In response to criticism of the “multiparty” model, the Energy Bill before Parliament provides for a single counterparty model for contracts for difference (CfDs). Under this model, a designated counterparty will be obliged to offer CfDs to generators where directed to do so by the secretary of state or National Grid. A generator’s acceptance of that offer will result in the formation of a bilateral contract between the generator and the CfD counterparty. The counterparty will be owned by government but funded by suppliers and will also be obliged to pass on generators’ CfD payments to suppliers.
The multiparty model depended on a complex web of obligations partly set out in the CfD itself, partly in licences and industry codes, but predominantly defined by statute and secondary legislation. This complexity was in itself viewed as a potential obstacle to funding. Under the single counterparty model, obligations between the CfD counterparty and the generator will be set out in the CfD itself, although these contractual terms could be supplemented by regulations – for instance, specifying the circumstances in which the CfD counterparty may exercise its right to terminate for breach or agree to amendments.
The secretary of state may vary the licences of generators and transmission and distribution companies as well as industry codes for the purpose of allowing or requiring services to be provided to a CfD counterparty and enforcing CfD obligations. So although the single counterparty model should make it substantially easier to identify the generator’s obligations under CfDs, details such as invoicing, metering and reconciliation are still likely to be governed by industry codes such as the balancing and settlement code. Suppliers’ obligations will continue to be set out in a complex web of provisions under legislation and industry codes.
Under the multiparty model, each supplier would be responsible for paying a proportion of the amount due to the generator under the CfD, leading to concerns as to how the generator would recover payments due to it if there was a shortfall. Generators would be dependent on a settlement intermediary to identify suppliers in breach and secure payments due from them. Under the single counterparty approach, the payment obligation rests with the CfD counterparty, and the generator need not concern itself with the basis on which liability for CfD payments is allocated among suppliers.
It is not just disputes about the level of individual suppliers’ contributions that are potentially problematic under the multiparty model. Dispute resolution would be particularly difficult if the CfD could not be amended to forestall a repetition of a dispute. This is much easier under the single counterparty model. Disputes are conducted between the generator and the CfD counterparty whose duties, such as to consult or seek the consent of the secretary of state in connection with dispute resolution, will be established by regulations. It remains to be seen whether CfD contract amendments will be permissible under general European procurement law – a problem that has emerged in the context of National Grid’s long-term Short Term Operating Reserve contracts.
As multiparty CfDs are in effect legislative instruments, protecting generators against changes in law would be particularly problematic. Moreover, such measures tend to be regarded as unconstitutional and would stand little chance of support in Parliament. Multiparty CfDs would be vulnerable to legislative changes not only in the Bill as enacted, but also to the raft of secondary legislation required to give effect to CfDs. Any term providing for compensation or relief as a consequence of such change could itself be subject to amendment or repeal. Under the single counterparty model, the CfD can protect generators from such matters. Even though it is not possible to entirely remove the risk of legislation being introduced which invalidates that protection, the risk of a CfD being altered to the detriment of the generator is substantially reduced, with measures to that affect potentially open to challenge under human rights law.
The CfD counterparty will be a company owned by government, but will not be underwritten by government. The Bill provides for regulations requiring electricity suppliers to pay the counterparty to enable it to make payments under CfDs. It may provide for the remaining suppliers to pick up the shortfall in the event of a supplier insolvency, although the possibility of a funding shortfall is not entirely removed.
The CfD counterparty will be obliged to pay generators only what it has received from suppliers. Therefore, if there is a shortfall in payments from suppliers, the counterparty will not be under an obligation to pay generators until such time as the shortfall has been rectified. The credit risk for both suppliers and generators of a major supplier default is comparable to the risk that currently exists under the Renewables Obligation, although the potential magnitude of the shortfall is greater, not least because liabilities for investment contracts, in particular for nuclear projects, may also be transferred to the CfD counterparty.
The move to a single counterparty model is unlikely to have any impact on how suppliers should account for potential liabilities associated with CfDs – their obligations will continue to be defined by general law. For generators the situation could have worsened. Contractual CfDs are likely to be classified as derivatives, in which case generators’ exposure to payments to the CfD counterparty over the lifetime of the CfD will need to be accounted for. CfDs may also fall within the Financial Services Authority’s remit as a result of the change.
Under the single counterparty model, funders should have no difficulty in taking security over CfDs and entering into direct agreements with the counterparty, enabling them to take over the CfD if the generator is in material breach of its terms or the terms of loan arrangements – measures that are essential for large-scale project finance.
Taken as a whole, the move to the single counterparty model offers a significant improvement for investors in new low-carbon generation. Whether the changes will reduce the cost of capital and attract substantial investment remains to be seen. Ultimately, that depends on the premium that will be offered to low-carbon generation.
The one real drawback with moving to a single counterparty model is that channelling CfD payments through a government-owned body removes any doubt as to whether state aid clearance for CfDs will be required from the European Commission. It will not be just George Osborne on the back of the Department of Energy and Climate Change when it comes to setting strike prices.
Paul Brennan is an energy specialist at law firm Morgan Cole LLP
This article first appeared in Utility Week’s print edition of 8th February 2013.
Get Utility Week’s expert news and comment – unique and indispensible – direct to your desk. Sign up for a trial subscription here: http://bit.ly/zzxQxx