Seconds out…round 2 for CfDs
We tried it once in the UK and it was too complicated for a marketplace used to (very) vanilla/simple (exit the park pre-build or at the date of issue of the provisional acceptance certificate (PAC-date)/accreditation for renewables obligation certificates (ROC) date (ROC-Accredition-Date) transactions (asset/share sales), but some do say that where there’s a will there’s a way, so yes we’re going to have Contracts for Difference (CfDs), once again.
What happened last time?
Round 1 was roundly lambasted by the international solar industry (and most other renewable energy tech.-cos.) encamped in the UK as a failure, as simply put, the bids for solar projects and some others were unduly low so as to win the CfD but that meant the plants couldn’t be built as the financial model to deliver the project simply couldn’t factor in the low price/W generated and to be paid for generation by Low Carbon Contracts Limited (https://lowcarboncontracts.uk/) under the relevant contract for difference agreement. Insufficient revenue streams via the power purchase agreement and the CfD contract aggregated, meant paying off the relevant debt, then getting to net-positive didn’t model well under the CfD-model hence sporadic (if any) bids at the really low end.
This year most renewable energy companies are consolidating through M&A or JVs, whilst some companies are selling rights-holding asset-SPV pipelines to the highest bidders, with the rest of the industry departing the UK for some countries in Europe which haven’t exhausted solar (or where other technologies are needed in abundance and PPAs pay relatively well), ASEAN, a select few countries in North Africa and the GCC, sub-Saharan Africa, the Caribbean & South America.
The remaining renewable energy technologies, excluding the big favourites of offshore wind and nuclear, might plug away and hope that they can model well under long term PPAs, but their cost-base has to (if it hasn’t already) drill down to meagre levels to ensure any semblance of (net profit) success where only very high volumes of low worth contracts make a viable plan.
What happened today in the British Government Budget announcement?
At Edie it was stated:(http://www.edie.net/news/11/Budget-2016-energy-environment-green-policy-George-Osborne-key-points/):
“…The official Budget document reads: “The government will auction Contracts for Difference of up to £730m this Parliament for up to 4GW of offshore wind and other less established renewables, with a first auction of £290m. Support for offshore wind will be capped initially at £105/MWh (in 2011-12 prices), falling to £85/MWh for projects commissioning by 2026.” ..”.
What are the key points when it comes to CfDs?
The following are worthy of consideration when considering CfDs:
• What is a CfD?
Section 6(2) of the Energy Act 2013 defines this as a contract under which a supplier funds certain payments and as being a contract that the CfD Counterparty (incorporated under the Companies Act 2006/a public authority) is required to enter into under the Act.
• What are the key points to be aware of in relation to a CfD?
a. Change in Law
– QCiL events or “Qualifying Changes in Law” have now been drafted into the standard terms and conditions (“STAC”) for CfDs most recently updated in December 2015 (Link here) and have been designed to compensate a Generator in the event that a change of law is a material and unforeseeable change that uniquely targets specific technologies, individual projects or certain CfD holders as a group. The QCiL protection covers political decisions to shut a Generator down/general changes that have a discriminatory effect without any objective justification. The QCiL protection extends to changes in law that would limit a Generator’s ability to deliver exported electricity or to receive appropriate payment for delivered exported electricity. The QCiL compensation will provide protection against certain changes in network charges relating to balancing system payments and transmission loss.
b. Credit Support Documents – “Collateral”
– This is referred to as “collateral” in STAC and will not include parent company guarantees, and will include a letter of credit or equivalent on-demand liquid form of guaranteed payment security that, e.g. in the event that the issuer loses their credit rating or folds, can be replaced within five working days with an equivalent form of security. Despite a request for a similar form of security to be provided by the CfD Counterparty, the counter from DECC was that the provisions in the legislation including the ability for the Secretary of State to replace the insolvency remote CfD Counterparty in the event of default (limited/no measure to terminate for CfD Counterparty default under the terms and conditions).
c. Variability in wholesale electricity market price
– The CfD when it is issued has the relevant strike price for the period within which it is issued attributed to it, which was £125/MWh for 2013-2014, and 2014-2015 (“Initial Strike Price”). This can be adjusted during the lifetime of the CfD in accordance with STAC. The Net Payable Amount under the CfD Agreement is the price that the Generator under the CfD receives if the Net Payable Amount after all deductions is positive (“NPA”, but if the NPA is negative, any NPA will be repaid by the CfD Counterparty – see g. below). The “Market Reference Price” (being the Baseload/intermittent market reference price) is calculated by reference to a “ Calculation Season” (a six-month period from 1 April or 1 October during which the Baseload Market Reference Price is calculated: see condition 15.2 of STAC for the formula expressed in MWh in respect of each Settlement Unit, relating to the Baseload forward season trading day price calculated in respect of a trading day, reference price sample period or where a fallback Baseload price applies, in relation to a Settlement Unit (as defined under the draft CfD Agreement as each, “half hour period in a day divided into half hour-long periods starting at 00:00 on such day”). Where the Market Reference Price is higher than the Strike Price, the Generator pays the CfD Counterparty who in turn pays the Supplier, the difference between the two, and if lower, then the CfD Counterparty obtains the difference from the Supplier and pays the Generator such amount (or ‘top-up payment’). The aim of the payment regime is for the Generator to be paid close to the Market Reference Price so that it obtains a predictable and steady revenue stream for power, but as we saw with round 1, the minimum strike price needs to be at a de minimis threshold level to make commercial sense.
