● an overview of consultation responses on the low-carbon generation support mechanism and further work undertaken as a result;
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● the rationale for choosing a FiT CfD as opposed to a PFiT;
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● headline proposals for the design of the FiT CfD (including on reference prices) and on the form of price discovery, highlighting where further work is needed; and
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● our broad approach to wider issues relevant to the FiT CfD.
Rationale for a Feed‑in Tariff with Contracts for Difference
2.3.2 As set out in Section 2.1, without further reform the existing market will not deliver the scale of long-term investment in low-carbon generation, at the pace we need, nor will it give consumers the best deal. If we are to meet our long-term carbon targets, we need to reform the market now.
2.3.3 In the Electricity Market Reform consultation document30, the Government proposed a FiT CfD as the lead option for driving decarbonisation. A PFiT was suggested as a fall back option.
30 http://www.decc.gov.uk/en/content/cms/consultations/emr/emr.aspx
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Box 5: Descriptions of Feed-in Tariff mechanisms
A Feed‑in Tariff with Contract for Difference (FiT CfD) is a long-term contract between an electricity generator and a contract counterparty. The contract enables the generator to stabilise its revenues at a pre-agreed level (the strike price) for the duration of the contract. Under the FiT CfD, payments can flow from the contract counterparty to the generator, and vice versa.
A ‘two-way’ FiT CfD provides for payments to be made to a generator when the market price for its electricity (the reference price) is below the strike price set out in the contract. However, when the reference price is above the strike price, the generator pays back the difference. That is, generators return money to consumers if electricity prices are higher than the agreed tariff.
Figure 4: The operation of a baseload Feed-in Tariff with Contract for Difference
–20
Reference price (e.g. annual average electricity price) FıT CfD top-up Monthly electricity price
Generator topped-up
Figure 5: The operation of an intermittent Feed-in Tariff with Contract for Difference
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£/MWh FiT CfD payment
£/MWh Monthly electricity
Box 5: Descriptions of Feed-inTariff mechanisms (continued) This is similar to the model of FiT used in the Netherlands for renewables (though they call it a ‘sliding premium’) and in Denmark for offshore wind. It provides a similar level of revenue certainty to a Fixed FiT, but by setting the level of support according to the average price it preserves the efficiencies created by the market price signal, i.e. generators will have an incentive to sell their output above the average price because they will keep any upside.
A Premium FiT (PFiT) is a static payment which generators receive in addition to their revenues from selling electricity in the wholesale market.
Figure 6: The operation of a Premium Feed-in Tariff
0 20 40 60 80 100 120 140
Electricity price £/MWh
Monthly electricity price Electricity price plus PFıT
Fixed premium
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11
2.3.4 The Electricity Market Reform consultation document established four criteria against which decarbonisation mechanisms would be judged.
These were cost-effectiveness, coherence with the rest of the reform package, durability and practicality. The FiT CfD was identified as the support mechanism for low-carbon generation which offered the best balance of results across the four key criteria, because it was:
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● potentially more cost-effective than the alternatives due to lower scope for rents in high electricity price scenarios and reduced cost of capital as a result of removing long-term electricity price exposure and providing long-term revenue certainty;
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● complementary to other elements of the reform package, interacting particularly effectively with the Carbon Price Floor (CPF);
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● a more resilient and flexible mechanism which will operate effectively in a wider range of scenarios and can deal with unanticipated
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outcomes on carbon prices, fossil fuel prices or technology costs;
and
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● able to provide more certainty that carbon targets will be met than PFiTs, because the impact of uncertain future wholesale prices is removed in favour of predictable revenue.
2.3.5 Following the consultation, we carried out further analysis to test some of the initial conclusions set out above; and ensure that there could be a manageable transition to the new framework.
2.3.6 In particular, the Government undertook further modelling to understand:
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● the impact FiT CfDs would have on cost of capital for investors in low-carbon generation in more detail;
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● whether we could develop a viable model for the FiT CfD which would work in the UK market; and
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● how to manage the variability of the net costs of FiT CfDs.
If these issues could not be addressed then Government indicated that a PFiT mechanism could be an effective fall-back to drive investment in low-carbon generation.
2.3.7 Support for low-carbon generators under Electricity Market Reform is likely to fall under the definition used by the ONS for indirect taxation and spending. Similar arrangements to those in place to manage the overall impact of DECC levy-funded spending, including the existing RO, would therefore apply. Decisions on the overall size of the envelope for contracts will be taken at fiscal events (Spending Reviews and
Budgets) in order to consider the cost of support in the round against other pressures on Government finances.