Reset needed following ‘disastrous’ CfD auction

The government should undertake a “reset” of Contracts for Difference auctions, including changes to the pot structure and clearing process, an industry chief has argued.

Tom Glover, RWE’s country chair for the UK, made the call following the failure of any offshore wind projects to secure contracts in the latest allocation round.

Commentators have variously described the results of the auctions, released on Friday (8 September) as a “major setback”, a “catastrophic outcome,” an “avoidable yet deeply harmful failure” and the “biggest disaster for clean energy in almost a decade.”

One industry source, who was particularly scathing in their assessment, told Utility Week: “The government really needs a kicking. This is incredibly stupid.”

“Do they read the papers?”, they asked. “Have they seen there’s been a 300 basis point rise in interest rates since the last round? Have they noticed that there’s been quite a big increase in the cost of steel and cement and all those kinds of things? Who is the person who signed off on 44 quid?”

Despite repeated industry warnings over rapidly rising supply chain and financing costs, the government set the administrative strike price for offshore wind – the maximum allowed – at £44/MWh (2012 prices). This is £2/MWh less than in the previous allocation round last year.

The source said: “One of the problems is that the industry has cried wolf a lot and now we’ve just seen a wolf. I think that is an issue. But actually, the whole point of auctions is that they do establish the truth.”

They said the auction results will give ammunition to climate change deniers and other critics of the government’s decarbonisation agenda, including some of its own backbench MPs: “All of this makes it even more difficult for Rishi Sunak, who is allegedly sensible, to actually get stuff to happen.”

At the same time as the government has driven offshore wind out of the auctions, the source said there is still an “effective ban” on onshore wind projects in England. They said the changes to national planning policy announced this week are “not nearly enough” to lift the ban when some local councils “behave illegally” in turning down projects for what they know are illegitimate reasons.

Tom Glover from RWE said Friday was day of “mixed feelings” for the company as the failure of offshore wind projects helped it to bag contracts for 450MW of onshore wind and solar projects: “One side of the business is celebrating and the offshore wind business is in the dark doldrums of depression.” This is despite RWE not seeking a CfD for any offshore wind projects in this round.

Along with Vattenfall’s decision to back out of the contract it secured in the previous auction round for its 1.4GW Norfolk Boreas project, Glover said the results will leave a big gap in the offshore wind pipeline. He said the UK can no longer claim to be the global leader in offshore wind as it once was: “You can’t have two years of effectively stagnation and say you’re the global leader.”

Glover said even with serious intervention, the government’s 2030 target no longer seems very realistic: “If the government still want to do it and they really roll up the sleeves, maybe it’s possible, but it seems very difficult.”

He said this would put further pressure on the already strained supply chain which would need to delivery more capacity in each of the remaining years, increasing competition and further raising costs.

In terms of the impact on investor confidence, Glover said this episode will cause “nervousness,” particularly when it comes to development expenditure, which is “wasted money” if they never make it to a final investment decision. He said the damage is repairable if there’s a “really strong response” from government.

But Glover said there is some scepticism in the industry that this will happen, given that they were telling the government for months that supply chain costs had risen by 20 to 40% “and yet, they didn’t increase the prices.”

He said it is understandable for ministers to not simply take the industry at its word, but there were “enough global headlines to know we were serious.” That prices were not raised at all is “pretty inexcusable.”

Glover pointed out that the accepted strike prices for onshore wind rose by around 20% between the previous auction round and the latest – swelling from £42.27/MWh to £52.29/MWh. He said it is “bizarre” that the government did not allow offshore wind projects to bid at the same level.

He said the next allocation round will be taking place during an election year so “we really do need to hold the government’s feet to the fire” to make sure it is successful.

As well as raising the maximum strike prices, Glover said the government should review the market reference prices for calculating the budgetary impacts of CfDs. He said the current figures for offshore wind are really low; “far lower than most external commentators’ low case.”

Although some people have called for bigger overall budgets, Glover said higher reference prices would mean the same budget could go much further: “I also find it really bizarre that we’ve just gone through a period of power prices being hundreds of pounds per megawatt-hour and we’re saying we don’t want to buy offshore wind at 50 or 60.”

Glover said the government should additionally consider having separate auction pots for offshore wind, onshore wind and solar as all three technologies are needed to meet net zero targets but have “different economics”. This would ensure they are all procured but without overpaying.

He said there may also be a case for two pots for offshore wind for new projects and extensions as: “The danger is, if you put them in the same pot, you don’t pay enough for the extensions or you overpay for the big ones.”

Furthermore, Glover said the government could change the rules for determining which projects clear the offshore wind auction so that just one project fails each year. He said this would be sufficient to ensure there is “competitive tension,” whilst securing as much capacity as possible.

He said he would personally go even further and allow the otherwise failing project to also secure a contract so long as its bid is within “X per cent” of the strike price of the next most expensive project.

Glover claimed this would incentivise the supply chain to offer “the absolute best prices to all projects”.  He said the current arrangements have put the supply in the position of not knowing whether all projects are going to be successful or none of them.

‘Entirely unforced error’

Adam Bell, director of policy at Stonehaven, said the latest auction results are an “entirely unforced error” and a “disaster for the government’s credibility on offshore wind delivery.”

