UK considers reform of renewables subsidy regimes

A conference has been held in the UK to consider whether the nation's two electricity subsidy mechanisms – the capacity market and the contracts for difference (CFD) regime – need to be reformed, and how.

With the government reportedly planning a wave of wind farms and nuclear facilities to shore up UK energy independence in the wake of Russia's invasion of Ukraine – and with lobbying from some quarters to relax a national ban on fracking, and attempts to persuade Middle Eastern OPEC nations to ramp up oil output – attendees at the London event agreed huge volumes of low-carbon electricity will be needed for the country to achieve a net zero economy by 2050.

As part of that national goal, the UK government wants carbon neutral electricity by 2035 although left-of-center national newspaper The Guardian yesterday reported prime minister Boris Johnson is preparing to bring that date forward.

Contracts for difference

David Newberry, Cambridge University, speaking at the electricity subsidy event organized by the Westminster Energy, Environment and Transport Forum at the end of February, said the UK would need to double its current renewable energy generation capacity this decade.

Reducing the cost of finance would help attract investors to renewables projects, he said, and he suggested the CFD rules – which allocate permits for clean power plants using an auction bidding mechanism to determine the level of subsidy for the power generated – should be tweaked to reflect the locations of solar, wind, and other clean power plants.

That is because, Newberry argued, renewable energy project revenues vary more due to site location than to the times when generation takes place.

Other energy industry stakeholders questioned the form of the CFD rules, albeit on issues which reflected their interests. Under the CFD regime, renewable energy generators bid a maximum tariff “strike price” to be received from the government. Generators receive the strike price minus the day-ahead hourly wholesale price of electricity as a bonus on top of any payments they receive separately from the commercial sale of the power they generate. When the day-ahead wholesale rate is higher than the strike price set at auction, generators sell the power and refund the difference to the government, reducing the burden on public finances.

Barnaby Wharton, head of policy at clean energy umbrella organization RenewableUK, said the CFD rules are “a hugely successful policy, driving cost reduction in offshore wind and delivering benefits to electricity consumers.”

The government in December launched a fourth CFD auction, three years after the last clean energy procurement round, and has pledged to stage the events annually from next March.

Whitehall is pushing for more offshore wind farms as they are seen as more socially acceptable than onshore clean power sites but Wharton said the aim of CFD auctions should be the national net zero target rather than delivering specific renewables technology.

The RenewableUK representative suggested it is time to seek a market-based system to drive renewables deployment, rather than relying on government contracting, because the CFD regime “won’t be with us forever.” Wharton said it is time to consider a net zero marginal price system to support renewables.

The prospect of such radical change to the subsidy regime prompted reactions from representatives of two utilities at the event.

Kate Turner is policy and regulation director at Scottish Power, which recently switched to a renewables-only portfolio for the electricity the company generates. She said the utility would like “to see clear parameters set for the newly announced, annual CFD auctions.”

David Bird, investment director at Octopus Energy, argued CFDs provide price certainty and have a place, at least for now, although he did ask “what the CFDs should do and for how long?”

Bird hinted CFDs provide price stability to technologies that are already cost competitive and for that reason he called for a new system that “combines the wholesale market, the balancing and other markets to work together for a fully decarbonized power sector by 2035.” An innovative system of that nature would include a greater role for managing energy demand and grid flexibility, Bird added, mentioning two functions Octopus has a strong focus on.

Capacity market

Another regime which came under the spotlight at the Westminster event was the UK capacity market, which pays generators to have sufficient extra power generation capacity on hand which can be ramped up rapidly to meet grid stress events.

Kathryn Bird, head of the capacity market policy, electricity security and market evolution team at the UK government's Department for Business, Energy and Industrial Strategy (BEIS), told the event her team works to address challenges related to the capacity market. That work, Bird said, is based on a call for feedback on the capacity market mechanism, held by BEIS from July to November.

That call for evidence aimed to address the mechanism’s future design and a summary of the responses received will be published this spring, with further stakeholder engagement to be sought immediately afterwards, the aim being to consult on any reform options which could be proposed.

Questions under consideration by BEIS as part of the exercise include how to align the capacity market with net zero targets; whether the auction design needs to change, perhaps by having different categories of auctions with multiple clearing prices; how to manage the transition from unabated to abated fossil fuel plants; and whether there is a need for a new support mechanism or a redesign of the existing systems to address technologies such as hydrogen or other projects with long build times.

While attendees at the Westminster event said they were broadly supportive of reform to the capacity market, many emphasized the risk of ending up with an overly complicated system that could hinder progress.

The need for flexibility

The elephant in the room, as always when renewables are under discussion, was the need for flexibility in the electricity grid, with Keith Bell, of Scotland's University of Strathclyde, stressing the need for flexible measures such as energy storage, demand-side response, and electric grid interconnectors, to fill the gaps at periods when no solar or wind power is being generated.

Bell said the option of using electric vehicle (EV) batteries for grid storage was interesting but stressed the power rate is crucial for the operation of batteries. On the subject of such vehicle-to-grid deployment, Bell asked what would EV energy storage capacity be used for? When would it be available? And at what times would EV batteries be plugged in?

The University of Strathclyde academic added, the different stages of market maturity for competing energy storage technologies would be reflected in a range of costs that would have to be taken into account in a revised capacity market system.

Batteries and demand-side response projects are eligible for inclusion under the current capacity market rules but the devil is in the detail and the de-rating factor applied to shorter-duration batteries – which means less revenue because they supply a shorter solution to keeping the lights on – often rules out energy storage sites from viable operation under the grid-back-up subsidy regime. Even those battery facilities which secure capacity market payments often need other sources of income.

The switch from electricity settlement prices based on historical customer consumption patterns to real-time prices set every half hour is expected to do much to boost the demand for network flexibility services, but that change is not due to take place market wide in the UK until October 2025.

The lack of any solar industry representatives at the Westminster event reflected how little the sector has turned to either CFDs or the capacity market for support in the UK.

Solar returned to the fold in the current CFD auction round, after being banned from the exercises since 2015, but only to the extent it will compete with onshore wind facilities for a £10 million (€11.9 million) slice of the total £285 million (€340 million) pot.

The very low derating score applied to solar projects in the capacity market – because of the tech's rigidly time-sensitive hours of generation – has ensured it is not a viable route for remuneration. The answer to that conundrum could lie in the development of solar farms which include grid flexibility technology.

This copy was amended on 15/03/22 to reflect David Newberry did not call for CFD rules to incentivize renewables facilities near centers of energy demand, he instead pointed out the business case for such plants differed according to location and the CFD regime should reflect that. The previous statement that Octopus Energy benefits from CFD payments was incorrect and has been removed.