Removing the contracts for difference (CfD) mechanism for offshore wind projects would significantly increase the cost of decarbonising the grid, according to the UK Energy Research Centre (ERC).
The falling cost of generating electricity from renewables, termed “price cannibalisation”, has prompted question marks over whether technologies such as offshore wind need continued government support such as CfDs.
However, new research by the ERC alongside a group of academics warns that fully exposing investors to wholesale market prices could increase the cost of decarbonising the grid by “at least a third”. It adds that removing the CfD mechanism for offshore wind projects could put the UK’s entire energy transition at risk.
Consequently, the group warns against significant changes to the way low carbon infrastructure is funded, in its paper Transition Risk: Investment signals in a decarbonising electricity system.
It says that during the transition from reliance on fossil fuel to low carbon generation, massive investment will be required in renewables, electrification of transport and heat, flexible demand, hydrogen infrastructure, interconnectors, carbon capture and storage and nuclear.
During this build out phase, which the UK is in the middle of as it seeks to decarbonise the grid by 2035, uncertainties surrounding the final state of the decarbonised system mean future wholesale markets contain “significant price risk”.
The UK’s CfD regime provides a fixed price for renewables, shielding investors from these risks, helping to “minimise the cost of capital for these projects during this critical build-phase of the transition”, the paper says.
But “significant changes to this commercial framework for investment in clean energy could increase the cost of capital”, the report warns.
As an example, the researchers estimate these increased costs would rise from £15 billion per annum to around £18 billion – £20 billion per year for offshore wind alone. This is based on a one per cent increase in the cost of capital, which translates into additional costs of £1 billion per year for offshore deployment.
Given the huge amounts of capital required to deliver a decarbonised grid, such an increase could “put the transition itself at risk”, the report warns.
It adds: “The greater the exposure to wholesale market prices, the greater the risk and cost of capital will be.
“Imposing risks on investors which they are not in a good position to manage could simply increase the cost of capital needed to finance the transition without any commensurate benefits in terms of improving the design and quality of the projects.”
During the build out phase, the research adds that there is a strong case for sharing out these costs between investors and consumers.
However once a steady-state low emission grid has been largely built, it will be more feasible for investors to hedge against risks in the market, meaning alternatives to CfDs to address price cannibalisation may become attractive in the longer-term as the risk characteristics of the decarbonised system are better understood, says the study.