Low-carbon auctions ‘no longer technology neutral’

The introduction of a three-pot structure for future Contracts for Difference auctions means they are effectively “no longer technology neutral”, an analyst has told Utility Week.

James Brabben, wholesale manager for Cornwall Insight, said the decision is nevertheless the right one given the government’s commitment to build 40GW of offshore wind by 2030.

He said ring-fenced funding may also be needed to achieve its target of installing 1GW of floating wind by the end of the decade.

Earlier this week, the Department for Business, Energy and Industrial Strategy  (BEIS) published its response to a consultation on proposed rule changes for future Contracts for Difference (CfD) auctions, among other things, confirming its plans to introduce a separate pot for offshore wind.

Brabben said offshore wind is still too expensive to succeed in the first pot for more mature technologies – onshore wind and solar – but also cheap enough to dominate the second pot that is supposed to support a variety of emerging technologies.

“Pot 3 for offshore wind is sensible because it’s too competitive for pot 2,” he remarked. “It blows all of those out of the water. Realistically, if you want to build 40GW of offshore wind then you shouldn’t put it in a pot with onshore wind and solar which could outcompete it.

“It’s kind of favouring technologies. It’s no longer technology neutral but it works for what government wants to do.”

Despite the removal of fixed-foundation offshore windfarms from pot 2, Brabben said floating offshore wind may still need some form of extra support, perhaps including a minimum capacity requirement in auctions, as “the pipeline of floating wind is not that high at the moment. It’s certainly not 1GW.”

Richard Howard, research director at Aurora Energy Research, agreed that floating wind would likely be outbid by other technologies such as advanced energy-from-waste and remote islands wind, which have already proven competitive when stacked up against fixed-bottom offshore turbines.

“It’s a little bit like the situation that tidal stream and wave has been in for a number of years, where theoretically there are CfDs available but they never get access to them,” he said.

Howard said this isn’t the only reason why the government may struggle to achieve the target: “At the moment, there isn’t a huge pipeline of floating offshore wind sites partly because the Crown Estate and the Scottish Crown Estate have tended to award sites that are more suitable for fixed bottom.

“Some of the sites stray into the floating wind water depths – 50 metres plus – but if the Crown Estate and Scottish Crown Estate really wanted to pursue sites specifically for floating wind, they would probably be doing it in different places, and in Scotland in particular, there’s some sites that, if you could do floating wind there, you would be accessing very winds speeds.”

He said the Scottish Crown Estate has been working to provide access to sites like this but “these projects are at a very early stage of development and will take a long time to come to fruition. It’s questionable whether they would even be built by 2030.

“What we might see first in that space is some developers that have sites that stray into the forty to fifty metre water depths doing something that’s more of a testing of floating wind alongside conventional offshore wind installations.”

Howard said the government has good reason to pursue floating wind if it plans to make offshore wind the backbone of Britain’s electricity system: “The windfarms are producing more of the time – approaching continuously to be honest.

“Obviously, the load factor will vary a bit – it won’t be 100 per cent the whole time – but it will be producing something almost all of the time and the overall average load factor could be very high. In the region of 60 per cent and even beyond is not unthinkable.”

“Some of the test sites where they have looked at floating wind, they’re already achieving numbers in excess of that and those aren’t even in the windiest places you could find.”

Single clearing price

The government has also decided to remove the distinction between delivery years in auctions so that they clear at a single price. Brabben also welcomed this change to the scheme, saying it would simplify the auctions and remove opportunities for strategic bidding.

“Lots of people were bidding on the basis of what delivery year is best – i.e. could I get better value bidding in one year than another – and all of that behaviour was based on war games. People were saying: ‘Well, I think that generator will bid in that year and if they do that means I’m going to bid in a different year.’”

“What this does now is avoids that complexity both for the generators and for BEIS and National Grid running the auction, in the fact that you just have to be the cheapest pounds-per-megawatt-hour site to make sure that you’re progressing in the auction rather than trying to work out the year and perhaps try to game the system”.

