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UTILITY Week 21st March 2014

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UtILItY WEEK | 21st - 27th March 2014 | 19 Finance & Investment Market view A central pillar of Electricity Market Reform is the contract for difference (CfD), which will form the basis of support to renewable generators and will ensure they receive a stable income over a defined period of time. Unlike the contracts for difference of the Pool days, CfDs do not make any provision for the delivery of power, but, crucially a generator must generate power to receive CfD payments, because they are made against megawatt-hours produced. In recent years there has been a general deterioration in the availability of power purchase agreements (PPAs), particularly for smaller renewable generators, leading to concerns that PPAs may simply cease to be available if things continue as they are. Per- haps surprisingly, the Department of Climate Change (Decc) seems to be of the view that renewable projects with a CfD should be pro- ject financeable without any long-term PPA in place. This is arguably a rather narrow approach because it ignores two of the more significant risks facing generators, namely the risk of not being despatched (and therefore not get- ting any CfD payment) and the risk associ- ated with imbalance, which is not dealt with under the CfD but will need to be managed for or by the generator, just as it needs to be managed now. Following a call for evidence and the commissioning of further analysis on the issue, Decc has now issued a consultation on the implementation of a scheme to pro- vide an oaker of last resort as a means of ensuring that generators will always have access to a PPA to sit alongside their CfD. The oaker of last resort process will ensure that there is always a PPA available for renew- able projects (referred to as a backstop PPA), albeit that the price for electricity under the backstop PPA will be at a significant dis- count to market. The proposal is that all licensed suppli- ers with a market share exceeding a certain threshold level will be obliged to make com- petitive bids for backstop PPAs under which they will offer a price to manage the output of renewable projects. There will also be a possibility for voluntary participation by suppliers who are below the threshold. Sup- pliers will have to meet a creditworthiness test or supply a letter of credit to support their obligations. All renewable genera- tors will be eligible for a backstop PPA, and terms will be grandfathered from the date on which the generator's CfD is granted. It is proposed that a generator can access a backstop PPA at any time during the life of its CfD, although the first backstop PPAs are unlikely to be available before early 2016. Each backstop PPA will have a term of one year, and generators would have a right to terminate on six weeks' notice aer six months. The terms will be set, with no opportunity for negotiation, and the stated aim is that from initial request by a generator to signature, the process will take no more than six weeks. A generator that has previ- ously defaulted under a backstop PPA will not be eligible to enter into any subsequent backstop PPA. The costs and benefits to suppliers of entering into a backstop PPA will be levelised across all licensed suppliers, on a quarterly basis, by volume supplied. The frequency of levelisation will be reviewed annually in order to ensure that the cumulative costs on suppliers do not become overly burdensome. A mutualisation process is also envisaged to guard against any shortfall in the levelisa- tion fund due to supplier default. This pro- cess of levelisation and mutualisation is seen as being the means to keep suppliers' bids low, because any supplier bidding a high fee would effectively be providing money to its competitor suppliers once the levelisation process is factored in. The power price paid under a backstop PPA is designed to be subject to a significant discount to the price available in the market, to reflect the fact that the backstop PPA is designed to be just that, a backstop. The pro- posal is that the power price discount will be fixed at £25/MWh), indexed to CPI (the same indexation as is applied in the CfD). This is proposed as a better alternative than a per- centage discount to the market price. As to the terms of the backstop PPA, the strong preference in the consultation paper is for a single set of terms and conditions which will not be negotiated. The CfD Market Readiness Working Groups have been look- ing at PPA issues and have been examining how existing market PPA terms will need to change both to reflect the difference between the CfD regime and the Renewables Obliga- tion and the fact that backstop PPAs will be regulated rather than commercial contracts. The Index price – against which the fixed discount will be applied – will be the refer- ence price under the CfD. Given the fixed discount, there is clearly a potential for the price under the PPA to fall to, or below, zero. There is therefore specific reference to cur- tailment provisions in the consultation, with the possibility for the generator to curtail when it is no longer economic to generate (a function of price and the generator's short run marginal costs, which will be notified to the oake in advance). In addition, it is proposed that the oaker should be able to curtail the generator on condition that the generator is suitably compensated. This will allow the oaker to participate in the bal- ancing or intra-day market, thereby ensuring that the generating asset continues to play a "normal" role in the market. Generally, the consultation is a welcome addition to the CfD process, because it will ensure that renewable generators have a route to market in all circumstances. Market opinion is, however, divided as to whether the proposals will result in the PPA market improving, or there being a race to the bot- tom as far as prices are concerned. The consultation closes on 24 March 2014. Lis Blunsdon, counsel, Hogan Lovells Offtaker of last resort To ensure generators always have a purchaser for their output, Decc has proposed an offtaker of last resort to sit alongside CfDs. Lis Blunsdon explains how it will work. backstop ppa £25/MWh Proposed discount to the market price that generators will be able to receive from the offtaker of last resort. Suppliers will bid to be the offtaker and the costs and benefits will be levelised among all suppliers.

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