Contracts for Difference (CfD) to accelerate electricity market reform and launch auctions for renewable energy

Context

• Contracts for Difference (CfD) was introduced as part of the Electricity Market Reform in 2013, after its initial announcement in a 2011 White Paper.
• Electricity Market Reform was a government policy to incentivise investment in secure, low-carbon electricity, improve the security of the UK’s electricity supply, and improve affordability for consumers.

Problem

• The UK experienced an increase in electricity demand and a reduction of existing capacity due to the rapid closure of older, polluting power stations. Renewable energy appeared to be an alternative affordable source of energy generation.
• The closing capacity needed to be replaced with a cleaner mix of generation to help meet climate change and renewable targets. There was a need for private investment to bring forward the renewables infrastructure.

Stakeholders involved

• Low Carbon Contracts Company (LCCC)
• National Grid
• Wind farm operators

Innovation

• The CfD was a 15-year contract between a low-carbon generator and the LCCC, a UK government–owned limited liability company. [1] The government determined key parameters ahead of each allocation round, including the list of eligible technologies, the budget, administrative strike prices, etc.
• CfDs were available to a wide range of low-carbon technologies and classified into different ‘pots’ for emerging and established technologies, with separate respective funding caps. [2]
• Offshore wind projects were permitted to be built in phases and commissioned up to two years after the start of the first phase.

Timeline

Results and impact

• The three allocation rounds had a total of 11 winning bids; nearly 10,000 MW was awarded.
• Significantly increased share of offshore wind, which made up over 20% share of the awarded technologies in terms of number of projects in the last three allocation rounds.
• Program delivered below budget. There were significant technology cost reductions over the last three rounds since the strike prices were set by government. The strike price was below the reference price and the budget was therefore not fully exhausted. The budgets for ‘Pot 2’ (less established technologies) such as offshore wind, wave, tidal, etc. were GBP155–260 million, GBP296 million and GBP65 million respectively in Rounds 1, 2, and 3. [3]

Key lessons learnt

• Governance: The government was able to determine and revise key parameters ahead of each allocation round, including the list of eligible technologies, the budget, administrative strike prices, and the maximum and minimum levels of each technology it was seeking.
• Procurement: The non-delivery disincentive mechanism was set out by Department of Energy & Climate Change to discourage generators from applying for a CfD without fulfilling the obligation in project delivery. The government was also considering the introduction of a bid bond where applicants provide a deposit – either by cash payment, bank guarantee, or letter of credit – which would be forfeited upon non-delivery.
• Technology: As the balance of different generating technologies changes to deliver the power sector’s contribution to net zero, it is important that electricity markets and any support arrangements reflect wider system costs and benefits. For example, as offshore wind projects were bigger in size and lower in cost compared to other technologies, a new third ‘pot’ has been introduced for offshore wind projects.

[1] LCCC pays a ‘top-up’ payment to generators, equal to the difference between a strike price and the market reference price. However, the generator must pay the LCCC if the reference price exceeds the strike price.

[2,3] With the exception of energy from waste, all other technologies offered CfDs cleared below the administered strike price. This was seen by government as a successful attempt at addressing the policy outcome in incentivising investment in secure, low-carbon electricity.