By PETER ATHERTON
The results of second round of Contract for Difference (CfD) auctions for new low-carbon power generation were announced by the government on 11 September.
In total 11 projects were awarded CfD’s with a combined capacity of 3,345MW. The vast bulk of this capacity is accounted for by three offshore wind farms that between them have a proposed capacity of 3,196MW.
All projects are due to commission between the years 2021 to 2023 – although in the case of the three offshore wind farms the they will commission in phases with phase one only being ready by 2022-23.
Two things stand out from this auction that will have big implications for the power sector going forward. First is that offshore wind won 95% of the available capacity (and therefore the money).
And the second is that the three projects cleared the auction with strike prices of £74.75/MWh (Triton Knoll) and £57.50 (Hornsea 2 and Moray East).
Of course these strike prices are somewhat misleading as they are expressed in 2012 money. If we take actual inflation into account Triton Knoll for example would be receiving c.£82/MWh if it were operating this coming winter and at around £92/MWh when it opens if we assume an average inflation rate of 2.5% to commissioning. The same numbers for Hornsea 2 and Moray East are c.£64/MWh and £74/MWh. These adjusted numbers reflect the price that consumers will actually pay.
Nevertheless, even adjusting for inflation, there is no doubt that these three contracts are dramatically lower than previous awards for offshore wind.
Only back in 2015 the government awarded five offshore wind projects CfD’s at prices between £140-150/MWh. Just three years later the price has more than halved.
The dramatic reduction in strike prices can only be explained by three possible factors.
- First that there has been a significant reduction in both construction and operating costs for offshore.
- Second, the government vastly over paid for offshore wind back in 2014, and/or:
- Third the bidders for the latest round of contracts have under-bid and / or are accepting much lower returns.
So, which of these factors is true? Probably all three.
There is no doubt that underlying costs in offshore wind construction and operation have reduced significantly.
Several factors have played a part. Turbines have got bigger, and their siting to get the best wind conditions has improved. Together these factors have greatly improved the expected load factor / wind yield.
Also as other countries like Holland and Germany have expanded offshore wind supply chain, the equipment, installation, and maintenance services has expanded bringing greater capacity, more competition, and lower costs.
Finally, the depression in offshore oil and gas development has meant that the cost of skilled labour and resources like shipping that overlap between oil and offshore wind have come down.
That the government grossly overpaid for the 2014 round of contracts issued under its Final Investment Decision (FiD) process looks increasingly obvious.
The cost of these has been much criticised by National Audit Office amongst others. It seems clear that, when the government directly negotiates contracts with developers (e.g. the FiD contracts and Hinkley Point C), they end up paying very high prices. Only when the government removes itself from the negotiation and instigates an auction process (capacity market, renewable CfDs today) do prices tumble.
The final potential factor, namely the developers have possibly under-bid and / or are accepting lower returns, is hard to gauge at the moment. All three projects will, armed with their CfDs, now seek to obtain financing and it will be interesting to follow their progress.
One obvious question is why Triton Knoll requires a strike price some 30% higher than Hornsea 2 and Moray East? Whilst Triton Knoll is the smallest of the three projects at 860MW, this is only 90MW smaller than Moray East. Triton is also only 20 miles off the Lincolnshire coast whereas Hornsea 2 is 50 miles offshore – suggesting higher costs.
Hornsea 2 should be able to benefit from the infrastructure laid down for the Hornsea 1 development, but Triton is in the same region and should get some of the same benefits especially with regards to skilled labour etc.
Moray East on the other hand is off the north of Scotland coast where the weather conditions are likely to be the most challenging and where there are far fewer developments.
So on the face of it, it’s hard to explain the sharply higher strike price for Triton Knoll compared to the other two projects as there is no obvious reason why that project would have significantly higher costs. Indeed given its location one would expect Moray East to have the highest costs.
As for the required returns the developers are targeting, alas this information has not been made public. It would be logical however that hurdle rates have fallen in the past few years as construction techniques and turbine technology mature.
Simply put, construction and operating risk today should be lower than it was on earlier projects. There is also now a proven secondary market for these assets (backed by CfDs), which provides developers with a clear exit to monetise their investment. Therefore the hurdle rates of 12-15% seen a few years ago may now be down to single figures.
If we assume that the developers of these three projects can successfully build them and earn a reasonable return at these strike prices it will be a significant step forward for the off-shore wind industry and lower estimates for the cost of the governments long term decarbonisation program.
It will also put significant pressure on other technologies especially new nuclear. The economic case for Hinkley Point C has taken another body blow.
Cornwall Insight Associate Peter Atherton is an equity analyst having headed utility research at several eminent City institutions, most recently Jefferies.
28 Sept 2017