Expanded National CIS: What are the pros and cons?

The expanded Capacity Investment Scheme (CIS) announced last week aims to bring forward 32GW of generation investment - 9GW dispatchable capacity and 23GW variable renewable capacity - with the costs of the scheme funded by the Federal Government.  It can be expected to encourage new capacity which will represent a significant injection of renewables into a grid with ongoing system constraints so does not come without some risks. Below we take a look at the model being used and consider some of the pros and cons of the scheme.

Cap and Collar

The CIS is based on a “cap and collar” scheme where project proponents are guaranteed revenue within a set range (see Figure 1) under Contracts for Difference (CfDs).  CfDs, or a variation thereof, have been used in Australia and overseas. The common principles are typically:

• Bids are invited from proponents. Project selection criteria are made clear at this point.
• Tender selection is carried out administratively, based on meeting threshold criteria (usually focussed on weeding out non-credible bids), and evaluating against selection criteria. Usually, the primary criterion is value-for-money, but some weighting is often given to other factors. In this case, lowest cost projects may not win the tender.
• A successful project will receive the benefit of the scheme for a predetermined number of years with 10-15 years typically considered appropriate to allow a project to be financed.
• Some jurisdictional schemes have a single round, but for a large target, annual rounds would be held. The Government announced that for the extended CIS, tenders would be held every six months.

The CIS is intended to act as a backstop provider of revenue, with projects free to (and expected to) find commercial counterparties and to take the opportunity to earn revenue from renewables certificates (currently Large-Scale Generation Certificates, known as LGCs, and in the future potentially certificates generated under the Renewable Electricity Guarantee of Origin scheme, REGOs). From the government’s perspective, this reduces the cost of the scheme.

Figure 1: How the CIS works

Source: DCCEWW

For the 9GW of dispatchable capacity, comparability of different technology types will be carried out on a MW basis, with each project rated on its ability to provide firm capacity for a four-hour period. The eligibility requirement of zero Scope 1 emissions remains, with gas projects excluded from the scheme. Given projects need to be online by 2030, there might similarly be constraints on the ability to identify and develop a pumped hydro project within the timeframe.

In the case of the 23GW of variable renewables proposed under the scheme, this capacity criteria is obviously not relevant. These projects will likely be compared on the MWh they are expected to deliver to the system (i.e. after adjusting for loss factors). The revenue floor and ceiling would need to be converted to a MWh basis. However, we expect that revenue would still be measured on an annual basis, rather than applying the floor/ceiling to each MWh of output.

What are some pros and cons of a CIS-style CfD?

Some key things to think about with the CIS-style CfD are to what extent could market outcomes be distorted, whether the scheme will deliver what the Government is targeting, and what the costs to consumers and taxpayers will be.

• Will the CIS-style CfD distort market outcomes?

Schemes that target renewables deployment dampen overall market signals for when and where energy is most valuable and the extent to which a plant contributes to system costs, such as frequency control requirements.

But a CIS-style CfD using a high and low revenue range for a project avoids some of the distortionary impacts of a single fixed-price CfD. A fixed-price CfD incentivises lowest cost renewables regardless of whether they are delivering value to the system.

In theory, the project that requires the least revenue contribution over the life of the CfD contract should have the smallest gap between their cost and the value they provide to the system. This evaluation is predicated on the model correctly predicting the net payment each bid will require from the government.

If a project underperforms - e.g. if it is curtailed more often, or the weather resource turns out to be lower than expected, then the project is more likely to fall below the revenue floor and the government will have to pay out more than it expected to. In this way, volume risk is shared with the government to a greater degree than other support schemes. Price risk is also shared, although this can be partially mitigated by a zero-price floor clause where negative prices do not contribute towards the annual revenue calculation. The risks of poor forecasting are lower the more the government can rely on independent input assumptions about each project’s expected performance.

• Will a CfD deliver against the Government’s policy objectives?

Another risk for Government to manage with the expanded CIS is in an environment with escalating costs, there is some risk that successful tenderers do not proceed, as was the case recently in the UK offshore wind sector, long presented as one of the most successful renewable support schemes internationally. The UK’s challenges have been compounded by the government’s choice to put a tight cap on the maximum strike price (albeit at a higher level than the actual strike price achieved in the previous round). 

A CIS-style CfD only partially mitigates these risks, given it is using expected revenues as a benchmark rather than costs, so bids will be based on the costs proponents expect to incur at the time of bidding. Pre-screening of bids to be shortlisted can include criteria that favour more advanced projects, nonetheless, limited progress can be made until financing is locked in, and financing will be predicated on winning a contract under the scheme.

The complexity associated with running a series of tenders should not be underestimated, with potential delays in getting the tenders up and running.  AEMO Services' Long-term Energy Services Agreement (LTESA) tenders offer a reasonable insight into the likely CIS process and timeframes, with three LTESA tender rounds completed in New South Wales to date.  All three tender rounds took approximately eight months from announcement of the tender to the tender being awarded, with detailed documentation required to inform bidders of the assessment criteria and process.[1] 

The CIS will also have an interaction with the relevant State jurisdictions to navigate, with negotiations of the bilateral Renewable Energy Transformation Agreements (RETAs) also required ahead of tender processes commencing.  These RETAs may include jurisdictional commitments to exceed their current renewable targets, ensure reliability is maintained via reliability benchmarks through the transition, manage the orderly exit of thermal units, invest in strategic electricity reserves to address tail risk and streamline planning and environmental approval processes.  Each RETA will be jurisdiction specific, and 18GW of the 32GW will be subject to the RETAs, with capacity reallocated absent jurisdictional commitments being made.

• Cost of the CIS-style CfD

The CIS-style CfD costs will be funded by taxpayers, and for this reason will not directly hit energy bills.  Regardless, the costs of the scheme must still be borne by the community.

If significant capacity comes into the energy system where there are supply constraints in transmission, the bang for buck from this additional capacity could be constrained for a period of time, meaning the costs are higher than they would otherwise be.  Relieving these supply constraints (transmission, social licence, supply chain, labour constraints, the impact of small scale solar on large scale renewables) will help ensure Government can get the best return possible on its investment of taxpayer funds.  Absent this, taxpayers could carry the risk that a portion of this extra generation can’t be delivered to consumers, meaning an inefficiently large amount of capital is deployed and utilised less than is expected during the tender. 

[1] https://aemoservices.com.au/tenders/tender-round-3-generation-and-long-duration-storage