Subsidy-free renewable energy – commercial reality or government fantasy?

Overview

The past few years have seen a steady withdrawal of government financial mechanisms for renewable energy, with some technologies left with no support for new development.

At the same time, the government confirmed in the autumn budget that it would not invest further in renewables beyond the £557 million already committed to Contracts for Difference (CfDs) until at least 2025, or when the cost to the Treasury falls.

Trade bodies and renewable energy developers have criticised the uncertainty. Some are frustrated, and predict jobs moving overseas if the government does not act soon to provide a route to market

James Court, head of policy and external affairs at the Renewable Energy Association (REA), says that the route to market for renewable energy, barring those with very particular sites, and a very particular investor or power purchase agreement (PPA), has largely been blocked. “Away from these very unique sites, you’ve got to ask – how do we get new generation online?” he says.

Others have begun to adapt to the new reality and are optimistic about the opportunities for new business models. A succession of recent reports has led to much talk of a new era of “subsidy-free” renewable energy. In March, analysts Aurora Energy Research predicted that subsidy-free renewable energy was “on the cusp of a breakthrough” in Britain, and that the trend would “revolutionise” the energy market.

Some 18GW of subsidy-free renewable energy was possible in Britain by 2030, the analysts believed. Further cost reductions alongside the expected increase in commodity prices will lead to onshore wind and solar projects achieving grid parity in the early 2020s. Offshore wind could gain this milestone in the late 2020s or in the 2030s, they predicted.

Jonathan Marshall, head of analysis at the Energy and Climate Intelligence Unit (ECIU), says that the hype around subsidy-free renewables was understandable. “Renewable energy has always been targeted for being heavily reliant on subsidies, even though the whole energy industry is reliant on support or market mechanisms in one sense or another. So, for the renewables sector to go above and beyond everyone else is an industry response to the flack it’s been taking for the past 10-15 years.”

But what is “subsidy-free”?

Definitions of what subsidy free actually means vary. According to Aurora Energy Research, such projects are those that do not have long-term government contracts or subsidies. The firm does not count Contracts for Difference (CfD) as a subsidy, since these contracts are essentially procuring a service, according to Hugo Batten, head of GB renewables at Aurora.

Marshall says that true “subsidy-free”, where a project was completely supported by market payments, would be “a bit of a long-shot”, since even conventional energy generation is supported through the capacity market.

The model that is more likely to be achievable is for renewables to be given access to a market stabilisation tool such as the CfD mentioned above, but that over the length of the contract, the generator does not incur additional cost – the so-called “subsidy-free” CfD. The main role of this mechanism would be to remove much of the risk from the developer, which would reduce the cost of capital “tremendously”, Marshall says.

Several trends in renewables have coincided to catalyse this debate. More efficient and advanced technologies, and clever design of projects, has brought rapid cost reductions across renewable technologies. Anesco claims to have cut the cost of design, engineering and construction by 30 per cent for its Clayhill project – claimed to be the UK’s first subsidy-free solar farm – by rethinking each step of the process.

Another key trend is the possibility for “revenue stacking” brought about by the growth of storage technologies. Revenue stacking allows developers to fund and de-risk projects through a variety of sources. For example, co-locating renewable technologies with battery storage enables additional revenues from grid services such as frequency response and balancing.

Court describes the potential for co-location of solar and battery technology as “hugely exciting”. There are some regulatory issues over whether co-located projects will still be eligible for existing payments under the Renewable Obligation Certificates (ROCs) and Feed-in-Tariffs (FiTs). The industry has been trying to resolve this with Ofgem, he says.

“But the issues are not insurmountable, it’s a work in progress,” he adds.

Threat to community benefits

However, the race to be subsidy free has raised some concerns that some of the side benefits of renewables could be lost. During the planning process for onshore wind, developers are often asked by local councils to pay into a community fund or provide other benefits such as adapting schemes to improve biodiversity on site.

“Belts will have to be tightened. It may go back to how it was previously, where there wasn’t a rule about community benefits, it was just what you needed to do to get communities on side,” according to Simon Wannop, director of REG Power, which develops and operates onshore wind and solar projects.

