It’s about time but there’s not much left

In the latest in our Generation Outlook series, Utility Week speaks to industry experts about the government’s announcement in February that Contracts for Difference auctions will from now on be held on an annual basis. Will this be enough to deliver the tens of gigawatts of low-carbon generation that will be needed to get the power sector to net zero by 2035?

“I remember all the years back when this was being designed,” says Regen chief executive Merlin Hyman. “The idea was very regular auctions, perhaps twice a year.”

The first competitive Contracts for Difference (CfD) allocation round took place in 2015 but since then only two more have been completed in 2017 and 2019. The fourth round – the largest to date – is currently ongoing, having opened to applications towards the end of last year.

The CfD scheme is now widely regarded as one of the success stories of UK energy policy in recent years, rapidly driving down the costs of offshore wind to just £39.65/MWh (2012 prices) in the 2019 auctions.

One of the main reasons for its success is the certainty it provides. By guaranteeing a fixed price for electricity, the 15-year contracts have lowered the cost of financing projects, which are less exposed to price risks.

However, the scheme has also been a source of uncertainty as well, with little clarity over when exactly auctions will be held and what technologies will be able to participate beyond the next round.

Onshore wind and solar projects in particular were left in a holding pattern after the government withdrew support in 2015, excluding the technologies from the second and third allocation rounds and closing the Renewables Obligation and Feed-in Tariff schemes to new applicants over the following years.

Ministers argued they were sufficiently mature to make it on their own but after a last minute dash to grab the last of the outgoing subsidies, installations plummeted and have remained in the doldrums ever since. Despite persistent petitions by developers, they maintained this position for nearly half a decade.

Things finally began to change in early 2020 when the government revealed that onshore wind and solar would be able to participate in the fourth CfD allocation round, which would include both a pot 1 auction for these “more-established” technologies as well as new third pot dedicated specifically for offshore wind.

But the completion of this turnaround came in February of this year with the announcement that allocation rounds will from now on be held annually and will all include pot 1 auctions.

A mountain to climb

Edward Pizzey, research associate at Aurora Energy Research, says these changes are “definitely needed” if the government is going to meet its climate commitments, particularly after it pledged to get the power sector to net zero by 2035 – 15 years earlier than the economy as a whole.

Even with the accelerated buildout of offshore wind, overall renewables deployment peaked in 2015 and “since then it’s dropped off quite significantly,” meaning we’ve been left with a “mountain to climb”. Depending on what scenario you go by, the UK will need deploy in the region of 6GW to 8GW of renewable generation every year going forward, Pizzey explains.

This will need to include onshore wind and solar and “it’s clear that renewables weren’t quite ready to go merchant, especially not a year ago before these crazy prices. It was quite obvious that merchant onshore wind and solar was still a little way off when they pulled the plug, maybe a little prematurely.”

“We had forecast merchant renewables kick-off in the mid to late 20s in terms of onshore wind and solar and that’s just too late at that point,” he adds.

Costs have fallen significantly but Pizzey says the price certainty CfDs provide remains important, “especially as we move to a net zero world where the wholesale market could become increasingly volatile”.

The growing volume of subsidised renewables will mean there’s “a lot of stuff setting a very low marginal price on the wholesale market – effectively zero because they’re paid up until six consecutive zero hours.

“If there’s a system where there’s a lot of low prices because there’s lots of renewables on the system, potentially that CfD is quite attractive to have if you can look past these crazy high prices over the next five years that are probably obscuring the view”.

He continues: “I’m not saying merchant can’t happen or won’t happen. I think especially for co-located projects – so those with batteries – they’re looking to make money out of arbitrage opportunities and participate in the Capacity Market and do these other things, so there will be projects that go merchant, but for developers with low risk appetite this is quite a nice opportunity for them”.

Developers reluctance to proceed on a merchant basis is demonstrated by the large 8GW pipeline of shovel-ready projects that have planning permission but have not been given the final go-ahead. Pizzey said there is also another 8GW that is also in the process of securing consent.

Annual pot 1 auctions should ensure this gets built out: “Providing something every year like clockwork, a bit like the Capacity Market right now, just provides a level of certainty and security and knowledge that you won’t have to wait too long to re-enter that project.”

Pizzey says the auctions will provide the “constant conveyor belt of projects” that the UK needs rather than the “lumpy and bumpy” deployment that has been seen previously.

“The move to annual auctions is hugely welcomed by the everyone in the industry,” says Renewable UK director of future energy systems Barnaby Wharton. “The problem we’ve faced with less frequent auctions is that you see projects that may just miss out on one auction, in this case, then having to wait nearly three years for the next auction.

“And clearly maintaining a project for that time costs money and ultimately that money has to be borne by the consumer. Moving to annual auctions gives confidence that projects will be able to get away sooner, means they’re hanging around for less time, and supports moving towards our net zero targets.”

“The ongoing commitment and recognition of the important role that onshore wind and solar can play, and will have to play, in order to meet our net zero target is really important,” he adds. “I think it is a hugely significant announcement that they will be continuing support for those technologies going forward.”

Like Pizzey, Wharton says some developers may still want to go down the merchant route: “These are now increasingly mature technologies and I’m sure some developers will look at current energy prices and think actually it will be worth taking the merchant risk.”

But he says most will prefer a fixed income stream “and it’s important that we get the volumes that the CfD will bring.”

A signal for investment

Regen’s Merlin Hyman says the move will give the whole industry the confidence to start making long-term investments they may have been holding back on: “It will allow developers to build their portfolios, utilities to invest in grid infrastructure, the supply chain to build job skills capabilities.

