The UK’s much-anticipated contract for difference auction, due to take place in Q2 2019, could result in offshore wind that costs the government just £2/MWh (US$2.6). Depending on how wholesale electricity prices evolve, it could even result in projects returning funds to the government.
In a statement issued shortly after Hitachi stepped back from the Wylfa nuclear power project in the UK earlier this month, UK Business and Energy Secretary Greg Clark made a point of noting that the cost of renewable technologies such as offshore wind has fallen dramatically, to the point, he said “where they now require very little public subsidy and will soon require none.”
Subsidy-free deals for offshore wind energy have been concluded before, but not in the UK – the world’s leading offshore wind energy market – where, unlike some countries, auctions include the cost of grid connection, which adds to contract costs. In 2017, the government awarded contracts for offshore wind at record-low prices of £57.50 per megawatt hour (MWh), but industry analysts believe the UK is now also on the verge of zero-subsidy offshore wind.
That the next auction will result in what will very nearly be zero-subsidy offshore wind in the UK is confirmed by documentation released by the Department for Business, Energy and Industrial Strategy (BEIS) this month.
In the document, Contracts for Difference Scheme for Renewable Electricity Generation - Draft Allocation Framework for the Third Allocation Round, 2019, data from BEIS shows that it expects to contract for electricity with a subsidy of less than £2/MWh for projects opening in 2024/25.
Carbon Brief policy editor Dr Simon Evans explained that the key to what BEIS thinks is ‘do-able’ lies in the difference between the administrative strike price (ASP) for the upcoming contract for difference (CfD) auction and the reference price.
“One is the maximum bid BEIS will accept in the auction, the other is its estimate of wholesale prices when intermittent renewables are generating. For projects commissioning in 2024/25, this difference is less than £2/MWh and, hence, if the BEIS wholesale price estimate is correct, it will pay just £2/MWh for electricity from offshore wind. In my book, that’s nearly subsidy free,” he said.
Data from the CFD allocation framework showing how close the ASP and reference price are (source: Cornwall Insight)
Cornwall Insight senior consultant Tom Edwards agreed. As he told OWJ recently, BEIS has been looking at other European auctions, that have cleared €40/50 (US$46-57) MWh, and believes there is still more cost reduction that can be achieved in the UK.
He told OWJ, “These are the numbers used to allocate the auction pot, so while there is only a £2/MWh difference between the cap and the intermittent reference price, other market participants believe power prices could be even lower as a result of price cannibalisation. Under these assumptions we believe BEIS could procure between 1.2 GW and 7 GW of offshore wind capacity, depending on the delivery year of the project.
Under these assumptions we believe BEIS could procure between 1.2 GW and 7 GW of offshore wind capacity, depending on the delivery year of the project.
“However,” said Mr Edwards, “even if on average these projects are near to subsidy-free, investors are likely to require some revenue stabilisation to guarantee returns, hence our call for a CfD stabilisation floor.”
Aurora Energy Research senior associate Dimitri Kyriazis agreed that the small spread between the ASPs and intermittent reference prices could lead to a significant offshore wind capacity winning CfD contracts in the auction. “If a significant amount of offshore wind capacity bids in 2024/25 at or below £53/MWh then projects securing contracts could reach the 6 GW capacity cap for the auction,” he said.
However, he sounded a note of caution. “With regard to the competitiveness of the auction, it is important to note that in order to win CFD contracts, offshore wind projects will need to submit lower bids than any project in the UK so far, which could be quite challenging for the offshore wind industry in the context of supply chain constraints.
“The reduction in ASPs certainly contributes to the reduction of CfD subsidy costs compared to previous auctions. However, the actual subsidy cost for offshore wind projects that are successful in Round 3 will ultimately depend on the wholesale price the projects will be able achieve from 2023/24 onwards, which will effectively determine the reference price.
“The level of price cannibalisation is a key uncertainty in this regard. As more offshore wind capacity with very low marginal cost enters the system, the wholesale price could fall significantly during periods of high wind output.
“Aurora modelling indicates that the effect of price cannibalisation could lead to reference prices that are lower than the intermittent reference price assumed by BEIS. This might mean that offshore wind projects are actually slightly further from subsidy-free status than the government seems to be assuming.
“However,” he explained, “it is important to note that CfD spending is only part of the bigger picture of consumer cost implications when it comes to supporting renewable technologies. Higher offshore wind capacity in the system could lead to a decrease in wholesale costs to consumers, offsetting to an extent the effect of CfD spending to support projects.”
A consultant at Offshore Wind Consultants, Juan Frias told OWJ he also expects the CFD to result in projects that will almost be subsidy-free.
“The ASPs are the maximum numbers the developers can bid. They are £56/MWh and £53/MWh for projects commissioned in 2023/24 and 2024/25, respectively. The reference prices are the average electricity market prices when renewables are generating, and these are £48.62/MWh and £51.32/MWh for 2023/24 and 2024/25, respectively. The reference prices are set to calculate the budget impact of each project. Because the difference between the ASPs and the reference prices is so small, potentially, many GWs could clear the auction, even though the budget is capped at £60M and there is a cap of 6 GW of capacity.
“If the estimates from BEIS of wholesale electricity prices are correct, then projects in 2023/2024/2025 would need very little subsidy. However, if, for example, gas prices were lower or there is a large build-out of solar PV or onshore wind, wholesale electricity prices would be depressed below the reference price and the cost of subsidies for the projects would go up.
“If on the other hand decommissioning of nuclear and coal plants were to lead to an increase in wholesale prices, above reference price, and if wholesale prices were to rise above the ASPs offshore wind projects would actually have to pay money back to the government.”
Mr Frias highlighted that having a CfD provides a route to market for projects and helps to reduce the cost of financing them. This reduces the levelised cost of energy for projects, which is important because finance costs are particularly significant for renewable energy because projects are capital intensive compared to natural gas, where fuel costs dominate over capital costs with regards to LCOE.”
“The alternative to CfDs would be to sign power purchase agreements (PPAs) with corporate purchasers but finding offtakers for 6 GW in 2023/24/25 would be very challenging. What is more, PPAs are generally of shorter duration than a 15-year CfDs offered by the government,” he said.
“Our understanding is that the actual subsidy paid will be the difference between the reference price and the strike price, so that could be a lot more or a lot less than £2/MWh. Under some scenarios, it could even go negative.
Experts at BVG Associates told OWJ, “Our understanding is that the actual subsidy paid will be the difference between the reference price and the strike price, so that could be a lot more or a lot less than £2/MWh. Under some scenarios, it could even go negative.
“We expect the allocation to turn into an auction and actual bid prices to be less than the £56/MWh and £53/MWh for the two years in question. This means that the difference between the actual ‘strike price’ and the actual ‘reference price’ in the settlement periods is likely to result in a payment to the government and so is ‘subsidy free.’”