Rachel Ruffle, managing director in the UK and Ireland for developer RES agrees that cost cutting could make developers question providing other benefits. “Wind farms have been offering community benefits, but other forms of generation aren’t expected to do that. If we’re supposed to compete with other technology, then why do we have to meet these burdens?”

Leonie Greene, head of external affairs at the Solar Trade Association (STA), is also concerned that excessive pressure to cut costs could lead to loss of quality in project design. Since the early days of its development, the solar industry has been keen to commit to high levels of environmental protection and community engagement so as to avoid the public relations problems the wind industry faced.

“Some of the features on some of the schemes concern us – it’s really important that schemes are done well. Some really big schemes are being put together to make the economics work and they will be harder to get through planning,” she says.

Onshore wind

Coming out of the doldrums?

In May, developer Energiekontor achieved financial close on the 8.2MW Withernwick II wind farm in the East Riding of Yorkshire. The developer says the plant is subsidy-free, made viable by a corporate power purchase agreement (PPA) with a company it describes as “one of the UK’s leading companies supplying consumer goods”.

Peter Szabo, the firm’s chief executive, said: “The financial close of the Withernwick II project, the UK’s first profitable wind farm under pure market conditions, shows that our strategy to reduce costs by improving efficiency is bearing fruit.

“It also underlines our pioneering role in the quest to realise wind farms and solar parks with a lower levelised cost of electricity than fossil and nuclear alternatives.”

However, Marshall says: “Bringing a wind farm to market via a PPA is clearly a step forwards, but unfortunately the potential of the PPA market in the UK is not sufficient to make a big impact on onshore wind capacity.”

Most commentators agree that the UK PPA market is currently too small to really support the growth of renewables. Although it grew steadily in the first years of the decade, reaching 267MW capacity come under a PPA in 2016, 2017 saw only 61MW of projects signed, and 2018 so far has seen 10MW, according to Bloomberg New Energy Finance.

Wannop believes that corporate PPAs account for less than 10 per cent of the renewable energy market. PPAs are constrained by banks wanting the purchaser to be investment grade, which in reality limits the market to the FTSE 50, he says. “There are lots of projects chasing not many corporate PPAs,” he says.

Piers Guy, UK country manager for developer Vattenfall, says that the firm is exploring the possibility of PPAs for its onshore wind projects. It is planning to divide up the output from its 165MW South Kyle project in Scotland into 1MW contracts. “We’re trying to open up the market at a level that makes it appealing to a wider number of businesses,” he says. However, despite this innovation in PPAs, Guy says that the firm’s primary focus is on onshore wind being able to bid in the CfD at no net cost to the consumer.

Vattenfall, together with developers ScottishPower Renewables, Innogy and Statkraft, commissioned research into the potential for onshore wind from consultants BVG Associates. Its report, published in June found that if 1GW of onshore wind was allowed to compete in five CfD auctions at 18-month intervals from 2019, the cost of new projects could drop beneath the government’s forecast wholesale electricity price from 2023, paying back £1.6 billion to UK consumers.

According to Lindsey McQuaid, strategic regional sales manager for Scottish Power Renewables, 2018 is a key year for this issue to be resolved. “The renewables obligation created a foundation and we need to make the most of that. The longer the hiatus continues, the more likely it is that the supply chain will leave, and jobs with it. We’re teetering on the edge,” she believes.

Return of the CfD?

Indeed, many in the sector are hopeful that the government is shifting its stance slightly on onshore wind, and that it could allow it to bid in the next CfD auction in spring 2019, even if just on the basis of a “subsidy-free” CfD.

In line with its 2015 manifesto commitment, the government barred onshore wind and solar PV from the second round of the CfD in 2017. However, it has since been under pressure from the Scottish and Welsh governments, both of whom support onshore wind as the lowest cost form of electricity generation.

Energy and clean growth minister Claire Perry has publicly stated that the government is working towards allowing onshore wind, where communities are in support.

Speaking at the All-Energy conference in Glasgow in May, Perry said: “I would like to see onshore wind deployment happening, and there is a lot of work going on as we speak to try and sort that out. But we also need to politically preserve our manifesto commitment on onshore wind, which we don’t think is the right technology for a lot of England.”

