1. This section sets out emerging thinking on CfD length, that is, the length of the CfD from the payment start date as defined in section C. In principle, the Government is minded to select CfD lengths that strike an acceptable balance between minimising the overall costs on consumers; ensuring that the CfD scheme is affordable; and facilitating low costs of capital.
2. Analysis is currently being done on CfD lengths for different types of low-carbon generation, focussing in particular on the impact of different CfD lengths on:
electricity consumers, in terms of the net present value of support provided over the lifetime of the CfD;
the affordability of the CfD scheme; and
investor financing costs, including the availability of debt financing for project financed independent generation.
3. The analysis has included modelling the project cashflows for a range of projects to examine the interactions between strike prices and support costs for different CfD lengths. To inform this modelling, information has been drawn from published sources, including cost assumptions from reports prepared by ARUP21 and Parsons Brinkerhoff22 for DECC, confidential evidence collected as part of the Renewables Obligation Banding Review Consultation, and discussions with a range of stakeholders, debt financiers and equity investors. Key assumptions underpinning the modelling include:
that project finance rather than on balance sheet financing is used;
that project finance debt providers will require debt to be repaid within the shorter of the CfD life or the Power Purchase Agreement (less a ‘tail’ of 1-2 years) or 15 years;
projects could secure debt financing as long as minimum cover ratios are met (subject to caps on maximum allowed gearing); and
that the CfD has a fixed index-linked strike price for its entire life.
4. The following factors are central to the analysis and initial conclusions:
Investors discount future costs and returns at a higher rate than Government’s social discount rate. Other things being equal, this points towards shorter CfDs as the cost to consumers of future payments is higher than the benefit to developers.
21 Review of the generation costs and deployment potential of renewable electricity technologies in the UK, ARUP, October 2011 http://www.decc.gov.uk/assets/decc/11/consultation/ro-banding/3237-cons-ro-banding-arup-report.pdf
22 Electricity Generation Cost Model – 2011 Update Revision 1, Parsons Brinkerhoff, August 2011 http://www.decc.gov.uk/assets/decc/11/about-us/economics-social-research/2127-electricity-generation-cost-model-2011.pdf
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5. For renewable technologies, the initial analysis points to a CfD length of 15 years.
A CfD length of 15 years appears to represent an effective balance between enabling a range of projects to secure debt finance and achieve required returns to equity, and minimising the costs of consumer support.
6. Figures 12 and 13 below show the relationship between the strike price and support costs for intermittent CfD lengths of 12, 15, 18 and 20 years23 (onshore and offshore wind are shown). As the length of the CfD increases from 12 to 20 years, the size of the support provided by the CfD increases – while strike prices are lower this is outweighed by the longer length of support provided. The modelling indicates that a CfD length of 12 years may in fact be optimal in terms of lowest overall support costs, but Government is mindful of investor concerns that this may impact on the cost or availability of debt finance for some renewables projects with different risk profiles (for example, some offshore wind projects). A 15 year CfD length appears to represent an effective balance.
Discussions with stakeholders on this will continue.
Figures 12 and 13: Relationship between strike prices and NPV, onshore and
Relationship between strike prices and NPV, onshore wind
% change strike prices % change NPV
Relationship between strike prices and NPV, offshore wind
% change strike prices % change NPV
7. Figures 14 and 15 below show broadly similar results for dedicated biomass and for biomass conversion, although for the latter decisions on CfD length will also be affected by the maximum operational life of the converted plant.
23 The following simplifying assumptions have been made: that required debt returns are fixed as long as minimum cover ratios are met, and that equity investors’ hurdle rates do not vary with
gearing/variability of prospective equity returns.
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Relationship between strike prices and NPV, dedicated biomass
% change NPV
Relationship between strike prices and NPV, biomass conversion
% change strike prices % change NPV
Similar analysis for other renewable technologies (including for example wave and tidal) has not yet been carried out.
8. The Government has yet to form a firm view on the optimal CfD length for nuclear plants, but in principle would expect a CfD length of no less than 15 years. In part due to the possible scale of these investments and the potential operational life of the plant, the Government considers that it is prudent to form a view following the Financial Investment Decision Enabling process. This may include a decision as to whether to establish a standard CfD length for nuclear as a technology, or alternatively vary CfD length by project.
9. In relation to early stage CCS projects, it may be appropriate to allow for different CfD lengths for different projects, for example distinguishing between a retrofit to an existing plant and a new build thermal plant with CCS. In addition, the terms on which such projects are likely to be financed will become clearer as the CCS Commercialisation Programme competition progresses and this will inform the Government’s view on CfD length. Subject to the outcome of the competition, the initial view is that CfD length for projects supported under the Commercialisation Programme should be 10 years.
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