UK offshore wind market thinks beyond CfDs as prices tumble

IN DEPTH | Falling prices mean the world's biggest offshore wind market could embrace PPAs and merchant power sales, writes Christopher Hopson

The downward trajectory of prices in UK contract-for-difference (CfD) rounds will put increasing pressure on developers, as Britain's world-leading sector evolves to embrace a variety of scenarios such as merchant and corporate power sales, industry experts told Recharge.

A record low strike price of £39.65/MWh ($48.8/MWh) was achieved by offshore wind which secured 5.47GW of the 6GW awarded in the third auction that ended in September.

KPMG calculates that the CfD mechanism has provided the support necessary to cut offshore wind costs by 65% in just four years. Bridget Beals, director, power & utilities at KPMG, told Recharge that the ability of UK offshore wind developers to continue on the current trajectory in reducing costs can’t be sustained and it’s likely there will have to be a limit at some stage.

“The outcomes of the CfD auction were a resounding success for offshore wind. In particular, the results show the impact of the certainty provided by the CfD for developers and demonstrate why the CfD in some form will continue to be required.”

Yet, she believes there is a longer-term question about how long this sort of price competition is sustainable in the marketplace, and whether or not some tweaks will be required to the CfD structure.

“What I think is challenging is the degree to which margins have come out of development risk and the supply chain, while at the same time we are still trying to develop an industrial supply chain in the UK for offshore wind.”

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Pressure is only likely to increase on existing developers with the arrival of cash-rich oil and gas supermajors such as Shell and BP moving into the renewables space. Incumbent players could be left struggling as subsidies are reduced and wind and solar plants increasingly rely on merchant power sales.

Global power groups have until now featured heavily in UK renewable energy scene, with the likes of Iberdrola, Enel, EDPR and RWE leading the charge, along with transformed oil and gas group Orsted in offshore wind.

In Round 3 the government allocated £65m of CfD subsidy for so-called Pot 2 [less established renewable technologies] with an overall cap set at 6GW. In practice the auction was capacity constrained, with none of the budget allocated, due to clearing prices being below the reference price.

“The UK government expects a negative notional budget impact of deploying offshore wind based on their reference price,” said Wood Mackenzie’s senior research analyst Shimeng Yang. “The actual CfD top-up payment will be determined by the wholesale power price over the next 15 years. However, we expect this would lead to a positive gain for the UK government.”

"Maybe due to technical progress there will be some more project costs which can be squeezed out."

Beals said that current trends may lead wind players towards looking for alternative routes to market, such as power purchase agreements (PPAs).

Merchant risk is when the generator takes the risk of selling into the wholesale market. Corporate PPAs can offset that risk by taking a fixed price from a third party.

“Maybe due to technical progress, such as bigger turbines, there will be some more project costs which can be squeezed out, but I don’t believe that will be enduring,” said Beals.

Specialist industry consultancy BVG associate director Mike Blanch told Recharge that while the arrival of oil and gas companies could “possibly” be a challenge for some incumbents in the years ahead, that “it would probably lead to more industry partnerships”.

Dogger Bank offshore projects dominated Round 3 with CfD awards for three 1.2GW Equinor/SSE projects and Innogy’s 1.4GW Sofia projects, all off England, plus the 454MW Seagreen project off the east coast of Scotland.

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“As the winning strike prices are below the projected wholesale cost of electricity, the projects will effectively be ‘paying back’ to consumers on each unit of electricity they produce,” said the Renewable Energy Association’s head of policy Frank Gordon.

He added that not only does this show that renewables can lower the net cost of energy for consumers, as has long been argued, but this saving could be recycled back into extra support for climate action – to meet the UK’s net-zero target and to support a wider set of renewable technologies.

“The cost reductions seen in recent years in the UK have not only come from marginal reductions from developers, but they were enabled in many cases by technology development and proper regulatory guidance – especially when considering offshore connections,” the International Energy Agency’s head of power generation Brent Wanner told Recharge.

"There is not a one-size-fits-all mechanism that serves all jurisdictions and projects."

“That said there is not a one-size-fits-all regulatory mechanism that serves all jurisdictions and offshore wind projects. A combination of elements will make projects even more competitive in the future, including innovative project-financing schemes and improving technology.

“Manufacturers have signalled [a move] towards even larger turbines – reaching 15-20MW in size – and digital solutions are expected to drive down operations and maintenance costs.”

Around 5.47GW of offshore wind projects and about 270MW of remote island onshore wind secured support in the auction, leaving about 2.75GW of projects out in the cold after failing to get a deal.

Offshore projects missing out were Iberdrola’s giant 1.2GW East Anglia 3 (EA3) off England’s east coast; EDPR/Engie’s 800MW-plus Moray West in Scotland’s outer Moray Firth and the Chinese-owned 700MW Inch Cape project in the Firth of Forth.

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BVG said it was disappointing news for Scotland’s offshore wind sector that only 466MW of about 3.1GW bid were successful – likely due to the double whammy of deep water and higher grid charges north of the border. Also while four smaller remote island projects won CfDs, the giant 475MW Viking wind farm on Shetland was left out in the cold.

Following the awards Scotland’s energy minister Paul Wheelhouse called on the UK government to “urgently review the limitations of the CfD auction system” as 5GW out of the 6GW awarded in the round went to two major offshore wind projects in England.

“Basically it was an auction based on the lowest price so Scotland can’t be grumpy,” BVG’s associate director Alun Roberts told Recharge. “Obviously you have a huge wind resources off Scotland and the political will, but if you have what are effectively deeper water projects with higher transmission charges it’s just a headache. It should fare better in the next allocation round for which several of the English projects will be in deeper waters than Dogger Bank.”

Roberts said the strike prices achieved in Round 3 showed the extraordinary progress the wind industry has made in reducing prices. “These prices show that developers now see CfDs as a price stabilisation mechanism rather than a subsidy.

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“The question now is whether other developers which declined to bid so low prefer to accept merchant risk, probably also with corporate PPA’s – a route the industry has been contemplating for some years.”

If the CfD price gets too low then it looks less attractive because the generator can get more on the open market overall. “Potentially all the unsuccessful projects from auctions could go down this route,” said Roberts.

Sources indicated that several UK developers are considering accepting merchant risk, probably with corporate PPA’s, including SSE Renewables 1.1GW Seagreen mega-development to be built off Scotland, using turbines from MHI Vestas.

SSE Renewables said Seagreen’s CfD provides a 15 year price certainty at £41.61/MWh for over 40% of the project “which we expect to support the projects ability to secure financing for the full 1,075MW”.

“Plans are in place to progress financing and an equity stake sell-down to move towards a final investment decision in 2020,” an SSE spokesperson told Recharge.

Among a clutch of unsuccessful Round 3 bidders it is understood Spain’s Iberdrola believes that corporate PPAs might be a route which will make it possible for projects such as EA3 to be explored, or even built without the support of CfDs.

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A spokesperson for Iberdrola unit ScottishPower declined to comment on future financing options for EA3, but confirmed “we will look at how we can further optimise the project to ensure the benefits are maximised for all”.

“Whilst we are disappointed not to have secured a contract for EA3 in this round, we still believe [it] is a great project which would bring further benefits to the East Anglia region and the wider UK economy,” the company added.

Yang said the upcoming Round 4 CfD discussions will now go beyond the budget allocation, focusing on capacity caps to ensure competitiveness, as well as the volumes needed to reach the UK’s 30GW offshore wind target by 2030.

“Furthermore, the declining UK offshore wind strike prices will force developers to prepare for bids below current power prices or to follow a pure merchant route to market.”

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