A win for Decc and for consumers

Contracts for difference auction shows competition is better than centrally set “best guesses”.

Thursday 26 February was a good day for the Department of Energy and Climate Change (Decc) and, in particular, a good day for the Electricity Market Reform (EMR) team. The contracts for difference (CfD) auction results were out and the strike prices were well below those we had initially set centrally (in the case of onshore wind, a 17 per cent cut).

Working out of government and in the energy sector means I have the pleasure of witnessing the pace at which new ideas are translating into more efficient generation and consequently lower costs. Therefore, it is no surprise that if civil servants are given the impossible task of setting a “fair” price for renewable power, then even with the best supporting analysis they are going to get it wrong and almost certainly are going to over-pay.

If you imagine having to run an analytical process to “assess” costs in the sector, define the likely need for power from that sector and create a resulting supply/demand curve, then the results are going to be rough at best. Combining this with the usual elongated consultations (legally required) and a sector constantly saying you have underestimated their costs, then it is not hard to understand why, in the light of the auction results, the previous “administrative” prices look high.

Clearly, the auction is a win for Decc and is a win for consumers. However, it is also good news for the renewables sector. With costs and bills high on the public’s agenda, we need to demonstrate that, as has been argued for the past ten years, costs will come down as renewables scale up. This argument looks much more credible with the auction results we have seen. For example, with offshore wind at a strike price of £114, the aim of reaching £100/MWh by 2020 looks achievable and further savings beyond this perfectly possible.

Equally, these auctions put renewables in pole position for “winning” the low-carbon race. The new benchmark for established technologies is lower (with onshore wind, about £80/MWh, for example). Other sectors will struggle to match this – at least at that headline strike price. We still need baseload and do not yet have cheap ways of tackling the intermittency, so the overall comparison should not be on price alone. However, nuclear, for example, will need to make aggressive cuts from the Hinkley deal to remain a cost-effective competitor to renewables.

So with the champagne corks popping in Decc, what could be improved?

•    More may be needed to tackle “winners’ curse” – aggressive bids that are too low to deliver are a big problem in infrastructure auctions and clearly were a problem here for solar. It may not be popular with all developers, but a “bid bond” where a security payment is put down and lost if the project is consequently not delivered could help tackle this.

•    Greater clarity on how much will be allocated to “pots” in future auctions – as soon as possible after the election we need a clear outline of the likely pots for allocation until 2020.

•    A much more clear long-term direction of travel – over time, a much clearer view of ­budgets post-2020. Many projects are already spending significant amounts in the hope they are able to access CfDs. They don’t need certainty now, but do need to know that the budget for low-carbon generation is large enough to accommodate them if they can deliver in this period.

Finally, if there remain people hoping for a return to administratively set prices, I am afraid I cannot see Decc changing course. In fact, expect the opposite – Decc will want to look for greater competition between different generation sectors. This is not simple, and Decc may rely on informal benchmarking between different generation types, but the vision of EMR is to return as soon as possible to technology-neutral competition. This auction’s results are a great step towards that.

Jonathan Brearley, director, Brearley Economics