Cornwall Insight* head of research Ed Reed argues that a contract for difference with a floor price could make zero-subsidy projects more attractive to investors and alleviate concerns about the effect of wholesale prices.
There is much interest in the renewable energy sector at the moment that ‘subsidy-free’ investment could call forward significant renewable generation capacity, but Cornwall Insight has cautioned that the outlook for wholesale power prices challenges these assertions.
Its Wholesale Power Price Cannibalisation paper detailed how the value earned from wholesale power is going to become increasingly important for renewables investments as subsidies are removed.
However, price cannibalisation that arises from the influence on the wholesale electricity price at times of high output from intermittent, weather-driven generation – such as wind – leads to suppressed or sometimes negative wholesale power prices.
The greater the fraction of output on the system to meet demand from intermittent generation at any given time, the greater this effect becomes.
We are hearing that developers are being offered power purchase agreements (PPAs) where price cannibalisation effects are already factored into the offer, which may be risking investment, and alternative approaches to underpin investment would likely be welcomed with open arms.
Against this backdrop we have begun to explore how wholesale ‘revenue stabilisation’ mechanisms will be necessary to attract investment in renewables while keeping consumer costs manageable.
The recent announcement by Business and Energy Secretary Greg Clark that the government will not be backing Swansea Bay Tidal Lagoon is the latest example of the ongoing struggle to define policies to support new low-carbon generation while limiting consumer levies, albeit in this case for a first-of-a-kind technology.
For generation that is commercialised – by which we mean anything that can currently compete in an auction for a contract for difference (CfD), rather than seek a CfD via a bilateral negotiation with government, such as new nuclear or tidal lagoons – we see merit in developing a CfD floor price.
Project finance banks will always tend towards wanting to derisk wholesale price exposure. Under a floor price CfD, contracts would be auctioned in the same fashion as today but applicants would bid in the floor price, rather than the fixed price payment they require to make the project investable.
If wholesale power prices fall below the floor price, then levy funded payments would be made to the recipient up to the floor. Where wholesale power prices rise above the floor again, the recipient would not receive the positive difference until the gross value of payments received under the CfD had been reimbursed to the Low Carbon Contracts Company.
The potential for investors to capture upside would likely mean a lower floor price would be acceptable than the fixed strike prices currently bid into CfD auctions.
Investors are likely to view the floor level as the means to raise their target level of project finance debt. Only if wholesale power prices were drastically below the floor price for most of the 15-year CfD period would there be any serious risk of unrebated consumer costs. This is unlikely.
Government could model its own view of an administered floor price (AFP) for different technologies, using the AFP to cap floor price bids. Levies would therefore provide working capital support to stabilise revenues, but only until costs were paid back.
In simple terms, investors would capture some upside with a safety net capable of raising debt, while consumers remain protected against rising levy costs in a rebate-style model.
A Department for Business, Energy & Industrial Strategy senior official recently confirmed there would be no changes to the CfD rules ahead of the next CfD auction earmarked for spring 2019. But, with a longer-term review of the Energy Market Reform framework commencing this summer, there will be opportunity for the case for reform to be made.
While our floor price CfD model requires further development, it could offer what we believe is a viable alternative for technologies that have benefited from subsidies to reduce deployment costs to a level that is competitive with conventional generation.
Indeed, we are of the view that the entire debate around how investment in new generation of any description is made in a market with increasingly volatile wholesale prices and a plethora of existing support arrangements is crying out for a strategic review of the generation market.
Alongside the merits of a technology neutral floor price CfD open for all competitive generation, a review could also assess the policy approach to unproven and uncommercialised technologies, or those requiring state intervention.
Costs have fallen by such a degree that it is now possible (where investors can manage price risk) for conventional thermal and commercialised renewables to compete and deliver required carbon emission reductions and security of supply.
This begs the question whether subsidy support for new technologies, such as tidal lagoons, is in the consumer interest. Of course, if the government wants to support these technologies for other policy reasons, such as delivering industrial strategy goals, regional regeneration or employment, then it should be done with close attention to how any intervention would work with or against the grain of the electricity market.
* Cornwall Insight is involved in many of the issues that affect energy markets. Its work covers issues including network regulation and competition, market design, infrastructure pricing and the economic and policy basis for low-carbon energy.