– The Strike Price is fully indexed 100% to the Consumer Price Index throughout the entire Term (see i. below).
e. Less than forecast metered output/Capacity Adjustment
– Developers will be able to have a limited amount of flexibility to adjust their target capacity for a plant, to a limited extent above or below the Installed Capacity Estimate due to a Relevant Construction Event (“RCE”) by means of a RCE notice (Part 4 of STAC) which is defined as an event that the Generator acting to a Reasonable and Prudent Standard would not be aware at the application date and which renders the development/construction/installation/conversion/commissioning of a Facility uneconomic. This is to be welcomed by developers, who albeit with the RCE would have to have the director’s certify separately as to the truthfulness of the RCE notice, the capacity can be reduced, however under-estimation does not seem to have been provided for in the STAC but the DECC guidance does mention this, which may again something that is discussed during this consultation period.
– This is not a determining factor for payments which is to be welcomed, however the forecast availability will be considered as a part of the Generator (owner of the Asset) information in relation to a prospective plant for which a CfD is sought and so has some materiality as it is explicitly referred to within the STAC and so is required to be submitted.
g. Conditions Precedent
– These will be conditions prior to first payments being received under the CfD so that once standards in connection, metering, capacity installed, and contract payment/Collateral (credit support – see b. above) have been provided, then, payments will be able to flow (see i. below).
h. Developer Asset-Co (or Developer backed by Funder – Asset-Co) supply chain plan/development phase deliverables
– General Project Commitments
(annex 5 in the generic agreement: (Link here) will need to be submitted with applications for allocations together with broadly the same criteria as set out above for the Development Phase (including a Directors Certificate that the Generator that owns the Asset e.g. Developer/Developer-Consortium with a funder, have financial resources for the total project spend (‘proof of funds’) to deliver the asset(s), evidence that the site for the plant is relatively unencumbered by third party property rights and where necessary easements/other rights have been/can be obtained, and all other consents for the installation of the PV plant have been obtained) as a part of the Project Commitments in the CfD Agreement, together with evidence of an EPC agreement (Construction Phase) and evidence of a framework (major kit) supply (“Material Equipment”) agreement and a binding purchase order for the Material Equipment (so e.g. modules, inverter, mounts, cabling for solar). Very large portfolios of assets being developed require more sophisticated responses in terms of the supply chain plan to obtain Secretary of State approval for submission of the related application for allotment of related CfDs in compliance with the related guidance.
– If the Net Payable Amount (see condition 23 of STAC) is a negative number in the relevant billing cycle then the Generator pays the CfD Counterparty the absolute value of the Net Payable Amount within 10 working days; but, if positive, then within 28 calendar days (1 month), the CfD Counterparty will pay the Generator the Net Payable Amount to allow the CfD Counterparty to recover the same amount from the Supplier. The “pay when paid” configuration is confirmed in the most recent guidance, so that the CfD Counterparty has time to get funds from the supplier to cover any Net Payable Amount relating to any strike price adjustment, qualifying law change compensation (as well as any relevant true-up payment).
– It is anticipated that each CfD will endure 15 years. This can be varied to the extent that a CfD Counterparty can offer a CfD on certain specified terms, e.g. where the generic terms do not suit the funding structure, and bilateral negotiations to permit, e.g. sharing of refinancing gains – with an example in the DECC guidance being where a “…project is sufficiently expensive or important..”. The DECC guidance goes on to cite that refinancing bespoke term negotiations may arise, “…[w]here the largest Generators are able to later negotiate cheaper financing following construction, bespoke contract terms may enable suppliers (and therefore consumers) to share the benefits of lower financing costs. ..”. As such, only those solar developers with aggregated large-scale portfolios of development Assets might be able to petition to negotiate such bespoke conditions where e.g. all parties have tier-1 ratings with the usual credit reference agencies. The DECC guidance goes on to provide that large projects may have refinancing clauses which might enable developers to be free to recycle capital, however the definition of what ‘large’ will entail will require to be further requested during this consultation period by relevant interested parties.
k. Force Majeure
– The provisions will allow relief relate to events beyond a developer’s control (e.g. QCiL – see a. above), for example where a network operator is at fault.
l. Dispute Resolution
– The provisions allow for senior representatives, failing which expert determination, failing which LCIA (London Court of International Arbitration) binding arbitration.
– This relates to events such as non-payment of the NPA despite a 20 business day cure period, credit support (Collateral) default, metering access termination event, or the finally installed capacity is lower than the required installed capacity (after the Start Date). In the consultation documents published, the reasoning behind no termination for the insolvency-remote Government backed CfD Counterparty is that it can be replaced by the Government if for any reason it defaults in its payments, or if the supplier defaults in its obligations to provide the NPA payments to the CfD Counterparty to on-pay to the Generator then it can be replaced (akin to the Government acting in a form of trustee-role during the Term of the CfD to ensure that no matter what, even if late, payment is still made to the Generator if due).
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