Concerns have been raised that strong competition in the upcoming Contracts for Difference (CfD) auction could push developers to bid at excessively low prices that they are ultimately unable or unwilling to deliver.
Gareth Miller, chief executive at the consultancy Cornwall Insights, said the government may want to consider strengthening delivery penalties to prevent the occurrence of the so-called “winner’s curse”.
Earlier this week, the government released the preliminary budget for the next auction due to take place in May 2019. According to the document, up to £60 million of annual subsidies will be allocated to less established technologies such as offshore wind – an amount which Greenpeace described as “bewildering” and “pitiful”.
However, speaking to Utility Week, Miller said he was more surprised by the stringent caps on strikes prices respectively set at £56/MWh and £53/MWh for offshore wind projects commissioning in 2023/24 and 2024/25.
As they are not much higher than the wholesale references prices published alongside the draft budget, Miller said if developers did bid at these levels, the auction could potentially secure more than 4GW of capacity.
They would not need to go much lower for the contracts to effectively be “subsidy-free”, meaning the amount of procured would only be limited by the 6GW capacity cap that the government has proposed.
Miller said there are good reasons to think these strike prices are achievable.
Rising interest rates, the falling pound against the euro and the nature of the projects bidding in the auction, which will be “much further out to sea… in deeper water”, are all likely to put upwards pressure on costs, he explained.
On the other hand, “learning rates have continued to drive cost reductions in offshore wind” and the price caps are only marginally less than the £57.50/MWh achieved by two projects in the most recent auction in September 2017, “so it’s not far to drop.”
Although they are not directly comparable with those in the UK, several recent European auctions have seen substantially lower bids.
“You can’t imagine that BEIS will have set these price in isolation of engagement with the market,” he added. “So they must have an expectation that these prices are achievable.”
Miller said there is actually likely be strong competition for contracts: “Every auction we’ve had to date – capacity auctions and CfD auctions – has surprised on the downside in terms of price. Prices have always come in below the pre-auction consensus and that’s because these auctions are incredibly competitive.”
He continued: “If you look at what the Crown Estate estimates is out there, consented and capable of coming into an auction, it’s about 8GW.
“The way that those projects are phased and the decisions developers take on phasing will have an impact on precisely whether it’s 8GW or a slightly smaller number. But it’s a lot of capacity.”
The government may have committed to holding auctions every two years over the next decade but Miller said there’s no guarantee this will happen: “There’s no guarantee that this government will even be in power in two years’ time to be able to run the next auction. So the risk of being stranded mid-development if you don’t win in this auction is enough to encourage people to bid extremely aggressively.”
On this basis, he raised concerns that developers may fall victim to the “winner’s curse”.
“If you’re going to set prices this low and you’re going to buy a lot of capacity at these prices, should we look at the delivery penalties under the CfD?,” he asked. “At the moment, there’s no financial consequence for failing to deliver.
“So we procure capacity – in this instance four or five years ahead – and as a government they sit there and congratulate themselves on the low prices… What if these projects don’t deliver and what are the incentives on delivery that exist within the CfD? There’s no letters of credit or bid bonds that have to be submitted as part of this auction.
“And I think if BEIS is really going to encourage this to-the-bone bidding the risk of this winner’s curse gets greater. And as that risk rises, I do wonder whether BEIS should consider whether they should tighten up the delivery penalties.”