Contracts for Difference (CfD) auctions are no longer working well for the offshore wind sector and may need to be replaced with an alternative mechanism.
The growing size of projects, which require developers to spend hundreds of millions of pounds on development without knowing whether they will go ahead, is reducing the attractiveness of the sector to international investors who face less risk in other countries.
This is one of the main findings in a new report from the Mission Zero Coalition authored by former energy minister Chris Skidmore and Renewable UK chief executive Dan McGrail. The coalition was established in March 2023 to push for the implementation of the recommendations from Skidmore’s independent review for government on the delivery of its 2050 net zero target.
Its latest report has been released to mark the fifth anniversary of the signature of the target into law by Skidmore. The findings are based on a series of evidence gathering sessions held by the organisation’s power generation network headed by McGrail.
The report says CfD auctions are “highly effective in liquid markets where ‘at risk’ development costs are low,” providing a useful tool for price discovery. This is the case in sectors such as onshore wind and solar in which developing a 100MW project to the point of being able to enter an auction costs up to £5 million and £2 million respectively.
However, the report says developing an offshore wind farm “of any size” is likely to cost in the region of £200 million to £400 million: “These costs are accelerating, and recent evidence suggests that the constraints being felt in the supply chain are requiring developers to place greater and greater commitments to suppliers before CfD auctions, potentially up to £1 billion.
“These are risks which UK developers are taking for the right to enter an auction,” it adds. “This is clearly unsustainable and is a major risk factor for the attractiveness of the UK market, especially when other geographies are running combined seabed and CfD auctions, eliminating all of this risk.”
It says many suppliers, particularly of turbines and electrical equipment, are “simply unwilling to dedicate scarce manufacturing slots to a project that might win in a CfD auction.”
After no offshore projects entered bids into last year’s fifth CfD allocation round, the report says the presence of an auction in the UK’s offshore wind market “may now be in the perverse situation where it is actually costing consumers money rather than fulfilling the mission of protecting them. This may be a temporary effect, but the failure of the UK to react could have long-term consequences, especially if supply chains and developers redirect their capital elsewhere.”
For the ongoing sixth allocation round, the government has increased the strike price cap that deterred any bids and raised the ring-fenced budget for offshore wind to £800 million – four times what was available in the previous round. Nevertheless, the report says it is “questionable whether this goes far enough to address the missed year, and the government’s 50GW offshore wind target is now very much in doubt.”
The report continues: “The logic of auctions when offshore wind is such a clear policy objective, especially in a Labour run government scenario which seeks to decarbonise electricity by 2030, is flawed. There is no other comparable infrastructure at this scale, whether in energy or beyond, which is subject to auctions.”
It says political sensitivity around energy bills has led government ministers and officials to protect the auction model. Meanwhile, the mechanics of the auctions have been designed to protect the Treasury by “using fanciful load factors and reference prices, which ironically results in less renewables being built than are available and thus costing the consumer more in the medium-term.”
“This is a highly technical point but is at the core of why CfD auctions are becoming less and less attractive for overseas investors,” the report states. “Equally, this forces governments to set higher budgets than are actually required and makes life politically more complicated.”
The report says the “one-size-fits-all” auction model is also failing emerging technologies such as floating offshore wind and marine energy: “Costs are simply too volatile and the lack of upside in a CfD commercial model leaves only risk for investors, when risks are already inevitably higher.”
It says the Renewables Obligation scheme, which CfDs replaced, allowed developers to make a final investment decision at the same time as securing a route to market, “whereas the CfD auction manufactures an 18-month gap between the auction and the FID.”
Some technologies such as floating solar are currently unable to access the auctions.
The report sets out a series of short, medium and long-term recommendations for the government once it takes office following the general election next month.
In its first 100 days, the new government should launch a consultation on the introduction of CfDs for innovative solar technologies. In the first year, it should conduct a full independent review of the CfD auction system and implement a model to enable technologies such as floating offshore wind to take final investment decisions.
Over the full five-year term of the next parliament, the government should review the whole of the CfD regime and consider alternative allocation models, in particular for offshore wind. It should also review the cost included in CfDs bids, especially those which are not controllable by the developer and should possibly be transferred to general taxation, and evaluate reforms to the offshore wind leasing process to de-risk development.
Other recommendations in the report include reforms to the planning system and measures to accelerate the buildout of the power grid.
Chris Skidmore, chair of the Mission Zero Coalition, said: “In a week’s time whoever forms the next government will need to prioritise the net zero transition further and faster than ever before if we are to meet our target of decarbonising 68% by 2030.
“The report provides a comprehensive roadmap on what needs to happen not only in the next five years, but in the next 100 days and one year. I hope that the incoming government will use it as a template to deliver what we need to achieve to meet net zero.”
RenewableUK chief executive Dan McGrail said: “We hope that the next government will use the detailed recommendations set out in this report as a blueprint to enable the UK to stay on track to reach net zero.
“Ofgem estimates a net zero grid would deliver £10 billion of savings for consumers by 2050, so the imperative to build a grid that’s fit for purpose to make the most of renewables is as important for billpayers and our energy security as it is for the planet.
“As the report states, the longer we wait to decarbonise, the more billpayers lose out”.