Less offshore wind = more gas, more £££

The UK’s looming offshore wind shortfall could cost billions in extra gas consumption

The UK is highly likely to miss its target to install 50GW of offshore wind by 2030. With no offshore wind projects bidding for Contracts for Difference (CfD) in last week’s big auction result, the world’s second biggest market for the technology outside China is stalling. The country will pay a hefty price for this failure in terms of additional unplanned gas burn. But how much are we talking about?

The capacity shortfall in 2030 is likely to be significant, perhaps as much as 50% judging by stuttering deployment momentum. Even in an optimistic scenario of a 10GW shortfall, the UK could end up paying £2.1 billion more every year if the gap is filled by gas-fired generation. That’s equivalent to £31.5 billion over the course of a 15-year CfD.

This is how the numbers break down. A 10GW chunk of wind operating at 40% capacity factor would generate 35,040,000 MWh per year. Let’s assume that amount of power is instead generated from a standard fleet of combined cycle gas turbines (CCGTs) with a typical heat rate of 7,000 Btu per kWh. That gives us a gas fuel volume of 245,280,000 MMBtu – equivalent to roughly 6.8 billion cubic metres (Bcm) of gas, or ~9% of the UK’s total gas consumption in 2022.

Gas ain’t free

The forward price on the National Balancing Point (NBP), the UK’s virtual trading hub for spot-traded natural gas, varies between 75 and 99 pence per therm (p/th) in 2028, the furthest year out on the curve. Let’s take the 2028 average – 86.9p/th – as our reference price. This equates to £8.69/MMBtu. Multiply that by the volume of gas (245,280,000 MMBtu) and you get a fuel cost of £2.1 billion for the missing 10GW of offshore wind. Over 15 years, that’s £31.5 billion.

Health warning: these are very rough calculations that rest on a number of (perhaps dubious) assumptions. The spot price of gas in 2030 cannot be known, and in any case British CCGTs running as baseload generation are unlikely to buy their fuel on the spot market. But even under a long-term supply agreement priced at a 50% discount to the 2028 forward price (£4.35/MMBtu), the extra gas cost still comes in at £1 billion per year (or £15 billion over 15 years).

What about subsidies?

Of course, this fails to acknowledge the amount of subsidy that the wind farms would receive. This part is much harder to calculate, but worth understanding because the structure of the CfD means that wind farms often save consumers money: generators receive a top-up on the reference price up to the strike price, but must pay back the difference between the two when the former rises above the latter (which happens regularly these days).

Let’s assume those missing 10GW would have won CfDs at auction with a uniform strike price of £50/MWh (in 2012 prices, which is the monetary standard in CfD regulations). That’s £68/MWh in today’s money. Output of 35,040,000 MWh would generate £2.4 billion of guaranteed revenue – potentially much less than might otherwise be earned by selling that power on a ‘merchant’ basis (i.e. with no CfD, taking on full wholesale price risk but reaping the upside when prices spike).

How much less? The reference price for intermittent CfD generators such as wind is calculated on an hourly basis using day-ahead exchange data (historic hourly reference prices are published here). Let’s take the average hourly reference price since the scheme began in June 2016: £92.39/MWh, adjusting for inflation.

With a strike price of £68/MWh, an average reference price of £92.39/MWh and annual generation of 35,040,000 MWh per year, 10GW of wind would be saving consumers £855 million per year, or £12.8 billion over the course of the 15-year CfD (all else being equal).

So, if the UK loses 10GW of planned offshore wind capacity then it loses potential savings of £855 million per year and incurs an additional gas cost penalty of £2.1 billion — pushing the cost to consumers to a staggering £2.96 billion – every year! So even if the replacement gas is procured on the cheap via long term contracts and ‘only’ costs an extra £1 billion, then the net cost to consumers from missing the 50GW offshore wind target by 20% still comes in at almost £2 billion per year.

But, but, but…

By now, you’re probably thinking ‘those gas and power prices are pretty steep, what if wholesale markets are awash with gas by then and prices come down significantly?’ Sure, the wind CfD savings would be zero if the average reference price matches the strike price. And who knows, maybe global gas/LNG markets will be flooded again by 2030 as new supply investments triggered by events of the last 18 months start to bear fruit.

Well, it is hard to see NBP trading much below £4.35/MMBtu for any extended period. UK gas production is falling faster than demand so Britain’s LNG import dependency in 2030 will be even greater than today. And at sub-£4/MMBtu, the UK will not be attracting LNG cargoes from anywhere (apart from maybe Qatar) since that price leaves no almost margin after accounting for the cost of feed gas, liquefaction and shipping.

Also, the calculations were based on an optimistic outlook of 40GW offshore wind installed by 2030. Today, the UK has 14GW and the industry has never installed more than 3GW per year. Even if momentum is somehow sustained at a breakneck 3.5GW per year, that still delivers only 35GW by 2030, not the 40GW contemplated above. If the shortfall against the 50GW target is 15GW, the extra gas fuel costs calculated above would be 50% higher.

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The accountability vacuum

The iniquity in all this is that there is no political accountability for gas power prices, because these are a function of global commodity markets over which the UK government has no control. But it has a very tight control over the price consumers pay for offshore wind, and has been squeezing the sector to deliver ever-cheaper power over many years.

The UK Treasury exerts this controls over the CfD via a mechanism called the Levy Control Framework (LCF). The Department for Energy Security and Net Zero (DESNZ) must get the maximum possible ‘bang’ for each buck in the LCF.

To do so, DESNZ sets a budget for each ‘pot’ of technologies, which caps how much of the LCF will be ‘spent’ at each auction. It also sets a maximum ceiling price for each technology to keep a lid on clearing prices. Developers must scrap it out by bidding in their best price. Projects are awarded CfDs starting with the cheapest first, until the budget for each pot is exhausted.

There is no comparable cost containment mechanism for gas-fired power. The UK has a retail price cap that limits how much energy suppliers can bill households, but if wholesale prices rise significantly then the cap rises too – as happened in the wake of Russia’s full invasion of Ukraine, when global gas prices went ballistic.

Penny-wise, pound-foolish

The UK’s penny-pinching approach to renewables spectacularly backfired last week. DESNZ set a rather paltry budget of £190 million/year to Pot 1 for “established technologies” and threw offshore wind in to compete with onshore wind, large scale solar PV, energy from waste and hydro for the first time. Worse still, the ceiling price of £44/MWh was way too low considering eye-watering cost inflation and interest rate hikes since the previous auction, and (predictably) no offshore wind farms placed any bids.

As a result, the next cheapest projects hoovered up the budget, with 1.5GW of onshore wind and 1.9GW of solar PV winning CfDs instead. Overall, the fifth allocation round awarded CfDs to just 3.6GW of capacity. In terms of value for money, this compares very poorly to the previous (fourth) allocation round, which contracted more than 10.6GW of capacity for only a slight larger slice of the LCF budget (£265 million/year).

So, for the sake of ‘saving’ some spare change in the LCF, the UK government has sucked the wind out of the sails of its world-leading offshore wind industry and set itself up for monumental failure in 2030. Turning to volatile global gas markets to make up the shortfall is a high-risk, high-carbon strategy. The cost could literally run into the tens of billions of pounds and blow the UK’s carbon budget. Just don’t expect any heads to roll; the architects of this mess will be long gone by then.

Seb Kennedy | Energy Flux | 11 September 2023

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1. Article updated post-publication to reflect the UK’s installed capacity for offshore wind is currently 14GW, not 12GW as stated in original version.