Design of Renewable Energy CfD Auctions

1. Introduction

A Renewable Energy Contract for Difference (CfD) auction is a competitive process through which renewable-energy projects compete for a long-term price-support contract.

The basic idea is simple. A renewable generator receives a strike price under the CfD. When the relevant market/reference price is below the strike price, the CfD generally provides a payment to the generator. When the reference price is above the strike price, the generator generally pays the difference back.

Therefore, CfD auctions try to achieve two objectives:

give renewable projects enough revenue certainty to attract investment; and

use competition to discover a reasonable support price.

In Great Britain, the CfD scheme is administered through allocation rounds, with projects competing within technology-specific categories.

2. Legal Foundation

The UK's CfD framework is primarily based on the Energy Act 2013 and regulations made under it.

The Secretary of State has powers concerning the design and allocation of renewable-support contracts, while Low Carbon Contracts Company (LCCC) administers signed CfDs.

The scheme therefore combines:

Government policy + competitive auctions + private contracts + regulatory oversight.

3. Main Stages of a CfD Auction

A typical renewable CfD auction has several stages:

Step 1: Technology eligibility

The government decides which technologies can participate.

Examples may include:

offshore wind;

onshore wind;

solar PV;

tidal stream; and

other eligible low-carbon technologies.

Step 2: Budget allocation

A total budget is established for the allocation round.

Step 3: Administrative requirements

Projects must demonstrate that they satisfy eligibility and delivery requirements.

Step 4: Competitive bidding

Eligible projects compete on price.

Step 5: Allocation

Contracts are awarded according to the auction rules and available budget.

Step 6: Contract delivery

Successful projects must meet development and generation obligations.

4. Strike Price

The strike price is central to a CfD.

Suppose:

Strike price = £70/MWh

Reference price = £50/MWh

The generator may receive £20/MWh under the CfD mechanism.

If:

Strike price = £70/MWh

Reference price = £90/MWh

the generator may pay £20/MWh back under the two-way CfD structure.

This gives generators greater revenue certainty while allowing consumers to benefit when market prices are higher than the strike price.

5. Why Auctions Are Used

An auction is used instead of simply giving every renewable generator the same subsidy.

Competition can reveal the price at which different projects are willing to deliver renewable electricity.

This can:

reduce support costs;

encourage efficiency;

reveal technology costs;

allocate limited public support; and

encourage competition between eligible projects.

However, auction design must also avoid bids that are unrealistically low and cannot ultimately be delivered.

6. Technology-Specific Allocation

Renewable technologies have different costs and development characteristics.

For example:

offshore wind may have high construction costs;

solar may have different capital and operating costs;

tidal projects may still face technological development risks.

Therefore, the government may create different allocation pots or categories.

This prevents a mature low-cost technology from automatically winning all available support at the expense of emerging technologies.

The legal challenge is to balance competition with technology diversity.

7. Budget and Auction Caps

The government can limit:

total auction expenditure;

maximum strike prices;

technology-specific budgets; and

project eligibility.

These limits are important because the CfD scheme ultimately affects electricity-market participants and, depending on the funding structure, consumers.

A carefully designed auction therefore needs a transparent methodology explaining:

why a particular budget was chosen;

why a particular technology category was created; and

how the maximum strike price was calculated.

8. Administrative Strike Price

An administrative strike price can operate as a ceiling.

For example, if the maximum permitted strike price for a technology is £80/MWh, a project cannot successfully bid above that level.

This protects the scheme against excessive support costs.

However, if the ceiling is set too low, viable projects may not participate.

Therefore, the government must balance:

affordability + investment attractiveness + competition.

9. Auction Competition and Bid Strategy

A developer does not necessarily bid its total construction cost.

It considers:

construction costs;

financing costs;

expected electricity prices;

operating costs;

inflation;

risk;

expected project life; and

required return on investment.

This makes CfD auctions partly a financial-risk allocation mechanism.

A low bid may win an auction but could create problems if costs later increase.

Therefore, auction rules should contain mechanisms dealing with:

construction delays;

supply-chain problems;

inflation;

termination;

non-delivery; and

change in law.

10. Case Law: R (British Gas Trading Ltd) v Secretary of State

In R (British Gas Trading Ltd) v Secretary of State for Energy Security and Net Zero [2023] EWHC 737 (Admin), the High Court considered government intervention in the energy sector and the legal framework surrounding support arrangements for energy customers.

