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UK’s DESNZ talks big game with large AR6 budget pot, although low reference prices are a concern.
Low reference prices mean offshore wind projects will have to fight tooth and nail for budget in the UKs’ upcoming CfD auction, however, under certain scenarios there could be grounds for optimism.
The offshore wind sector has been hoping for a big response from the UK government ever since the country’s last auction for contracts-for-difference (CfDs) - AR5 - in H1 2023 failed to attract a single bid from an offshore wind project, with the sector’s no-show having been put down in large part to the Department for Energy Security and Net Zero’s (DESNZ’s) unwillingness to increase the maximum bidding cap for the technology despite soaring supply chain and financing costs.
The industry got half of what it wanted when DESNZ in mid-November 2023 confirmed a 66% increase in the administrative strike price for fixed-bottom offshore wind, from GBP 44/MWh (in 2012 prices) to up to a new figure of GBP 73/MWh, while it also announced a similar rise for floating projects, with the cap increasing from GBP 116/MWh to GBP 176/MWh.
However, these increased caps were seen as largely irrelevant until it became known how much budget would be set aside for offshore wind in AR6. This piece of the jigsaw puzzle was finally revealed in early March, together, importantly, with the reference price at which the CfD budget will start to kick in, with DESNZ announcing an GBP 800m allocation for fixed bottom offshore wind, and around GBP 200m for other technologies (including floating offshore).
Broadly speaking, the offshore wind industry was relieved to see the more realistic caps, and a larger budget pot, as this means bidders could potentially now secure CfDs this year at prices that give them a reasonable chance of delivering viable projects.
However, with the application window for AR6 opening (March 27), there are differing views as to how much offshore capacity might ultimately secure CfDs in the latest edition of the competition, with predictions typically ranging from 3 GW - 5 GW.
Budget will go furthest for the fastest projects
How productive the round ultimately is for offshore wind could come down to how many parties are able to bid in projects with a delivery year of 2027-2028, as doing so would mean each winning project would eat into less of the GBP 800m budget pot.
This is because the market reference price - the price at which government starts to calculate the budgeted cost of the CfD scheme - is materially higher for delivery year 2027-2028, at GBP 37.74/MWh, than it is for delivery year 2028-2029, at GBP 30.22/MWh, or the super low GBP 25.81/MWh rate set for 2029-2030.
Using very approximate load factor metrics, were the majority of offshore wind projects to bid into delivery year 2027-2028 at a strike price of GBP 67/MWh (in 2012 prices), for example, this would mean that each project would be tapping the budget pot for in the region of GBP 30/MWh, which could potentially lead to in the region of 6 GW of capacity awarded.
But if most projects bid for delivery year 2028-2029 this could drop to 4 GW of awarded capacity or less, as the budget starts to be eaten into at a reference price GBP 7/MWh lower.
Those more optimistic about offshore wind’s prospects in AR6 nevertheless point to the potential positive impact that investors' gradually reducing cost of capital may have.
“Projects’ levelised cost of energy (LCOE) has gone up by up to 50% over the last couple of years, but two-thirds of that increase is down to the cost of capital (long-term risk-free annualised cost of capital went up from 0% to 4%),” says Green Giraffe’s Clement Weber.
He adds: “This long-term risk-free annualised cost of capital has already started to recede to around 3.5% over recent months which, together with inflation being controlled and CAPEX costs now plateauing, will make bidders more competitive as it has a real downward impact on LCOE. We could therefore see more than the estimated 3 GW -5 GW of offshore wind capacity allocated, as long as there isn’t another big market shock.”
Nevertheless, even assuming more optimistic outcomes, “this pot is not going to go very far in a world where we have ambitions of reaching 50 GW of offshore by 2030,” cautions PwC partner Ronan O’Regan.
He adds: “There is a long lead time for these projects - you’d need to get closer to 10 GW of offshore wind each CfD round through to 2026 to make this by 2030.”
Weber concurs.
“The highest risk for the sector is the timing difference between CfD award and final investment decision (FID): in the UK there are around 18 months between CfD and FID, but offshore wind turbines (and other segments of the supply chain) need to be ordered around five years in advance, which creates a real headache for developers.”
Consented offshore wind schemes potentially lining up a CfD bid this year include Orsted’s 2.6 GW Hornsea 4, Vattenfall’s 2.8 GW Norfolk Vanguard, ScottishPower’s East Anglia One North and East Anglia Three schemes, and Equinor’s 700 MW-plus Sheringham and Dudgeon wind farm extensions.
REMA
Another potential storm cloud on the horizon for offshore wind may come in the form of the UK’s ongoing review of electricity market arrangements (REMA).
The UK government launched a second round of consultation on its REMA plans this month, with one of the key proposals indicating a potential move to zonal energy pricing.
Given a large percentage of the offshore wind projects in the UK currently being planned or under construction are located in similar parts of the north of England and Scotland, this could ultimately significantly drag down wholesale prices in these areas once all of these schemes are online.
This in turn means offshore wind developers may have to bid higher CfD prices to offset the low energy prices they are likely to encounter once projects come off their 15-year CfDs.
“If you’re bidding for a 15-year CfD and you’re assuming a 22-year asset life when you model, you’re thinking how much revenue can you generate from the final seven years of the project’s assumed life,” Regan says.
As such, at the least, the REMA proposals add a further layer of complexity to offshore wind sponsors’ CfD bidding strategies.
CfDs more attractive than PPAs
Twelve months ago, with wholesale power prices still high, onshore wind, offshore wind and solar PV project developers could entertain thoughts of securing long-term PPAs at prices over GBP 80/MWh, therefore providing an attractive alternative to bidding for a CfD.
This in turn meant that there was arguably less competition for CfDs in AR5, and winning onshore wind and solar PV strike prices came in at GBP 52.29/MWh and GBP 47/MWh (in 2012 money).
However, with wholesale power prices now materially lower, developers would be lucky to secure PPAs at GBP 70/MWh. As such, there is a general industry view that CfDs have again become the preferred option - which could lead to heightened competition for CfDs and potentially lower prices than last time around in 2023.
“We have projects ready to bid into AR6 but haven’t taken a view yet - our assumption for the current auction is that most investors will want to go for a CfD, unless they’ve got a good PPA locked in,” one European developer told NPM Europe in an interview at the WindEurope conference in Bilbao (March 21).
Of course, for the most well-placed projects, with higher forecast load factors or competitive grid costs, for example, PPAs could still remain a viable option, even at prices 15% lower than were available last year.
Trade association Energy UK, for one, is projecting that AR6 could potentially deliver 700 MW of onshore wind and 1 GW of solar should strike prices stay the same as AR5. However, were strike prices to come in at the auction ceiling “administrative strike price", the round might ultimately deliver 500 MW of onshore wind and 600 MW of solar.
Floating offshore
AR5 in 2023 was not only a no-show for fixed bottom offshore wind, but also for floating offshore wind players.
However, with a materially higher administrative strike price set for AR6 there is market optimism that the round could lead to contract awards for the still fledgling space.
“The budget announced keeps the competitive tension - which is good for everyone - and makes space for one to two floating offshore winners,” Weber says.
There are three prime contenders to compete for floating offshore wind CfDs this year, with EDF’s Blyth 2, Simply Blue’s Erebus and Copenhagen Infrastructure Partners and Hexicon’s Pentland projects all able to participate, although a clutch of further projects could also potentially secure consents in time to bid this year.
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