Tom Melhuish 10 min read

Renewable Energy and Contracts for Difference (CfD): Driving Sustainable Development in the UK

Supporting low-carbon electricity generation is key to creating a sustainable future, and the Contracts for Difference (CfD) scheme is the government’s main mechanism for supporting it.

In this article, we delve deep into the Contracts for Difference scheme. We explore how it works to support a more sustainable future.

What are Contracts for Difference (CfD), and how do they work?

Contracts for Difference (CfDs) are a type of financial contract between a low-carbon electricity generator and the UK government, which provides stable and predictable incentives for investment in renewables.

The UK government introduced the CfD scheme in 2013 to encourage investment in low-carbon electricity generation – part of the UK government’s efforts to reduce greenhouse gas emissions and meet its legally binding net-zero emissions target by 2050.

The CfD scheme is designed to provide a stable and predictable financial incentive for renewable energy projects, which helps to attract investment and support the UK’s transition to a low-carbon economy.

The contracts are awarded in “allocation rounds”, where consultation is followed by awarding CfDs to the selected generators. We discuss this in more detail throughout the guide on how they work and who’s involved in the process.

How do Contracts for Difference work?

Under the CfD scheme, eligible renewable energy projects can apply for a contract that guarantees a fixed price for the electricity generated over a set period.

This fixed price is known as the “strike price,” which is agreed upon between the generator and the government.

You can see recent strike prices for the 6th allocation here.

If the market price for electricity is below the strike price, the government pays the generator the difference, and if it is above the strike price, the generator pays the difference to the government.

The CfD scheme is managed by the Low Carbon Contracts Company (LCCC) and the Electricity Settlements Company (ESC) on behalf of the UK government.

The LCCC is responsible for entering into and managing CfDs, while the ESC is responsible for calculating and making payments under the CfD contracts.

The UK government has published a detailed guide to the CfD scheme, providing information on applying for a CfD, how the contracts work, and the eligibility criteria for renewable energy projects.

💡Corporate Power Purchase Agreements provide an alternative mechanism to secure the price of energy for a renewable energy investor.

Who are the delivery partners?

When allocating the contracts to renewable energy generators, several parties are involved in the delivery of Contracts for Difference. These are:

The Low Carbon Contracts Company (LCCC) is a private company owned by BEIS. The LCCC is the counterparty to the contracts awarded in CfD allocation rounds (auctions). The LCCCs’ primary role is to issue the contracts, manage them during construction and delivery, and make CfD payments.

The National Grid ESO is the Delivery Body for the CfD scheme – they are responsible for running the CfD allocation process.

Finally, Ofgem is the energy regulator responsible for hearing certain appeals relating to the CfDs from allocation to implementation.

The benefits of CfDs for renewable energy projects

The benefits of CfDs for renewable energy projects range from providing a stable revenue stream to the generators to encouraging innovation. Here, we look at each benefit in more detail:

  1. Stable revenue stream – Under a CfD, renewable energy generators receive a fixed price for the electricity they produce for a set time. This provides them with a stable and predictable revenue stream, which can help to reduce the financial risk of investing in renewable business energy.
  2. Lower financing costs – The stability of revenue from a CfD can also help to reduce the financing costs of renewable energy projects. Lenders are more willing to provide loans when they see a predictable income stream.
  3. Encourages innovation – The CfD scheme incentivises innovation in the renewable energy sector by awarding contracts to projects that can generate the cheapest electricity. This encourages developers to find new and innovative ways to reduce costs and improve efficiency.
  4. Supports decarbonisation – Using CfDs for renewable energy projects supports the UK government’s goal of decarbonising the energy sector. By providing financial support for renewable energy projects, the government is helping to reduce the UK’s reliance on fossil fuels and transition towards a more sustainable energy system.
  5. Increases energy security – Investing in renewable energy helps to increase energy security by reducing the UK’s reliance on imported fossil fuels. This can help to reduce the country’s exposure to business gas price volatility and supply disruptions in the global energy markets.

The risks associated with CfDs for renewable energy projects

As well as the huge benefits of CfDs, they have risks. Here, we explore the risks in a bit more detail.