However, onshore wind was “obviously perfect” in Scotland, where there is a much less concentrated population, she added.

Onshore wind on remote Scottish islands has already been allowed to compete in the next round of auctions after the government secured EU state aid approval to classify it as a separate technology in the scheme.

A successful auction result could demonstrate what the technology was capable of, believes Marshall. “These projects will be slightly more expensive because they will have to pay for cabling, but it will still be a chance for onshore wind to show what it can do when employing the latest technology, which is much more advanced than when the last round of projects was planned,” he says.

Record low prices for offshore wind at the last auction won over critics of that technology, and the same could happen for onshore wind if it was given even a small amount to bid for, he believes.

“Onshore wind would likely clear at lower than the wholesale price, which would effectively be subsidy free,” he says.

REG’s Wannop believes that “subsidy-free” CfDs are essential for the future of onshore wind and solar. REG has a project pipeline of more than 500MW at various stages of development. “We have some consented sites, but we’re trying to make them work without subsidy, which is challenging.”

“Onshore wind and solar projects can be built now, subsidy free, if they’re the right site. But we need a fixed price for 10-15 years to give us and our investors certainty in the returns we can make. We’ve just done a PPA tender, but the longest we could get a fixed price for was under ten years. It’s not a good deal for us as a generator.

“If we assume that corporate PPAs are limited in terms of the volume available, we need another route to market. The solution is subsidy-free CfD, which is at or below the reference price set by government. Wind or solar can bid below the reference price – if the government designs it in the right way, they might find that these technologies might actually end up returning money to the consumer,” he says.

Corporate PPAs would deliver much less benefit back to consumers, he says.

Potential for cost reductions

Recent predictions by analysts have highlighted the potential for subsidy-free renewables. Research by consultants Baringa Partners for trade body Scottish Renewables published in April 2017 found that 1GW of onshore wind could be brought forward in the UK without the need for any direct subsidy.

The consultants expect the auction to clear at £49.40/MWh, meaning that successful onshore wind projects would receive limited payments above the wholesale price of power in the first five years of their operation. After this, they would pay back a greater amount to the public purse — estimated at £18 million — over the remaining 12 years of their contract as the wholesale power price increases.

Meanwhile, a report by Arup for developer Scottish Power Renewables published in July 2017 found that onshore wind could become the lowest cost form of new energy generated in the UK if it was allowed to bid in the CfD auction.

The report argues the case for a “market stabilisation” (or subsidy-free) CfD, to bring forward investment and level the playing field with gas generation. The authors estimate that the strike price for onshore wind would need to be capped at £50-55/MWh to achieve this.

Bullish expectations

However, in contrast with these predictions, Ruffle says RES is already building projects without any form of support.

She says: “We’ve got around 140MW of consented projects that are not getting a subsidy. Some of them are a bit far out in terms of getting grid connection, so there are the normal development issues, but we’re absolutely confident that they’re viable and that we have good interest from investors in those projects.”

Ruffle says that the company chooses sites in locations with good wind resource – all its consented projects are in Scotland – and road access to save money on building tracks. Technology improvements such as more efficient and larger turbines have combined with reductions in supply chain costs to cut the cost of the technology, she says.

Expectations of investors have changed from those who traditionally invested in onshore wind, who were used to the technology having a guaranteed fixed price for 10-15 years, to new entrants who were used to other sectors where this was never the norm, she says.

“Investors who are used to other sectors are much more comfortable with the concept that is predicated on the fundamentals of the project. Electricity demand is solid, and if anything should increase due to technologies such as electric cars and general electrification of the grid,” she says.

RES has not planned its pipeline on any hope that a CfD will become available, she says. Access to the auction would not necessarily be a game-changer for the industry since projects in good locations do not need the support anyway, she believes.

“But if onshore wind was in the auction, the price would probably be really low, which would publicly show everyone how cost-effective wind is. It would level the playing field with other forms of generation, most of which are subsidised,” she says.

