Ofgem launches consultation on evolution of the OFTO tender regime

On 12 December 2024 Ofgem published its consultation on the extension and evolution of the OFTO tender process. The consultation covers three key areas: (i) extension to OFTO’s Tendered Revenue Stream (TRS) for existing licence holders, (ii) increasing the duration of the original TRS term for future licence-holders, and (iii) other proposals for enhancing the efficiency of the tender process.

This builds on a number of previous consultations relating to the regulatory process for OFTO assets which are nearing the end of their original design life and, accordingly, the end of their tender revenue stream period under their licences. The consultation is particularly relevant for OFTOs who secured licences in early tender rounds, which are due to reach the end of the regulated revenue streams from 2030 onwards, but will also be of interest to OFTOs under later tender rounds and indeed bidders in upcoming rounds.

Background

The latest consultation follows three previous consultations in this area in March 2021 on end of tender revenue stream policy (decision issued in July 2021), June 2022 on policy objectives, competition, asset value and the performance incentive mechanism (decision issued in January 2024) and November 2022 on modifications to offshore transmission licences (decisions issued in June and July 2023). In addition, Ofgem recently published guidance in relation to health reviews for windfarm and OFTO assets in November 2024.

Extension Revenue Stream proposals

In the consultation Ofgem makes a number of proposals in relation to extension of the OFTO revenue stream (known as the Extension Revenue Stream or ERS, which will be distinct from the TRS already awarded) as follows:

• OFTOs will submit formal bids to Ofgem for the ERS 4 years before the end of their existing TRS period. This is expected to comprise details of O&M costs, operational costs, insurance, financing, advisory fees and any additional costs such as tax. It will not include investment works which will be dealt with separately or decommissioning costs which are already captured under the TRS. Given the ERS bids will not need to include the costs of purchasing and financing the OFTO assets, bids are expected to be substantially lower than the TRS.
• In respect of major repairs or failures occurring in the ERS period, Ofgem has proposed three possible options:
  1. OFTOs could be responsible for their own repair costs with recourse to licence protections in specific circumstances (as under the TRS period), however Ofgem has noted this risks encouraging OFTOs to build a contingency pot for repairs which is likely to prove unnecessary, at a cost to consumers and developers;
  2. OFTOs could be responsible for minor repairs, with repairs over a certain threshold falling to the windfarm to make at their discretion; or
  3. OFTOs would operate the transmission system only up to the first major failure event with the option to run the system with lower availability in the case of a partial failure.
• In respect of the availability target for the ERS period, Ofgem has considered a number of adjustments to the availability incentive mechanism, including lowering the availability target or level of bonus payments, introducing a more balanced scorecard metric for performance, withholding availability bonus payments until the end of the extension period, or linking availability bonuses to the TRS and penalties to the ERS. However, it has ultimately proposed to retain the existing 98% availability target.
• Ofgem has proposed to align the TR1 OFTO licences with those from TR2 onwards in respect of the requirement for financial security to be uprated in line with inflation. In addition, it is proposed that OFTOs will withdraw their existing financial security at the end of the TRS and replace it with a new form of financial security equal to 50% of the ERS, also updated for inflation.
• Ofgem has proposed to amend the OFTO licence to allow it to make partial awards for investment works where there will be a significant impact on cash flows (i.e. where the costs of investment are high in comparison to the OFTO’s TRS), but it does not propose to make partial awards available for the cost of health reviews, which is considered minimal.
• It is expected that extensions will be granted for a period of 5 years or more, with consideration of shorter periods on a case-by-case basis where requested by a developer. Ofgem has proposed that windfarms should enter into a guarantee with Ofgem and/or the OFTO, which would require the generator to pay outstanding costs owed to the system operator (or a proportion thereof), in the event of an early exit, either by way of ringfencing funds or providing credit cover. This would allow recovery of sunk OFTO costs, such as repair and investment works already undertaken and early exit fees in respect of O&M and insurance services. ERS periods would also continue for a specified period (e.g. one year) following windfarm switch-off to allow the OFTO to meet its costs of winding down transmission.

Possible extension to the existing TRS period

In addition to considering proposals relating to any extension tender revenue stream to be granted, the consultation also considers whether it is appropriate to extend the duration of the original TRS term (currently a maximum of 25 years) to a longer period that is more in line with the life expectancy of offshore windfarms.

The consultation details a number of advantages and disadvantages of increasing the TRS period, covering a wide range of issues such as the efficiency of the tender process and avoiding the need for an extension process where assets remain viable. It also notes the potential issues around the technical capacity of the windfarm and transmission assets such as the additional maintenance and monitoring requirements for a longer-term asset and how these can be mitigated by licence protections. The consultation additionally considers the financial and commercial viability of a longer TRS period with regard to operating costs and the potential challenges of obtaining OFTO financing for a longer period based on the current debt market.

Ultimately, Ofgem does not make any firm proposals in this area and instead is seeking to gather further evidence before proposing any changes. In particular, it intends to take lessons from the first group of extension assets to inform its assessment of this issue. As a result, we do not expect any decision to formally extend the TRS period to be announced at this stage, but stakeholders should use this opportunity to note their concerns or suggestions around the potential implications of this.

Other proposals for improving the efficiency of the tender process

The current tender process allows for an 18 month generator commissioning period during which the developer can transmit electricity without a licence or specific exemption for the purposes of commissioning the transmission assets. This period is set out in the Energy Act 2013 in what is known as the generator commissioning clause or GCC. Whilst, as noted in the consultation, any potential extension to the GCC period would be a matter solely for the Department of Energy Security and Net Zero (DESNZ) (and indeed has been the topic of a call for evidence by DESNZ in recent years), Ofgem has nevertheless considered how any potential extension could be used to maximise efficiency within the tender process. This is particularly relevant in the context of the more frequent requests for extensions to the GCC over recent tender rounds.

The consultation sets out three proposed timetables for a 6 month, 9 month or 12 month extension to the existing 18 month GCC. A key feature of all three scenarios is the delay of the start of the ITT period to allow bidders to conduct a more thorough due diligence process, which would be aided by the transmission assets being further along in their commissioning processes and the likelihood of snagging issues having been resolved. The possibility of bringing forward the Initial Transfer Value and Final Transfer Value decisions to allow these to be made in conjunction with or before the submission of bids is also considered by Ofgem to be advantageous and allow more definitive bids to be submitted. The consultation appears to suggest that a 9-month extension would be optimum to improve the efficiency of the tender process whilst reducing the risk of the OFTO’s financing offer being timed out.

Ofgem has also considered the possibility of creating a vendor due diligence report requirement, which it considers would reduce the due diligence to be carried out by bidders and in turn lower the cost and resource burden. We expect OFTOs are likely to have strong views on this point as in the past bidders have demonstrated a reluctance to rely on vendor due diligence and have favoured carrying out their own review. In particular, we would expect OFTOs to require robust reliance and liability provisions to be in place in respect of such reporting (for example, in favour of the OFTO’s lenders) which may not be acceptable to vendors.

Next Steps

The question of “what happens next?” has long been a point of discussion in the OFTO and offshore wind market, and we expect market participants and stakeholders to take a keen interest in Ofgem’s proposals for the ERS. The consultation is open for responses until 28 February 2025, with a decision expected in Q2 of 2025.