are making investment decisions on merchant low carbon projects actively consider later bidding into CfD allocation rounds and whether this approach is likely to change.
EXTENSIONS AND REPOWERING
Finally, BEIS ask whether extensions to existing projects (where shared infrastructure means cheaper build and maintenance costs) or repowering older projects (which still using some existing infrastructure so are cheaper than building from scratch) should be allowed to bid for a CfD.
There is a lot to consider here. It is encouraging that BEIS are looking at whether the CfD in its current form will still be fit for purpose in the next few years, as they clearly envisage support for clean power projects will still be needed and are keen that projects which are insulated to a large extent from power price volatility do not end up skewing the market for other non-CfD projects.
It is also good to see that they recognise the need for flexibility in the system and are looking at ways to support projects that offer flexibility services, whether that be through co-location with storage, sector coupling or being paid for deemed rather than actual generation (taking account of demand reduction and storage).
However there are some worrying signals for investors too. The pledge to hold a CfD auction every two years now seems shaky and the length of a CfD contract could be reduced.
Overall, BEIS do recognise that investors are more concerned with revenue certainty than the absolute value of returns, so hopefully any future reforms to the CfD and any other renewable policy support will have this premise at their heart.