Hedging Your Bets – EMR Update

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Dane Wilkins
Renewable Energy Capital, UK

In August 2013 DECC published further details on the draft contract terms it will offer investors in low-carbon energy projects under the proposed Feed in Tariffs with Contracts for Difference (“FiT CfDs”). The updated terms shed further light on the types of risk facing both developers and investors wanting to commission low carbon projects under the new CfD regime.

CfDs have been designed to mitigate price risk and provide efficient long term support for low carbon generation but the devil is in the detail and there are a number of other risks that need to carefully considered. In this brief the Jones Lang LaSalle Renewable Energy Capital team investigates what those risks are and how they compare and contrast to those that exist under the current Renewables Obligation (“RO”) – read “Hedging Your Bets – EMR update”.  

Below we comment on the top five risks posed by CfDs.

  1. Price Risk – CfDs have been explicitly designed to mitigate power price risk but it is not yet clear how this ambition will be interpreted by thePPA market. In particular questions remain as to how the market will evolve over the long term and whether it will be able to provide independent generators with the type ofPPA they require to secure investment backing on commercially acceptable terms.
  2. Basis Risk – further clarity is needed on how the market reference price will be calculated and whether it will be truly representative of prices actually available in the PPA market. We believe the government should consider introducing further measures to boost trading volumes and encourage market transparency to ensure a visible and reliable reference price is maintained.
  3. Liquidity Risk – CfDs will mitigate the need for fixed and floor price mechanisms often required by lenders. This should make it easier for projects to secure a commercially viable route to market. However, removing the obligation on suppliers to purchase renewable energy under the RO could increase liquidity risk particularly if licensed electricity suppliers shy away from offering competitively priced PPAs to independent operators.
  4. Balancing Risk –imbalance charges are likely to increase in future as more intermittent generation is connected to the grid but it is unclear by how much or when. This will have important consequences for PPA providers’ willingness to provide longer term PPAs under CfDs. This in turn is likely to affect a project’s ability to secure financial backing from institutional investors who seek to match long term liabilities with the secure income streams available through longer term PPAs.
  5. Eligibility Risk –developers and investors will be concerned at the prospect CfDs could be withdrawn should projects not meet certain investment and construction milestones. As such it will be important to caveat legitimate claims in CfD contract terms to ensure developers are protected against situations beyond their control.  

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