CfDs drive down prices

27 November 2019

The 3rd allocation round (completed Sep 2019) of the UK’s Contracts for Difference (CfD) auction – a support scheme for ‘less established’ low carbon generation technologies – achieved record low prices for offshore wind. By Simon Virley, Head of Energy and Natural Resources, KPMG.

The first delivery year (2023/24) – see table – cleared at the lowest price of £39.650/MWh (2012 real), with the second year close behind at £41.611/MWh (2012 real). On signing, these projects secure 15 year contracts which provides valuable power price certainty in a dynamic and evolving power market.

Offshore wind secured 5.47 GW of contracts, representing 95% of the capacity awarded.

The CfD mechanism has been instrumental in rapidly driving costs within offshore wind, with clearing prices in this third round achieving parity with the wholesale power market.

The £39.650/MWh (2012 real) prices achieved in September are equivalent to £45.46/MWh in 2019 prices, versus a contemporary day ahead price of about £40/MWh.

Such competition for CfD contracts illustrates the value investors place on the revenue security, which enables access to low cost finance. The ability to commit to such low strike prices during the CfD term may also reflect investor assumptions about asset life and wholesale prices during the post-CfD period.

In just four years, the CfD mechanism has provided the support necessary to cut offshore wind costs by 65%. The first CfD allocation round, held in 2015, awarded contracts to 1.2 GW of offshore wind at a price of £114-120/ MWh (2012 real).

The latest results demonstrate both dramatic cost reduction, and development of scale. With the September awards, total offshore wind capacity supported under UK schemes has reached almost 20 GW.

SSE and Equinor secured 3.6 GW of offshore wind projects, in the Dogger Bank zone. These developments are pioneering large scale projects, much further out to sea than has been seen previously in UK waters. Innogy’s adjacent Sofia development also secured a CfD.

East Anglia 3 (Scottish Power), Inch Cape (SDIC) and Moray West (EDPR) did not secure a CfD in this allocation round.

Round 3 made £65 million of CfD subsidy available for ‘less established’ (aka Pot 2) technologies, with an overall cap set at 6 GW in total. In practice, the auction was capacity constrained, with none of the budget allocated, due to clearing prices below the reference prices. Entering the auction, 9.8 GW of offshore wind projects were eligible to bid. A maximum (‘administration’) strike price of £56/MWh for offshore wind set the playing field well below the anticipated competitive range for many of the other Pot 2 technologies. However, alongside offshore wind, 34 MW of ‘advanced conversion technology’ projects were successful.

‘Remote islands wind’ projects (onshore wind on islands off the coast of Scotland), which were a new addition to Pot 2 in this round, were also successful, securing 275 MW.

The filing for judicial review submitted by Banks Renewables casts some uncertainty over the results. Until resolved, this uncertainty may prohibit developers from taking FID and may prolong their exposure to movement in macro economic factors such as foreign exchange and inflation, as well as development costs such as booking fees. This will be particularly challenging in the current climate, with Brexit uncertainty eating into the already tight margins required to achieve such low clearing prices.

2.85 GW of the capacity secured during this allocation round will become operational in 2023/24, with a further 2.9 GW coming on line in 2024/25. This capacity connects to the UK grid at a crucial time as 4 GW of existing coal and 2.3 GW of nuclear capacity is being decommissioned over the same period.

The intermittency of this new predominantly offshore wind capacity will simultaneously create opportunities for complementary flexible generation to provide grid stability.

The additional buoyancy in the offshore wind market created by the latest CfD allocation round is to be welcomed ahead of the Crown Estate Round 4 seabed lease auctions which launched in October 2019. Together these initiatives are providing the foundation for growth towards the 30 GW by 2030 target of the UK government’s offshore wind ‘sector deal’ and, longer term, the UK Climate Change Committee’s recommendation of 75 GW of offshore wind by 2050.

Capacity per delivery year (Source KPMG)
Auction results for CfD third allocation round
Strike prices awarded under the CfD regime (Source: BEIS)

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