A ‘backstop offtaker’ is needed to help independent generators

Decc’s “backstop offtaker” is critical in providing market options for independent generators, and it should be available from mid-2014, argues Nigel Cornwall

Independent players are key to helping deliver the three key energy policy objectives of sustainability, security of supply, and affordability.

Non-big six players already have an established record of investing in both low-carbon and conventional generation, and over half of the UK’s renewables capacity is already owned by them. The development of emerging renewables technologies, including offshore wind, is also to a large extent being driven by independent companies. Many marine projects — both wave and tidal — are being pioneered by smaller companies too, albeit with big six backing in some instances.

This is a particularly important development as the cost of these technologies, and therefore affordability, will only be driven down through increased deployment from a wide range of developers.

Despite this progress, the market continues to present significant challenges for independents. In particular, the Department of Energy and Climate Change (Decc) has noted issues with the power purchase agreement (PPA) market, with many generators claiming there has been a decline in bankable offers. Consultant Baringa recently published a review of the offtake market and highlighted several drivers for worsening terms and reduced competition, including the increased ability of the big six to meet their Renewables Obligation commitments through their own projects and existing PPAs.

Notwithstanding its confidence that these issues will be mitigated by the implementation of the contracts for difference (CfD) feed-in tariff regime, Decc now accepts that there are issues with accessing the offtake market.

It has taken steps towards easing the transition to the new arrangements through market readiness working groups, within which industry members are helping to establish sample PPAs that provide the basis for commercial negotiations on a more level playing field. But a further proposal offers much more potential, if implemented correctly: this is the “backstop offtaker”, which would provide a fall-back for projects unable to obtain a minimum level of terms in a PPA.

This would place an obligation on larger suppliers to enter into a PPA with any eligible generator, where the generator cannot secure appropriate terms from the market. This mechanism could lead to an effective floor price being guaranteed for projects, and subject to getting the lenders on-side could remove the need to sign a long-term PPA.

This move would represent an important shift in the market. At present, lenders require a long-term purchase commitment from a credit-worthy entity. This combination of duration and credit limits the market to a small group of investment grade players. And because the contracts look typically over 10 to 15 years, they must per force factor in a long-term view of balancing risk, which are invariably unfavourable to the generator.

By contrast, discounts against market value in short-term PPAs are generally much lower, owing to reduced risks. We have observed a similar market development in small-scale feed-in tariffs (FiTs), where, supported by guaranteed production rates, many projects have opted out of the guaranteed export rate to instead sell their output to the market in short-term deals at higher values.

Linked to this, the backstop offtaker proposals could also lead to the introduction of new green electricity markets.

While the government has refused to include these within its policy proposals under EMR, this does not mean the industry cannot bring these forward independently. And we think the backstop offtaker proposals, provided they are implemented in parallel with CfDs, will enable this.

Again, by providing a floor price, many renewables generators will be able to sell their power through short-term auctions similar to the already function- ing Non-Fossil Purchasing Agency (NFPA) e-Power platform, and receive considerably closer to market values than otherwise would be possible.

National Grid noted in its EMR Analytical Report annexes that projects are estimated to see between 5% and 13% discounts in PPAs under both the RO and CfD, but with average discounts around 10%, in a market dominated by a handful of suppliers with considerable market share. By contrast we recently published analysis of the July 2013 NFPA e-Power auction, which showed average discounts of just 2% with 17 participating suppliers.

To counteract the increased complexity in market access under CfDs, it is critical that the backstop offtaker proposal is finalised and implemented. It also needs to be available from mid-2014 when the initial CfDs are set to be available, and not a later date as Decc presently seems to envisage.

Such a move will provide more market options to independent generators (including community energy schemes), and bring in more natural counterparties into the market through short-term trading, which in turn will stimulate new aggregators.

Nigel Cornwall is managing director of Cornwall Energy.

For a more detailed discussion of this issue see the Cornwall Energy website, www.cornwallenergy.com

 

From New Power, October 2013.

Also in this issue:

Cash-out reform; PV’s boom and bust; triad costs under the microscope; are we close to the end game on EMR?

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