Reflections on CfD AR#2 – Taking the fast train

Monday the 11th of September 2017 is set to go down as one of the key dates in the development of renewables in GB. The results of the auction round announced shortly after 7am led to a collective dropping of jaws onto the floor that could probably be heard in Antarctica. I can take some pride in the fact that I called the result in terms of all three bidding offshore projects getting contracts, and the collective capacity of those, but I was way off on the strike prices set for Hornsea 2 and Moray. Here are some reflections on the results, having had a few days to meditate on them.

Full Steam Ahead

Clearly the big winner out of the round is offshore wind in general. It can now claim not only to be (massively) cheaper than Hinkley Point C, but it is now competitive with new gas plant, not something I thought I would be saying for a good few years yet. With strike prices of £57.50/MWh, LCOE is down to about £50/MWh, which is comparable with current forecasts of wholesale power price (though I am personally thoroughly suspicious of such forecasts).

This seals offshore’s place in UK energy policy; it already had political backing due to its scale and economic development potential, but now it must surely be untouchable. Ministers will be happy that they have an unarguable success story to point to, and they will not be minded to kill this particular goose as soon as it starts laying golden eggs. One can expect a certain amount of doubling-down on the technology, with Amber Rudd’s cautious ’10 GW in the 2020s’ line when she was Secretary of State for DECC very probably up for a rewrite. At these prices, why would Government limit the technology like that?

Mind the Gap

There are a number of features of the results which are artefacts of the design of the auction. It’s interesting to look at these and learn lessons for future rounds.

The staff at Innogy and Statkraft must be in line for a large bonus as they played a blinder with their bidding strategy for Triton Knoll. They must have bid lower (probably much lower) than the £74.75/MWh that they received, but benefitted from the pay-as-clear nature of the auction, with the successful fuelled technology projects pulling them up into the £70s. In a similar vein, it’s worth noting that one of the two projects receiving £57.50/MWh must have bid an even lower price. Which project that was is probably indicated by the immediate FID for Hornsea 2. No problem for Dong to meet its Milestone Delivery Date there.

The aspect of the results that really caught my eye was the overall budget usage. At the maximum, the 3.35GW of projects took only £176m of budget – only 60% of what was available. The low bids by offshore wind left plenty of room for the fuelled tech to get in up to the 150MW maximum they were allowed – though if they had bid too high then the act of pulling up the much larger offshore capacity to their clearing price could have broken the budget. Conversely, since the fuelled projects were not allowed to be pulled up to the clearing price of offshore, spare a thought for the people behind the Redruth EfW project, who bid £40/MWh in 2022/23, the sole fuelled project to clear in that year. I expect that this is an instance of Brearley’s Law, which states that in every auction there is at least one stupid bid. Like the solar projects that bid £50/MWh in AR#1, the likelihood is that this contract will not be signed.

The question then remains as to why there was that £120m left on the table. With fuelled technologies limited to only 150MW of capacity, and the three offshore projects bidding low, that only left marine and geothermal as bidders. The latter isn’t yet credible, which leaves marine, and in particular Atlantis with their Meygen Ic project. A statement from the company indicates that they bid a price of about £100/MWh. There was enough budget to support a 74MW tidal project at a strike price of £100/MWh – this is only about £10m of budget draw on its own. However, there clearly wasn’t budget to pay everyone in that year £100/MWh, and therefore Atlantis lost out due to the pay-as-clear nature of the auction.

The low budget usage also highlights the impact of the exponential affordability of capacity as strike prices approach reference prices – as the difference tends towards zero, the affordable capacity tends towards infinity. In particular, for the £57.50/MWh projects, in 2024/25 they would have been drawing just over £5/MWh, allowing huge capacity for very little budget draw, and in that year the total draw was only £150m.

At a Junction

Having had this success for offshore wind, the question arises as to what it does to the calculus around future policy. The £730m budget pledged for auctions by Government in late 2015 will now stretch further than originally envisaged. A lot further. Far from the 4GW that was expected from this budget, one is looking at perhaps 15GW being affordable, with the remaining budget of £570m (in 2012£) stretching to at least 10GW of additional capacity and probably more. This gives rise to my feeling that Government will go further than the ‘10GW in the 2020s’ line: by just spreading the already committed budget more thinly over more years, then objectives for the next decade can be met and exceeded. There is a residual risk that Government takes some of the budget back, saying it is now not necessary to meet its objectives for offshore wind. But why hit investor confidence in this way when, for no additional budget negotiation with Treasury, you can over-achieve on your ambition? I think the industry can rest easy that the business will flow for the next decade at least.

Where the news is bad is for virtually all the other renewable technologies. For onshore wind and ground-mounted solar, the risk is increased that Pot 1 auctions will be kicked further down the road. Given the low prices for offshore wind, the financial cost of excluding these cheaper technologies is relatively small, and certainly will look small in comparison to the high political cost of supporting them. Why do a politically difficult thing, when you can do a politically easy thing instead at not much extra cost? Given the current parliamentary arithmetic and the all-consuming political morass that is Brexit, the notion of a Conservative minister standing up and intensely annoying 50-100 of his or her own backbenchers seems somewhat fanciful. I believe the power industry overall has to come up with its own solution that allows customers to get access to the cheapest renewables – and which is larger than the niches of corporate PPAs or merchant development – because it seems unlikely that Government will do it for us.

For the higher cost, newer technologies, there are also dangers, but possibly the success of offshore wind might open some political space for them. There have already been calls to forget new nuclear or tidal lagoons because of the cheapness of offshore. Given the political environment of Brexit and ongoing austerity, these calls might be heeded, and it will certainly need the expenditure of political capital to get support for the next-generation of low-carbon technology. With vocal support in Scotland for tidal stream and wave, and Wales for tidal lagoon, this is not impossible, and the success of offshore wind might tempt Government ministers to try and repeat the trick with technologies where the UK can corner the industrial opportunity.

In my view these technologies should highlight the system benefits of having a diversified portfolio of variable renewables. While storage is a great match for wind and solar, it does have round trip losses and costs money – it is generally better to use electricity when it is generated, and having a diverse renewable portfolio increases the chances of this as it smoothes out the power production from the fleet overall.

Journey’s End

Clearly the result of AR#2 is an important milestone in the decarbonisation journey, but it by no means the end. This is a marathon and not a sprint, and perseverance is necessary. This has paid off for offshore wind, but there is more to do for the other technologies that we are also going to need. As the saying goes, it is better to travel hopefully than arrive. Here’s to the next stop on the ride.

 

Dr Gordon Edge
Director, Inflection Point Energy Consulting

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