Although the case did not directly concern a CfD auction, it demonstrates an important public-law principle: government energy schemes involving financial consequences must operate within their statutory powers and follow legally proper decision-making processes.

This is relevant to CfD auction design because the government cannot simply create financial mechanisms without an appropriate statutory and regulatory basis.

11. Case Law: PreussenElektra AG v Schleswag AG

In PreussenElektra AG v Schleswag AG, Case C-379/98, the Court of Justice considered a German system requiring electricity suppliers to purchase renewable electricity at prescribed minimum prices.

The Court considered the compatibility of the scheme with EU State-aid rules.

Relevance to CfD auctions

The case is important because it demonstrates that renewable-energy support mechanisms can raise questions concerning:

State aid;

market competition;

electricity suppliers; and

renewable-energy support.

Modern CfD schemes are designed in a more competitive manner, with auctions helping to discover support prices rather than simply guaranteeing a fixed statutory price.

12. Case Law: Tempus Energy v Commission

Tempus Energy Ltd v Commission, Case T-793/14 is another important energy-law authority.

The case concerned the UK's Capacity Market rather than CfDs. The General Court found that the European Commission had failed to undertake a sufficiently detailed examination before approving the scheme as State aid, particularly regarding demand-side response.

Relevance to CfD auctions

The broader principle is important:

Government-designed energy-support schemes must be properly assessed and justified.

Auction design should therefore consider whether its structure unfairly favours some participants or fails to recognise relevant market alternatives.

13. State Aid and Competition Law

Renewable CfD auctions can raise competition-law questions because the government is providing a financial support mechanism.

Under the modern UK framework, EU State-aid law is no longer generally applicable domestically following Brexit, but other legal controls remain relevant, including the UK's subsidy control regime.

A renewable support scheme must therefore consider:

whether support is necessary;

whether it is proportionate;

whether it distorts competition unnecessarily; and

whether it achieves a legitimate policy objective.

14. CfD and Risk Allocation

One of the most important features of a CfD is risk allocation.

Traditional renewable projects face significant market-price risk.

A CfD transfers some of that risk away from the generator.

However, the generator still faces other risks:

construction risk;

financing risk;

planning risk;

supply-chain risk;

grid-connection risk; and

operational risk.

Therefore, a CfD does not guarantee that a renewable project will always be profitable.

It mainly provides protection against certain electricity-price risks.

15. Negative Pricing

CfD auction design must also consider negative electricity prices.

Negative prices can occur when electricity supply exceeds demand or when system conditions create unusual market outcomes.

Modern CfD rules contain provisions dealing with periods of negative pricing.

These rules are important because unlimited support during negative-price periods could weaken incentives for generators to respond to market conditions.

16. Consumer Protection

CfD auctions also have a consumer dimension.

A successful auction can reduce the long-term cost of renewable electricity procurement by encouraging competition.

However, if auction rules produce excessive support payments, consumers may ultimately bear higher costs.

Therefore, auction design should consider:

auction competitiveness;

strike-price levels;

contract duration;

payment mechanisms;

budget limits; and

market-price exposure.

17. Important Principles of Good CfD Auction Design

A legally and economically sound CfD auction should provide:

1. Transparency

Rules should be published clearly.

2. Fair competition

Eligible developers should have equal access.

3. Technology awareness

Different technologies may require different treatment.

4. Cost control

Budgets and price ceilings should protect consumers.

5. Investment certainty

Developers need predictable contractual conditions.

6. Delivery incentives

Successful bidders should have genuine incentives to build their projects.

7. Flexibility

The scheme should adapt to changing technology and market conditions.

18. Conclusion

The design of renewable-energy CfD auctions is a combination of energy policy, contract law, competition law and economic regulation.

A good auction should:

identify eligible technologies;

establish a clear budget;

set appropriate administrative price limits;

allow genuine competition;

allocate contracts transparently;

provide reasonable revenue certainty;

control consumer costs;

address project-delivery risks; and

regularly review the auction framework.

The cases PreussenElektra v Schleswag and Tempus Energy v Commission are useful comparative authorities because they demonstrate how government energy-support mechanisms interact with competition and State-aid principles.

In simple words, a renewable CfD auction is a competitive system in which renewable-energy developers compete for long-term price protection. The government must design the auction carefully so that it provides enough certainty to encourage renewable investment while maintaining competition, affordability, transparency and accountability.