  1. Counterparty risk – The CfD scheme is administered by the Low Carbon Contracts Company (LCCC), a government-owned company. There is a risk that the LCCC may not be able to meet its contractual obligations to pay generators under the CfD, which could lead to delays in payment or even non-payment.
  2. Political risk – The UK government can change the terms of the CfD scheme or withdraw it entirely. This could create uncertainty for renewable energy developers and investors and may make it more challenging to secure financing for new projects.
  3. Technology risk – Renewable energy technologies are still developing, and there is a risk that projects supported by CfDs may become obsolete or uneconomic as new technologies emerge. This could lead to losses for investors and could impact the long-term viability of the renewable energy sector.
  4. Market risk – The price of electricity can be volatile, and there is a risk that the strike price agreed under a CfD may become uneconomic if wholesale electricity prices fall. This could impact the revenue of renewable energy generators and make it more difficult to attract investment in new projects.
  5. Operational risk – Renewable energy projects can be complex to develop and operate, and technical or operational problems could impact the project’s performance. This could lead to lower electricity production and revenue than expected, affecting the project’s financial viability.

The role of CfDs in driving sustainable development in the UK

Contracts for Difference (CFDs) have played a significant role in driving sustainable development in the UK by providing financial incentives for the development of renewable energy projects.

Providing a stable revenue stream for the developer makes securing financing for their project easier.

Since introducing the CFD scheme, the UK has seen a significant increase in renewable energy capacity.

Through the CfD scheme, the UK government aims to reduce carbon emissions and promote sustainable development by increasing the share of renewable energy in the country’s fuel mix.

According to the UK government’s Department for Business, Energy & Industrial Strategy (BEIS), the CfD scheme has successfully driven down the cost of renewable energy technologies and increased the deployment of low-carbon electricity generation.

The CfD scheme has helped the UK achieve its legally binding net-zero greenhouse gas emissions target by 2050.

According to a report by the Committee on Climate Change, the CfD scheme played a key role in reducing the cost of offshore wind energy, which is now the cheapest form of new electricity generation in the UK.

This cost reduction has helped to accelerate the deployment of offshore UK wind farms, which is expected to account for a significant share of the UK’s electricity generation in the coming years.

The CfD scheme has played a significant role in driving sustainable development in the UK by promoting low-carbon electricity generation and reducing carbon emissions.

💡Business energy suppliers and commercial gas suppliers are among the biggest investors in new UK renewable electricity generation.

How CfDs support renewable energy development in the UK

CfDs are key to supporting the growth in renewable energy development. They provide a lot of benefits to the generators through the CfD scheme.

The benefits that the CfDs are offering for the generators will help increase renewable energy development and production by offering:

  1. Price stability – CfDs provide long-term revenue certainty, which reduces the risk of revenue fluctuations and helps to attract investment.
  2. Lower financing costs – CfDs reduce the cost of capital for renewable energy projects, making them more financially viable.
  3. Reduced market risk – Renewable energy developers are protected from fluctuations in the market price for electricity, which can be volatile.
  4. Increased investor confidence – The government backing of CfDs provides investors with confidence that the projects will be financially viable.
  5. Increased renewable energy deployment – CfDs help to incentivise the development of new renewable energy projects, which in turn helps to reduce greenhouse gas emissions and tackle climate change.

CfDs are an important policy tool for supporting renewable energy development in the UK, as they provide long-term revenue stability, reduce financing costs, and help to attract investment.

How renewable energy plays a vital role in the UK’s commitment to sustainable development

Renewable energy is a huge part of the UK’s commitment to sustainable development. The key factors renewable energy is responsible for the following factors:

  1. Tackling climate change – Renewable energy sources such as wind, solar, and hydropower produce very low or zero greenhouse gas emissions, making them a key tool in reducing the UK’s carbon footprint and helping to tackle climate change.
  2. Reducing reliance on fossil fuels – By deploying more renewable energy, the UK can reduce its dependence on fossil fuels, which are finite resources and contribute to climate change. As seen in the recent energy crisis, the UK’s reliance on fossil fuels was evident.
  3. Increasing energy security – Renewable energy sources are often domestic and abundant, providing the UK with greater energy security and reducing its reliance on imported fossil fuels.
  4. Creating jobs and economic growth – The renewable energy sector is a growing industry, and investment in renewable energy can create jobs and stimulate economic growth in the UK.
  5. Improving air quality – Fossil fuel combustion is a significant contributor to air pollution, which has negative impacts on human health. By increasing the deployment of renewable energy, the UK can reduce air pollution and improve public health.

The future of renewable energy and CfDs in the UK

The future of CfDs and renewable energy is encouraging. The government recently announced that it would now be looking to run allocation rounds annually instead of the more sporadic 2-year approach they’ve taken recently.

In a press release in 2022, the announcement to increase the allocation was made – as the government made a bold statement of its commitment to accelerating clean energy and accelerating deployment to achieve the acceleration.

This could see 95% of Great Britain’s electricity set to be low carbon by 2030, raising significant energy storage challenges. The shift to renewable energy is expected to significantly impact business electricity prices. Regardless of the scenario, AquaSwitch is here to help with our business energy comparison service.

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