- Fifth allocation round opens March 30
- Faster process, removes merchant nose
- Outlook for UK hydrogen, CCUS, SAF
UK’s LCCC anticipates AR5 process improvements, new CFD markets, states a Platts news source.
The UK’s fifth allocation round for Contracts for Difference (AR5) will reduce award processing to six months, remove the “merchant nose” phenomenon and improve the positioning of emerging technologies, the Low Carbon Contracts Company told S&P Global Commodity Insights in a March 21 interview.
AR5 is set to open to applications on March 30. With a budget of GBP205 million ($251 million), the competition is the first to move to an annual cadence.
“AR4 was a nine-month process — that’s too long for an annual process so this time, the longest timeline scenario is six months, with potential to cut it further in future,” said Andy Hawkins, LCCC’s Policy and Commercial Development Manager.
The earliest possible date for contracts to be sent to LCCC for signing is July 4-5, and the latest is Sept. 7-8, he said.
Last year AR4 winners said a nine-month timeline had disadvantaged them in a rising market, with rumors of delegations to government seeking an uplift to awarded strike prices.
Instead, the government is clearly expecting another ultra-competitive round, reducing its administrative (ceiling) strike price for offshore wind from GBP46/MWh in AR4 to GBP44/MWh in AR5 – below that for solar (GBP47/MWh) and onshore wind (GBP53/MWh).
“LCCCs guiding principle is to maintain investor confidence in the CFD scheme and minimize costs to consumers,” said Andrew Deeley, LCCC’s director of strategy and development.
“The more we can do to streamline the process, whilst following the rules, the better.”
Merchant nose
One change that won’t necessarily be welcomed by investors is removal of the merchant nose opportunity.
This is where operational projects delay the triggering of CFDs in order to benefit from high prices, a practice that has drawn criticism from the government.
From AR5 on, LCCC “will use parameters to identify when a project has commenced operation” and, if need be, require commencement of a CFD, said Deeley.
“We can’t and won’t take a subjective unilateral decision, there are parameters that have to be met to ensure the CFD can commence,” he said.
LCCC officials noted, however, that AR3 and AR4 awardees would remain within their rights to operate for a period in merchant mode before triggering contracts.
Further, existing operators who had not commenced CFDs “have a fiduciary duty to their shareholders [to maximize returns] and are working within their contracts,” they said.
Only a start date after 12-month target commissioning windows would result in contract erosion, they said.
Payback time
Despite the odd wrinkle, however, there is no doubt the UK’s two-way CFD scheme has been a success, with the concept finding its way into the European Commission’s recent electricity market reform proposals.
Since establishment as a private law company owned by the Secretary of State in 2014, the LCCC has become the contractual counterparty to 167 projects amounting to 29.7 GW.
Once operational these projects, roughly two-thirds of them offshore wind, will meet around 30% of the UK’s power needs.
In the meantime those in operation are already paying back due to high wholesale prices.
“Over the last four quarters we’ve had GBP300 million paid back to LCCC by generators and then on to suppliers as market reference prices have exceeded strike prices,” Deeley said.
Whether, as hoped, this payback amount would climb as lower priced CFD-backed projects came online “depends on your view of market prices,” said Gordon Edge, LCCC’s head of strategy and corporate affairs.
“There might be a lot of lower priced power coming into the portfolio, but market prices might be low too — notably, capture prices might be low.”
Variable technologies in LCCC’s portfolio like wind and solar are subject to an Intermittent Market Reference Price, used to calculate whether projects get paid or payback under their two-way contracts.
The price is an average of exchange day-ahead prices on an hourly basis.
As more and more renewables come on the system, hourly generation prices for wind and solar assets — capture prices — are likely to be squeezed by potential oversupply conditions: the dreaded cannibalization effect (see table of AR5 projections).
Co-location demand
One way to side-step this effect is to co-locate your wind or solar asset with a battery or an electrolyzer.
The growing urgency to do this is the next challenge facing LCCC.
“We’re getting a lot of requests around co-location and how that works around a CFD. We’ve set up a metering team to improve arrangements and allow this. In the summer we hope to be able to share details,” said Hawkins.
It’s all about the metering. LCCC must ensure asset generation is rewarded, not power that has gone into an associated battery and out again from another source.
Further, behind-the-meter solar and battery storage technologies are both DC, noted Edge.
“You don’t want to put your solar power through an inverter and incur losses while storing, you want to put the power straight in [to the battery]. So if you want to meter that solar output for CFD purposes, it has to be on DC metering and that is quite a new thing. In short, when you are not going through an inverter it’s not clear in metering terms whose power is whose. That’s a complication,” he said.
CCUS and hydrogen
On electrolysis, Deeley said it was no surprise that offshore wind farm developers may look to use capacity to generate green hydrogen to aid the delivery of these hydrogen targets.
“We need to make sure the industry’s new business models interact and the contract efficiencies are there,” he said.
More generally, existing CFDs were already proving beneficial when looking at business models for hydrogen as well as carbon capture, utilization and storage.
“We’re also working with other government departments to raise awareness of the CFD mechanism and the benefits it brings, which could be used in sectors like transport for sustainable aviation fuels,” Deeley said.
With LCCC well placed to be appointed counterparty to low carbon hydrogen and CCUS contracts, the company is gearing up for a significant ramp-up in engagement.
“UK government hopes to support at least 250 MW of hydrogen contracts in the first allocation round. In the event we are the formally appointed counterparty, this will introduce a new set of stakeholders to LCCC. That would require a different level of engagement from LCCC which we would look forward to,” Deeley said.
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Source: Platts
