Offshore Wind Strikes Back
Article, As published in London - Onshore Energy Conference Magazine – November 2017
Insurance / Quantification / Property
With everything that has been going on in the news recently you may have missed what I consider to be a significant event in the UK power market. The Contracts for Difference (“CfD”) Second Allocation Results were released in September 2017 and the Strike Price for new offshore wind power is now cheaper than new nuclear. In this article I will examine the implications of CfDs on Business Interruption risks.
As part of the UK’s Energy Market Reforms, CfDs are replacing ROCs (Renewable Obligation Certificates) as the principle subsidy to encourage investment in new low carbon generation capacity. The central mechanism of CfDs is the Strike Price. This is the price that a generator will be guaranteed for its output. These contracts typically last 15 years but longer periods can be negotiated.
The way the Strike Price works is that the plant continues to generate and sell its electricity in exactly the same way as normal except that if the prevailing wholesale price falls below the Strike Price then the LCCC (Low Carbon Contracts Company) will make up the difference, as illustrated on the graph below. The system also works in reverse so if the wholesale price rises above the Strike Price then the plant pays the difference to the LCCC. All prices are based on 2012 values and are index linked for inflation.
The first allocation took place in February 2015 and the Strike Price for new offshore wind projects ranged from £114.39 to £119.89 per MWh. This compares with the Strike Price agreed for Hinckley Point C nuclear power station of £92.50 per MWh. However, in the second allocation in September 2017, the price for new offshore projects reduced to between £57.50 and £74.75 per MWh, as shown on the table below. This makes them up to 40% cheaper than Hinckley.
So what are the implications of CfDs for Business Interruption (“BI”) risks? On the face of it, they should make life easier as the Strike Prices provides certainty in respect of selling price rather than its usual volatility. This in turn should help make the process of setting sums insured and quantifying BI losses more straight forward.
However, there are some important things that the Strike Price does not do. For example, it only applies to actual generation and hence total revenue will still vary in proportion to output. Therefore, all the usual uncertainties with predicting generation following an incident remain, such as operating capacity, planned / unplanned outages, weather conditions etc.
Also, whilst CfDs are part of what are referred to as “the Energy Market Reforms”, the title is misleading. CfDs are merely a bolt-on to the existing market which continues to operate as before. Therefore, if a plant has forward sold its output, as is likely to be the case with nuclear and biomass fuelled units, any lost generation following an incident will still need to be bought back from the wholesale markets to avoid imbalance charges. These buy-back prices are uncertain and are likely to be different to the original forward contract prices.
Furthermore, as with all valued BI policies, it is likely that there will still be areas of uncertainty with the overall quantification of the loss due to issues such as establishing gross profit margins, determining the incremental element and economics of mitigation measures, and identifying and quantifying the full extent of cost savings. However, the Strike Price does make one piece of the BI jigsaw puzzle easier to slot into place.