CMS

The Hinkley C Project: FiT CfD in action

Question

To what extent will the agreement concerning the Hinkley nuclear power project inform the implementation of reforms to the electricity market?

Answer

In October 2013 the UK government reached an initial agreement with an EDF-led consortium (EDF) for a proposed investment contract on the Hinkley Point C Nuclear Station (Hinkley Project). According to this agreement, the government will guarantee a price of up to £92.50per MWh of electricity for 35 years - more than twice the current market rate - for generation from the Hinkley Project. The agreement is part of the new Feed in Tariffs Contracts for Difference (FiT CfD) scheme under the unfolding Electricity Market Reforms. However, whether it will serve as a path setter for the operation of FiT CfD in the United Kingdom remains to be seen.

At present, the government incentivises renewable electricity generation in the United Kingdom through the Renewable Obligation Certificate (ROC) regime. Under the ROC, electricity suppliers have an obligation to present a certain number of ROCs to Ofgem, the regulator, each year. This obligation creates a demand for ROCs which are issued to eligible renewable generators by Ofgem. The generators can then sell these ROCs either directly to suppliers or to traders.

The proposed investment contract in the Hinkley Project, on the other hand, is an early form of the FiT CfD scheme, which is expected to roll out in 2014. Under the FiT CfD scheme, the low-carbon generator will enter into a contract with the government CfD authority (which is yet to be established). The generator will sell its electricity into the market normally. However, the generator will also receive a top up, that is, the difference between the “strike price” (a fixed price intended to reflect the cost of producing electricity using a particular low-carbon technology) and the “reference price” (which is intended to reflect an average market price for wholesale electricity). On the other hand, if the reference price is higher than the strike price, the generator will pay the difference to the authority.

Thus in the case of the Hinkley Project, where a strike price of £92.50 per MWh was agreed, if the reference price is lower than the strike price, the government authority will top up EDF's income to this level. However, EDF will have to pay the difference to the authority if the reference price is higher than the strike price.

The existing ROC system is expected to continue parallel to the FiT CfD scheme at least until 2037; however, new accreditations under this system are expected to end by 31 March 2017. All new generators will need to mandatorily obtain FiT CfD accreditation from that point onwards.

Reasons for FiT CfD

It is estimated that the United Kingdom needs to replace nearly 20% of its ageing coal and nuclear power plants in the coming years. Estimates further suggest that investments of up to £110 billion are needed over the next 10 years for the United Kingdom to meet its climate change targets. The government has introduced FiT CfD in order to jumpstart this investment in renewables and boost electricity production.

FiT CfD are designed to stabilise the volatility of electricity prices for renewable generators. For electricity generators that rely on certain types of low-carbon sources such as wind, it is difficult to predict accurately the electricity output or to utilise fully the electricity demand. By ensuring a certain return for investing in low-carbon generation, FiT CfD reduces the risks that such generators face. It is hoped that this will in turn incentivise investment in low-carbon generation. Tied into this theme of stability, renewable electricity generators will also have greater certainty over their rights and obligations under the FiT CfD, which is structured as a private law contract as opposed to under the ROC, which - as a scheme based on regulations - is more subject to change.

The case of the Hinkley Project differs from this reasoning in some respects. Nuclear generation is not a new technology; it is not in a nascent state of development and so it does not require support on that account.

However, nuclear generation has become much more expensive since the 2011 Fukushima disaster, when stricter safety rules were imposed on nuclear plants all over Europe. The Hinkley Project is the first nuclear plant to be built in Europe since the disaster and its strike price is therefore supposed to be reflective of the high cost of nuclear power generation in Europe. Interestingly, the agreement provides for the strike price to be reduced to £89.50 per MWh if EDF goes ahead with its second nuclear project at Sizewell C, which would allow it to share costs over the two projects.

The private law nature of the FiT CfD is also reflected in the fact that the British government has agreed to reimburse EDF for its investments if it decides to close the Hinkley Project at a later date for reasons other than safety or security.

Issues with the Hinkley Project agreement and FiT CfD

While the agreement on the Hinkley Project is under the new FiT CfD regime, it may not serve to be the best example of the affect that FiT CfD will have on renewable electricity generators. Some of the issues raised by the Hinkley agreement are quite specific to nuclear generation.

For example, while the government has agreed to the scheme, it is subject to the approval of the EU state aid regime. Under the EU rules, while there is an exception created to allow for premium price incentives to renewable energy, state aid to non renewables is dealt with on a case-to-case basis. The EU Commission has already rejected the proposal to get EU state aid guidelines amended to allow state aid for nuclear power projects to be included on the same basis as renewables. It remains to be seen whether the European Union will approve the United Kingdom’s FiT CfD scheme for the Hinkley Project.

At present, the major issue with this new FiT CfD regime in the United Kingdom remains the uncertainty surrounding its operation. As of now, the government consulted regarding the FiT CfD structure and has released draft strike prices for various renewables. However, much of the operation of the FiT CfD is to be decided by secondary legislation, which is unlikely to be published before next year. Without the certainty of strike prices and the FiT CfD structure, there is fear that investors will choose to wait rather than invest in new renewable generation.

Karthy Nair is a third-seat trainee in the energy department at CMS Cameron McKenna LLP.

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