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The Energy Bill And Contracts For Difference

December 7, 2013

By Paul Homewood

 

One of the main planks of the Energy Bill, currently wending its way through the UK Parliament, is the system of “Contracts for Difference”, of CfD’s, which lay down effectively guaranteed prices for renewable energy suppliers. These will replace the present complicated system of ROC’s, and are intended to be more transparent.

In the words of DECC:

Government is proposing to legislate for Contracts for Difference (CfD), which will provide long term support for all forms of low-carbon generation – including Nuclear, Renewables and Carbon Capture and Storage. Such contracts will remove exposure to volatile wholesale electricity prices and provide a steady revenue stream for investors of all generation technologies, produce a more competitive market and therefore ensure electricity remains affordable.

To bring forward the billions of pounds of investment needed in new, low-carbon electricity generation and associated network infrastructure, Government is publishing key information on Contracts for Difference. This includes draft Strike Prices and key CfD terms which will form the basis for the final CfD contracts – therefore setting out the crucial information that developers require to make their investment decisions.

 

So let’s have a look at the Strike Prices under proposal.

 

image

 

The current wholesale price for electricity hovers around £50/MWh, so, for instance, onshore wind generators will receive approximately a subsidy of £50 for each MWh produced.

 

wholesale-versus-retail-prices

http://www.businesselectricityprices.org.uk/wholesale-business-electricity-prices/

 

Some other points worth noting:

 

1) The Strike Prices will be revised up each year for inflation, using the CPI. It is commonly claimed that, as the wholesale cost of conventional power increases, the effective subsidy will be gradually reduced, till it disappears entirely.

However, the indexing of the Strike Prices means that, for this assumption to be true, conventional power prices would need to increase above the rate of inflation.

Taking an example then, if the current wholesale price of £50/MWh increases by 5% above inflation, in 10 years time it would still only be £77.50/MWh, at today’s prices, still well below the subsidised renewable prices.

For the current wholesale price to reach the £100/MWh, which is guaranteed for onshore wind, it would need to increase by nearly 8% above inflation, every year for the next 10 years.

 

2) The contract period for renewables, (but not nuclear), is set to be 15 years. So every new wind installation will be guaranteed these prices for 15 years, starting from the time they are commissioned (i.e. not from now).

 

3) It is the Government that is contracted to “pay the difference” to the operators, i.e. they will pay the difference between what the generators actually receive on the market, and the Strike Price. However, the Government then passes these costs onto the consumer, via suppliers.

 

4) The Strike Prices apply to generators commissioning in that particular year.

So, for instance, an offshore wind operator, starting up in 2015, will receive £155/MWh for 15 years, whereas one starting up in 2019 will receive £135/MWh for its 15 years.

The lower price for later installations is intended to reflect the fact that “they will become more efficient” as time goes on. This is, of course, a common argument of the wind industry, intended to infer that subsidies will only be “temporary”.

It is interesting to note in this context that the Committee on Climate Change was so concerned by the reducing of offshore subsidies, that they wrote to Ed Davey in September:

 

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 http://www.theccc.org.uk/publication/letter-ccc-responds-to-draft-emr-delivery-plan/

 

It is still possible that the Strike Prices for offshore could be increased, as the Bill goes through Parliament. It is also possible that they could be revised upwards for future years, if operators prove to be reluctant to be take up the current offer.

In this respect, it is worth noting that RWE have recently cancelled the giant Atlantic Array wind farm they had planned for the Bristol Channel because, in their own words,” however the commercial reality means that in the current market conditions, overcoming the technical challenges within The Bristol Channel Zone would be uneconomic for RWE at this time.”

  

5) The existing system of ROC’s (Renewable Obligation Certificates) will remain for existing renewable generators.

 

6) If the market price renewable operators receive exceeds the Strike Price, the difference is returned to the Government, and thence back to suppliers.

 

7) The cost of these subsidies is included within the “Levy Control Framework”, a cap on off-balance sheet spending imposed by the Treasury on the Department for Energy and Climate Change (DECC). The LCF is also intended to cover subsidies for new nuclear and CCS projects, although there will be no new nuclear before 2020.

The LCF has been set at £4.3bn for 2015/16, rising to £7.6bn in 2020/21 (both at 2012 prices).

However, the LCF does not include the cost of the Capacity Mechanism, also being introduced under the Energy Bill, which pays gas power stations and others to provide back up capacity, to cover for intermittent renewables. The provision of this standby capacity will be arranged via auctions next year, so exact costs are not yet known. However, various estimates put the cost at over £1bn a year.

 

Footnote

The Chancellor’s Autumn Statement yesterday indicates that offshore subsidies will be increased,with reductions in onshore ones to pay for it. The implication is that more needs to be done to attract uneconomic offshore windfarms, which DECC know will be needed to produce much of the extra renewable capacity needed in the next two decades.

This would appear to confirm the concern expressed by the Committee on Climate Change.

Full details are expected next week.

5 Comments
  1. Glen Bishop permalink
    December 7, 2013 12:20 pm

    Paul – Do the numbers above take account of the recently announced £5 switch from onshore to offshore wind? That would make offshore start point £160/MWh.

    I wrote to my MP about offshore wind costs, making the point that the promised cost reductions were unlikely to occur. North Sea oil and gas construcytion costs have increased steadily (not a bad analogue for turbine installation), offshore turbines are not like widget or electonic component manufacture, most are already made in low cost labour countries and they require much larger amounts of concrete, steel and copper per MWh than gas, nuclear or coal – these are all energy intensive so renewables are likely to see greater cost increases than conventional fuels. His reply was as follows:

    “So far as offshore wind is concerned, I think we have yet to see whether your pessimism, or the optimism of those active in this sector about those costs, will prove to be well founded.

    In the meanwhile, there is no doubt that offshore wind is at present very expensive as a means of reducing carbon and, unless the costs do come down sharply, then there must be some pretty strict limits on the amount of it that we can afford in future.”

    • December 7, 2013 12:43 pm

      No, Glen.

      They’re the original numbers put out in June, when the Bill was introduced.

    • J Martin permalink
      December 7, 2013 5:07 pm

      A relatively positive response from your nameless MP, in the last paragraph, the beginnings of a healthy change in attitude, an awakening to the unaffordable reality, perhaps even a sign of growing scepticism ?

  2. Gamecock permalink
    December 8, 2013 3:43 pm

    Pretty elaborate scheme to get people to accept higher than necessary electricity prices.

    “they will become more efficient”

    When they become efficient enough to compete, they will be built with no government involvement.

    There is no urgency. They will be viable in the marketplace in a few hundred years.

  3. Billy Liar permalink
    December 8, 2013 7:03 pm

    We’re sunk – along with the Atlantic Array. Not satisfied with building up huge PPP debts, MPs are now promising to pay billions to power companies to invest in inefficient technologies.

    You couldn’t make it up.

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