Lockdowns around the world because of the Covid-19 pandemic are depressing demand for power and driving down prices. The crisis will – it is hoped – come to be seen as a temporary interruption to the smooth functioning of energy markets, but could affect appetite for unsubsidised projects and how developers approach the UK’s Allocation Round 4 (Round 4)
Research by leading energy analysts including Cornwall Insight and Aurora Energy Research has confirmed that Covid-19 has already had a profound effect on power prices.
In mid-April Cornwall Insight highlighted a growing number of negative pricing events across wholesale markets, events that it had predicted, but only as the volume of intermittent, subsidised, renewables plant on the system grew significantly.
“The recent shock to demand has brought forward what we might have expected to observe in the future, when renewables make up a greater proportion of generation,” the company said, noting that Great Britain might face longer-term demand impacts due to an economic downturn, which could affect prices in the winter of 2020/21.
A report from Aurora Energy Research explored four scenarios for the impact of Covid-19 on European power markets: at one extreme considering a ‘moderate’ scenario where lockdowns are eased in Q2 2020, through to a worst-case scenario characterised by a European and global depression.
The analysis showed that even in a more moderate scenario, power demand and prices are expected to be significantly lower in 2020 compared to pre-Covid-19 expectations, and that a recovery might not happen until 2022. A more severe scenario could see wholesale power prices fall by 30-50% in 2020, and markets not recovering fully until 2025.
The implication of the report is that utilities could be significantly affected by the drop in power prices, with impacts varying by country and technology type. Among the worst hit will be merchant-exposed wind and solar projects, Aurora Energy Research expects.
In contrast, subsidised renewable schemes which make up the bulk if not all of UK offshore wind will see revenues partly or fully protected by governments, despite the fall in market prices, although these higher subsidy costs will feed through to consumers.
But with offshore wind transitioning to subsidy-free projects – and merchant projects or quasi-merchant projects expected by some to become commonplace in the UK market – the impact of low power prices could be felt sooner than expected, analysts suggest.
Developer/utilities such as SSE Renewables have already highlighted that a target of 40 GW of offshore wind capacity in the UK by 2030 combined with a large amount of other zero/low marginal cost generation, such as onshore wind, solar and nuclear, is expected to have a significant impact on wholesale electricity markets, with an increasing number of periods of low or even negative wholesale electricity prices.
The company believes that low power prices would become an increasingly significant risk for the deployment of future offshore wind projects where merchant returns post-CfD are a vital consideration for developers looking to submit viable bid prices in an increasingly competitive market.
“Long-term wholesale energy price expectations are a critical factor when considering project life extensions and repowering existing offshore windfarms after their subsidy ends,” SSE said. And although almost all existing offshore wind projects in the UK are fully subsidised, not all of them are – in SSE’s Seagreen project, for example, only 42% of the output is covered by a CfD, and the rest of which will be farmed down to investors.
Cornwall Insight believes reduced demand and low prices caused by the pandemic could make some developers re-assess the business case for upcoming projects. “Typically, low wholesale prices might attract companies to the comfort and security of a contract for difference (CfD),” the company told OWJ. “However, the potentially large number of bidders in the UK’s Round 4 offshore wind auctions could significantly increase competition and lower prices, which could also put some potential participants off.”
Generally, it said, generators take a 15-year plus view on the market to underwrite investment and will want to put Covid-19 in this context. But the longer Covid-19’s impact persists the more influence it would have on the cost of construction and supply changes.
There is another important issue too, says Cornwall Insight. “If prices do stay low, then existing CfDs become more expensive, because of higher top-up payments. That might have an impact on the budget the government is willing to commit to in Round 4.
“In addition, whatever budget is there for Round 4 could procure less capacity if the government reflects lower prices in its auction calculations, as each project bidding would also have a higher forecast top-up payment.”
Aurora Energy Research head of commissioned projects, Western Europe, Felix Chow-Kambitsch told OWJ, “Wholesale power prices have certainly fallen significantly due to Covid-19. Subsidy-free and merchant-exposed renewables are adversely affected by this fall.
“This puts prospective wind projects with near-term merchant exposure at risk. It would be challenging to proceed with an investment decision for a project with significant merchant exposure in this environment.
“Low power prices will likely lead to more cautious bidding behaviour by merchant exposed projects in upcoming wind auctions. In contrast, the price certainty provided by CfDs would likely be more valued as a result of the fall in power prices.”
In a recent blog, Renewables Consulting Group chief operating officer Lee Clarke said, “Although resilient, renewables are unlikely to emerge unscathed.
“Renewable energy infrastructure requires massive upfront investment. Yet the cash flow companies rely on to make investments has been compromised.
“Wholesale power prices have tumbled as electricity demand has slumped and at the same time many utilities are being asked to forbear on bills to consumers and businesses. High debt will weigh heavily on the capacity of the private sector to make necessary investments.”
He highlighted that Swedish utility Vattenfall recently announced it would not take part in the Netherlands’ Hollandse Kust Noord offshore wind tender because of the coronavirus pandemic, citing what it described as “a careful evaluation of risk-reward.” Despite this, the Netherlands Enterprise Agency has confirmed the tender will continue as planned and is open until 30 April 2020.
Mr Clarke noted that the Crown Estate is pressing ahead with Round 4 with only a small delay to assist bidders with getting to grips with remote working. The Crown Estate Scotland has signalled a similar approach for the forthcoming ScotWind offshore wind leasing round, moves that have been welcomed by industry.
“But where debt finance is required, lenders are likely to be wary of committing funds until the impacts of the pandemic are understood and risks mitigated,” Mr Clarke said.
“Projects underpinned by guaranteed contracts – power purchase agreements or CfDs – could provide a relatively safe home for investment, with the sector providing a stable return, but the burden of additional extraordinary costs due to the crisis may stretch project budgets to the point of default or breach of financial covenants.”
Mr Chow-Kambitsch concluded, “As a consequence of Covid-19 and its effect on energy demand, wind now represents a more substantial proportion of Great Britain’s energy mix. This has resulted in not only record low wholesale prices but a surge in negative pricing events.
“However, while we expect a dampening in overall growth in renewables over the short- to medium-term, the momentum for repowering in developed economies and building capacity in developing economies is unstoppable.
“Stimulus and pandemic recovery packages could also accelerate the shift to sustainable energy. Some renewable technologies could be ramped up relatively quickly once restrictions are eased and supply chains recover.”