Introduction
On 17 April 2023 the Department for Energy Security and Net Zero (“DESNZ”) launched a call for evidence (the “Consultation”) to consider ways in which the Contract for Difference (“CfD”) auction allocation process for renewable energy projects in the UK could capture wider, non-price, factors in the value of renewable projects. This Consultation follows a number of wider CfD reforms which address a range of variations to the CfD Allocation Rounds (“AR”). For more information on the recent development, please see our commentary on the AR5 and AR6 consultation.
The reforms explored in the Consultation would result in a significant shift in how CfDs are allocated, such that applicants for CfDs would have to balance overall costs with non-price factors, including sustainability, addressing skills gaps, and enabling system flexibility and operability. Further, these reforms (if introduced) would undoubtedly increase the complexity of the CfD auction, and potentially create an increased risk of unintended consequences arising from the auction design.
The Consultation follows from the ongoing review of existing market arrangements through the Review of Electricity Market Arrangements and the findings of the Net Zero Review and the Offshore Wind Acceleration Taskforce Report, exploring ways of mitigating the challenges identified in the reports, which include supply chain disruptions, upward pressure on project costs for the transition to net zero and energy security.
The Consultation is divided broadly into two categories: (1) the types of non-price factors that could be considered, and (2) how non-price factors could be introduced to the existing CfD auction allocation regime (including which projects may be eligible).
A summary of this and the modifications proposed to the CfD scheme are outlined within this law-now.
Potential non-price factors
While the current regime in Great Britain awards CfDs to applicant projects on the basis of the bid price submitted (calculated on the basis of price, project budget availability and GW capacity within relevant delivery years and pots), DESNZ is now considering attributing weight to a range of wider economic and environmental renewable project factors, including:
- Supply chain sustainability: considering factors that would help drive the sustainability of renewable industries – reducing their carbon impact and increasing access to resources and materials needed to reliably deploy long term sustainability at scale.
- Skills training: considering factors that would encourage investment in skills needed to build a long term sustainable and reliable supply chain.
- Innovation, grid flexibility and operability: considering factors that support innovation in renewable energy – specifically addressing sustainability, technology development and capacity issues.
The Consultation outlines that when designing a mechanism to recognise non-price factors in CfD bids, DESNZ believes there are a number of overarching principles which should be observed. These principles include:
- ensuring non-price factors encourage commitments/actions from renewable energy project developers that deliver maximum impact to industry challenges faced;
- ensuring non-price factors are quantifiable and objectively measurable;
- limiting the administrative burden associated with non-price factors;
- ensuring non-price factors can be implemented within a reasonable period of time measured against the timescale of need; and
- ensuring that non-price factors are compliant with DESNZ’s international commitments.
Implementing non-price factors
As outlined above, CfDs are currently awarded following a competitive auction that assess bid submission based on price, project budget availability and GW capacity. In order to incorporate the potential non-price factors into the equation, DESNZ has proposed three models:
Model 1: CfD Strike Price “Top-Up”
One of the models proposed to introduce the wider non-price factors into the bidding process involves a top-up to the CfD strike price. Under this model, auctions would continue to run as they are, and projects which progress and submit high scoring non-pricing factors (above a pre-determined minimum standard) could receive a “top-up” to their CfD strike price in recognition of the non-pricing factor benefits of the project. This would be a specific percent and potentially administered on a sliding scale over a number of years from the start of the project to aid a project’s revenue stabilisation.
This is aimed at incentivising project developers to commit additional investment to their project that supports wider renewable targets and addresses renewable energy industry challenges currently being faced. While the model represents the least disruptive proposal to the current CfD auction process as it involves the fewest changes to the current CfD regime, setting an appropriate top-up value which does not under-pay or over-compensate may not be a straightforward task and presents a significant challenge.
Model 2: Bid re-ranking
The second model proposed within the Consultation is a re-ranking of CfD auction bids. Under the current CfD auction regime, project developers submit sealed bits which are ranked on the basis of price (per MWh/delivery year). The estimated budget for each project is then calculated in ascending order (or bid price) until the capacity cap or budget for the CfD auction allocation is exceeded.
Under the proposed bid re-ranking model, non-price factors would be scored for projects and this would consequently have a direct impact on the bid stacking strategy which is used to award CfDs, in turn making it possible for projects scoring sufficiently high enough on non-price factors to be favoured over another project bidding solely on price, at auction. This bid re-ranking model consequently has the potential to incentivise applicants to take into account a range of deployment and energy security issues and is similar to the model developed in many EU countries. In terms of how the bid re-ranking is to be implemented, DESNZ has identified two potential sub-models. The first option is to define a reduction in the project’s bid price that would be awarded for a certain non-price factor score. The second option is to amend the current ranking methodology to define the proportion of marks awarded for price and non-price factor scoring respectively. Regardless of which sub-model is adopted, defining an appropriate reduction value in the first, and setting the appropriate weighting of non-price factors in the second, may prove challenging.
Model 3: Amending valuation formula
The third model consists of amending the valuation formula used to estimate the annual budget impact of projects bidding in a CfD allocation round.
If this model was actioned, the formula would be amended so that that project scoring more highly on non-price factors would be deemed to have a lower estimated budget impact, thereby increasing the opportunity for such projects to win a CfD. The incentive here is to maximise performance on non-price factors to maximise a project’s chance of being awarded a CfD at auction by minimising its budget impact, with the cumulative effect of enabling additional project(s) to fit within the CfD allocation budget. One challenge relating to this model is how the amendment formula is quantified, and specifically how the reduction value in budget impact is calculated.
DESNZ also note that this model may enable a free-rider effect whereby projects who are not submitting high scoring non-price factors nonetheless benefit from others that do, since more projects could ultimately secure a winning bid.
Thresholds and potential exemptions
The Consultation also provides that DESNZ is considering which projects could be obliged to (or could be exempted from) submitting non-price factors.
Generating stations with a capacity of 300MW or more, and all floating offshore wind projects, are currently subject to supply chain plan requirements. DESNZ is seeking feedback on whether it is fair to keep the current 300MW threshold limit in the event that non-price factors are incorporated into the CfD auction regime. To this end, DESNZ is assessing whether the potential administrative and financial burden of partaking in the process for sub-300MW projects would outweigh the potential reward for submitting and delivering high scoring non-price factors for the project, and whether bespoke non-price factors could address some of these challenges.
Compliance
The Consultation seeks feedback on deterring non-delivery of the non-price commitments, and proposes the following penalty options for such non-delivery:
- the withdrawal of any “top-up” - if a financial “top-up” were introduced;
- having a set range of financial penalties, proportionate to the level of non-delivery of a non-price factor; and
- netting off penalty payments from CfD revenues.
Call for Evidence and Next Steps
DESNZ is interested to hear any alternative solutions to introducing non-price factors and evidence supporting the same. Notably, the Consultation highlights that this includes models outside the CfD regime that explore the overall electricity market design.
The Consultation on the proposed reforms is open until 22 May 2023. Following this, DESNZ will analyse and summarise the responses before setting out its response. To view and respond to the Consultation, please click here.
Article co-authored by James Woodhouse Trainee Solicitor at CMS.
