The UK government’s plans to launch a “wholesale” contract for difference (WCfD) for operational renewables next year is likely to benefit investors seeking stable revenues, but might disappoint those expecting a windfall from merchant revenues.

The plans, which were announced on Tuesday (21 April), will potentially affect around one-third of UK renewable energy generation.

Power prices are often determined by gas prices – a link that the WCfD plan is trying to weaken to make electricity more affordable.

Industry sources who spoke with Infralogic pointed out that this is expected to stabilise – but potentially reduce – returns to investors in the affected projects.

Stable revenue for ROC projects

The projects that can apply for the new WCfDs are primarily older generation plants that were commissioned in 2015/16 and are not backed by CfDs, but instead by renewable obligation certificates (ROCs).

The ROC, introduced in 2002, was a form of incentive designed to encourage the large-scale adoption of renewable energy and today backs around 30 GW of project capacity.

Some of those projects benefited from high revenues when merchant power prices were high although others entered into power purchase agreements (PPA), said a legal director specialising in Clean Energy.

The government said the WCfD move is voluntary, although developers that don’t accept the proposal will be subject to a 10% increase to the levy on excess profits, from 45% to 55%.

One UK-based renewable energy advisor described this as a “carrot and stick” approach by the government, adding that most renewable energy investors would be minded to sign up for the scheme just to protect their assets from the risk of further price tampering.

The first allocation process for the WCfD is expected to launch next year, similarly to how CfDs are awarded in the conventional allocation rounds – although the contract duration is yet to be announced.

David Cunningham, co-head of renewables advisor Savills Earth Capital Advisors, predicted the WCfD will not be much longer than the remaining ROC life on those projects.

The legal director gave a similar prediction, with the contract potentially as short as three-to-five years.

Losing the merchant upside

The link between gas and power prices has already weakened in the past few years but remains important.

The Department for Energy Security and Net Zero (DESNZ) said, as it announced the plans, that gas currently sets the UK wholesale price around 60% of the time, down from 90% in the early 2020s.

A CfD would remove merchant upsides that some investors have benefited from in the past during periods of high gas prices, such as in the wake of the Russia-Ukraine war, when spot electricity prices reached as high as GBP 582/MWh.

While spot prices have come down since then to around GBP 88/MWh today, according to Trading Economics, they are expected to rise this year as gas prices increase due to the Iran war.

However, given the increasing penetration of renewable energy, situations where there is a significant “upside” to take from merchant power prices may become increasingly uncommon, said the renewable energy advisor.

By 2035, according to Modo Energy, solar and wind will generate 70% of electricity during peak solar hours, likely leading to lower energy prices.

Listed renewables on the up

Share prices of listed investors edged up following the news, with Greencoat UK Wind rising 2.8% the following day and TRIG rising 3.3%.

TRIG, managed by InfraRed Capital Partners, said in an update that the proposals align with its “strategy to secure a high proportion of fixed-price revenues” and that it intends to take part in the scheme next year.

“The key barometer of the response is that yieldcos have jumped on the back of it,” said Cunningham, adding that the reduced volatility provides greater certainty for dividend profiles.

Shifali Aggarwal, head of energy advisory at Forvis Mazars, likewise said that the CfD could provide the listed funds which have a high proportion of ROC assets an “exit ramp” from merchant power price volatility, potentially narrowing the deep discounts to NAV they currently face.

Yet, she added, while stock market reactions are short term, it is harder to make a long-term prediction on the impact on revenues until the government announces the strike price for the new CfD round.

The legal director expected the WCfD will be lower than the equivalent CfD for allocation round 8, although this will also depend on the contract duration once announced.

But if the government gets this right then the impact on valuation will be broadly positive.

Boosts for M&A, refinancing market

Observers agreed that the stability provided through WCfDs will aid in the valuation of older renewable energy portfolios, potentially boosting M&A activity.

Tom Forman, a partner in law firm CMS’ energy and climate change team, said a well-calculated strike price “could provide meaningful long term revenue certainty and allow investors to optimise their revenue position”.

The power price swings of the past few years have been causing issues for investors with the valuation of projects and portfolios, making it harder for buyers and sellers to agree on prices.

According to Aggarwal, investors like pension funds and insurance companies that were shying away from pure play renewables due to recent price volatility will likely take this opportunity to enter the market.

The same clarity will also be a boon to the refinancing market.

Projects backed by ROCs are at least 11 years old and many are likely to be refinanced in the next few years, with this process aided by the WCfD.

“With price stability allowing for easier projection of revenues, this could open the doors to cheaper debt,” Forman said, although adds that it will depend on the details of the WCfD strike price.

The legal director said the “sweet spot” is for projects coming off PPAs of around 10-12 years in particular.

Seeking higher returns

Not all reactions to the new plan have been positive, however. In some quarters, it reinforced a sense of growing uncertainty over renewables regulation, following a series of other reforms.

Last year the government announced it would switch the indexation of some renewable energy subsidies from RPI to CPI, prompting concerns that some projects could lose almost 20% of their value. It also proposed introducing zonal power pricing – although this was ultimately scrapped.

Forman said that taken together these measures have contributed to a sustained period of regulatory uncertainty at precisely the time the UK is seeking record levels of private investment in energy infrastructure.

“Investors are increasingly focused on the cumulative effect of multiple interventions across their portfolios. Even where individual measures may be understandable in isolation, the overall impact on investor confidence – for both existing assets and future projects – is a key consideration when making long term investment decisions,” he said.

While a WCfD will promote price stability, more intrepid investors might assess what other levers they can pull to boost returns.

Aggarwal said that platform investors focused on higher returns, such as KKR or Brookfield, might take further moves into hybrid strategies combining different renewables asset, as they seek to capture upside out of CfD periods using battery storage.

This would continue a trend that started last year. According to Infralogic data, last year saw a record number of UK solar plus storage deals, with 18 schemes worth around GBP 1bn either financed or sold. The year before saw just a fraction of these volumes.

While many investors will be happy to take the carrot on offer, others will be willing to risk the stick in pursuit of higher returns.