This report was co-produced with the Oxford Institute for Energy Studies. The views expressed herein are those of the author and do not necessarily represent the views of FTI Consulting, Inc. or its other professionals (download the PDF to access the full report).
Contracts for Difference ("CfDs") are increasingly seen as the method of choice for incentivising private investment in renewable power projects and new clean energy technologies, vitally important to the energy transition.
Previously known mainly as a financial hedging instrument, CfDs have become more widely known as a source of success for the accelerated development of offshore wind in the UK. They also play a central role in European attempts to reform electricity markets to accommodate increasing levels of renewable generation in several countries. Both the UK's ongoing Review of Electricity Market Arrangements ("REMA") and the EU's Electricity Market Reform identify CfDs as a key instrument for decarbonising electricity generation.
This paper explains the concept of CfDs and compares this instrument with other support mechanisms for clean energy deployment. It highlights the reasons why CfDs have been favoured over other support schemes and addresses some of the key perceived challenges that could affect their uptake beyond the power sector. It then discusses the market experience with CfDs to date and provides an outlook on the future role of CfDs in accelerating the energy transition. Understanding CfDs will be of particular interest to corporates and industrial players involved in energy transition projects, to PE and infrastructure firms that may find them an attractive way to manage investment in the clean energy space, and to law firms that support investments into energy transition projects.
Following the successful experience with CfDs in renewables, it has been recognised that the CfD concept may be suitable for applications beyond electricity generation. CfD-based business models are already being developed for clean hydrogen and carbon capture and storage ("CCS"), and there is scope for a wider use of CfDs for other low-carbon solutions as the energy transition progresses – as the example of Carbon CfDs ("CCfDs") illustrates.
As countries around the world announce (or reaffirm) their intention to prioritise CfDs to support investment in renewable energy projects, it will be critical for corporates and industrial players involved in energy transition projects to have knowledge of the characteristics, advantages and limitations of CfDs – for example how these contracts provide corporates with a long-term stable revenue stream that can make their projects "bankable", but also how CfDs can put excessive pressure on projects to reduce cost and thus increase execution risk.
Privateequityandinfrastructurefirmswill also regard CfDs as a welcome incentive, providing price stability and hedging the risk of clean energy projects, particularly for offshore wind farms. After extensive uncertainty in the energy space, investment opportunities are finally re-appearing and institutional investors need to be wary of the practical challenges associated with CfDs, including the complex contractual structures of some of the contracts – particularly for technologies such as hydrogen and CCSS – and the ever-evolving nature of the legislation that underpins these schemes.
As more investment flows into energy transition projects, input from lawfirms will be required to avoid contractual pitfalls and to mitigate risks. Firms will be required to stay up-to-date on CfDs, with these long-term contracts (lasting up to 20 years) requiring ongoing monitoring to understand how the value of assets change over time as new market rules evolve.
To make successful investments in projects that are underpinned by CfD schemes, particularly in the context of new clean energy markets and applications, it will be critical for investors to become familiar and comfortable with the relevant legal and contractual framework and price the investment risk accordingly.
FTI Consulting supports businesses across the value chain navigate the energy transition by providing a wide array of advisory services addressing the strategic, financial, operational, transactional, reputational, regulatory, and capital needs of our clients. The Power, Renewables & Energy Transition practice covers conventional and renewable energy technologies, including onshore wind, offshore wind, solar photovoltaic ("PV"), concentrating solar-thermal power ("CSP"), energy storage, biofuels, electric vehicles, thermal generation and more.
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