Contracts for Difference: UK Government releases final terms of CfD AR5
The fifth allocation round for the UK’s contract for difference (“CfD”) auction opened on 30 March 2023 for bidding. This is the first CfD auction round to run on an accelerated annual basis, as part of the UK Government’s ambitious net zero objectives. AR5 is scheduled to close on 24 April 2023 and will see offshore wind competing against more established technologies, with floating offshore wind competing alongside other newer technologies.
We previously looked at the changes to CfDs being proposed for AR5, a number of which were subject to consultation. The Government has now published responses to the consultation alongside the final CfD Standard Terms and Conditions, the Private Network Agreement and the generic CfD Agreement and other contract variants for AR5. In this article, we reflect on the amendments made to the CfD Standard Terms and Conditions in response to the Government’s consultation.
Please get in touch if you would like more detail on the legislative and regulatory regimes underpinning AR5 or the UK CfD scheme generally.
Final changes to the CfD for AR5
The main changes to the AR5 CfD are:
- The Government has, as anticipated, minimised flexibility for a generator to nominate a start date to take advantage of high merchant power prices, whilst still allowing flexibility in choosing a start date for generators who face genuine delays in achieving commercial operations. The final CfD terms therefore provide that the CfD counterparty, the Low Carbon Contracts Company (or LCCC), may issue a Unilateral Commercial Operations Notice (a “UCON”) where it considers that commercial operations have commenced (even if the operational conditions precedent have not been satisfied), thereby triggering the generator’s liability to pay difference payments. However, in light of the responses it received through the consultation on the removal of the merchant nose flexibility, the Government has clarified and/or adjusted the final terms of the CfD in relation to this matter as follows:
- A UCON may be issued by the LCCC only after the Target Commissioning Window has started. Generators will therefore be entitled (as they currently are) to operate their facility on a merchant basis prior to commencement of the Target Commissioning Window, thereby incentivising early commissioning. However, the Government confirmed that a UCON may be issued prior to the Target Commissioning Date (despite some respondents requesting that a UCON not be capable of being issued prior to the Target Commissioning Date). This is to avoid generators setting their Target Commissioning Dates deliberately late in their respective Target Commissioning Windows. We expect that generators’ ability to take advantage of the merchant nose flexibility prior to commencement of the Target Commissioning Window will, in practice, be relatively limited.
- A UCON would only be issued by the LCCC if commercial operations are deemed to have started. Commercial operations will be deemed to have started where the total electrical output of the facility equals or exceeds the Threshold Level (being 50% of the Installed Capacity Estimate, increased from the 25% proposed in the draft terms) in at least the Required Number of Settlement Units in any consecutive 28 day period (being 12 for baseload technologies and 5 for intermittent technologies). The Government has clarified that the intention is not that generators meeting the Threshold Level while undergoing genuine pre-commissioning testing should have to begin their CfD payments. To this end, a UCON may not be issued if all commissioning tests relating to commissioning an Installed Capacity of at least 80% of the Installed Capacity Estimate have not yet been completed (unless due to a failure to apply a Reasonable and Prudent Standard).
- The Government has, as anticipated in the draft terms, provided that the LCCC may suspend positive difference payments to generators if the UCON is issued by the LCCC before all operational conditions precedent are completed, whilst liability for generators to make difference payments to LCCC will continue. However, the drafting has been clarified to provide that after the operational conditions precedent are completed, any suspended amounts owed to the generators will be repaid (but without adjustments for interest or inflation).
- Whilst the existing CfD dispute resolution process will apply, an expert determination provision has been included to determine if a UCON should have been issued by the LCCC.
The Government intends to publish guidance in conjunction with the LCCC in due course to set out the implementation of these new arrangements. Whilst these clarifications and adjustments are helpful, they do not materially alter the substance of the changes: the merchant nose flexibility which previously existed in the CfD has been reduced.
- Data provision: The AR5 CfD simplifies the reporting requirements for generators to align the contract requirements with existing LCCC guidance.
- Private network agreement: Certain definitions in the private network agreement have been amended to better align with the Contract for Difference (Allocation) Regulations 2014 (the “CfD Regulations”).
- Interest rate methodology: AR5 CfD incorporates the Bank of England Sterling Overnight Index Average (SONIA) Compounded Index value rate as the Interest Rate Methodology as The Government has added one percentage point to the SONIA Compounded Index value rate to cover the administrative costs and underlying risks associated with lending by a bank to a business (rather than inter-bank lending). The standard terms have been amended to clarify that the interest rate would be calculated from the date on which payment is received by the generator until the payment is repaid. The interest rate would only apply when an interest rate has not otherwise been defined in the relevant contract.
Following an amendment to the CfD Regulations in July 2022, a change to the non-delivery disincentive has also been made (i.e. where a bidder does not sign a CfD offer or a CfD is subsequently terminated for non-delivery), such that the bidder/generator will not be permitted to participate in the following two allocation rounds (rather than just the following one allocation round, as under the previous CfD Regulations). This change is effective and in place for AR5 and future allocation rounds.
The following two key changes have been implemented for AR5:
- Supply chain requirements: As part of the bidding process, all floating offshore wind projects (irrespective of size) will need to demonstrate that they comply with the supply chain requirements, with a pass rate of 50%. For other projects, the supply chain requirements are triggered above 300MW and require a pass rate of 60% (see here).
- BSUoS charges: Following Ofgem’s decision in April 2022 to change the way in which Balancing Services Use of System (“BSUoS”) charges are collected, with the result that generators will no longer be liable for these charges from April 2023, certain changes has been made for the purposes of AR5 to remove the compensation mechanism for generators that was previously included in respect of these charges.