The government will need to take a “robust stance” when setting the terms of its planned Contracts for Difference (CfD) expansion if the move is to deliver a genuine reduction in wholesale power prices, one of its initial proponents has stated.
Rob Gross, a director at the UK Energy Research Centre (UKERC), was responding to criticism of the measure after new prime minister Liz Truss confirmed the government’s adoption of the policy as part of its response to the energy crisis.
Speaking in the House of Commons on Thursday (8 September), Truss said existing nuclear and renewable generators would be shifted onto CfDs to “end the situation where electricity prices are set by the marginal price of gas”.
“This means generators will receive a fair price, reflecting their cost of production, further bringing down the cost of this generation,” she added.
Back in April, UKERC issued a discussion paper suggesting that wholesale power prices could be reduced by offering existing renewable and nuclear generators without CfDs the chance to bid for the contracts in a “pot zero” auction. The paper argued generators would be willing to forgo the current sky-high power prices and any additional subsidies through the Renewables Obligation (RO) scheme in exchange for long-term certainty over their revenues provided by the contracts.
Last week, the industry trade bodies Energy UK and Renewable UK both gave their backing to a version of the proposals. Energy UK said an expansion of the CfD scheme would be significantly better than a “damaging” windfall tax on non-gas generators, which Truss has ruled out.
However, the proposals have faced pushback, with Labour’s shadow climate change secretary Ed Miliband telling BBC Radio 4’s Today programme on Thursday morning that such a measure would “lock in massive windfall profits” and offer a “terrible deal” for billpayers.
Writing on Twitter, Tim Lord, associate senior fellow at the Tony Blair Institute for Global Change, said if the scheme was voluntary, generators would only take the contracts if they gained more revenues over the long-term than they lost in the short-term.
He described the situation as “heads I win, tails you lose,” and said auctions would not help to address the issue as there would be “no competitive pressure”.
Richard Hall, chief energy economist for Citizens Advice, also warned on Twitter that the government was in an “incredibly weak” negotiating position: “Wholesale prices are so sky high that generators would have to be offered very attractive future terms to compensate them for the loss of revenue now.
“Bluntly, it’s a sellers’ market and the government has all the characteristics of a distressed buyer. The short term situation is so bleak there are incredibly strong incentives to strike a deal even on bad terms and generators will know this.”
Hall said the government would have more leverage if it had kept the threat of a windfall tax on the table.
“If any deals negotiated simply re-profile generators current revenue expectations, rather than reducing them, it may simply kick the can down the road – reducing prices now but at the expense of tomorrow’s consumers,” he added.
Gross, who is a professor of energy policy and technology at Imperial College London and was lead author of the UKERC paper in April, told Utility Week the success of the scheme would depend on the exact details “and we don’t really have any detail at the moment.”
The government has not yet said how it plans to move existing generators onto CfDs, including whether the scheme will be voluntary as proposed by Energy UK.
“I think it’s right to point out that if not handled properly, there’s the risk that this doesn’t deliver very quickly and it doesn’t deliver very effectively,” said Gross, adding that the government would need to take a “robust stance”.
He agreed that “it’s not a great negotiating tactic” to remove the threat of a windfall tax but said this doesn’t mean the government is in a weak position: “I’m obviously not privy to the conversations that the government may be having with industry behind closed doors but even in the absence of the threat of a windfall tax, I think both parties to the negotiation would be cognisant of the fact an element of compulsion could follow if a voluntary approach doesn’t deliver”.
Gross emphasised the value of revenue stability to generators, which could make the contracts attractive “even at a relatively low price”. The UKERC paper argued this certainty would allow generators to refinance their projects, lowering their costs.
He also questioned how else the government could deal with the issue, saying windfall taxes are not a “panacea,” partly because it’s not clear where windfalls have accrued between generators, traders and suppliers.
Gross did note his own concerns about how quickly the scheme could be implemented, saying if it takes a long time for forward hedges to expire, this could take away some of its value.
He said there is additionally a question over the length of the contracts, particularly in relation to nuclear generators, most of which are due to shut down by the end of the current decade.
Writing in a blog following the government’s announcement, Dan Monzani, managing director for the UK and Ireland at Aurora Energy Research, said persuading renewable generators receiving subsidies through the RO scheme to swap them for CfDs with the same expiry dates would require average strike prices of £175/MWh for offshore wind, £137/MWh for onshore wind and £143/MWh (2012 prices).
With wholesale power currently trading at around £400/MWh, Aurora calculated the savings from these swaps, if they covered the whole fleet, at £25.65 billion over the next two years.