How CfD is unlocking investment for nation - Stephen Sheal

Getting the price right for electricity is vital (Picture: Adobe)

As a policy innovation, Contracts for Difference has quite a lot going for it, says Stephen Sheal

The latest round of the UK Government’s Contracts for Difference (CfD) auction has recently closed. Since 2014, a series of CfD allocation rounds — there have been six to date — have been the principal policy mechanism through which the government has supported the transition to low carbon electricity generation, primarily by incentivising investment in renewables.

The CfD scheme works by means of a guarantee to pay the suppliers of renewable energy a flat indexed rate for their electricity over a 15-year period, calculated by the difference between the ‘strike price’ (which reflects the cost of investing in a particular low carbon technology) and the ‘reference price’ (a measure of the average GB market price for electricity). Eligible developers apply through a competitive ‘sealed bid’ system, with successful applicants entering into a contract with the government-owned Low Carbon Contracts Company (LCCC).

As a policy innovation, CfD has quite a lot going for it. One of the most stubborn obstacles on the road to net zero has been that the combination of unpredictable energy prices and the high upfront costs of renewables investment, coupled with a relatively lengthy wait for returns, acts as a brake on investment.

Stephen Sheal is Director of Government Affairs and Policy, Net Zero Technology Centre

By offering investors a degree of protection, the CfD reduces those disincentives and actively encourages investment in innovative low carbon electricity generation. This approach has the advantage that it strengthens the UK’s energy security as well as boosting investment in renewables. But its success depends on getting the strike price right.

The previous round of CfD failed to result in any new contracts, a set-back for renewables development in the North Sea and a blow to net zero ambitions. But that does not necessarily mean that the policy itself is fatally flawed. Rather, the failure of the last round highlights the importance of setting the strike price at a realistic level so that potential investors can see that the numbers stack up. While policy makers are rightly keen to be concerned about securing value for tax payers’ money, energy markets are notoriously volatile, so creating an environment where international investors can have greater confidence is essential to success.

There’s no doubt that CfD has played an invaluable role in unlocking investment in offshore wind, and has helped to drive down the cost of renewable projects and technologies. It could also be argued that CfD has helped the UK secure foreign direct investment in an extremely competitive global context. What is less apparent, however, is whether the CfD approach has delivered the anticipated benefits for the wider supply chain in areas like manufacturing, or research and development.

The outstanding challenge is how to ensure that that the investment in offshore wind unlocked by CfD follows through into the supply chain, supporting high quality jobs and supporting innovation. There are enormous opportunities for Scotland and the UK in this area, given the skills profile of our existing workforce and our research-intensive universities with an enviable track-record in technological sectors, but that is not yet happening at the scale it might. Likewise, we might ask why investment in offshore wind is not (yet) translating into the creation of new opportunities in manufacturing on anything like the scale it could, and arguably, should.

Policy initiatives that complement CfD might be part of the solution. A longer-term industrial strategy, for example, that uses CfD not only as a lever for investment, but puts a focus on maximising the potential of that investment for the wider supply chain might help to shift the log jam. Taking a co-ordinated approach to skills and workforce planning might be another piece of the puzzle moving forward. There’s already quite a lot being done to support the spin-out of innovative technology from universities and research institutes, but greater emphasis on bringing these to scale here would help bolster the tech ecosystem as well as helping to boost economic productivity.

The outcome of this current CfD round remains to be seen, and we have to hope that the results will be more positive than last time. However, the need to transition to low carbon energy is as pressing as ever, and the opportunities are huge, especially for those at the forefront of innovative technological development. Looking ahead, it will be important to learn from the experience with onshore wind over the last ten years to inform future policy planning.