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Lessons from first auction of CfDs

The first Contracts for Difference (CfD) auction marked a generational shift in how the Government supports renewable energy generation.

Initial indications are that the auction was a success, with budgets committed under a competitive process and the market clearing well below administrative strike prices.

However, as with all new support regimes, there is a learning curve for regulators and industry as the process is applied to real projects. The next stage is to convert paper projects into real UK infrastructure. With hundreds of millions of pounds at stake, there are already two key points for developers in the next allocation round.

Engage with the finance community

It is important this happens early, and that developers have a clear view of both their intended financial structure and realistic routes to financial close before submitting their auction bids.

Bearing in mind that projects have only 12 months to submit their Milestone Requirements Notice following receipt of the CfD (essentially, to achieve financial close within 12 months), developers should be aware of how long the journey to financial close can take.

Under the former Renewables Obligation, many projects spent years getting to a financeable structure, particularly if senior debt was required. Unless developers have road-tested the intended structure robustly with the finance community in advance of placing their bid, the 12 months after CfD award will feel like a very short time to reach close.

Bankability issues may permanently end developers’ project aspirations if they fail to meet a milestone cut-off date and lose their CfD contract. It is not clear how much discretion, if any, the Low Carbon Contracts Company (LCCC) will use to extend contract terms if milestones are missed. So investors and developers are strongly advised to treat deadlines seriously, resolve any truly ‘unbankable’ issues before bidding and maintain active dialogue with their LCCC counterparty.

Dash for cash

These issues do not relate solely to raising senior debt. If the project depends on securing new equity partners, it is critical the bid prices have been set to accommodate their target returns and allow time for their adequate due diligence.

This is a particularly significant risk when seeking to attract industrial or utility sponsors, which may have lengthy internal processes or require more fundamental input to the underlying project.  

Then there are the simple practicalities of closing a deal. With all projects attempting to reach financial close with the same deadline, the most experienced advisers and investors in the sector may be simply too busy to devote resource to your project. Developers should ensure they are at the top of the priority list by engaging early and having a streamlined, credible fundraising process.  

Realistic auction bids

In anticipating a successful level to bid at, developers should remember that the strike price achieved is an anchor for a major revenue stream within projects, but it also limits the potential for equity.

Much like achieving the right contract price on feedstock supply, projects need to be realistic about where the overall economics will settle at the end of the financing process. While the bid price should be as competitive as possible, the project needs to be able to manage the unexpected costs, delays, due diligence overruns and additional credit support requirements which may be needed to reach financial close.

Inexperienced developers run the risk of submitting too low a bid price, then winning the auction but failing to make the final project economics work. Over-optimism has been the ‘developer’s curse’ within the waste sector for decades. Ultimately, if costs are higher than budgeted within the strike price, the best outcome would be reduced equity returns and the worst would be failure to fund the project.

Therefore we would emphasise the importance of taking an appropriately conservative view on financing, and urge project developers to take market soundings before bid submission.

Chris Holmes is managing director for waste and bioenergy at UK Green Investment Bank

  • The next CfD application window is indicated to run from 21 October to 4 November

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