Howard told Utility Week it is not obvious how this will affect clearing prices in auctions: “In allocation round three, let’s say for offshore wind, there were two different clearing prices that were both very similar for projects in 2023/24 and 2024/25, which were the years that people were bidding for and the numbers were within a few pounds of each other, so it doesn’t seem like the delivery year structure led to any material difference.”

“But in the previous one in AR2, it was quite different. So you had one clearing price in 2021/22, which was up at the £75 mark and you had one offshore project at that level which was Triton Knoll, and then you had some projects, Hornsea Two and Moray, which were down at the £57.50 mark so it was significantly different across the different delivery years.”

Howard said the interesting question is what would have happened if that auction had been held under the new rules: “It’s slightly hard to predict whether that change to the rules would result in higher or lower clearing prices and the outcome actually depends on the exact shape of the bid stack.”

He explained: “If that £75 bid would have been accepted and it became the clearing price in all years then some people would have got more money, but if it had meant that the marginal bid was not accepted then it might have resulted in a lower price.”

At the same time, Howard said there is also no clear benefit to distinguishing between delivery years that are so close together: “I suppose if you were auctioning a lot of delivery years at once – let’s say you were auctioning five delivery years at once – it’s possible to believe the costs would come down by enough that it would make a difference and later projects would be cheaper.

“But in reality, the last couple of auctions have been for two delivery years… If you’re only doing it across two delivery years, then the cost won’t be that different from one year to the next.”

He therefore supported the change: “It just simplifies the whole of logic of the auction.”

Negative prices

Another rule change confirmed in the government’s response was that new contract holders will no longer be allowed to collect top-up payments during any period in which wholesale prices are negative. Under the current arrangements, this rule only applies when negative prices persist for six hours or more.

Howard said this additional merchant risk will need to be factored into developers’ bids and will likely add around £1/MWh to strike prices in auctions, qualifying that: “It depends slightly on the scenario and depends slightly on the technology.”

He said that, although this is not a significant increase in the grand scheme of things, it is still an important reform as it “reduces that perverse incentive that we’re encouraging people to carry on generating power when the price of power is negative and nobody wants that power.”

A recent report from Frontier Economics warned that if the government continues to use the day-ahead price as the reference price for the wholesale market, the updated rule could lead to “significant unintended consequences” as generators begin to their sell more of their power in the intraday market, where the emergence of negative prices would not remove their access to top-up payments.

Howard said, whilst this is a possibility, it would be a brave strategy to take as the much smaller size of the intraday market means “there would then be a risk that would fail to sell your power altogether or you end up crushing the intraday market price.”

However, he also acknowledged that the increased occurrence of extremely low and negative prices will create new opportunities to game the system: “There’s some potential for some strategic portfolio optimisation there on the part of generators.

“If you, for example, had a lot of CfD renewable capacity exposed to those negative prices and you had a big enough portfolio, you could potentially shift things around and self-curtail a little bit so it doesn’t head so far south.”

He continued: “People like me used to get very excited about how power prices were formed in the peak periods – we still to do get excited about that – but what’s becoming at least as interesting is what happens right at the bottom of the stack when it get towards zero and then below and then below zero”.

“There’s some interesting game theory around that,” he added. “No one wants to be the one that turns off and forces prices up a little bit when everybody else benefits from that.”

Brabben also noted that: “It’s only going to be from these contracts forward which is I think is an important point because we already have a fleet of 45-55GW of renewables that are either non-responsive – or if they’re newer CFD, then they’re only six-hour responsive – to negative prices. We are still going to see negative prices.”

He said generators hoping to limit their exposure will have been disappointed by the lack of further clarity over the government plans to integrate co-located storage into the scheme “which kind of felt like at the time it was compensating for this idea of negative prices.

“You might have negative prices but actually if we help you get storage into your projects you can reduce those risks.”