• CfDs: Not Unduly Distorting the Market, But Not Best Value for Money?
  • November 18, 2014
  • Law Firm: Dentons Canada LLP - Toronto Office
  • The European Commission’s state aid decision clearing the UK’s "enduring regime" of renewables contracts for difference (dated 23 July, published on 2 October 2014) confirms the CfD regime as a model example of the kind of renewables support scheme that the Commission wants to encourage, as described in its April 2014 Guidelines on state aid for environmental protection and energy.

    The decision is littered with cross-references to the Guidelines, reflecting the fact that key details of the CfD regime were effectively developed in dialogue with the Commission. Among the key points in favour of the regime as far as the Commission is concerned are that the strike price mechanism limits the ability of generators to benefit from very high prices; that "the strike price paid will be established via a competitive bidding process"; and that it cannot be higher than the administratively set strike price, which is based on "the levelised costs of eligible technologies and reasonable hurdle rates". Other points to note include future measures to ensure that generators do not have an incentive to generate electricity when prices are negative and details of the treatment of biomass conversions and imported renewable electricity.

    Given the Commission’s emphasis on the benefits of strike price competition, it is interesting to note the parallel clearance for the award of early "FID-enabling" CfD "investment contracts" - outside the enduring regime, and with no competition on strike prices - to five UK offshore wind farms (Walney, Dudgeon, Hornsea, Burbo Bank and Beatrice). For the Commission, the award of these contracts was justified because "the Commission was able to verify that the amount of aid for each project is limited to what would be necessary to allow the project to reach a reasonable rate of return" and "the Commission further notes that...the notified projects are all reaching an IRR below the central value of the hurdle rates considered by the UK". However, as if DECC needed to be reminded that it cannot please everybody all the time, within a day of the release of the two state aid decisions, the Public Accounts Committee published a report that criticised the investment contracts as poor value for money, repeating a number of points first made in a National Audit Office report in June.

    The PAC’s headline criticism is that the investment contracts will consume up to 58% of the total funds available for renewable CfDs to 2020/2021 - without accounting for a correspondingly large proportion of the new renewable generating capacity that is to be funded by CfDs. They argue that committing so much of the overall CfD budget to the five offshore wind projects and three biomass projects (which have yet to receive state aid clearance) was both unnecessary (because the 2020 targets for renewables deployment could have been met in any event) and represents poor value for consumers, because the enduring regime, with its more competitive allocation processes, can be expected to deliver more MW of renewable power per £ of subsidy. Ultimately, as both the PAC and NAO acknowledge to some extent, the effect of the investment contract regime may have been to ensure the continuing healthy development of the offshore wind industry in the UK, albeit potentially at the cost of support for some later offshore wind (and possibly other) projects.

    Whilst there may be a wider political context to the line taken by each of the Commission and the PAC, their different appraisals of the investment contracts regime also reflect their different functions. The Commission, in reviewing proposed state aid measures, is properly concerned only with their impact on competition within the EU internal market. It is not in the business of telling Member States that one renewable technology or project is better or worse value than another for UK consumers, provided that neither is being given more aid than is strictly necessary to remedy the market failure that inhibits its development in the absence of aid. If gaining state aid approval were simply a matter of comparing the level of subsidy per MW of new generating capacity, the investment contracts for the biomass conversions at Drax and Lynemouth (with an estimated CfD level of support of £2.6m/MW and an assumed load factor of 64.5%) would not still be awaiting clearance when the aid to the five offshore wind farms (with estimated CfD levels of support of between £3.4m/MW and £4.4m/MW and an assumed load factor of 37.7%) has been approved.