Markets & Policies

Cheaper and cheaper offshore wind in UK’s sails… and Hinkley Point C

The latest UK Contracts for Difference allocation results for offshore wind farms put once again the spotlight on the falling costs of renewable technologies, and revive the debate about Hinkley Point C nuclear power station.

With the second Contracts for Difference auction the UK hit a new national record low in the incentives awarded to offshore wind, showing once again how the competitive approach can drive cost reductions in the renewable energy industry. But it also turns again the lights on the debate about Hinkley Point C, the UK’s nuclear power station that should be commissioned in 2025, and which signed a Contracts for Difference with the Government in 2016.

UK Contracts for Difference

The UK Contracts for Difference scheme was introduced with the Energy Act 2013 as one of the tools to deliver a low carbon energy and reliable supplies to the UK and to minimize costs to consumers in the context of the Electricity Market Reform (EMR). The CfD scheme replaced the Renewables Obligation (RO) programme, which came into effect in 2002 and closed to all new generating capacity on 31 March 2017.

The RO was based on obligation placed on UK electricity suppliers to source an increasing proportion of supplied electricity from renewable sources, with RO tradable certificates issued to renewable generators and used by suppliers to demonstrate that they had met their obligation.

CfD are private law contracts between a low carbon electricity generator and the Low Carbon Contracts Company (LCCC), a government-owned company. Under this contract the generator is paid the difference between the market price and an agreed strike price, and when the market price is higher than the strike price the generator has to pay back the CfD counterparty (LCCC) the difference.  An operator of an eligible technology needs to take part to a competitive allocation process in order to get a CfD. The auction is pay as bid, so that each successful operator gets its own bidding as strike price, and the contract term is 15 years from the commissioning date.

Offshore Wind CfD remarkable results

In between the full implementation of the CfD scheme and the closure of the RO mechanism the UK Government awarded early CfD for renewable electricity with administratively set strike prices according to the commissioning date and technology. With the early contracts the Government wanted to avoid the risk of a hiatus in investment in renewable electricity generation during the transition period, but the absence of price competition and the strike price levels ignited an internal debate. The National Audit Office (NAO) investigated the case, finding that the early CfD provided certainty to the contractors at least five months earlier than they could have achieved under the full CfD scheme, but probably at the expensed of increased costs to consumers: the early contracts committed 58% of the funds available for renewables CfD to 2020-2021, and it is not clear if they were needed to meet the UK’s 2020 renewable energy target.

What is clear now is that with the full CfD scheme the support granted to renewables, and offshore wind in particular, showed and impressive decline, as reported in Table 1.

With the second allocation round two offshore wind projects winning bids were basically an half of the strike prices awarded with the first round, and 2.5 times lower that the average early contracts’ strike price. This development, which happened in less than 3 and a half years, probably validates the NAO findings about the too high costs of early contracts.

Did Germany do it better?

The record low achieved by CfD auction procedures was outstanding in the UK, but less impressive if compared to what happened in other European countries. In the German first offshore wind auction round results, published on April 2017 by the Bundesnetzagentur[1], DONG Energy awarded the right to build two offshore wind projects in the German North Sea bidding at ZERO €/MWh, which means receiving no subsidy on top of the wholesale electricity price. And although, as stated by DONG Energy Germany, this zero subsidy bid had some cost enabling factors, such as expected technological improvement, location, scale, extended lifetime and extended realization window, the final outcome was a breakthrough for the industry.

Competitive procedures yield positive results both in the UK and Germany, the two EU countries hosting most of the offshore wind capacity at the end of 2016, but the German results show that huge improvements can be achieved in the near term in other countries too.

The CfD granted to Hinkley Point C

Back in the UK, the second CfD allocation round results could not help to call to mind the signing between the UK Government and EDF of the long term CfD for Hinkley Point C (HPC) nuclear power plant, which happened one year ago, in September 2016.  Unlike the renewables CfD, the strike price for HPC was not based on a price competition, but agreed between the Government and NNBG[2]. The final agreement was for a strike price equal to 92.50 £/MWh[3], 61% more than the CfD second allocation round best winning bidding of offshore wind, equal to 57.50 £/MWh (as reported in Table 1).

Based on a NAO report published in June 2017 “… the Department[4] has not sufficiently considered the costs and risks of its deal for consumers. It only considered the impact on bills up to 2030, which does not take account of the fact that consumers are locked into paying for Hinkley Point C long afterwards…”.

Looking for the perfect electricity mix

The UK is facing the challenge of transforming its electricity generation mix in order to get rid of coal, the most polluting fossil fuel, and in order to meet its long term greenhouse gas emissions reduction targets.

Assessing or valuating the UK Government choices for the country energy transition goes well beyond the scope of an article. But the recent results of competitive mechanisms to allocate incentive to renewables are a good food for thought about where the energy world is heading to and where it should and could go.

 

[1] The German Federal Network Agency for Electricity, Gas, Telecommunications, Post and Railway, a separate higher federal authority within the scope of business of the Federal Ministry of Economics and Energy
[2] The company set up for the purpose of building HPC to be 66.5% owned by EDF, 33.5% owned by China General Nuclear Corporation
[3] A Strike Price of £92.50/MWh applies if Sizewell C does not go ahead, while £89.50/MWh will apply if Sizewell C does go ahead.
[4] Department for Business, Energy & Industrial Strategy (BEIS)

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