BEIS warned against profit-sharing mechanism for CfDs

The Department for Business, Energy and Industrial Strategy (BEIS) has been warned not to implement a profit-sharing mechanism to mitigate against the impact of higher-than-expected load factors on the Contracts for Difference scheme.

Forcing developers to share any windfalls “would not achieve the desired result and could also scare off investors”, a former head of strategy at the Department of Energy and Climate Change (Decc) told Utility Week.

“Trying to design a profit-sharing mechanism and implement it in a way that’s fair to both the investors as well as consumers is quite complex,” said Alon Carmel, senior consultant at NERA Economic Consulting. “If you make it too rigid, then it just becomes an unfair penalty on the builders of that wind.”

“If the investors see that there’s a profit-sharing mechanism which takes away all the upside of the investment then they’re going to be far less willing to make the investment and go somewhere else; or they’ll expect a risk premium to be baked into the contract.”

The former head of Levy Control Framework (LCF) strategy at the now defunct Decc made the comments after BEIS published a report on the “lessons learned” from the LCF budget overspend revealed in 2015.

The Office for Budget Responsibility projected last July that by 2020/21 annual spending on the low-carbon subsidy mechanisms covered by the LCF – Contracts for Difference, the Renewables Obligation and the Feed-in-Tariff – would reach £9.1 billion (2011/12 prices); well above the £7.6 billion budget cap. The government responded by cutting back subsidies to try and bring costs under control; closing elements of the RO a year early and slashing FiT rates.

The report said one of factors which contributed to the projected overspend was the underestimation of the load factors – the ratios of the maximum possible output to the actual output – which would be achieved by renewable projects.

In a response to the report, BEIS said it had considered whether to introduce “generation caps or a gain share mechanism to mitigate the LCF impact of higher load factors”. It concluded that “such an approach would not be deliverable for the next allocation round” for the Contracts for Difference but added that it was “looking at options” for future rounds.

Carmel said it was a “false notion” that BEIS could claw back the “windfall” if a developer’s actual load factor was higher than what the department had assumed: “If they think they can achieve a load factor of 50 per cent, and BEIS assumes that the load factor is 40 per cent, it’s just going to mean that wind farm is going to bid more aggressively to win the auction. What happens is that the clearing price goes down and consumers don’t pay any more than they would have.”

BEIS said itself that the competitive process for awarding Contracts for Difference ensures that “consumers benefit through lower strike prices where developers’ load factor assumptions are higher than BEIS”.

The next Contracts for Difference auction is scheduled to open to applications in April. £290 million of annual funding will made available to “less established” technologies such as offshore wind and tidal power.