The reference price for baseload generation under the UK FIT CfD contracts will initially be calculated from the two reference prices each year; one set every six months.
Previously we had stated our preference for the baseload reference price to be based on annual forward prices; giving a single market reference price for each year. This approach would deliver the most efficient outage planning by operators and therefore support security of supply and help minimise the total costs of managing the system.
However, industry has expressed concerns about low liquidity and consequent basis risk (i.e. of not being able to sell their output at the reference price) if we move straight to a year-ahead price. Additionally a number of concerns have been raised regarding the high cost of collateral and the inability to trade in a way that matches the reference price, due to restrictions on the minimum volumes which are traded. Overall, this could lead to greater risks to investors, and increase costs to consumers.
Some stakeholders have argued that the day-ahead index should be used for baseload generation, as this index would be the most robust. However, as we recognised in the November Operational Framework, using this approach for baseload generation could distort trading decisions and reduce incentives to time maintenance appropriately, thereby increasing overall costs.
Consequently, the reference price for baseload generation will initially be calculated from a forward season index / indices selected using objective criteria to be set out in the contract (i.e. that there will be two reference prices each year; one set every six months). The criteria for selecting the index / indices are still being developed and as such are not included in the Draft CfD Contract Terms published today. However the following paragraphs set out our current intentions. We welcome views on these metrics and will work with industry to develop precise parameters over the coming months.
Given concerns around the reliability of reported prices, and practical difficulties of avoiding double-counting trades, it is intended that the index / indices used as a price source will be based upon actual, auditable trades. However, if a review shows that there is a sustained and material difference between the reference price and a reported market index, and that there is adequate confidence that this is not as a result of market manipulation, a reported index may be included in the reference price calculation (at an appropriate weighting factor). Any indices which cover less than a set percentage of total relevant volumes or fewer than a set number of trades will be disregarded.
For intermittent generation, the reference price will be the GB day-ahead hourly price published under the GB European market hub coupling arrangements. The contract sets out the backup arrangements for where this price is not directly available, which involves utilising prices from the two constituent auction platforms for the GB Hub day-ahead price – namely N2Ex and APX-UK.
Reference Price Adjustment Post CfD Signature
4.30. We are mindful of the need to ensure that the CfD Market Reference Price continues to be a fair representation of the price of electricity in the market (for intermittent and baseload generators) for the term of the CfD.
4.31. In particular, we are conscious of the need to take account of :
a. the potential for EU Market Coupling Arrangements to cause changes to the market in which a CfD Generator operates;
b. new relevant indices that are not used in the market reference price formulae being introduced into the electricity market or indices used within these formulae ceasing to exist, and
c. material changes to the volumes of electricity being traded through different platforms used within the market reference price formulae as time passes.
4.32. It is our longer term intent to move from a Baseload Reference Price based upon season-ahead prices to a Baseload Reference Price based upon year-ahead prices for baseload generation. This move will occur when suitable indices are available in the market to achieve a robust reference price.
4.33. The formulae currently set out in Clause 7 (Baseload Market Reference Price) and Clause 8 (Intermittent Market Reference Price) do not allow for such changes to be factored in to the way in which the Baseload and Intermittent Market Reference Prices are calculated.
4.34. We are therefore developing provisions for the final CfD that will set out how these formulae will be updated following certain trigger events (such as, in particular, those referred to in the paragraph above).
4.35. It is our position that:
a. the way in which the Baseload and Intermittent Market Reference Prices would be adjusted, and the triggers for such adjustment should be deterministic in nature. This will provide potential generator signatories foresight and confidence in the way in which the Baseload and Intermittent Market Reference Prices could be adjusted following CfD signature; and
b. the provisions around (i) the triggers for Baseload and Intermittent Market Reference Price review, and (ii) the mechanics behind how the Baseload and Intermittent Market Reference Price would be adjusted would be set out within the CfD as contractual mechanisms.
4.36. We are mindful that it may not be possible to develop entirely deterministic procedures for the way in which the Intermittent/Baseload Market Reference Price would be adjusted in all circumstances. If this is the case, we consider that an independent expert or panel of experts would need to be provided for in the drafting of the CfD. Should such a panel be required we envisage that it would need to exercise a certain amount of discretion to adjust the Market Reference Price in accordance with stated principles. We are conscious in this instance that it would be important that potential generators and the CfD Counterparty could be confident in the impartiality of the independent expert(s).
4.37. It is our intention that any changes to the Baseload/Intermittent Market Reference Price should apply to all CfDs. We will work with industry to develop the most appropriate means to achieve this when we publish our final position in December.