Conclusions and recommendations
1. In April 2014, the Department announced the
award of contracts to eight renewable electricity projects under
an early version of the new 'Contracts for Difference' scheme.
Under the new scheme the Department fixes the price which renewable
electricity generators can receive for each unit of electricity
they produce (known as the 'strike price'). A newly formed 'Counterparty
Body' will pay generators the difference between the market price
and the strike price for the electricity they generate, where
the strike price is higher. If the market price is higher than
the strike price, generators will pay the difference to the Counterparty
Body. The Counterparty recoups its costs from energy suppliers
who in turn may pass on the cost to consumers, so the consumer
picks up the bill. This scheme is replacing one which requires
electricity suppliers to pay for Renewables Obligation Certificates
which give renewable generators a premium over the wholesale price
for each unit of electricity they supply, as the government's
main method for supporting new renewable electricity generation.
The Department awarded these eight early contracts to reduce the
risk of a delay in investment in renewable electricity projects
during the transition to the new scheme. Two of the contracts
are for power plants converted from burning coal to biomass, five
are for offshore wind farms and one is for a purpose built biomass
plant providing heat as well as power.
2. We are not satisfied that sufficient consideration
was given to securing value for consumers during the transition
from the existing arrangements to the new scheme. To avoid
a gap in investment during the transition from the Renewables
Obligation scheme to the Contracts for Difference scheme, the
Department decided to offer early contracts without price competition.
The Department argued that the early contracts were necessary
to ensure continued investment and that they provided better value.
But its quantified economic case shows no clear net benefit from
awarding early contracts compared to allowing competition when
the main scheme comes into force in December 2014. It is not clear
that choosing to award so many early contracts was the best way
to secure value for consumers. As the Department recognises, competition
under the main Contracts for Difference regime may well secure
better prices and less cost to consumers than those set administratively
under the transitional arrangements.
Recommendation: Before embarking on future
major reforms, the Department should consider fully its options
for managing the process of transition, weighing up the impact
on value for money of different types of transitional arrangements
with different scales and durations.
3. Most of the budget available for contracts
to be awarded under the new arrangements through price competition
has already been spent on the early contracts awarded without
price competition. The Department has awarded 58% of its budget
for renewable electricity projects from 2015-16 to 2020-21 on
the eight early contracts agreed under transitional arrangements
designed to prevent a gap in investment in renewable electricity
generation. The Department maintains that these transitional arrangements
have encouraged project developers to progress their projects
and build supply chains to a point where the market may be ready
for price competition under the main Contracts for Difference
scheme. But we are concerned that the Department has awarded 58%
of the available budget to achieve this effect and that little
now remains for the main competitive regime.
Recommendation: The Department must now
seek to award the remaining funds using price competition.
4. The Department had no detailed knowledge
and understanding of the developers' costs and estimates. They
were too ready to accept arguments put forward by project developers
that consumers should bear the risk of inflation in the prices
they paid. The Department did not robustly challenge developers
who claimed investment would be deferred if the contractors bore
more of the risk of inflation. The Department also failed to challenge
developers' claims that investors would not come forward if contracts
were designed to ensure that consumers shared in higher than expected
profits. The early contracts include strike prices which are
fully indexed to the Consumer Price Index (CPI), resulting in
consumers rather than project developers bearing the risk of high
inflation. The Department argued that this was necessary to avoid
project developers demanding higher strike prices. The Department
also decided not to include claw-back provisions which would have
ensured that consumers shared in any excessive profits achieved
by project developers, for example through re-financing gains.
The Department asserted that including claw-back provisions would
have made the projects 'uninvestable'. However, no evidence to
substantiate these assertions was available and in our experience
of reviewing public contracts, particularly PFI contracts, claw-back
arrangements are essential to protect the interests of taxpayers
and consumers.
Recommendation: For future Contracts for
Difference, the Department should ensure it requires information
from project developers on projects' costs and returns and includes
contract clauses to allow it the opportunity to claw-back for
consumers a share of any excessive profits.
5. The Department awarded these early contracts
without clearly identifying how much capacity it needed from each
technology to keep on track to meet its strategic objectives.
The Department awarded the early contracts to mitigate the risk
of not meeting the 2020 renewable energy target and to support
the development of renewable electricity. The Department's data
shows significant new renewable generation capacity is in construction,
awaiting construction, or seeking planning permission. It is not
therefore clear that these early contracts were all necessary
to meet the 2020 targets. It is also not clear why the Department
awarded so many early contracts to offshore wind projects, when
offshore wind is currently the most expensive technology to support
and other cheaper technologies could be deployed instead. Its
early decisions have pre-empted resources and constrained future
choices. For example, biomass conversion of coal plants could
be an effective way of delivering energy until the next generation
of nuclear energy joins the grid.
Recommendation: The Department should ensure
its future decisions on the budgets for support for different
technologies and its process of allocating contracts are based
on a clear understanding of how best to achieve the balance of
technologies required to meet its strategic objectives at least
cost for consumers. In the event of a capacity crunch, clearly
consumers will end up paying more.
6. The Department awarded these early contracts
on the basis of wider benefits which it considered outweighed
risks to value for money. The Department went ahead with the
early contracts because it expected them to achieve wider benefits,
on which it could not put a monetary value. The Department argued
that there would be benefits to the renewable electricity supply
chain, that it was necessary to show the new system could work
and that early investment was required to meet the 2020 targets.
The Department proposes to conduct an evaluation of the benefits
from these early contracts.
Recommendation: The Department should ensure
it conducts and publishes a robust evaluation of the actual benefits
and costs of this scheme. This evaluation should assess the quantified
and unquantified costs and benefits against the Department's business
case for the scheme and make an evidenced assessment of what it
has achieved and whether awarding early contracts has genuinely
been worthwhile.
7. The government owned Counterparty Body
will play a crucial role in protecting consumers' interests. The
Counterparty Body will need to actively manage contracts, to ensure
claims for increases in strike prices are reasonable, to identify
and apply reductions in strike prices, and to calculate who needs
to be paid what and organise those payments. The Counterparty
Body should also monitor information from project developers on
projects' costs and returns to determine whether returns are reasonable
with a view to introducing claw-back clauses in new contracts
if there are excessive profits. The Department is in the process
of setting up the Counterparty Body. It has appointed a Chair
and is in the process of recruiting staff.
Recommendation: The Department must ensure
the Counterparty Body is wholly independent of the industry and
has the skills, resources and information it needs to manage all
Contracts for Difference effectively and hold it to account for
ensuring that the interests of consumers are fully protected.
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