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In theory, auctions incentivise projects to reveal their true costs. If the budget or pot was exceeded, DECC held an auction for the relevant criteria of the CfD mechanism (either a minimum or a maximum). For each commissioning year, DECC ranked the bids from lowest to highest if the combined value of all applications within a commissioning year did not exceed the relevant budget or pot, all applications were approved at the ASP (see Figure 2). Prospective generators were invited to submit a sealed bid for the strike price they would be willing to accept in order to operate their generation unit, up to the ASP published by DECC. Funding in the first allocation round was divided into three pots: pot 1 for established technologies, such as solar and onshore wind pot 2 for less established technologies such as offshore wind and pot 3 for biomass projects. The budget was also allocated across different pots, with minimum and maximum budgets set according to technology type. The first CfD auction consisted of a basic sealed-bid auction format, with modifications that allowed for flexible bids. An auction allocation mechanism allows DECC to determine the true cost of establishing renewable generation from various prospective projects, and to approve the most efficient of these. As a result, DECC’s published administrative strike prices (ASPs) may offer the early CfD generators a higher rate of return than they would have otherwise needed to proceed with deployment.
Strike price generator#
In the case of early CfD allocation, DECC has less information than the generator about the latter’s true cost and required return from building and operating a wind farm, and therefore cannot accurately determine the strike price that is necessary to bring forward the investment (i.e. The NAO’s concerns relate to the expected difference in prices achieved in a non-competitive, as opposed to a competitive, allocation mechanism. While the European Commission has stated that it does not intend to raise objections to the early CfDs for the five wind projects, it has yet to decide on the compatibility of the proposed CfDs with two biomass conversion projects (Drax and Lynemouth). The early allocation of CfDs also raised concerns that state aid approval might not be granted to the projects in question in the absence of a competitive allocation process. The NAO considered that DECC might have ‘provide higher returns than needed to secure the investment’. This non-competitive CfD allocation was subsequently criticised by the National Audit Office (NAO) for allocating £16.6bn, or around 58% of the funds available through the Levy Control Framework, for renewable generation CfDs, thereby potentially crowding out other projects that could have been procured more efficiently at a later date. In April 2014, the Department of Energy & Climate Change (DECC) approved eight projects (five wind farms and three biomass-related projects) for early CfD contracts. This is shown in Figure 1.Īlthough CfDs were intended to be allocated through auctions in the early stages of the EMR, there were concerns that this could not be achieved quickly enough to prevent an ‘investment hiatus’. When the reference electricity price, which is based on the market price, is above the contracted strike price, a payment is made by the generator to the LCCC for the surplus revenue when the wholesale electricity price is below the contracted strike price, a payment is made by the LCCC to the generator for the shortfall. The LCCC is a government-owned company that was established to manage CfD contracts and the resulting difference payments that would be funded by charges levied on electricity suppliers.
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As the government planned to transition away from the existing Renewables Obligation (RO), the aim was to set the strike prices in a manner that would allow the median project within the group of potential projects for a given technology to achieve equivalent returns (accounting for differences in risk) under both the RO and the CfD. It consists of a private law contract between a low-carbon generator and a counterparty, the Low Carbon Contracts Company (LCCC), which stipulates that the generator will provide electricity at a pre-determined ‘strike price’.