Contracts for difference, or to give them their full name FIT CfD (Feed in tariff with contract for difference) are the UK government's proposed mechanism for providing incentives for future investment in low carbon electricity generation.
Why are they important?
FIT CfD is part of the wider proposals
contained within the Electricity Market Reform White paper published in 2011
and further refined in the Draft Energy Bill in 2012. An overhaul of the UK
electricity market is urgently required for several reasons:
- Expected loss of around 25% of UK generating capacity in next ten years as older plants close.
- Commitment to 15% energy from renewables by 2020.
- Legally binding target of 80% reduction in CO2 emissions by 2050.
All this means that the electricity sector must largely decarbonize by 2030, although there has been a subtle change in government rhetoric in this regard where the term 'during' the 2030s has been introduced. In any case, large-scale development of low carbon electricity generation using technologies such as wind, nuclear, CCS (carbon capture and storage) and biomass are required urgently.
What is their aim?
The aim is to provide generators with
confidence that the relatively large investments needed to develop low carbon
technologies will be on a sound financial footing. The CfD involves making a
contract with a supplier that they will receive a fixed price for the
electricity they generate regardless of the market price, thus providing
certainty for the investment and incentives to invest in new technology.
How do they work?
The market electricity price will fluctuate
due to a variety of factors including supply and demand, wholesale fuel prices
and other market conditions. Under a CfD scenario, a contract would be made
with a generator to pay a minimum price per MWh of electricity generated over a
fixed time period, regardless of the market price. This is known as the 'strike
price'. If the market price is below the strike price, the generator would
receive a top-up payment. Conversely, if the market price is above the strike
price, the generator is required to pay back the difference. This is shown
graphically below.
Operation of a CfD - image from DECC
Why this scheme?
According to the UK government's analysis,
the FIT CfD is a more cost-effective support mechanism than other related
schemes such as a so-called premium fit (PFIT) where generators are paid a
fixed to-up above the market price regardless of how high or low the market
price fluctuates.
How will the scheme be implemented?
The details of exactly how the FIT CfD will
operate are hugely complex and indeed this is one criticism that has been
levelled at the proposals. The mechanism will need to be tailored differently to
different technologies, there are uncertainties about how the strike price will
be determined and measures will need to be implemented to prevent manipulation
of the market price. Concerns have also been raised that the mechanism will
unfairly favour nuclear power.
What next?
Despite these concerns, it is apparent that
FIT CfD scheme will be implemented by The UK government in some form and is
likely to the major support mechnaism for future low carbon electricity
generation, replacing the current Renewables Obligation (RO) certification
scheme. The time scales set out in the white paper indicate that the first CfDs
could be in place by early 2014.
More details can be found on the DECC
website.
Image by Finsec
Nicely done - think you've reduced several trees worth of paper to a few succinct paragraphs. Next week capacity payments? Also, its a great review of what's happening but do you have an opinion?
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