Zero-carbon power markets work very differently to those supplied by thermal power plants. While the end-product may remain the same, the operation, regulation, and related legal and contracting arrangements of wholesale markets need to be very different to take into account intermittency and the dramatically higher number of generating assets.
In recognition of this, the UK is undertaking its Review of Electricity Market Arrangements (REMA). This review, launched in July 2022, is intended to explore, among other things, how to decouple the system from gas prices, incentivise consumers to use more of their power when clean energy supply is abundant – and less when it’s not- , and increase the participation of flexible low-carbon technologies, such as batteries.
Kwasi Kwarteng, then Business and Energy Secretary, hailed REMA as “the biggest electricity market shake up in decades”. The government launched a consultation to consider a range of options for reforms covering wholesale markets, the balancing mechanism, ancillary services provision, the Capacity Market and contracts for difference (CfDs).
In March this year, the government released a report summarising the 225 responses it received to its consultation. It plans to undertake a second consultation this year – presumably on as-yet-unannounced concrete proposals – but has not provided a timeline for reform. However, in discussions with industry, the Department for Energy Security & Net Zero has suggested a number “intervention options”.
Some of the headline reforms include: splitting the wholesale market in two, with separate markets for firm and variable power; pricing based on location, replacing a single national power price; and a range of reforms to the UK’s Contracts for Difference (CfD) regime, which supports low-carbon generators.
A number of respondents to the consultation noted the potential of corporate power purchase agreements (PPAs) to provide an alternative to CfDs in underpinning investment in low-cost renewable energy capacity. The government is now considering what it could do to help stimulate the PPA market.
Below, we consider how some of these options could affect the market for corporate clean energy PPAs and give our initial thoughts – always bearing in mind that, for any market reform, the devil will be in the details.
Introducing standardised PPA contracts
For consumers of power, entering into PPAs can be complex and time-consuming. Contracts are typically bespoke, incurring legal costs and taking time to negotiate. By introducing standard PPA contracts, some consultation respondents argued that the government could reduce costs, increase liquidity and encourage the growth of the PPA market.
Our view is that introducing standardised contracts would be far from straightforward without allowing for some flexibility in key commercial terms. We know, from over fifteen years of experience in negotiating CPPAs, that developers and corporates want bespoke terms to address some of the contractual and commercial risks. That said, we do think it is possible to create contractual frameworks and to have standardisation of certain legal clauses across all PPAs. It really comes down to lawyers agreeing to standardised terms but as we know that would reduce the fees they could charge.
Government to provide guidance on striking PPA deals and creating a green power pool
It is unclear what the government is considering here in terms of guidance, or how this proposal would work.
On splitting the wholesale power market to create a green power pool, respondents to the survey warned it would create significant market disruption, and could undermine market confidence. Nonetheless, 47% of respondents supported the suggestions, versus 38% against. Our view is that the market can do this without any government intervention; as we move towards 24/7 clean energy it’s likely that we will see corporates paying a premium for green electrons.
Create a voluntary central contract register
Such a register could provide a means to benchmark transaction pricing which may lower price discovery and transaction costs. However, a lot of the important commercial information in such contracts is confidential, raising questions over whether counterparties would be willing to share useful information. In addition, the unique characteristics of a project and its LCOE mean it is hard to compare project pricing without detailed project information. This proposal is therefore likely to be of limited impact.
Government to underwrite PPA contracts
A big challenge for PPA sellers is that, in long-term PPA contracts, they are exposed to the credit risk of the buyer – and, for any but the largest of corporate buyers, this risk can be considerable.
The idea here is the government provides a ‘credit wrap’, making the seller good in the event of default. Similar schemes are underway in Norway and Spain. The challenge is that it puts the government in a position where civil servants are having to make individual credit decisions on specific corporates. A better option might be to set up, or contract out to, a specialist credit insurer that operates with government support. Nonetheless, we remain concerned that, while such an approach could support the growth of the PPA market, it would socialise risk, and potentially lead to poor decision-making.
Give preference to CfD sellers with merchant PPAs
It is unclear how this proposal would work but, potentially, it could encourage PPA supply by favouring those generators seeking CfDs from the government which have already entered into PPAs for some of their output.
However, we see serious difficulties in designing this, in particular in its interactions with the existing auction process. It would risk creating preserve incentives, for example encouraging bidders to enter into PPAs to deliberately game the process.
Similarly, we are sceptical about the value of allowing private buyers to bid into the government CfD auction. It would add to the risk taken on by the government, which we don’t believe would be worth it for the limited positive impact it would have.
Allow PPA buyers to avoid CfD costs
Every electricity supplier is subject to the Supplier Obligation, a levy that funds payments to CfD generators when wholesale power prices are below CfD strike prices. This spreads the cost of the CfD (which effectively subsidises renewables) across the market in proportion to the power sold.
However, it can be argued that buyers entering into clean energy PPAs with new-to-ground generation are already directly supporting renewables, by helping to increase the volume of renewable energy capacity in the system. We believe they shouldn’t have to pay twice and, as such, Squeaky put forward a proposal that buyers who enter into corporate PPAs be exempted from some CFD costs. If, as is quite possible, this levy rises above £10/MWh, its exemption could make a material difference to the economics of PPAs.
There will be various factors that need to be carefully considered, such as how much of the Supplier Obligation they would be exempted from, how to tackle PPAs entered into with existing (non-additional) generation, etc., but there is clear merit for the government to consult on this.
There are other proposals for which the information provided is, at this point, insufficient to pass initial judgement on, such as proposals for reforms to the Renewable Energy Guarantee of Origin system. Equally, a suggestion that suppliers could be obliged to offer competitive sleeving arrangements, helping to bring down the cost of credit risk management, has potential, but needs more consideration – this is an issue we will return to in a future blog.
Overall, we are encouraged to see the government engaging seriously with promoting the PPA market. We believe it will need to play an important role in supporting the necessary growth of the UK’s renewables sector – the CfD alone simply cannot do all the heavy lifting needed. But any reforms will have to be carefully considered and, to the degree possible, should allow the market to operate as efficiently as possible.