Negative wind subsidies help cash-strapped UK energy suppliers
The Contract for Difference mechanism is easing the big squeeze on retailers
The UK government is facing a political crisis over soaring energy bills. The next increase in the retail price cap in April promises to be brutal: average household bills will rise by around 50% to £2,000 per year, and could hit £2,300 in October. Ministers are scrambling for ways to square the circle of alleviating suppliers’ ballooning wholesale costs without heaping too much pain on hard-up consumers. Is the answer to their problems blowing in the wind?
Moves are afoot for the Treasury, or more likely lenders, to underwrite UK energy retail sector losses — which are estimated at £20 billion and rising. Even with government intervention, regulator Ofgem will have little choice but to pass some costs through to utility bills come April. Its priority is to stop more suppliers from going bust. This will add fuel to the fire of the cost-of-living crisis that threatens to dominate the UK political agenda in 2022.
In the meantime, some power generators, energy producers and traders are making obscene profits from blistering wholesale prices. If only there was a market mechanism to redistribute those windfall profits… Oh wait, there is – say hello to the humble Contract for Difference!
There’s a silver lining to the doom and gloom of the winter energy crunch: UK wind subsidies are going much, much deeper into negative territory. And the Contracts for Difference (CfD) mechanism that makes this possible might offer a long-term solution to mitigating future bouts of extreme pricing, which promise to become more frequent and spikey as the energy transition progresses.
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Energy Flux first reported on negative UK wind subsidies back in September, when the market reference price (i.e. wholesale power prices) rose above the ‘strike price’ for wind CfDs. When this happened, wind farms started paying money back to suppliers. To recap:
In ‘normal’ times, the UK’s CfD subsidy regime pays a top-up to eligible generators up to a pre-set maximum (the strike price). Since wholesale power prices are almost always below the strike price, the CfD holder receives a premium, which suppliers charge back to electricity consumers.
But with the price of UK day-ahead power soaring to eye-watering levels amidst a Europe-wide energy crunch, CfD strike prices are now below the amount that generators are earning for their power. So, they have to pay back the difference (hence the ‘d’ in CfD).
Since I wrote that, wholesale gas and power prices have gone from merely stratospheric to fully interstellar. This has turned the concept of UK consumers ‘subsidising’ wind farms on its head. Today we are sitting squarely on the other side of the CfD looking-glass: between October and December 2021, wind generators paid more than £108 million back to suppliers:
As winter drags on and plunging temperatures keep wholesale gas and power prices firmly in ‘berserk’ territory, negative subsidies will plumb new depths. Total CfD reconciliation payments to suppliers are expected to total £353 million for Q4’21 and top £774 million by the end of Q1’22. And it won’t stop there.