Solar

Commercial solar struggles while local authority projects soar

The solar industry made headlines in September 2017 when the first subsidy-free solar farm was opened to great fanfare by clean growth minister Claire Perry. The 10MW Clayhill solar farm in Bedfordshire developed by Anesco cut costs by 30 per cent by rethinking all aspects of project design. It also has 6MW of energy storage on site, meaning that Anesco can “revenue stack”, receiving payments in return for grid services such as frequency response and balancing services.

In the nine months since it opened, Clayhill has been profitable, reports Anesco’s executive chairman Steve Shine. The company has plans for two further projects using the same model but has delayed decisions on these until it is clear whether solar will be allowed into the next round of CfD auctions.

“We’re as confident as you can be. We think onshore wind and solar will be in the next round, but with a special focus on hybrid (using solar with storage). The cost has come down – we can build hybrid now for the same price as we used to build solar only,” he says.

Without batteries, solar projects can only receive around a 4 per cent return on investment, which is not enough for investors, he adds.

Anesco is able to predict revenue streams from the various sources open to its projects using a bespoke financial model developed with consultants at Cornwall Insight. Mike Mahoney, head of wholesale and modelling at the firm, said that the model allows Anesco to test various scenarios and work out the most financially advantageous way to use its assets. Battery technology can be used in different ways to make the most of different revenue streams, he says. “The model aims to find the best way to maximise value from those assets,” he says.

However, the business model used by Anesco at Clayhill has yet to be replicated across the sector. The government has been happy to use the advent of the UK’s first subsidy-free solar farm as justification for its exclusion of solar projects from the CfD auction. However, in a parliamentary written answer to a question by Zach Goldsmith MP in December, energy minister Richard Harrington admitted that it did not know of any other solar developers working on subsidy-free projects. He also said that the government did not have detailed knowledge of Anesco’s business model.

“We’re not convinced the business model stacks up,” says the STA’s Greene.

Rest of the market struggles

Away from Anesco, the commercial solar market is at a virtual standstill. Solar installations grew to 12, 335MW between 2010 and March 2017, when the Renewable Obligation (RO) closed. Since then, only 177MW capacity has been added, according to government data. “There’s lots of projects desperate to get away – there was at least 1GW of schemes with planning permission and grid connections that didn’t get in on time for the RO,” says Greene.

Greene did not expect this pipeline to come forward till next year.

Solar developer Hive Energy is planning to build “a couple” of solar projects without subsidy over the next year, including a 40MW solar park on land around its headquarters in Hampshire. It is also looking at selling energy direct to city councils for locations where they have a set demand that they can match to the output of a solar farm.

Hugh Brennan, managing director of the firm, says “At the moment, we’re focussed on making renewable electricity as efficiently as possible, rather than on how much money we’re going to make from that electricity,” he says.

Similar to reports from onshore wind developers, Brennan has seen a change of approach from investors in solar energy who are not expecting the guaranteed returns of the past. “A different type of investor is coming in, who understand that the need for energy is the same as the need for bread and milk, but that there are good years and bad years and it won’t be the same return every year,” he says.

The firm is looking at how batteries can help its business case, and describes revenue stacking as “nice to have”, but he stresses that technology improvements in equipment such as inverters and the fall in price of solar panels is all coming together. The technology to adjust electricity generation in real time in response to demand from National Grid has become cleverer and cheaper. “There is less need for big, expensive kit,” he says.

Local authorities now driving the market

In contrast to the struggles of the commercial solar sector, a new trend has developed over the past couple of years which is “keeping most of the sector afloat”, according to Greene. Local authorities are now driving installation of solar technology in new build homes, all without any financial support from government.

Authorities around the country are also asking developers to meet higher building standards than those set by national government, including Bristol City Council and Sheffield City Council. The Greater London Authority has a Solar Action Plan which aims to achieve 1GW of installed capacity by 2030, and 2GW by 2050. As part of this, it is maximising use of solar technologies on its own buildings and is encouraging solar installations through the planning system.

The Scottish Government has also insisted on high standards for new build and two thirds of new build homes now opt to use solar as a cost-effective way to meet the standards, according to STA data.

“This side of the market is absolutely being driven by regional and local government,” says Greene. “Solar is great for local government, it has one of the lowest hurdle rates, so it fits well with their low risk profile and provides a very stable return. They can get local energy purchases, who they know are going to be there for 20-30 years, and they have access to finance as low as 0 per cent interest from Salix Energy.”

