Discover more from Energy Flux
How to keep offshore wind subsidies in check
If you read last week’s headlines about the increase in the administrative strike price for the UK’s next Contracts for Difference allocation round, you could be forgiven for thinking that offshore wind generators will be receiving ‘more subsidies’. While this is not entirely false, the reality is that a higher ASP merely increases the cap for strike prices, which are set competitively at auction. The clearing price is ultimately determined by the amount of subsidy available – the CfD budget – which is not yet known.
The UK government faces the unenviable task of setting a budget for the sixth CfD allocation round (AR6) that achieves two conflicting policy priorities. First, it must restore confidence and re-inject momentum into an industrial sector that is deep in crisis. At the same time, it must achieve value for money for consumers.
The 66% increase in the offshore wind ASP from £44/MWh to £73/MWh (in 2012 money) goes some way to achieving the first of these. It means that some new capacity will clear at AR6, rather than a repeat of the previous auction when no projects bid. Whether it achieves the second depends on the price at which the AR6 bids clear, which in turn depends on the budget.
There is a direct correlation between budget size and clearing prices. The more money that is available in each ‘pot’ of technologies, the less intense the competition because more projects will be able to clear the auction. In contrast, a small budget constrains access to CfDs and projects must bid lower to increase their chances of winning.
The CfD budget determines how much capacity will be procured at auction and is therefore the most important parameter in determining value for money from each allocation round. In fact, the ASP – the ceiling price – is almost irrelevant. It could be set at £300/MWh, or even scrapped altogether, and projects would still bid according to the amount of budget available. If the pot is small, a bid of £300/MWh stands no chance of clearing the auction. But with a big enough budget even the most expensive project will win a CfD.
A high clearing price is expensive because CfD auctions operate on a ‘pay as clear’ basis, rather than ‘pay-as-bid’. Every CfD is awarded at the price of the highest successful bidder, not the price bid by each project. So if the budget really was big enough to support a clearing price of £300/MWh, every single participating project would get £300/MWh – even if they bid well below this.
When setting the budget, the government needs to assess: how much volume must be contracted to achieve priority 1 (industry momentum), and how close is the resulting clearing price to priority 2 (value for money)?
Neither are easy to determine. On the question of pace: a total of 10.19 GW of offshore wind capacity was procured across the first four CfD auctions (AR1-4), with each auction contracting on average 1.9GW more than the last. To regain this pace and make up for the zero bids at AR5, AR6 would need to contract roughly 15GW of new offshore wind capacity. Coincidentally, that’s the amount of capacity that trade body Regen says could be eligible to participate in AR6.
As for value for money: offshore wind procurement prices have surged in other jurisdictions this year, with developers in New York requesting big hikes to power purchase agreements (PPAs) from state regulator NYSERDA. Empire Wind 2 asked for its $107.50/MWh original price to be increased to $177.84/MWh and Beacon Wind asked to boost its $118/MWh PPA to $190.82/MWh. NYSERDA duly declined.
The ceiling price for AR6 of £73/MWh in 2012 money is £100.32/MWh when adjusted for inflation, which equates to $125/MWh – so already the next CfD round will be less expensive than those (rather outlandish) New York PPA requests. But does it make sense to sharpen bids and push clearing prices lower by constraining the budget?
Compared to current market prices, £100.32/MWh is by no means cheap. The N2EX UK day-ahead price averaged £84/MWh in October and £97/MWh so far in 2023. This is well below the 2022 average (£204/MWh) but well above the 2014-21 average (£53/MWh).
Bear in mind that AR6 projects will not come online until 2026-27 at the earliest, when power prices could be much lower than today; the day-ahead price is almost always set by natural gas, the marginal generator, and there will likely be a glut of liquefied natural gas (LNG) in the global market between 2026 and 2030 following an influx of new LNG supply.
Squeezing the AR6 budget would help to bring the offshore wind clearing price down towards day-ahead electricity prices that might be expected in a low-gas price market environment. It would also avoid locking in high prices. Prices at subsequent auctions (AR7 onwards) are likely to be lower than AR6 as the costs of materials and capital (borrowing) fall from recent highs.
The UK government seems to have learned its lesson from the bungled AR5 auction, when offshore wind failed to show up. The move to hike the ceiling price indicates a strong desire to steady the ship, so there is little danger of the budget being set so low that it can only support the two keenest projects in the pack. The biggest danger is that ministers and officials over-compensate for this year’s CfD flop by brandishing the chequebook.
The CfD is index-linked for 15 years, so it is debatable whether aiming to procure 15GW now is in the best interests of consumers or the industry itself. If the budget is set at a size that could support, say, 8GW or 9GW this would leave another 6GW or more ready to bid at AR7 in 2025, when lower prices can be expected.
Exhausting the pool of CfD-ready offshore wind projects at the tail-end of a sharp inflationary cycle seems unwise. Any jobs ‘boom’ it might create could just as quickly go bust. The offshore wind industry has been marred by boom-bust cycles; forcing consumers to pay over the odds to atone for a failed auction does not put the sector back on a sustainable footing.
Seb Kennedy | Energy Flux | 20th November 2023
Enjoyed this post? Get Energy Flux straight to your inbox - sign up for free: