In 2024, the Labour Party came to power promising to decarbonise the electricity system by 2030, a policy known as Clean Power 2030 or CP2030. The CfD is instrumental to that ambition – it has become a proven policy tool to secure investment in new electricity generation capacity in the UK.
While CfD auctions are held annually, to achieve CP2030, the three CfD auction rounds in 2025-2027 will be pivotal. To meet their target, the Government cannot afford any of these three auctions to be a failure. The first of these auctions – AR7 – will open on 7 August this year. Can they make sure it is a success?
The Government is tinkering with the rules right up to the opening of the auction, indicating at least nervousness on the part of the Government. It is trying to increase competition by opening the CfD auction to offshore wind projects which have not obtained consent for their projects. It is removing the need to commit to a fixed monetary budget before the auction opens, giving it more flexibility when allocation decisions are made. Most significantly, it is seeking to neutralise myriad policy uncertainties where policy decisions are not scheduled to be taken before AR7 opens. Three in particular are causing headaches for the organisers of AR7 – zonal markets, use of system charges and grid delays. They go to the heart of any business case, affecting revenue forecasts, expenditure forecasts and the date when revenues start to flow.
Given that decisions are not expected before AR7 opens what are investors and developers to make of bidding in AR7?
Zonal Markets
In 2022, the UK Government launched a review of the electricity market arrangements, known as REMA. It is a wide-ranging review that continues today. One of the changes being considered is the introduction of zonal markets. A decision is not expected until the end of this year – after AR7 opens.
How can a CfD bidder submit a bid if it doesn't know the value of its output? The Government is seeking to address this by committing to amend the reference price for AR7 CfD holders to the zonal price. This would mean that AR7 holders would be entitled to the difference between the strike price and the zonal market price for the duration of the CfD.
Bidders however face another uncertainty with zonal markets – volume risk – that is, that they cannot accurately forecast their lifetime output because the zonal price might be zero. Forecasting the periods of time when prices will be zero or less is fraught with uncertainty. Zonal markets will be smaller and less liquid resulting in more price volatility and therefore increasing the risk of negative price periods. Couple that with uncertainty as to how the balancing mechanism will operate in the context of zonal markets and it is clear that export volumes will be harder to forecast in a zonal market world.
The Government does not want CfD bidders to price this risk into their CfD bids, at least in AR7. It is therefore proposing to protect AR7 bidders against loss of revenue attributable to zonal markets, if they are introduced. This measure will not fully protect generators against constraint/zero prices (which would fully de-risk CfD bids). Rather the Government intends to protect generators against constraints to the extent they occur as a result of zonal markets as compared to a national market (and is considering three methodologies for doing so).
This approach relies on creating a national market counterfactual against which actual zonal market constraints would be compared. AR7 bidders will therefore need to price the basis risk between this protection and anticipated actual volume losses for their project, especially as it is not clear the extent to which the balancing mechanism will enable them to manage their exposure to constraints.
Volume risk exposure in zonal markets is a matter of debate. The immediate question though is whether a statement of intent by the Government will be treated by developers as sufficient protection for them to bid into AR7. On the one hand, bidders will be expected to sign CfD contracts with binding legal commitments while, on the other, the Government is setting out only an intention to protect bidders (and one that will probably require primary legislation). The Government could add change of law protection to the CfD but has not done so. Given the AR7 timetable, perhaps the Government will read the room and rule out zonal markets, if not before AR7 opens, then before bidders submit their CfD bids.
Use of System Charges
For many generators, transmission network use of system (TNUoS) charges are the largest operating cost they face. Indeed, in the north of Scotland, the lifetime charge for a 1GW project is forecast to amount to £1 billion (per Aurora Research May 2025). It is a cost that needs to be priced into a CfD bid.
Ofgem has put a temporary cap and floor on TNUoS charges in place, while it consults on permanent changes to the way in which TNUoS charges are calculated. Temporary protection helps existing operators, but it does not protect AR7 bidders because they do not know how TNUoS charges will be calculated when their projects become operational.
The problem is years in the making but CP2030 has sharpened the dilemma. To achieve CP2030, projects in the north of Scotland must be built. If north of Scotland projects are not allocated CfDs, the Government will fail to meet CP2030. If they are allocated CfDs, it is likely that a north of Scotland project will set the clearing price for the auction, resulting – in effect – in high TNUoS charges being reflected in the strike price across all CfD projects. The whole point of locational TNUoS charging is that it is intended to reduce costs to consumers. It would be ironic to say the least If the interaction between TNUoS and CfD policies ends up resulting in higher costs to consumers.
Ofgem could make a decision on TNUoS reform before bids are due to be submitted in AR7. Even then, unless the proposed TNUoS reform is far reaching, policy makers will still face this dilemma. Ideally, policy would reconcile locational charging, CP2030 and the CfD clearing price methodology by reforming TNUoS charges in a way that takes into account the cost to consumers of both systems charges and CfD costs, not just the former. There may not be time, however, for ideal policy development (even if there should have been) and so we may see further interim measures being taken by Government to apply in AR7.
Grid Connection Reform
The third unknown for AR7 bidders is grid connection dates. NESO is reviewing all existing grid connections as part of its reform of the grid queue (the NESO grid review), which means that developers will have confirmed connection dates and costs only at the end of the review.
AR7 is scheduled to open on 7 August 2025 with the application window closing on 27 August. The NESO grid review is not due to conclude until September, after the closure of the CfD application window. In submitting CfD applications, applicants must identify the delivery years into which they are bidding, and their target commissioning windows (TCW), which means, ideally, that they would know their connection dates.
Developers seeking "advancement" in the NESO grid review process face a 'chicken and egg' scenario. In order to participate in AR7, applicants must submit a signed grid connection agreement with a date falling within the delivery year. Yet, if their existing grid connection date is not in the same delivery year as their intended advanced connection date, they would not be eligible for the auction under the rules in place for AR6.
If applicants could be eligible on the basis of their intended advancement date, they could be in a position to bid in the sealed bid window as they should have their advanced grid connection dates by then. Ideally, the Allocation Regulations for AR7 will find a way to accommodate applicants wanting to secure CfDs based on their intended advancement dates – indeed, that would seem to align with the purposes of advancing connection dates.
The Government has not addressed what happens if an applicant's grid connection date is delayed, jeopardising its ability to meet its TCW. As of now, it would appear that applicants will need to decide if they can still meet their TCW or whether they will need to withdraw from the auction – there is no mechanism for applicants to adjust their applications. The CfD terms and conditions contain provisions permitting the TCW to be extended as a result of any "failure" by NESO to carry out connection works in a timely manner. Would that provision apply to a delay caused by an applicant being given a later connection date as a result of the NESO grid review? It is not clear that it would.
Given that the aim of the NESO grid review is to speed up deployment, the Government must hope that no applicants will find themselves in this position. A clarification from NESO/LCCC would be helpful.
And Finally…
AR7 will not be priced in 2012 prices (as was the case for each auction up to 2024). Remember this when the headline strike prices are published – they will be much higher than the headline figures for previous auctions but less so once inflation adjustments are made. Someone no doubt will make mischief.
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