What do you expect the wholesale price of electricity to be 10 years from now? Don’t know? Nobody does, which is why offshore wind could continue to need some form of financial support.
Predicting wholesale electricity prices in the short to medium term can be tricky. Take the UK market this spring, for instance. At one point, the wholesale price of electricity spiked to levels not seen in a decade when strong winds that had characterised late winter came to a halt. As a result, the price for baseload power soared to around £80 (US$106) per megawatt hour, which is almost twice as high as one might have expected to see early in March. That was because National Grid needed to make greater use of expensive gas-fired power when the winds dropped.
As OWJ has many times reported, the cost of electricity from offshore wind has fallen steeply, primarily as a result of engineering innovation. There are still plenty of technical challenges for the industry to address, and opportunities for the supply chain to enhance efficiency through R&D, but there was a strong sense at Global Offshore Wind 2018 in Manchester last week that finance – not cost reduction – for offshore wind has become the major preoccupation.
There is every confidence in the industry that technical innovation will take it over the line and into an era of zero-subsidies but financing a zero-subsidy merchant project is an altogether different kettle of fish compared to one with a nice chunky subsidy and guaranteed returns.
In Germany, where the coalition government has set a target of 65% of electricity to be generated by renewables, there is a concern that market revenues for offshore wind and other renewables could be ‘cannibalised’ as low-cost capacity enters the market.
The same fear has been expressed in the UK. That could be a problem for offshore wind because if no one really knows what the wholesale electricity prices will be in future and you cannot predict what you are going to be paid for the electricity you produce, how can you make an investment decision? Add in the fact that the cost of capital for subsidy-free renewables will be higher than for projects supported by a subsidy and next-generation offshore wind projects could face a financing challenge.
Analysis by consultants such as Aurora Energy Research shows that, in the right circumstances, subsidy-free renewables could almost eliminate the need for high-cost gas-powered electricity generation. That will make it easier for governments to meet carbon targets, but the merchant nature of investment for subsidy-free windfarms would expose the market to increasingly complex drivers of capture prices – that is, the price an asset or technology actually achieves in the market.
As Cornwall Insight noted recently, the value earned from wholesale power is going to become increasingly important for renewables, but price cannibalisation will be a major complication. This is because of what it described as the depressive influence on the wholesale electricity price at times of high output from intermittent, weather-driven generation such as solar, onshore and offshore wind.
When there is a lot of wind in the system it tends to drive down the wholesale price – so much so that there is a risk of price cannibalisation – whereas, as happened this spring, when the wind isn’t blowing, the wholesale price goes up. That is one reason, for instance, why there is so much interest in being able to store energy from offshore wind and other renewables – to prop up the capture price.
Contrast this scenario with the existing contracts for difference (CfD) regime in the UK, where generators are guaranteed a price for the power they produce, and the consumer effectively meets the difference between the wholesale price and the agreed ‘strike price.’ You can see why a lot of clever people are spending a lot of time thinking about new financing models for offshore wind, without which, some argue, it could become a victim of its own success.
Power purchase agreements (PPAs) are an option in the long-term but that market isn’t sufficiently developed to help meet renewable energy targets right now. Moreover, a company entering into a PPA might struggle to manage intermittency from renewables and there might not be that many who are large enough to enter a PPA for a large offshore windfarm, so some form of intermediary would probably be required.
All-in-all, there is a need for zero-subsidy offshore wind to find a way to reduce its dependence on the wholesale market. There are a number of potential solutions (see OWJ's upcoming article about finance), but just as the CfD scheme has provided certainty, reduced risk and played a key role in the hugely successful roll-out of offshore wind in the UK, so a new arrangement might be necessary as offshore wind transitions to zero-subsidy CfDs, to enable generators to hedge against risk.
One way or another, it seems likely that there will need to be a mechanism – such as guaranteed top-up payments when the capture price is low – that provides a solution, at least in the short term.