He said investors were already a little bit cautious but “still had a lot of goodwill towards the UK in terms of us getting it right in the end,” in large part because of the expectation that the government would act predictably and rationally.

The CfD scheme was an “example par excellence,” providing “a transparent price discovery mechanism with clear and predictable intervention points”, he said.

“It’s not perfect,” he added, “but it’s a lot better than some of the more convoluted routes”.

He said the UK’s reputation has been tarnished by ministers refusal to raise the price cap for offshore wind: “I suspect if the government had gone up towards £50/MWh as a cap, they might have got some through. The fact that they didn’t and didn’t even look at changing the cap is the tragedy of this situation.”

This refusal has distorted the auctions and undermined their ability to provide price discovery.

He said the government is able to change the parameters “almost whenever it chooses” and it was “already reasonably clear by the start of this year that this was going to be a more difficult round.”

“Whether it be a function of ministers not understanding the sector and being nervous of doing anything that increases costs – even when it would still save consumers money – or officials not wanting to give lobbyists an inch, that stubbornness in the face of overwhelming evidence is the sort of thing that spooks capital,” he remarked.

Bell, who was formerly the head of energy strategy for the government, said he does not believe, as some commentators have suggested, that it is now impossible to meet the target of deploying 50GW of offshore wind by 2050. But he said it is “incredibly unlikely and requires much harder decision making around the extent to which you need to reform planning, connections, environmental impact assessments and seabed leasing”.

At a minimum, the government needs to review its processes for setting price caps, introduce new flexibility to change them if the circumstances demand so, and increase budgets for subsequent auction rounds to help fill the gap that has been left.

Bell said the best way to restore trust would be for the government to hand responsibility for setting to the parameters to another party, namely the Electricity System Operator (soon to be Future System Operator), which is already the delivery body for the auctions and “will have a much better understanding of the actual capacity requirements of the system”.

However, he also acknowledged that the FSO has also become a dumping ground for “problems that are seen as too hard for the rest of government to solve, so this may be a bridge too far”.

Responding to this suggestion, Glover said he can see little point in doing this when the parameters are ultimately a policy decision and the government is holding the purse strings.

Bell said a more radical option for reform would be to move to Capacity Market-style descending clock auctions: “That would increase costs but it would at least guarantee delivery.”

Another possibility floated by analysts at the Energy and Climate Intelligence Unit is either re-running the auction or holding an additional stopgap auction specifically for offshore wind.

Head of analysis Simon Cran-McGreehin said it would be simpler to just wait for next year’s auction but the industry needs certainty quicker than that: “Normally the parameters for the next auction would be issued before Christmas or in Spring but they want to know this autumn what the boundaries are going to be. They want to know that it’s going to be worth their while hanging around in the UK and putting in bids”.

Cran-McGreehin said the government does have the power to hold an additional auction and “everyone has got their figures ready, everyone knows what they would bid.” He said they are not necessarily recommending this as a solution but the government does need to find a way to “backpedal and fix this situation quickly as possible.”

In a blog post on its website, the not-for-profit consultancy Regen said there is a limited amount the government can now do about the lack offshore wind in the latest allocation round: “It is not possible to re-run the auction, and any attempt to adjust prices post-auction would almost certainly run into legal challenges.

“Nor is there time to introduce a radically different revenue support mechanism, although this could be something for future consideration.”

Commenting on why the auction failed, Regen said although they don’t know the exact cost gap, their understanding is that the cap on strike prices was likely around 10 to 25% – or £5-12/MWh – below the viable level for investment.

“Assuming that government officials and ministers did at least hear the warnings from industry, it must be concluded that either they simply didn’t believe that cost increases were as bad as the industry claimed, or they were prepared to see the AR5 auction fail rather than go through a delay and revision process.

“Timing may also have been a factor; with the move to annual CfDs, they might have also felt they could manage any fall in CfD uptake in AR5 through future auction rounds rather than make immediate changes.”

It continued: “The position for floating wind was even more stark. Government officials were told point-blank by industry and supportive backbench MPs that the strike price would not be sufficient to bring projects forward. Given the importance of floating wind as an energy resource and a major export market, this is an obvious own goal.”

Regen said the auction marks a “watershed moment” for the current government and will act as a test of whether it has the drive and commitment to deliver on the “cornerstone” of its net zero strategy. It said ministers must now focus on “redesigning and resetting” the arrangements for the next allocation rounds: “This requires government and industry to move forward with a fresh approach, building an open and honest relationship based on a firm understanding of the industry’s cost model and financials.”

It urged the government to convene a taskforce with the offshore wind industry and its supply chain partners to “interrogate what’s happening with industry costs. Price competition within the CfD auctions needs to be balanced with a realistic appraisal of what the true industry costs are, with strike budgets and budgets set accordingly.”

Echoing Glover’s comments, Regen said the government should also amend the pot structure to “either reposition offshore wind in a separate pot to onshore wind and solar, or to establish budget minima for each technology within Pot 1.”

“In an ideal world, there would be free price competition between technologies,” Regen added. “However, this does not sit well with an imperative to build strategic industries and establish UK-based supply chains.”

Whatever changes are made, Bell said the government could do a lot to reassure investors in the short term through “the simple act of recognising that mistakes have been made,” although he questioned whether it is “capable of such humility.”

Perhaps energy minister Graham Stuart will offer a mea culpa when he meets with key industry figures next week.