Unlocking routes to market

On 19 January 2022, a webinar hosted by Cornwall Insight in partnership with the law firm Weightmans focused on routes to market for renewable projects that may not secure a contract during the fourth allocation round of the ‘Contracts for Difference’ (CfD) auction, which opened in December 2021. In the absence of the revenue certainty provided by a contract with a credit-worthy counterparty such as the government, developers have to find alternative business models to mitigate uncertainty, such as utility power purchase agreements (PPAs) and corporate PPAs, accepting various degrees of merchant risk. Our event considered the options available for developers and investors, based on asset type, connection and potential revenue streams. The recording is available here.

Panellists:

  • Gayatri Desai, Managing Director, Energy Transition, Canadian Imperial Bank of Commerce
  • Tim Dixon, Lead Analyst – Assets and Infrastructure, Cornwall Insight
  • Nick Fothergill, Partner, Weightmans
  • Levent Gürdenli, Partner, Weightmans
  • Marek Kubik, Managing Director, Fluence
  • Dan Atzori, Research Partner, Cornwall Insight (chair)

A significant pipeline

Contracts for Difference Allocation Round 4 (CfD AR4) has officially opened with the final budget set at £275mn in 2011/12 money, split across three technology pots, as shown in Figure 1. This is a large auction, with government loosely aiming to procure around 12GW of capacity, and it is expected to be highly competitive. While it is open to established and non-established technologies, offshore wind is set to dominate.

“It’s good to see solar and wind coming back into the auction process. There is a strong case to say that the pot should be bigger for mainstream generation technologies and the cap higher. More room needs to be made for them as they are going to carry a lot of the burden of the shift to further renewables. To hit the climate change targets we’re going to need more solar and onshore wind,” said Nick Fothergill, Partner at Weightmans.  

Figure 1: Contracts for Difference, Allocation Round 4 (CfD AR4)

PotTechnologyBudget
Pot oneOnshore Wind (>5MW), Solar PV (>5MW), Energy from Waste with CHP, Hydro (>5MW and <50MW), Landfill Gas and Sewage Gas£10mn. 5GW capacity cap, with 3.5GW maxima for both Onshore Wind and Solar PV
Pot twoACT, AD (>5MW), Dedicated Biomass with CHP, Floating Offshore Wind, Geothermal, Remote Island Wind (>5MW), Tidal Stream and Wave75mn, including a minimum of £24mn for Floating Offshore Wind and £20mn for Tidal Stream technologies
Pot threeOffshore wind£200mn

Source: Cornwall Insight

Meanwhile, the overall pipeline of renewables is very large. According to Cornwall Insight’s Renewables Pipeline Tracker, there is currently a total viable pipeline of 137.8GW. All projects are at various stages of development, but the majority is pre-construction and without a route to market, as they do not have a CfD or a PPA, and have not secured finance.

The pipeline capacity is dominated by four technologies: offshore wind, onshore wind (excluding remote island wind), solar PV and batteries (predominantly lithium-ion). These four technologies account for 85% of all sites, and 93% of capacity amounting to 127.7GW. Growth technologies have been offshore wind and battery, with the majority of onshore wind sites having planning approved pre-2018.

Except for battery storage, which will instead be eyeing up the upcoming Capacity Market auction, these technologies are all eligible to compete in AR4. However, capacity far outstrips the budgets and capacity caps set by BEIS.

Exploring alternative routes to market

Since CfD AR4 will be oversubscribed and much of the capacity will not procure a CfD or deem it too competitive to enter, many assets will be seeking alternative routes to market. Beyond CfD AR4, there is uncertainty on the future frequency of CfD auctions or the technologies that will be included are uncertain. This furthers the case for developers to look at other routes to market in the future, such as third party PPAs, CPPAs, private wire or optimisation agreements.

Without securing a CfD and without a large customer to sell to or a willingness to self-trade (which brings its own risks), then some form of PPA will be generally required. Options being explored include utility PPA (directly with suppliers), CPPA (with end users), private wire (also with end user) and optimisation agreement in the case of a battery or a flexibility asset. Within these, there are lots of considerations and options to choose from to support an asset to come to market, including length, fix, floors, revenue shares for optimisation, and structure for CPPAs.

PPAs, and particularly CPPAs, are increasingly fundamental as a route to market for supporting the build out of new build renewable assets, especially as we no longer have Renewable Obligation Certificates (ROCs) and Feed-in-Tariffs (FiTs). Since this auction is very likely to be highly competitive, a CPPA could allow a generator to end up with a better price than through the auction process.

Sleeved PPAs have been predominant, but now there are an increasing number of virtual or synthetic PPAs. Since they are easier to transact with different counterparties, they are well understood, and potentially better for disaggregated demand.

Unlocking corporate demand

There is still a knowledge gap among certain corporates. PPAs are a fundamentally different way of buying power, and it needs to be understood what the main risks and challenges around that are.

Aggregating demand will be critical for unlocking the market for small or medium enterprises, especially if technology can be used to implement or automate the process.

“For medium enterprises, aggregation is one model that we could explore further. Standardisation will be important as well as it can take a long time to transact one of these deals. The ability to offer and provide products which aren’t 15 to 20 years long will be paramount,” said Levent Gürdenli, Partner at Weightmans.

What is more, the basket PPA deals are sometimes being looked at. The anchor corporate – having one key corporate with a strong credit rating can bring other corporates into these deals.

“Generators are exploring hedging their power across a number of routes to market — part CfD, part merchant, part CPPA — and by doing that and diversifying it reduces some of the stringent credit requirements of the counterparties that are there for some of that,” said Tim Dixon, Lead Analyst Assets and Infrastructure at Cornwall Insight.

