United Kingdom

United Kingdom

'Price cannibalisation' warning after UK tender

Offshore wind prices were reduced by nearly a third in the UK's third contract for differences (CfD) tender, but falling market prices could dampen the effect of these cost reductions by the time the successful projects come online, an analyst has warned.

Iberdrola and the Green Investment Group's East Anglia One project secured a CfD deal in the first UK tender
Iberdrola and the Green Investment Group's East Anglia One project secured a CfD deal in the first UK tender

The 2019 tender’s lowest bid of £39.65/MWh (in 2012 prices) is 31% lower than the £57.50/MWh lowest bid in the most recent CfD auction in 2017, which itself marked a 50% reduction from the UK’s first CfD round in 2015.

Overall, the lowest 2019 prices are a third of those in the 2015 tender.

These cost reductions have been achieved through a mix of technological improvements, economies of scale, increasing investor confidence and the resulting lower cost of capital, and more practical experience leading to greater competencies.

One of the successful developers, Equinor, made this link clear, stating that the auction results "reflect the continued cost reductions and technological development and the increasing competitiveness of bottom-fixed offshore wind".

Driving these improvements has been increased competition, with the CfD scheme incentivising cost reductions.

The R&D fund Carbon Trust said: "We are now in a market where developers are no longer receiving subsidy payments from government, but they are given revenue certainty.

"The CfD regime has been shown to provide vital long-term revenue certainty for developers, which is essential for a project’s bankability."

Under CfD contracts, the UK government pays top-up support to fill the gap between market prices and the strike prices (£39.65-41.61/MWh) agreed in the power contract.

The gap between strike prices and the market price of energy narrows as successful bid prices fall.

If the strike price were to fall below the market price, developers would refund their excess profits to the government, making UK offshore wind not just subsidy-free, but a money-maker for the taxpayer.

Cornwall Insight’s wholesale manager James Brabben noted that the awarded price range — even when adjusted for inflation — is in line with today’s baseload market prices, which he added are currently trading at £45-55/MWh.

If these contracts were in place for operational projects today, their holders would be returning excess payments to the government.

Scottish Renewables’ chief executive Claire Mack welcomed the results: "Today’s results show just how affordable wind power can be when given the chance to compete in the energy market."

Price cannibalisation

However, Cornwall Insight’s James Brabben warned that the gap between strike price and reference price could grow as more renewables come online.

Adding more variable wind and solar to the grid could prompt a drop in wholesale market prices — a process known as ‘price cannibalisation’, he explained.

This could increase the top-up payments actually awarded to operators.

"The captured wholesale price of wind technologies will fall as more projects come online," Brabben said. "This will lead to very low wholesale prices at times of modest system demand in future. 

"By 2023-24, this cannibalisation effect will have grown and our analysis shows that regular levy payments may still be needed for these wind projects during the life of their CfD contracts. 

"So while it is right to say these contracts represent an outstanding deal for consumers, they are not necessarily guaranteed to be cost-free just yet."

However, the successful strike prices fall below government estimates (above) for market prices through to 2026/27.

The UK’s department of business, energy and industrial strategy (BEIS) forecasts day-ahead hourly prices — the reference prices — of £48.62/MWh, rising to £51.32/MWh — in 2012 prices — for 2023/24 and 2024/25.

If these forecasts hold, successful developers in today’s tender will be returning some of their hard-won profits to the government.

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