CfD: Time for reform?

RWE UK’s Senior Manager, Regulatory Affairs, James Brabben, spoke at the Energy Costs APPG meeting on the subject of ‘CfD: Time for reform’.
Here, James shares his reflections on what needs to happen to ensure success in future CfD rounds.

Last week I had the pleasure of speaking to the Energy Costs All Party Parliamentary Group (APPG) about reform to Contracts for Difference (CfD), following the most recent CfD Allocation Round – AR5.

This was a timely discussion following the outcome of the UK’s AR5 CfD auction round the week before, which was successful for a number of onshore technologies including onshore wind and solar, but failed to procure any offshore wind.

A missed opportunity

CfDs have a proven track record in their ability to drive investment into a range of renewable energy projects. They have played an essential role in protecting UK energy security, supporting the energy transition, and delivering progress towards UK Net Zero targets. However, AR5 could only be described as a preventable disaster, mainly for offshore wind.

RWE, alongside the wider industry, have been warning government for almost a year that a combination of low Administrative Strike Prices (the ceiling price for CfDs bids which are meant to reflect the cost of investing in a particular low carbon technology) and low reference prices (a forecast of the expected future electricity price) risked a failure to deliver the outcomes that government and industry need.

It reflects a long-term ‘race to the bottom’ on CfD prices which has risked the sustainability of the sector.

Last week, the industry was sadly proved right.

Whilst RWE was delighted to be successful in securing CfDs for three onshore wind and six solar projects, the failure to procure any offshore wind is a huge missed opportunity for the UK. These projects would have been instrumental in keeping the UK on track to meet net zero targets, reducing consumer bills, and driving up our energy independence. It will now prove very difficult to meet the UK’s 50GW offshore wind target without immediate and radical action.

What needs to happen –
keep the CfD contract, reform the process to allocate it

It is important to re-iterate that offshore wind, onshore wind, and solar, continue to be the cheapest forms of new build power. Offshore wind’s scale and efficiency means it is poised to be the backbone of the future energy system. However, the UK seriously risks undermining its offshore wind ambitions unless it properly backs the sector.

Secondly the CfD contract is not broken. Once awarded, CfDs are a gold standard internationally, robust to market changes and highly investable. It is how these CfDs are allocated that needs a reset.

Without reforms ahead of the next CfD round, AR6, the UK risks falling further behind in the global renewables race. Other markets - such as Ireland - are moving to CfD-style contracts with more realistic budget allocations that reflect the current market conditions. This, combined with uncertainties like the Energy Generators Levy and looming REMA reforms, is only serving to dent investor confidence in the UK renewables market.

Looking ahead: AR6

We are therefore at a critical juncture for the sector. It won’t be long before we are into the next annual auction period, leaving little time to deliver radical scheme overhaul. Instead, relatively minor changes could make a material difference. But only if government acts fast.

For AR6 we need to see:

A rise in ASPs to market reflective levels ...
... that acknowledge the sharp cost increases seen in the past 12-18 months. This is true of all technologies, but especially offshore wind.

Whilst not wanting to get too technical, the methodology for setting ASPs is also outdated and opaque. Currently a “cut-off” is applied to offshore wind, onshore wind and solar to theoretically allow only the cheapest 50% of projects to bid below this. We know this would mean not hitting our long-term targets and consumers missing out on cheap power. So why not set it at 100% and allow more sites to competitively bid?
Market reflective reference prices.

For AR5, government figures were up to 50% lower than market forecasts. This essentially means the budget can buy less, as each project costs more to theoretically “top-up”. Realistic reference prices would limit the need for drastic budget increases to make up for AR5 and ensure higher procurement across all technologies.
We need a separate pot for offshore wind.

This not only gives more certainty to the sector and supply chain, but also allows for better budget allocation. Split pots will allow for more solar and onshore wind to clear separately from offshore wind too.
Separate pots also allow for delivery year extensions.

Increasing the number of delivery years allows more eligible projects to enter the auction, helping government catch up on AR5.
The auction needs to acknowledge the diversity of offshore wind.

We believe specific carve-outs are required for some offshore projects, including those at a smaller scale and nearer to shore. Bluntly, without all eligible offshore wind projects developing, we will not get close to 50GW by 2030, perhaps even missing 40GW by 2030. The current approach risks too many offshore projects losing out and their potential benefits being missed.
All of these tweaks can be tied together with more flexibility in the allocation framework ...

... to ensure government can make changes to auction parameters whenever needed, such as when world events impact prices and budgets.

AR7 and beyond

Once investor confidence is restored for AR6, longer-lasting reforms can be considered.

CfD budgets are opaque and short-term. From one auction to the next there is no certainty on how renewables will be procured. Future CfD budgets should be linked to the UK’s longer-term targets, with clear budgets focused on 2035 net zero targets.

This clarity will give much needed certainty to the sector, whilst still leaving room for Government to tweak the parameters ahead of each round.

In that sense, it would become more like the Capacity Market, with procurement linked to demand for renewables (i.e. the targets).

Since the CfD was created more than a decade ago the world has moved on. Renewables are the cheapest form of new generation and offshore wind, onshore wind and solar PV will be the backbone of our future energy system. The CfDs cautious “cost minimisation” approach needs to move to “value maximisation”. If the costs of CfDs were assessed against the counterfactual forms of new build generation such as gas or nuclear, rather than against each other in the current approach, we believe the scheme can legitimately procure far higher levels of renewables generation whilst still being in the interest of consumers.

At the risk of repeating myself, allocation reform is the only way to ensure a more sustainable investment environment, whilst at the same time supporting energy security and decarbonisation.

Crucially, none of the proposed reforms I’ve set out above will impact the ongoing Review of Electricity Market Arrangements (REMA) process, which isn’t expected to conclude until later in the decade. Government cannot hide behind this project in the face of more urgent challenges.

RWE wants to work with government now to get the right outcomes for the future.

As the leading power generator in the UK, with ambitions to invest £15bn by 2030 to support the energy transition, we need stronger government ambition and action to remove the barriers to delivery and provide us with the certainty we need to invest.

In the coming weeks RWE will be setting out further ideas – building on the thoughts in this blog – as to how we can fix the CfD process, to ensure we remain on track and protect our world leading offshore wind sector.