“If I don’t know when the next auction’s going to be – it’s probably two years but you don’t know what’s going to be in it – then it’s quite hard to invest against that. If this is an annual process going forward that you have confidence in, it’s much more likely that you’re going to invest to develop those capabilities right through the supply chain.”

Asked whether the government could do even more to strengthen this signal, for example, by setting out the likely parameters for future auctions, Hyman says “it’s not as clear as it could be” but the industry can make inferences from net zero scenarios and government papers.

Pizzey thinks this is not likely to happen: “The government don’t necessarily like to pick winners or force the market too much so just announcing annual auctions is a significant move in itself. I don’t think they’ll ever put targets for onshore wind and solar like they’ve done for offshore wind. I think that just won’t happen from talking to BEIS and other people.

“I think they’ll have to fill in the blanks and just stating the increased frequency of auctions and allowing those technologies to participate is probably enough”.

However, Wharton doesn’t see why this needs to be the case: “A schedule of capacity and budget going forward would be great. I think that’s something the government can do. It’s something they do in other countries.”

“Ireland, for example, have a schedule of auction parameters. I don’t think there’s any reason the government can’t do that, obviously with the caveat that the situation may change and they may want to tweak those or they may want to produce a range.”

“But we know where we need to get to,” he adds. “We are decarbonising the power system by 2035. We have some really good models and projections from the likes of the Climate Change Committee and the Electricity System Operator telling us what sort volumes that means in terms of capacity, so there’s no reason why the government can’t use those and set out what they expect to be procuring and when.

“Auctions five years away are less certain but for auctions in the next two or three years there should be a really clear set of parameters already.”

All other things being equal, a larger number of auctions will mean fewer projects bidding in each. Is there a risk they could become less competitive as a result?

Wharton doesn’t believe so, even with offshore wind projects, which tend to much larger and therefore less numerous: “There are some big projects out there but for competitive tension in an auction you only really need one project to be at risk of failing… The risk of one project failing is what will drive down the price in the auction because obviously you don’t want to be that project.

“Even with only a few projects in an auction it can be competitive and of course government has other levers they can pull. They’ve got the administrative strike prices and their budgets. Those sorts of levers they can pull to make sure consumers get value for money.”

By and large, Pizzey agrees: “They’ll just adapt the CfD round depending on whatever’s out there and available… I imagine they will just be highly responsive to what’s in the pipeline.”

However, this may mean not holding an offshore wind auction every year, at least to begin with. He says there are a decent number of projects that will be bidding into the fourth allocation round but there’s a bit of a gap after that: “There isn’t much in the offshore pipeline right now that’s ready to bid”.

He says there is a “huge pipeline of potential projects” from the Crown Estate’s fourth leasing round and Crown Estate Scotland’s ScotWind leasing round, with the former granting seabed rights to 8GW of project in February last year and the latter awarding rights to 24.8GW in January of this year. But, he adds, “they’re all quite far away”.

The remaining bottlenecks

Overall, the response to February’s announcement is one of enormous positivity.

So then, is the road now all clear for the industry to get on with building the many gigawatts of low-carbon generation the UK will need to reach net zero?

No quite, says Pizzey, as there are still several other bottlenecks such as consenting: “There’s going to be a whole lot more projects going through that process so it’s going to put a lot of strain on leasing and consenting governing bodies just to get through the sheer number of applications”.

There is also the matter of grid capacity, particularly for projects in Scotland: “You can’t just add 25GW of offshore wind capacity and expect it all just to come as planned. A lot of other things have got to happen in terms of developing the grid infrastructure which is a decade challenge really.”

Wharton says another issue is how to drive investment in nascent pot 2 technologies such as floating wind and tidal stream: “We’d like to continue to see minima available for those technologies going forward to make sure we continue learning by doing”.

“I’m not sure CfDs as they are currently constituted quite work for innovative technologies that we’re trying to get up from earlier technology readiness levels and into full commercial deployment,” remarks Hyman.

“In the case of floating offshore wind, you might want to align that better with the lease process and other aspects of the development process so you’re not expecting people to invest a great deal of time and money to get a lease before they’ve really an idea whether they’re going to get a CfD. It may be that the hurdles that you have to go through to get a CfD might be slightly differently aligned.”

There do appear to be serious efforts being made to address some of these concerns, with the government and Ofgem launching a joint review of offshore transmission.

As part of the review, the Department for Business, Energy and Industrial Strategy has proposed to take a more centralised, strategic approach to the development of offshore wind.

The department said this could include issuing an upfront plan for where and when offshore wind will be deployed. The plan could then provide a schedule for combined CfD and leasing rounds that could be coordinated with the installation of the necessary network infrastructure.

Ofgem also gave an update in February on its plans for the reform of transmission network charging, another key concern for renewable developers.

Whilst indicating it still believes the large regional differences that developers in Scotland have complained about remain a necessary feature of the regime, the regulator said it will instruct National Grid Electricity System Operator to lead efforts come up with some quick fixes to the unpredictability and volatility of charges, which it accepts are a problem.

And most recently there have also been reports that as part of its response to the Ukraine invasion, the government is considering relaxing the planning restrictions introduced in 2015 – often described as a de-factor moratorium – that made it much more difficult to build onshore wind farms in England.

With the rollout of renewables now looking to be stepping up a gear, “we need to be thinking about what the market looks like once we get to net zero,” Wharton concludes.

“Getting lets of renewables onto the system, I don’t think is a challenge now. The CfD has been a great tool at doing that and it does it at a low cost.

“I think the question is really: how do we enable the flexibility that we need on the system, whether it be short-or long-term storage, demand-side response – all those sorts of tools that will enable a truly net zero system – rather than relying on gas peakers to fill the gaps?”