What are Contracts for Difference, what is their role on the energy market and their influence on energy prices and what the legal regulations pertaining to such contracts look like – those were the issues discussed by experts in the course of the seminar entitled “Contracts for Difference for the zero-emission energy industry”.
The aim of the meeting has been to analyse the possibilities of reform of the Polish electricity market from an economic and legal standpoint, taking the British experience in this regard into account.
Mr Maciej Bukowski, chairman of the Warsaw Institute for Economic Studies (WISE) presented the economic perspective. The chairman of WISE presented the history of the functioning of Contracts for Difference on the markets as well as the three types of price guarantees provided by the government in order to reduce price risks, capital costs and the costs of energy generation using the given technology.
The first type thereof, i.e. the fixed feed-in tariff (fixed FiT) is a government guarantee of specific revenue on the sale of energy units, regardless of market prices. This method is expensive for the government to maintain and confers disproportionate benefits upon investors: when the fixed FiT method is used, they can benefit from high market prices and yet they incur no losses when the prices are low.
Another type of instrument is the feed-in premium (FiP) scheme, under which a fixed premium is paid by the government on top of the market price for energy. This solution poses a risk for investors, since if the prices decrease suddenly, energy generation may no longer be viable despite the premiums paid.
Mr Bukowski pointed out that it is the third option – Contracts For Difference (CFD) – which ensures the best balance between the risks faced by energy manufacturers and the government. Built upon the experience from the implementation of the Fixed FIT and Premium FIT guaranteed tariffs, CFDs combine their advantages (decreasing investment risks and capital costs) while at the same time minimising their drawbacks (low fiscal efficiency, disproportionate benefits for investors).
– Contracts for Difference involve ensuring a fixed income per energy unit for the manufacturer thereof. The difference between the market price and the contractual amount is covered by the government (when the price is low) or by the manufacturer (when the price is high). The CFD protects manufacturers against the risk of changing prices, which translates into lower capital cost. Mr Bukowski emphasized that it is worth noting that the introduction of CFD FIT for the zero-emission energy sector could make it possible to decrease the cost of the energy generated by approximately 1/10, owing to a lower investment risk. At the same time, this objective is achieved at a relatively low price for the budget, as the government has an opportunity to recover a part of the subsidy granted in cases where there is an increase in electricity prices – he added.
Information about the British experience with energy market reform was presented by Ms Julia Pyke from the Herbert Smith Freehills law office.
As Ms Pyke explained, the guarantee model introduced in the UK was based on quotas allocated under contracts for difference, financed on the basis of a compulsory fee imposed by the government upon all licensed electricity suppliers (known as the “Supplier Obligation”), the amount of which is then paid out to the specified counterparty (known as the “CFD Counterparty”) in order to make it possible for it to make payments to energy manufacturers under the applicable contracts.
Ms Pyke stated that the relatively high guaranteed price for energy generated in a nuclear power plant in the United Kingdom (92.5 GBP per MWh) should not be used as baseline for Poland due to differences in the regulatory environment, higher labour costs in the UK and the significant amount of uncertainty linked to the implementation of previously untested technological and regulatory solutions. She also pointed out that the implementation of the solution based on contracts for difference was a very time-consuming process. When we look at this issue in the light of the British experience in this regard, we may conclude that making legislative changes far in advance can make it possible to decrease the costs of implementation. Conversely, when last-minute legislative changes are made, costs can increase dramatically – Ms Pyke explained.
The current regulatory environment in the energy sector was discussed by Mr Jerzy Baehr, representing the WKB (Wierciński Kwieciński Baehr) law office. He emphasized that, due to the financing mechanism applied, contracts for difference may not be concluded on the basis of the provisions of the Polish Civil Code alone.
He opined that the present regulatory environment does not contain any general basis for the unconstrained introduction of contracts for difference in any sector whatsoever – in order to do so, a specific legal basis is always necessary. Mr Baehr emphasized that applicable legislation is the key to success insofar as the implementation of contracts for difference in the nuclear energy sector is concerned. – The more precise the principles applicable to the contracts are, the greater the degree of protection afforded to the interests of the investor. It is also important that regulations should not only apply to the elements of contracts for difference, but also to the procedure of conclusion thereof – Mr Baehr noted.
In the course of discussion, experts also considered the question whether contracts for difference in Poland should apply to sources of energy other than nuclear energy. They also discussed the question of whether there is a different way in which the energy mix for Poland could be determined for the next 20-30 years – one that does not involve nuclear energy.
“Contracts for Difference for the zero-emission energy industry” is the first among a series of seminars organised by the Warsaw Institute for Economic Studies and the Polish Confederation Lewiatan. It was held on March 4, 2015, at the offices of the Polish Confederation Lewiatan and was attended by representatives of government ministries, the business community, politicians and lawyers.
