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Falling costs mean long-term targets should remain within reach

Fri 11 Jan 2019 by David Foxwell

Falling costs mean long-term targets should remain within reach
If the cost of offshore wind energy continues to fall, analysts argue, long-term capacity targets could still be met, despite the small sum allocated to the upcoming CfD

Disappointment about the seemingly small sum allocated to the UK’s next contract for difference for offshore wind has been tempered by analysis of how much capacity £60M might actually buy as costs continue to fall

In late 2018, UK energy minister Claire Perry announced that £60M (US$77M) would be made available for the next competitive auction for a contract for difference (CfD) for renewable energy in the UK, an auction that is widely perceived as an ‘offshore wind round.’

That was lower than anticipated by many in the wind energy sector given the overall level of funding announced earlier this year by the government for future CfD auctions and caused questions to be asked about how much capacity that might buy.

Responding to some of the criticism levelled at the sum allocated to the auction, a Department for Business, Energy and Industrial Strategy (BEIS) spokesperson said, “the fall in the cost of renewable electricity means that we should be able to secure more generation than the last auction at a lower cost for consumers.”

Speaking to OWJ about the sum allocated to the next contract for difference auction in May 2019, Cornwall Insight senior consultant Tom Edwards said, “BEIS has been looking at other European auctions, that have cleared €40/50 (US$46-57) per megawatt hour (MWh) and believes there is still more cost reduction that can be achieved in the UK.

“BEIS believes that by rationing the amount made available for the auctions, it can secure bids that are as competitive as possible. It has updated its administered strike prices (ASPs, the caps on strike prices bids by technology) and looked at what it expects the wholesale price to be in the future. The £557M is still there but the thinking is that prices in the UK can come down further and that parties bidding in the auction will be prepared to bid lower.

“We think that if there is sufficient appetite £60M could buy anything between 1.9 GW and 3.2 GW of new offshore wind at £56/MWh and £53/MWh, the ASP ceiling for offshore wind in these auctions. BEIS believes up to 4 GW can be bought assuming parties bid even lower than the ceiling. A lot will depend on the level of competition. Had more money been made available for the auction in May 2019, a lot more capacity could have been awarded but perhaps not at such a competitive price.”

Concern has been expressed about whether some projects will be able to compete, given the unexpectedly small pot of money made available for the May auction. Mr Edwards noted that there are a relatively large volume of potential projects looking for a CfD, as there are 7.9 GW of consented projects which could bid into the auctions. However, he argued, a potential problem with the strategy BEIS has adopted might arise if prices have to increase again, for projects in deeper water or with higher transmission costs. Then there are potential issues such as the exchange rate and the effect that might have on the cost of projects in the UK. “If the BEIS strategy works, then it will be good news for consumers. The risk is that parties can’t compete at the price levels that have been outlined,” Mr Edwards said.

The ASPs for the May 2019 auction were set at £56 per megawatt-hour for delivery years 2023-24 and £53/MWh for 2024-25. They might be expected to fall further for subsequent delivery years. BEIS takes the view that as costs fall it should be able to secure more generation than in the last auction at a lower cost for consumers. “Despite these concerns, I think that 30 GW by 2030 is still do-able,” Mr Edwards concluded. “There are a lot of projects out there that are looking for contracts. That’s what BEIS is relying on.”

Bloomberg New Energy Finance senior associate offshore wind Tom Harries took a more sanguine view of the small amount of money BEIS has made available. “High power price assumptions offset any concerns about a low budget. CfD design is as much about budget impact as it is about budget size,” he said. “And if the 6 GW cap on the capacity that can be awarded in the auction is met, that could be more offshore wind than the previous rounds combined. The government pays the difference between the market price and the bid price. A higher power price forecast means less of a top-up is required and there is more budget to go around.”

Commenting on the minister’s announcement, Offshore Renewable Energy Catapult head of insights Gavin Smart highlighted that in the September 2017 Allocation Round 2 (AR2), CfDs were awarded at £57.50/MWh – a record low price for the UK. This allowed 3.2 GW of offshore wind to be allocated for a total annual budget draw of roughly £176M.

“Should we be surprised that the offshore wind price ceiling has been set at £56/MWh for 2023/24 and £53/MWh for 2024/25?” Mr Smart said. “In short, no. The equivalent ceilings in AR2 were £105/MWh and £100/MWh so this is a significant drop. However, given that successful bids in AR2 cleared at £57.50/MWh, it was always reasonable to think that government expectations for future rounds would be set around this level. To set a higher ceiling may well have been questionable.

Should we be surprised that only £60M – that is not much more than 10% of the total £557M – has been made available?

“That depends on whether we expected bids from technologies other than offshore wind to be encouraged,” he explained. “Given the low price ceilings for offshore wind – and the fact that these are only £4.65 and £1.65 higher than the relevant reference price used for estimating affordable capacity – it is possible to achieve 2 GW of offshore wind in each delivery year within the £60M budget. This is in line with what the industry has been asking for, so it appears tailor-made for offshore wind.

Were there any surprises? “For me, yes,” said Mr Smart. “The reference prices published for estimating budget affordability are in line with the reference prices used in AR2. Many of us had expected that using something approaching a capture price for intermittent technologies would result in a lower reference price, and therefore make each MWh more expensive to support. This is a key factor in estimating what is affordable for £60M.”

In broad terms, he believes, £60M allows for 4 GW of offshore wind. There is around 8 GW of offshore wind eligible to bid in the auction, of which around 6 GW is expected to bid. Strike price ceilings for offshore wind are the lowest in Pot 2. Even without further analysis, this suggests a couple of things.

“Firstly,” said Mr Smart, “the full budget will be utilised by offshore wind – 4 GW at the price ceilings or up to 6 GW at even more competitive price points – which would bring the 6-GW capacity cap into play.

“Secondly, the Offshore Wind Sector Deal is aiming for 30 GW by 2030, which would require a further 12 GW on top of the 14 GW already contracted and around 4 GW to come from the May 2019 auction. Even if offshore wind strike prices remain at the £53 level required for 2024/25 and reference prices in future auctions do not increase, this further 12 GW should cost, at the most, £180M (3 x £60M).

“If the trend of offshore wind cost and strike price reduction continues, and future reference prices continue to increase, this 12 GW would cost much less than £180M.”

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