Councils are also installing solar panels on their own land and property, using some of the energy to reduce its own energy costs, and the income from selling the rest to fund other services. One such is West Sussex County Council. It is building a 7.4MW solar farm on a former landfill site at Westhampnett. The council had previously built a 5MW plant on a former RAF airfield which benefitted from support from the feed-in-tariff (FiT).

Tom Coates, senior advisor and project manager at the council, explains that the authority considered finding a business to buy the energy it produced through a PPA, but decided that was too risky. Instead, it has incorporated 4MW(h) of battery storage on the scheme designed to enable it to earn revenue from grid services. The council estimates the scheme will pay back in 15 years and generate a net income of £7.9 million.

Chelmsford City Council installed 200kW of solar PV across its main council buildings, including two leisure centres, the main council offices and its operational services depot. The council funded the projects from their own capital funds, though would probably opt for third party investment for any future project, according to Michelle Wright, energy and contracts manager for the council. The schemes are estimated to pay back within five years.

Offshore wind

Hopes are high for a subsidy-free future

The offshore wind sector is still basking in the glory from the record-low prices achieved in last autumn’s CfD auction. Average prices for offshore wind closed at £62.14/MWh, with projects delivering in 2022/2023 at £57.50/MWh, a result which was hailed as taking the UK “into the next phase of the energy revolution” by Phil Grant, partner in energy and resources at Baringa Partners.

Prices of £57.50/MWh demonstrate a potential for offshore wind to be subsidy-free, he wrote in a blog in September.

Subsidy-free offshore wind has already become a reality in some parts of Europe. In the Netherlands, the government ran an auction specifically for projects that wanted to make a subsidy-free bid, with a contract awarded to developer in Vattenfall In March for its Hollandse Kust Zuid.

In April, six offshore wind projects won contracts at an auction in Germany, with the lowest winning bid €0/MWh premium above the wholesale power price. The auction followed a similar one held a year earlier, which saw several offshore wind projects winning contracts without subsidy.

Government intervention still required in UK market

However, these project prices are not directly comparable to the UK, since in those countries, the government pays for the cost of grid connection. In Great Britain, analysts at Aurora predicted in January that offshore wind capacity could grow five-fold to 30GW by the 2030s, if was allowed to bid for a subsidy-free CfD.

If the CfD was set at the level that offshore wind energy achieved in the market, no net subsidy payments would be required over the 15-year term of the CfD contract, the analysts stated. Revenues would be significantly de-risked, increasing the attractiveness to investors. Offshore wind could then generate savings for consumers of around £20 a year during that timeframe, the analysts calculated.

Aurora also recommends that the government adjusts regulation to allow offshore wind to access additional revenue streams such as balancing and ancillary market revenues. Offshore technology has the potential to provide a range of balancing services to the grid, in particular, the ability to ramp-up and down generation rapidly to help balance supply and demand, Aurora notes. Enabling offshore wind to revenue stack would reduce the cost of providing balancing services as well as increasing revenues for offshore wind asset owners, it states.

Vattenfall’s Guy says that the offshore wind industry could reach the point where it could be viable without any kind of subsidy by 2025-2030. However, the sector was “not that far away” from needing only a subsidy-free CfD, he believes.

“We’ll see a price reduction in the next auction round, so in practical terms there will be no net cost to the consumer,” he says.

Revenue stacking would “be helpful” to offshore wind, and it would still represent a small proportion of overall revenue, it would become increasingly important as the sector moved towards a position of being viable at no net cost to the consumer, he says.

Ultimately, the government should allow the sector to work on the system in the same way as conventional power stations, supporting the grid in the balancing and capacity markets, he says. “This would play an important part in the maturity of the industry,” he adds.

Ørsted, formerly known as Dong Energy, was one of the winners in the latest German auction, with a bid of €0/MWh to develop the 420 MW Borkum Riffgrund West 1 wind farm in the North Sea and is current building its UK CfD contract-winning project, Hornsea II. Its managing director, Matthew Wright, sees the downward trend in costs for offshore wind continuing. Economies of scale, a steady pipeline of projects, bigger and better turbines with improved technology will bring reductions in all areas, he says.

