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Topic Title: Electricity Market Reform: Allocation of Contracts for Difference
Topic Summary: The Crony-Capitalist Manifesto for Renewables
Created On: 23 January 2014 05:56 PM
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 23 January 2014 05:56 PM
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jarathoon

Posts: 1040
Joined: 05 September 2004

"Electricity Market Reform: Allocation of Contracts for Difference"

Consultation on Competitive Allocation

"This consultation document seeks views on the Government's approach to allocation of Contracts for Difference (CfD). Responses are invited from all interested parties by 12 February 2014."

This document excludes reference to Generation III Nuclear, which involves a separate process that is as secret negotiated, as it is uncompetitive. (Even uncompetitive compared with what most engineers could come up with on the back of a fag packet).

Independent electricity generators will also have to negotiate separate Power Purchase Agreements (PPAs) with electricity suppliers, once they get a Contract for Difference.

The price that these independent generators get for their electricity will not necessarily be the same as the reference price calculated by government. I now present a gross simplification of the process that is likely to ensue once an independent generator is awarded a contract for difference for your amusement...

Lets say an independent onshore wind generator is unexpectedly awarded a Contract for Difference (CfD) of £94 per MWh from DECC, after outbidding other competitors by £1 per MWh. The independent generator then goes to one of the big six and a half to negotiate a long term Power Purchase Agreement (PPA) type contract on the basis of its shiny new DECC awarded CfD.

The independent generator's guaranteed levy income is limited to the "strike price" minus the "reference" price. [This is guaranteed even if the generators electricity is sold to energy intensive industries on energy welfare, for which this calculation doesn't technically apply. In this case the generators income is topped up as if it did apply, by extra levies on everyone else, including the fuel poor. Do you ken (understand)? [I must point out that the full details of how the new energy welfare system will work have not been finalised yet. I expect that individual firms that apply for and recieve monthly energy wefare benefit cheques won't want to advertise this fact. We may never get to know what it feels like being on energy welfare benefits]

The independent generator will presumably want to negotiate a variable price as part of its long term PPA contract, not a fixed price. If they negotiate a fixed price they could possibly lose a large part of their levy in future years if the market/reference price increases substantially. (The reference being tied to the market price by some agreed formula. It should also be pointed out that the reference price could later shift relative to the market price, in some systematic fashion, if someone like me gets into government and changes the formula.)

However the big six and a half firms will say "what is the point of negotiating a long term deal if we can't negotiate a fixed price or substantial discount on the market rate". If fixed prices are off the table, then they may ask that the negotiation must cover the very big risk that future governments will want to fiddle with the reference price definition and with other related calculations to make the subsidy system less generous.

The independent generator may want to negotiate a price that slightly discounts the reference price set by government. The big six and a half firms will presumably want to negotiate a price that discounts the actual market price, so that if a future government decides to increase the reference price above the market price, the independent generator loses out, not them.

However even if they work out some deal based on how the reference price definition may or may not change in future, what does the "market price of electricity" really mean anymore anyway.

If future changes to the definition of "reference" price have been stopped by high end legal counsel drafting water tight contracts, then the last port of call for future governments will be to redefine what is meant by the "market" price. This will be possible because the new electricity "market" will be entirely a crony-capitalist creation of government anyway, and not a real market system at all. How do all parties protect themselves from that?

To conclude...

The Government thought that they were being really clever in coming up with a plan to reduce electricity firms future investment risk. The truth is that the opposite is now happening: they are replacing the risk that one or two of the big firms may choose the wrong investment strategy in difficult circumstances and fail, with the risk that there is a complete systematic collapse of the entire electricity system, with complete nationalisation as the end game. Some people, like Ed Miliband, will see this as a good thing, which of course amplifies this risk for investors considerably.

The risk that future law will clamp down on the mistaken and misguided practices of previous administrations is far greater, in my opinion, than most other sorts of market based risks that electricity firms would normally face in trying to honestly provide the best electricity deal they can for their customers, in open and free competition with other suppliers.

The countries first world war motto continues on today with even greater resonance now: "British Lions lead by Donkey's".

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James Arathoon
 23 January 2014 06:03 PM
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jarathoon

Posts: 1040
Joined: 05 September 2004

Should have said...

The countries first world war motto continues on today with even greater resonance now: "British Lions led by Donkey's".

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James Arathoon
 23 January 2014 09:22 PM
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statter

Posts: 125
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.... there is no need for a PPA with a cfd. The generator sells into the market at the relevant reference price (probably Day Ahead for wind) and gets the difference payment from the counterparty. These two add to give the strike price.

This incentivises the generator to sell at the reference price and this increases liquidity in the wholesale market and stops the generator getting a free ride. They will only achieve the reference price if they do this and then run accordingly.

The CfD is bankable without a PPA and that was one of the main drivers of all of this.
 24 January 2014 06:39 PM
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jarathoon

Posts: 1040
Joined: 05 September 2004

Originally posted by: statter

.... there is no need for a PPA with a cfd. The generator sells into the market at the relevant reference price (probably Day Ahead for wind) and gets the difference payment from the counterparty. These two add to give the strike price.


