13 October 2022 Energy and Infrastructure

Revenue cap on UK low-carbon generators

On 12 October 2022, the UK Government introduced the new Energy Prices Bill (the “Bill”). The Bill, if enacted, will provide the legislative basis for the energy price support provided to households and businesses as well as a “temporary” revenue cap (also referred to as “Cost-Plus Revenue Limit”) proposed to be imposed on certain low-carbon electricity generators. The precise mechanics of the temporary Cost-Plus Revenue Limit will be subject to a consultation. The Bill also allows the UK Government to consider a voluntary Contracts for Difference regime for existing generators, which while it will require time to develop and implement will ultimately represent medium and longer-term certainty to the low-carbon generation industry.

Current energy prices are having a significant impact on UK businesses and consumers, with the UK Government under pressure to take steps to reduce the impact of high gas prices on the cost of energy. In particular, the UK Government has sought to divorce the link between gas prices and the wholesale power price in respect of low-carbon electricity generators. See here for further details.

The potential scope of the Bill is far-reaching. In this note, we have set out some key considerations as to how the proposed Cost-Plus Revenue Limit / revenue cap might affect relevant generators.

Please get in touch if you would like more detail on the legislative and regulatory regime and how your business might be affected by it.

Summary of the Cost-Plus Revenue Limit:
  • Effective date: The UK Government intends for the Cost-Plus Revenue Limit to be in place at the start of 2023.
  • Duration of revenue cap: Five years (according to the Bill), though may be extended by the Secretary of State. However, the UK Government has stated in its press release accompanying the Bill that the cap will endure until such time as the markets return to normal or generators move onto other market arrangements, such as a Contract for Difference.
  • Retrospective effect: The Bill will authorise any steps taken by the Secretary of State on or after 1 January 2022 until the date that the Bill comes into force in relation to providing support for meeting costs related to the use or supply of energy.
  • Cap amount: The Bill does not specify the cap amount. However, we note that the analogous cap in the EU has been set at €180 per MWh. The UK Government has stated in its press release that the limit will allow generators to cover their costs and “receive an appropriate revenue that reflects their operational output, investment commitment and risk profile”. A relevant factor which may be considered in setting the cap amount is estimated wholesale prices prior to the onset of the energy crisis. Figures which have been leaked to the press in advance of the release of the Bill indicate that UK Government is anticipating setting the cap at a lower level than that in the EU. Further details will be required but a significant disparity with the EU approach creates a risk that investment into UK renewables projects becomes comparatively less attractive at a time when UK Government is looking to double growth in renewable investment to reach net zero targets. 
  • Periodic payments: The Bill enables the Secretary of State to impose a temporary requirement for electricity generators to make periodic payments, in connection with the Cost-Plus Revenue Limit. The payments will also be calculated by reference to the quantity of electricity generated during a certain period, amongst other factors. This is likely to be the legislative basis for the Cost-Plus Revenue Limit.
  • Relevant jurisdictions: England and Wales. The Bill will enable the UK Government to introduce a comparable scheme in Northern Ireland. It may also possibly extend to Scotland, depending on the conclusions of the ongoing discussions between the UK and Scottish Governments.
  • Relevant generating station: More detail is required but the policy is intended to apply to low-carbon generating assets not currently covered by a Contract for Difference. As defined in the Bill, the “relevant generating stations” that may be required to make these payments could include electricity generators that have a Contract for Difference in place if no payments have begun to fall due under such Contract for Difference. The UK Government has yet to confirm how baseload technologies such as nuclear and biomass will be treated in the policy. 
  • Revenues subject to the cap: The UK Government is considering an arrangement that allows generators to keep a proportion of their revenue above the cap, but this is yet to be confirmed.
Other wide-ranging powers under the Bill: 
  • In addition to the Cost-Plus Revenue Limit, the Bill (as introduced) also grants the Secretary of State the power to take any steps to acquire, make available or otherwise access energy or relevant infrastructure, including by entering into contracts. These powers will also include dealing with costs, whether those costs fall to the Secretary of State or others.
  • The Secretary of State will have the power to modify energy licences and any document maintained in accordance with the conditions of such energy licences.
  • The Bill provides for domestic and non-domestic energy price reduction schemes and grants the UK Government broad powers to implement a scheme which reduces the gas and electricity prices from what they would have been without the scheme to another price determined by the scheme. Gas and electricity suppliers who provide domestic electricity supply are required to “take all reasonable steps” to join the scheme.
  • The Bill will require the Secretary of State to publish such designated price reduction schemes so far as the Secretary of State considers it appropriate to do so. Whilst industry consultations are already underway, the Bill appears to grant wide-ranging discretion to the Secretary of State to implement the scheme as he sees fit.
  • Intermediaries (i.e. persons to whom energy price support is provided) may be required to pass on the benefits of the energy price support to the end users by a specified time.
  • The Secretary of State will not be contractually liable for things done or omitted in the performance or purported performance of the terms of the designated gas or electricity schemes, unless the liability relates to payment of an amount under the scheme.
Implications of the Cost-Plus Revenue Limit

