A number of factors may be about to put an end to the trend for falling energy prices in the Contracts For Difference (CfD) scheme. The CfD scheme has provided strong subsidy support whilst also providing consumers robust levels of protection. High investor confidence and steady reductions in capital costs have meant that the price achieved in the last four auctions by offshore wind assets had drastically reduced over the previous four auctions, from around £120/MWh (in 2012 prices) in 2015 to just around £37/MWh (also in 2012 prices) in the fourth allocation round last year. The scheme has therefore been seen as a significant success, aiding decarbonisation and protecting consumers, and resulting in the suggestion that subsidy free assets could be around the corner. However, as we move towards the next auction, Allocation Round 5 (AR5), with the application window for the auction set to take place in March, there are a range of possible drivers for changing trends which we discuss below.
Strike prices achieved by assets in the auctions are presented in 2012 prices and inflated using Consumer Price Index (CPI). After several years of relatively consistent, low inflation figures, the high level of inflation seen in the last year will add more uncertainty to participants in AR5 in establishing their strike price and potential strike prices for competitors. This could manifest in higher auction prices.
Technology costs have a higher level of uncertainty for participants in AR5. One of the fundamental drivers for the reduction in auction clearing prices across previous allocation rounds is the reduction in capital costs for a number of generation types, especially offshore wind assets. However, a combination of market drivers, inflation and geopolitics have meant that capital costs have increased in the last year to 18 months. With assets competing for contracts two or three years before delivery, this increased uncertainty in asset costs could impact prices.
In addition, wider energy industry change creates uncertainty for potential participants of AR5. The Review of Electricity Market Arrangements (REMA) is looking to make fundamental changes to the electricity industry, including how wholesale prices are calculated and how these are factored into the CfD scheme. Additional ongoing network reforms provide additional uncertainties which will need to be factored into the pricing approach undertaken by participants in the scheme.
These arguments indicate that the price reduction trends seen in prior auctions are unlikely to continue. This idea is reinforced by evidence from other markets, with the latest Spanish subsidy auction not obtaining any solar bids, whilst the German subsidy scheme sees continued underbidding and lack of engagement. The trend of lowering strike prices and maximum participation for optimum outcomes should not, therefore, be presumed to continue.
Some parameters of the auction itself may facilitate greater competition and dampen submitted prices, such as the moving of offshore wind generators into the same pot as solar and onshore wind assets, meaning the technologies are likely to provide additional competition. However, full details of the parameters of AR5 are unknown with elements such as the capacity limits, budget limits and any maximums and minimums still to be confirmed. The level of competitive tensions which will be in place for the allocation round are therefore unknown at this time.
Wider drivers from outside the CfD scheme already mean that there is a risk that the costs of the scheme will be higher, and the government will have to carefully set the key parameters of AR5 to mitigate the impacts of the wider market as they continue to push deployment of assets to meet key decarbonisation targets, such as the requirement for 50GW of offshore wind by 2030.
Cornwall Insight can provide a number of services in relation to AR5, including an overview of the eligibility requirements, breakdown of key contract structures, key bidding considerations as well as forecasts of eligible assets and possible clearing prices. Contact email@example.com for more information.