This presumably depends on there being enough liquidity in the day ahead market. Will investors be able to get such a liquidity guarantee in advance of their investment from DECC or Ofgem, or will they have to bet on there being enough liquidity, say x percent of the time, based on historical data?


This incentivises the generator to sell at the reference price and this increases liquidity in the wholesale market and stops the generator getting a free ride. They will only achieve the reference price if they do this and then run accordingly.


The cfd generators get the same income whatever positive market price they sell electricity at, even if the market/reference price is zero. For all positive electricity prices cfd generators get the same ride - completely flat.
Cfd generators could only compete using negative prices, as they offset some of their positive only levy to make a sale. Prices could conceivably go to minus the levy in the extreme, at which point the generators net income goes to zero. Negative day ahead pricing will defeat the whole object of what is being attempted, therefore this must be considered as another option for me when I get into government and try to reduce subsidies. [Although energy intensive industries would benefit from negative pricing, at the expense of the consumer - so I would have to kick the energy intensive industries off energy welfare at the same]

Therefore the day ahead reference price cannot be calculated from the cfd generators (or indeed even ROC wind farm generators), they can only compete on negative wholesale electricity prices.

Therefore the market or reference price must come from generators wishing to supply the predicted residual demand
Predicted Residual Demand = Predicted Demand - PPA (including legacy nuclear) - CFD generators (including new nuclear) - ROC generators - miscellaneous

Supplying energy to meet the predicted residual demand is where the market/reference price must be generated. If the predicted residual demand is negative then presumably national grid has to pay generators not to generate or alternatively incentivise big electricity customers to use more electricity.

Which electricity generators will be setting the day ahead market/reference price? How volatile will it be once significant CfD's are issued?

Even though all consumers and most businesses don't pay the market/reference price for their electricity, reference price figure will be used to set what the energy intensive industries are charged for their electricity.

If this is too high then they will disconnect from the grid by either closing down in the UK or moving to off grid alternatives such as a locally fracked gas powered CHP systems. If it is too low the UK will attract lots of energy intensive industries to Britain and the consumer levies will increase substantially to pay for the ballooning energy welfare system.


The CfD is bankable without a PPA and that was one of the main drivers of all of this.


Really? That sounds distinctly like Hollywood history to me. I thought Ofgem's push for extra liquidity in the electricity market was much more recent than the start of DECC's romance with the CfD. My impression is that DECC has been flying by the seat of their pants for quite some time now (in fact ever since they were created by Messrs Brown and Miliband).


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James Arathoon
 24 January 2014 09:36 PM
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statter

Posts: 125
Joined: 06 February 2013

There is loads of liquidity in the day ahead market. Liquidity in day ahead hasn't been a problem.
I don't agree with many of your points on cfd generators.

[The cfd generators get the same income whatever positive market price they sell electricity at, even if the market/reference price is zero. For all positive electricity prices cfd generators get the same ride - completely flat. ]
No this is not true to get the flat revenue CFD gens have to sell at the reference price. It doesn't matter if the reference price is negative the result is the same.

[Cfd generators could only compete using negative prices, as they offset some of their positive only levy to make a sale.]

No this is not true CfD generators can always sell at reference price and keep their revenue whole that's the whole point of the scheme

[Prices could conceivably go to minus the levy in the extreme, at which point the generators net income goes to zero.]

Prices can go where they want to and the difference payment /(or cost) will always bring the CfD back to strike price. That's what a cfd is. Even if prices become more negative than the 'levy' the cfd generator will be whole.

[Therefore the market or reference price must come from generators wishing to supply the predicted residual demand
Predicted Residual Demand = Predicted Demand - PPA (including legacy nuclear) - CFD generators (including new nuclear) - ROC generators - miscellaneous]

The market reference price will come from ALL generators inc CfD that want to sell that product in the market. The market is agnostic to who is selling and why. Its a supply demand thing. Fundamental demand supply will end up driving the price....

[Which electricity generators will be setting the day ahead market/reference price? How volatile will it be once significant CfD's are issued? ]

As now there will be a lot of trades at different prices. the reference price will be set against these by formula. With increasing prices and volatility we can expect much more demand side participation in these markets too.

[Really? That sounds distinctly like Hollywood history to me. ]
Sorry they are.....Have a look at Eggborough. That was going to be bankable with a CfD and now it isn't as it wont get an early stage.
cfd.

Edited: 25 January 2014 at 07:06 AM by statter
 27 January 2014 08:12 AM
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Ipayyoursalary

Posts: 265
Joined: 21 November 2009

CfD, ROCs, PPA? Sounds like the global warming subsidy farming industry is trying to confuse the public with a storm of meaningless acronyms and bureaucracy. Trouble is the public can see for themselves there's been no warming for 17 years. They can also see their US counterparts paying HALF THE PRICE for their gas and elec (despite Obama's best efforts). So I reckon the jig is up for your lot statter. Time to find a real job in the productive economy - you know - producing things that people actually want - instead of trying to unneccesarily hike the price of essential energy supplies.
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