The UK government is very fond of trumpeting the achievements of the contract-for-difference (CfD) mechanism. In many respects, this pride is justified. The CfD was a true trail blazer globally, probably playing the single most important role in the astonishingly rapid commercialisation of offshore wind technology, which saw clearing prices fall from around £150/MWh in the FIDER [final investment decision enabling] era to less than £40/MWh in AR4.
It was truly effective, innovative and ahead of its time. It remains the gold standard which other governments look to.
However, one suspects that the government will be a little less forthright in its praise of the CfD following today’s announcement that no offshore wind has successfully progressed through AR5. This will be a huge disappointment for a government that was hoping to secure in excess of 4GW of additional capacity, and represents a severe blow to the notion that the UK will get close to its 50GW offshore wind deployment target by 2030.
This will not come as a surprise to many. The industry has been pointing to red lights flashing on cost dashboards and resultant jeopardy to auction outcomes for years. Vattenfall’s decision to place the 1.4GW Norfolk Boreas project on hold in July was an indication that profitability challenges are all too real, and the share price struggles of the likes Orsted and Siemens Gamesa have been well documented. The government’s response of increasing the budget from £205m to £227m last month was widely seen as a gesture which would have little bearing on the eventual outcome.
The CfD in its current form worked fantastically well when offshore wind was a high cost, emerging technology, and was extraordinarily effective at driving the commercialisation and cost-out of the technology which was critically needed to make the economic case for wind energy vs established fossil fuel technologies.
However, offshore wind is no longer an emerging technology. The majority of opportunities for cost reduction through scale and efficiency have been exploited, and the technology has reached a cost level which compares very favourably with fossil fuels. What is needed now is massive investment in both deployment of projects and in strengthening the supply chain, which is currently clearly incapable of meeting the ambitious deployment targets set by governments around the world.
Capital will always flow where there are returns. Government would do well to remember this.
Without much prospect of a profitable return for investors, these critical investments to grow volume of supply will not be made. The CfD in its current form has squeezed the margins of the industry and the supply chain to the point where investing in offshore wind is simply not attractive enough in comparison to other sectors. Capital will always flow where there are returns, and government would do well to remember this.
Many point the finger at the CfD’s focus on price above all else as the culprit, and others may simply view this as a freak result due to miscalibration of the administrative strike price. However, in my view it represents the failure of a framework which does too little to disincentivise rash behaviour.
Time for stiffer penalties
With too few penalties for non-delivery, the CfD encourages overzealous bidding – evidenced by Vattenfall’s decision to pull the plug on Norfolk Boreas, unable to deliver it at the price they themselves had bid less than a year earlier. Vattenfall are not alone in this predicament. Light penalties made sense when offshore wind was an inherently risky and untested proposition, but with the maturation of the sector it is time to incentivise developers to get serious about their bids, through financial penalties for non-delivery.
The prospect of further financial penalties may seem a counterintuitive way to drive investment, and will likely go down like a lead balloon with many developers and a supply chain struggling with unprofitable projects. In the short run, it may even be seen to reduce the attractiveness of the UK as a destination for investment. However, in the long run, this is the medicine the industry needs.
Forcing developers to consider bids and weigh up delivery risks more carefully would drive out speculative bidding behaviours and ensure the prices developers bid in to support schemes are actually deliverable. The unrealistic administrative strike price (ASP) in AR5 was a direct result of unrealistic bidding behaviours in AR4. These behaviours have in turn produced the squeeze on supplier profitability due to developers taking a ‘bid first, work it out later’ approach, which inevitably sees unrealistic savings demanded of suppliers down the chain.
Revising the CfD framework by introducing non-delivery penalties would maintain the price competition at the centre of the CfD scheme which has delivered such successful outcomes in the past. It would doubtless push strike prices up, by forcing developers to price in delivery risk. However, it would also force developers to get real about solidifying supply chain arrangements and hedging their commodity price risk before diving into bids. In this additional strike price premium, for the successful and well organised player, lies the reasonable return which the industry craves.
Properly funded support
To sweeten the pill and drive the rapid investment in the supply chain which is needed to deliver our ambitious targets, any reform should be coupled with properly funded support schemes for investment in infrastructure and supply chain development. Government also needs to be realistic about setting ASPs with enough wriggle room for the market to do its work, and abandon the expectation that prices will continue to fall year on year for eternity. The 23% premium on onshore wind clearing prices achieved in AR5 over AR4 should be instructive in estimating where offshore prices are likely to land.
We should remember the value the CfD offers, and ensure sound principles of competition and value for money are not thrown out with the bathwater, but Government also needs to be bold if the prospect of 40+ GW by 2030 is to be kept alive.
In a United Kingdom outside the EU and struggling economically relative to its peers, offshore wind has begun to look like a potential trump card. The UK’s access to an extensive shallow seas with bountiful wind resource, ideal for low cost offshore wind deployment, has set it up perfectly to be the zero carbon energy powerhouse of Northern Europe, exporting abundant cheap, green energy to industrial centres around the region. Successive governments have recognised this opportunity, as evidenced by the continual ratcheting up of our 2030 offshore wind target, from 30GW, through 40 to 50GW. Setting a target is one thing, however. Delivering it is quite another, as today’s results have demonstrated.
Scottish support for onshore
By way of comparison, it is informative to look at today’s results for onshore wind. A total of 1.7GW across 24 onshore wind projects have secured contracts at a strike price of £52.29/MWh in AR5, a greater capacity than awarded in AR4 and at a strike price that is 23% higher than the previous round. This is commensurate with expectations around the impact of commodity price increases since AR4. Government chose not to reduce the ASR for onshore between AR4 and AR5, whereas for offshore the ASR was reduced from £46/MWh to £44/MWh.
All of these onshore projects bar one are in Scotland, where government has thrown its weight behind onshore wind as part of a broad net-zero energy transition strategy. This support includes a favourable planning policy and will be further strengthened by the publication later this month of a wide ranging Onshore Wind Sector Deal that has been negotiated between the Scottish Government and the onshore wind sector in Scotland. In contrast, unfavourable planning legislation in England and Wales has stymied the development of new onshore wind capacity there. This situation is unlikely to change significantly regardless of changes to England and Wales planning policy that have been announced this week, to wide industry consternation.
The UK is a genuine world leader in offshore wind, and countries around the world look to it as an exemplar of best practice. If its rollout of offshore wind continues to falter, one must wonder whether the outbreak of global interest in the technology we have seen in recent years could recede, setting back the overall global energy transition - something we can ill afford.
Industry and government should not waste this opportunity to come around the table to find the right model which delivers value for the money to the consumer alongside a fair return on investment. Both the future of the global offshore wind industry and the UK’s economic prospects may well depend on it.
- Leo Bertels is managing consultant at renewables consultancy BVG Associates