This article was originally published in Energy Spectrum Issue 685 on 7 October 2019.
The Contract for Difference (CfD) results for Allocation Round 3 (AR3) once again provided some striking results for the industry to ponder.
In this Energy Perspective, we reflect on the success and consider what the results mean for future CfD policy.
I said you better run
BEIS published the results of AR3 on 20 September 2019 with 5.77GW of capacity awarded CfD contracts across 12 projects. Record low clearing prices (in 2011-12 money) were achieved at £39.65/MWh for Delivery Year 2023-24 and £41.61/MWh for 2024-25 (see Figure 1). AR3 only had budget allocation for Pot 2 “less established” technologies and was set at £65mn (2011-12 money) across both delivery years.
Even when converted to money of the day, clearing prices equate to about £45/MWh in 2023-24 and £47/MWh in 2024-25, within the range of today’s baseload market prices.
The offshore wind clearing prices represent a 66% reduction in offshore wind prices since Allocation Round One less than five years ago. The price levels were even comparable with recent European offshore wind price benchmarks, despite GB developers facing additional risks and costs in project development and connection.
The record low prices, below pre-auction expectations, highlights the continuing and rapid cost reductions for offshore wind globally, and the success of competitive CfD auctions in maximising benefits of these falls for the consumer.
Due to the pay-as-clear design of the auction we can say with certainty that some successful projects would have bid even lower than the clearing prices. They would then have been uplifted by a higher priced project. The sealed-bid aspect of the scheme means we will never know who this was.
Offshore wind dominated the auction with six projects totalling 5.47GW of the 5.77GW awarded contracts. Four of these projects have capacity of 1.2GW or higher. The size of these larger projects, driving economies of scale, and the maturing offshore wind supply chain likely contributed to their success.
Two Advanced Conversion Technologies (ACT) projects totalling 34.6MW and four Remote Island Wind (RIW) projects totalling 275.22MW were also successful. With RIW’s success, this meant a return for onshore wind assets to the CfD for the first time since Allocation Round 1 in 2014.
The 6GW capacity cap was important for AR3. Without this, effectively the auction may have kept procuring a much greater proportion of the pipeline as project bids were having no impact on the £65mn auction budget constraint.
Again due to the confidentiality of bids it is unknown what would have breached the cap but with a 230MW gap between the clearing capacity (5.77GW) and the cap (6.0GW) it is likely to have been an offshore wind or large Remote Island Wind project.
Undoubtedly the results are a landmark moment for the sector. Onshore wind made an unexpected but welcome return through a good showing from RIW projects.
Further and more significantly, offshore wind can now credibly say they are amongst some of the cheapest new build options in generation in general, and in the low carbon segment in particular.
Crying at the doorsteps
But there will also be disappointment for unsuccessful projects. These include Moray West and Inch Cape offshore wind farms and the Viking Wind project on Shetland. In addition, the Seagreen project was awarded a CfD for 454MW, likely the result of a flexible bid, leaving a portion of the bigger project outside the CfD.
SSE has stated that it remains committed to the Viking project and that it also plans to build out the Seagreen development to its maximum 1,075MW capacity. Moray West, a joint venture between EDPR and ENGIE, announced that it would look to bid into AR4 in 2021.
There are also concerns around the successful RIW CfD developments, with the capacity for projects awarded on Lewis and Orkney being below a capacity threshold set pre-auction by Ofgem to trigger new transmission links for both islands. These links are vital to their viability and to ensure power can be exported to the wider network.
A silver lining for the government is now the high probability of real competitive tension in AR4. The rollover of unsuccessful projects and those in development that were not ready to participate in AR3 leaves c9.4GW of wind capacity – both offshore and RIW– which could participate in AR4.
Standing in the welfare lines
There are now some wider and important issues for the government as it considers future CfDs.
Commentary that the AR3 CfDs are “cost-free” could risk exposing the regime to easy criticism in the future. The strike prices are below BEIS’s forecast of wholesale prices used in its bid assessments.
However, the reference figures used to value bids in the auction only look at a limited number of years that will be covered by the 15-year CfDs. There will certainly be significantly more wind delivered to the system in the period to the 2040s when the AR3 CfDs end. Lower captured wholesale prices for wind will occur as a result.
Our analysis forecasts low wholesale prices at times of high wind output and low system demand, enough to necessitate levy costs for material periods under the AR3 CfDs for much of their lifetime (see Figure 2). So these CfDs are not necessarily guaranteed to be subsidy-free if this means the absence of a levy cost on consumer bills.
This phenomenon of “price cannibalisation” opens up wider, complex and important questions about what kind of wholesale market we might have if - as the CCC net zero report indicates – 75GWs of offshore wind could be built under a CfD by 2050.
All CfD projects are, other than in extreme periods of negative pricing, insulated from wholesale market price signals. But such CfD projects will over time consitute one of the biggest impacts on price formation in the wholesale markets for everyone else, including merchant or subsidy-free wind projects.
We think the government should be thinking now – before we see significantly more CfD offshore wind capacity delivered - what the consequences are likely to be from such an outcome, and whether they are desirable.
Sounds like a whisper
We believe the results may also change thinking on the current CfD procurement process.
Firstly, with bidding prices now below wholesale reference price levels, the continuation of a budget-based approach to auctions seems illogical.
But a hard GW cap, as adopted in AR3, is out of kilter with the ultimate policy objective of procuring low carbon output and volumes rather than purely capacity, to keep the UK on track against binding decarbonisation objectives.
We consider that volume-based CfD auctions would be a good and pragmatic alternative, procuring volumes of low carbon output at levels aligned to requirements under carbon budgets or net-zero targets.
We wrote about this last year in our insight paper Turn up the volume. Focusing on the design of new auctions in Ireland under the Renewable Electricity Support Scheme (RESS), our A Great Leap Forward? Offshore Wind in Ireland is a great companion piece.
Secondly, the designation of offshore wind as “less established” looks unsustainable at these strike prices.
In response, the government could reinstate Pot 1 auctions for “established” technologies but include offshore wind in an expanded pot. Or they could move now to full technology-neutral auctions, seeing offshore wind competing with the broadest range of credible technologies.
To ensure offshore wind faces tension from technologies with similar cost profiles, there is a very strong argument to open up future auctions to include onshore wind and solar.
In such circumstances, the use of existing levers in auction design such as maxima and minima levels for different technologies could still be used to drive desired or balanced technology mix outcomes. As could the government setting Administered Strike Price caps to target top-quartile projects for different technologies.
The outcome of the Banks group JR will be instructive perhaps to how future policies on technology selection and allocation will unfold, particularly with regard to the future inclusion of onshore wind and solar.
More generally, whatever route is taken by government or the outcome of the JR, there is a strong case on the grounds of transparency and to uphold evidence-based policy making, for impact assessments to be published alongside future draft CfD budget notices.
These assessments could set out the reasons for allocation parameters adopted against government policy objectives, delivering complete transparency to the market.
Tables are starting to turn
AR3 has understandably been hailed as a watershed moment for the CfD scheme and offshore wind in particular, and rightly so. But surprises, even positive ones, should always lead to careful consideration of what they mean for future policy, particularly as AR3 indicates that the scale and pace of procurement of offshore wind, in particular, could be significantly ramped up.
There are now important associated policy questions on how such acceleration is best accommodated, both in the auction allocation design itself, and in the context of wider realities, such as consequential impacts on the wholesale markets.
We would certainly not advocate radical and sudden change to the CfD scheme, but long-term signposts might be important if the government considers changes are ultimately desirable at some stage.
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