Demystifying Contracts-for-Difference (CfD)

Who knew mechanisms to support the sale of electricity could get so much traction in the mainstream news?
However, given the ever increasing appearance of the impact of climate change in our social media feeds and news channels, alongside the ongoing ‘battle’ between those who want to expand renewable electricity as quickly as possible and those who see it as an impact itself on the local environment, perhaps it isn’t so strange.

What is Contracts-for-Difference?

The Contracts-for-Difference (CfD) scheme is a government led support mechanism that creates stable and predictable revenue streams for low-carbon electricity generators. By being predictable, and stable, its aim is to create certainty for investors to release their funding to build new renewable developments. The stable revenue is provided by creating a ‘Strike Price’. If the wholesale electricity market is above this, the generator has to pay the difference back to the government; but if it is below, the generator gets paid the difference. In effect, generators always know the £/MWh that they will be receiving for the exported electricity. The payment for this scheme is paid by most energy consumers connected to the Great Britain electricity grid.

The mechanism to set the ‘Strike Price’ takes the form of Allocation Rounds, of which the latest, which has grabbed the headlines, is the fifth. Generators bid into an auction and the Strike Price that is cleared is based on the bid made by the last project allocated before the auction closes, once the allocated funds have been exhausted. However, an ‘Administrative Strike Price’ (ASP) is also used. This provides a ceiling price, which is known prior to the allocation round, to notify potential bidders of the maximum the government (and by proxy, the British public and organisations that use the grid) are willing to pay.

The 5th CfD Allocation Round attracted so much attention in the news, as no bids were received for offshore wind projects; the first time ever. The general consensus from the industry participants is that the latest ASP was too low to reflect the reality of recent impacts of inflation on the offshore wind supply chain and costs of manufacturing.

It is worth noting that other renewable technologies were successfully awarded in the scheme and the below comparison shows the results of this against the current amount of capacity on the GB grid, either operational or under construction.
Renewable technologies comparison table against current GB grid capacity:

(data taken from the Renewable Energy Planning Database)

By comparison, there is currently 22,400MW of Offshore Wind capacity either Under Construction or Operational.

It is exciting to see such big increases particularly in Solar, suggesting a further 20% increase on large scale solar over and above what’s already installed or under construction, and the more immature technologies as well.

You will note in the table that the Strike Price are based on 2012 prices. This often gets missed in the headline reporting but is an important distinction. Within the CfD standard terms, prices are increased in line with CPI each year. Based on this, in 2023 prices, the prices would currently be as below:

But in addition, the projects in this allocation round are due to be delivered between April 2025 and March 2028, meaning their actual starting delivered prices will adjust by CPI even further – which way and by how much will depend on inflation.

How the government determines the administrative strike price is based on Government(DESNZ) latest view on ‘central hurdle rates’; effectively what they believe it costs, on average, to build, operate and fund each technology type. And this is where it gets a little unusual – the data used by Government for ASP was based on a number of assumptions, but central to this was a ‘2020 Electricity Generation Costs’ report.

Within this report, the Government’s own assumption is that the ‘Levelised Cost of Electricity Generation’ for the three main renewable technology types being commissioned in 2025 are:

The calculation for setting the ASP does look at other factors – however the guidance notes released by government do state: “The key data source used in setting ASPs is BEIS’s latest view on electricity generation costs”. And the results from setting the price so low are quite clear in the CfD Allocation Round 5.

What’s next?

Well, Offshore Wind projects are still being developed. However, the investor signals have been tarnished for the GB market and only time will tell how that will impact the pipeline of new offshore wind renewable projects going ahead. We won’t be waiting long for the next Allocation Round either. In February 2023, the government announced that these will now take place annually rather than every two years; meaning Allocation Round 6 is expected in March 2024. We will likely see toward Christmas 2023, if previous timelines are a benchmark, what the set ASP will be for this round and may show us if the government have taken on board the feedback from round 5.

This blog was written by Kane Stockwell, Net Zero Energy Supply Lead. Kane is focused on supporting public bodies on their journey to net zero. If you would like to talk to Kane about your organisation and how we can help, get in touch – kane.stockwell@laserenergy.org.uk