However, the credit worthiness of the counterpart does affect the bankability of a project. Even with relatively secure counterparties, the PPA will typically require independent security or financial stress tests which is an important consideration for generators and their funders. Potential liabilities, especially in an early termination scenario are quite significant.

There is potential for storage to help smooth out generation profiles which can help with unlocking PPAs for corporate offtakers. What is more, insurers are increasingly moving more into this space, taking on the risk of performance and volume of the project, and settling against a proxy generation.

Route to market options for storage projects

Routes to market agreements or optimisation agreements are increasingly offered by major suppliers, combining a number of revenue-generating options within a single agreement and with a single counterparty. These agreements go beyond a traditional PPA and can include access to the forward power market, Balancing Market (BM), ancillary services markets and minimum revenue guarantees.

More of these routes to market optimisation agreements are set to be used going forward, offering generators the benefit of transacting with a single counterparty, but having the potential to maximise or optimise their revenues along with access to multiple revenue streams. This represents an advantage for generators when trying to secure debt funding.

There are more well-trodden routes into the capacity market, BM and ancillary services markets. Competition among assets is strong in these markets and prices are affected accordingly, as the frequency response market is becoming increasingly saturated.

Battery storage has some cause for optimism as the growth in intermittent renewable power creates some inevitable need for storage assets. Co-located energy assets have seen a growth in importance in the energy mix, and batteries can now compete in the BM.

“We’re beginning to see some large scale and long duration projects coming to market, and some innovative debt financing to help them develop. Co-location of battery storage, particularly by a developer with a strong track record, is likely to be attractive to investors,” said Nick Fothergill, Partner at Weightmans.

Co-location has advantages of being compatible with existing subsidy regimes and can benefit from under-used grid connections, shared grid connection costs with other assets as well as there being minimal competition with the other co-located assets.

Large scale and long-duration electricity storage assets, which can balance the grid over long periods of time, are coming, and will be needed in conjunction with the rise in intermittency. Given that renewable generation must inevitably increase if climate targets are to be met, more routes to market will inevitably have to be found.

Looking forward

Hybrid approaches are set to become more frequent. Some projects may not need a full 15-20 year CPPA to get them over the line, so we will see more shorter term PPAs being entered into. This could help with corporate offtakers and then asset owners relying on merchant risk models for the tail end of a project life.

There are now innovative structures in terms of pricing or volume arrangements, such as floating prices with floors or more volume or profile fixing, particularly with solar generation.

Interestingly, blockchain technology has been used for the first time in this space, where a PPA was entered into for all demand which was matched with renewable generation on a real-time basis.

Weightmans Energy & Utilities team provide dedicated support to clients in the energy, water, waste and resources industries.

Our experts work closely with organisations involved in the energy sector, including large utilities, project developers, funders, new energy services companies, local authorities, waste companies and major energy consumers, providing commercially focused legal advice to help them benefit from the opportunities created by energy market regulation, policy and market drivers.

Visit us to learn more about our key focus areas.

Related thinking

Commercial and market outlook

Cornwall Insight responds to the announcement of an Energy Bill in the Queen’s Speech

The Queen’s Speech this week included a much-anticipated announcement that an Energy Bill will be introduced at some point over the next parliamentary session. The Bill is a logical conclusion of policy development in the period since the net zero commitment was made in the summer of 2019. It accommodates...

Business supply and services

Re-balancing the balancing costs –BSUoS charges to be levied solely on suppliers from April 2023

Balancing the electricity system costs money. National Grid in its role as Electricity System Operator (ESO) takes actions in every half hour to achieve the remarkable feat of keeping supply and demand finely balanced on our national electricity system – maintaining a system which runs between 49.8 and 50.2Hz with...

Low carbon generation

Reform in haste, repent at leisure: squaring electricity market reform with investor confidence

The review of electricity market arrangements (REMA) signalled by the energy security strategy could impact wholesale & balancing markets, & there could be a need to examine the capacity market rules & CFD contracts. It is too early to know what options will ultimately be adopted or when changes would...

Commercial and market outlook

Cornwall Insight responds to the publication of the energy strategy  

The Energy Security Strategy is a very political document that raises as many questions as it answers. There are clear favourites and as much can be read in to what is in the Strategy as what is not. 15 months on from the Powering Our Net Zero Future White Paper,...

Low carbon generation

Are renewables the answer to Ireland’s energy crisis?

The current crisis in the energy markets may seem like it’s all doom and gloom, every week another electricity or gas supplier announces a price hike with the consumer powerless, at the whim of the global commodity prices. However, offshore wind presents a unique opportunity for Ireland, to both decarbonise...

Commercial and market outlook

Perspective | Is the design of the electricity market costing consumers money?

This article is from our Energy Spectrum publication which was published on 4 March 2022. It has become increasingly clear the existing market design is unfit for either a future net zero world or a period of fossil fuel price crisis, but what market design might be best for our...

Low carbon generation

What to look out for in Third Party Charges in 2022-23

In recent months, the GB energy market has been exposed to extreme volatility as wholesale prices have grown rapidly, leading to a significant number of supplier exits and questions over consumer affordability of energy bills. This has resulted in notable movement across a number of non-commodity costs (also known as...

Low carbon generation

Government opens consultation on Maritime Area Consent for ORE

On 19 January, the Minister for the Environment, Climate and Communications, Eamon Ryan TD launched a consultation on important aspects of the new Maritime Area Consent (MAC) State consent regime for offshore renewable energy (ORE). This follows the publication of the full text of the Maritime Area Planning (MAP) Act...