“Over time, the costs will come down, the premium over the market will get smaller and smaller, and at some point, we won’t be paid above market price for this generation,” he says.

However, Wright does not want the sector to move to a point where there is no longer any mechanism to stabilise the market price, which has been one of the main benefits of the CfD. “In the UK, there are not many types of project that are built without some form of support, or guaranteed price. To rely completely on the wholesale power price is not where we want the market to go, it introduces a lot of extra risk,” he says.

Wright would support the introduction of a subsidy-free CfD once costs have reduced a bit further, but says clarity in the medium term is vital.

In June, sector body the Offshore Wind Industry Council proposed a “sector deal” to the government. This asks the government to provide greater clarity about how many more auctions there will be and when, and how much capacity they want to secure. This will allow the supply chain to invest and improve its productivity, it says.

In return, the industry has pledged to reduce costs, and provide local content for projects in UK waters in order to support some 28,000 jobs. It predicts it can bring about a £2.4 billion reduction in electricity system costs to consumers, the equivalent of 9 per cent compared to business as usual.Emerging technology

Lack of support delaying innovation

Developers of newer offshore technology also predict it can come in at low cost, given the right market environment, but are frustrated by lack of government support. There are more than 20 developers in each technology, with tidal stream having reached testing phase, while wave technologies are mostly still in the earlier phase of research and development.

The rejection of the Swansea Bay Tidal Lagoon at the end of June certainly is likely to cast an even bigger shadow over tidal lagoons as an option. Keith Clarke, the chair of Tidal Lagoon (Swansea Bay) hit back at the decision. He says: “The treatment of the pathfinder tidal lagoon makes a mockery of a supposed new Industrial Strategy for the UK that pledges to back the disrupters and embrace new industries for a new future. The reality is that the decision sucks the life out of innovation and timid leadership will condemn Brexit Britain to the 20 th century.”

A decade ago, there was “not much difference” in cost between wave and tidal technologies and that of offshore wind, according to the REA’s James Court. “There was so much optimism and excitement. But the goalposts have been moved and the sector has stalled, some of the leaders have exited the market,” he reports.

Costs of wind and solar energy have fallen much faster than expected, and although tidal stream technologies are now in testing phase, “it’s a difficult place to be when other technologies are talking about being subsidy free”, he says.

Andrew Scott, chief executive of Scotrenewables Tidal Power, which is currently testing its 2MW floating tidal turbine technology in Orkney, says that the technology is developing and has the potential to very quickly reduce in cost to around the same level as offshore wind. However, at the end of 2016, the government changed the rules for wave and tidal technologies in the CfD, meaning they now have to compete directly with offshore wind in the auction.

“For the first time in a decade, the UK does not have a specific market mechanism tailored to help wave and tidal come through the commercial phase. We’re in something of an industrial hiatus. The sector has had in excess of £500 million invested, but just as we get to a point where we could deliver a return to investors, the market has been removed. It’s a very frustrating time right now,” he says.

Marine technologies already have infrastructure and supply chain, so are not looking for a huge amount of support, he says. Scott would like to see the government bring in ring-fencing via the CfD. “We’re not talking huge capacities to give us the security to continue to get private sector investment, it could be just a handful of megawatts.”

Wave and tidal technologies could reduce costs significantly if given some government support, according to a report published in May by research centre the Offshore Renewable Energy Catapult (ORE).

It estimated the current levelised cost of energy of tidal stream technology as £300/MWh with 10MW deployed. If installed capacity rose to 100MW, costs could be cut to £150/MWh, and could reach £90/MWh once total installations reached 1GW, it found.

It calculated that if the technology was given £1.3 billion support via the CfD, it could support 4,000 jobs by 2030. Wave technology could support double the number of jobs with a similar support of £1.2 billion, it said.

In the meantime, tidal stream developers are being forced to look at other markets, such as Canada, where there is grant support for the technology, he says. “We would far rather deliver this as an industrial solution in Scotland than up sticks to Canada, but our shareholders are not patriotic about it – they just want a return on investment,” Scott says.