We set out below some of the headline points that may be relevant when considering the contractual implications of the revenue cap.

  • Project documents: The various project documents, including construction contracts, operation and maintenance contracts, power purchase agreements and any power price hedging arrangements, will need to be carefully reviewed to identify any implications of the revenue cap. For example:
    • The introduction of the revenue cap may trigger the change in law provisions in the project documents (e.g. in the power purchase agreements), which could trigger consultation, expert determination, compensation and/or termination rights; 
    • Some of the construction and operations contracts may contain certain revenue sharing arrangements and/or warranties with respect to generation, which could be affected by the revenue cap; 
    • The power price hedging arrangements (including any price collar or fixed pricing under route-to-market or corporate power purchase agreements) entered into by the generator may hedge considerably above the revenue cap. Whilst the mechanics of the revenue cap have not yet been finalised, if the cap simply requires the generator to surrender any and all revenue above the cap amount, the adverse impact on the generator could be severe, as it may be required to surrender the excess revenue twice (first to the hedging provider, and then to the UK Government); and
    • Some of the real estate arrangements such as leases may require payments that are linked to the relevant generator’s revenues. Similarly to the power price hedging arrangements above, if the revenue cap requires the relevant generators to surrender any and all revenue above the cap amount, this could have a significant adverse impact on the generator depending on the applicable terms.
  • Financing documents: The terms of the financing documents for the generators should be carefully reviewed to check for any implications of the revenue cap coming into effect. For example: 
    • This could be considered a “change in law” in the financing documents. Such “change in law”, depending on the terms of the financing documents, may have the effect of blocking any distributions from a relevant generator to the sponsors, causing a technical financing default and/or possible debt resizing or mandatory prepayment;
    • This could be considered a “material adverse change” (or similar) in the financing documents, depending on how it is defined in the documents. Such “material adverse change” can have similar consequences as those for change in law noted above including distribution block and default; 
    • Many of the consequences on other documents noted above may in turn have consequences in the financing documents – for example, any potential termination of the power purchase agreements due to the change in law would likely trigger a financing default; and
    • There may also be implications on the coverage ratios depending on the level of the revenue cap. It should be considered whether the ratios can be retested and if so, how these might affect any financing arrangements; and
  • Equity documents: If a relevant generator was subject to any M&A transaction, the sponsors may wish to review the terms of the sale and purchase document(s). For example, there may be compensation (e.g. by way of adjusting the sale and purchase price) applicable with respect to the reduced revenues due to the revenue cap.

We are closely engaging with key stakeholders in the energy sector to consider their options in light of the proposed revenue cap, as well as working with leading corporates, funds and financial institutions as they progress and structure their renewable energy transactions in the current climate. The challenges, as well as opportunities, posed to individual institutions will differ enormously depending on the relevant contractual, financial and commercial arrangements in place. 

Our sector-leading energy team consists of some of the most experienced and innovative experts in the market. We would be happy to discuss with you further and help you find tailored solutions that would work for you and your stakeholders.