Outcome of the second UK CfD allocation round

The outcome of the second Contracts for Difference (CfD) allocation round was announced on 11 September 2017. The allocation round has produced unprecedented low prices for renewable energy projects, that are likely to have implications not just for the renewable energy sector, but the UK's generation mix as a whole.

Background

The first CfD allocation round was held in October 2014.  While originally CfD allocation rounds for renewable energy projects were intended to take place on an annual basis, there was a two and half year lag before the second CfD allocation round commenced in April 2017.  During that time there have been some considerable changes to Government policy with regards to support for renewables, which have had an impact on the outcome of the second allocation round. As discussed in our briefing of 11 November 2016, one of the most significant changes was the fact that while a wide range of renewable energy technologies were eligible to take part in the first allocation round, in the second allocation round only less established technologies were eligible to participate: offshore wind, advanced conversion technologies (ACT) (with or without CHP), anaerobic digestion (with or without CHP), dedicated biomass with CHP, wave, tidal stream and geothermal technologies.  Moreover, there has been a greater than ever before focus on reducing the cost of energy to consumers, with a push for renewable energy to be deployed only if it can be cost competitive. 

The results

General overview

In total, 11 projects were awarded CfDs in the second allocation round, totalling 3.3 GW in capacity.  This is in contrast to the first allocation round (see our earlier briefing of July 2015, evaluating the UK's Electricity Market Reform), in which 27 projects were awarded CfDs, totalling 2.1 GW.  As discussed in more detail below, the main difference between the two results is the fact that in terms of capacity, the second allocation round was dominated by large-scale offshore wind farm projects, and the level of support awarded to projects was much lower than in the first allocation round.  See Figure 1 for the full results.

Figure 1 – Projects successful in the second CfD allocation round 

 In total, £176 million has been allocated out of the total £295 million budget that was made available for the allocation round.  This was not because lower prices meant that the total budget required was lower, but rather because of the application of the auction rules which required the Delivery Body (National Grid) to close a delivery year as soon as the next cheapest project in the bid stack was deemed to breach the budget.  Therefore, presumably when the auction took place and bids were considered for each delivery year in ascending price order (i.e. from lowest to highest strike price), a large capacity project (most likely offshore wind) did not fit within the remaining budget, which would have caused the auction for that delivery year to close, knocking out all other bids in the bid stack for that delivery year.

Offshore wind

Three offshore wind projects were successful in the second allocation round, totalling 3.2 GW out of the total 3.3 GW of CfD capacity awarded.  The fact that offshore wind has dominated the allocation round, at least in terms of capacity, does not come as a huge surprise, given that in structuring the allocation round the Government imposed a "maxima" of 150 MW in relation to fuelled technology projects to limit the available budget for such projects.  Moreover, the fact that all eligible technologies would be competing against each other on price meant that offshore wind was predicted to be in a winning position, in particular based on economies of scale and the cost savings that have been realised in developing offshore wind technology in the last few years.  

What has come as a surprise are the low strike prices awarded to the winning projects.  Before the allocation round took place, developers were prepared for the fact that lower levels of support were expected: earlier, the Department for Business, Energy and Industrial Strategy had expressly said that offshore wind farm projects would need to aim to be viable at a strike price support rate of £85/MWh by 2026, and for the second allocation round the administrative strike price (representing a cap on the price) for offshore wind was set at £105/MWh for the 2021/22 delivery year and £100/MWh for the 2022/23 delivery year – see Figure 2.  However, the final figures achieved in the auction - £74.75/MWh for one project and £57.50/MWh for the other two projects – had not been expected.  

Given that wholesale power prices are expected to average £53/MWh in the period from 2023 to 2035, offshore wind is approaching a position where it may be viable, or at least be expected to be viable, with no subsidy (although it should be noted that the strike prices quoted are 2012 prices, and will therefore benefit from several years of CPI indexation).  This is a position that only recently seemed like a much longer-term proposition.  However, in developing future policies for the deployment of renewable energy based on a "zero subsidy" model, the Government will need to be mindful of the fact that the value of a CfD to a project is not simply in the level of the strike price awarded , but also in the change in law protection and price stabilisation mechanism that a CfD provides.  The absence of such price stabilisation may make it very difficult for large-scale renewable energy projects to be bankable.

The strike price differential between the three offshore wind projects also raises some interesting questions about the allocation process.  While it is unclear what strike price was bid by the Triton Knoll offshore wind project and how much lower such price was below the clearing price of £74.75/MWh, it is very likely that for the 2021/22 delivery year a fuelled technology project set the clearing price, thereby pushing up the price originally bid by the project. However, a function of the allocation rules meant that while a clearing price of £57.50/MWh was set for the two offshore wind projects for the 2022/23 delivery year, the Redruth ACT project (delivering in the same year) was awarded a lower strike price of £40/MWh which was not pushed up by the offshore wind clearing price.

Figure 2 – Offshore wind strike prices (with relevant delivery years noted in brackets) 

Fuelled technologies

Despite concerns that ACT developers would be unable to compete with the competitive strike prices anticipated to be bid by the offshore wind sector, out of the eight remaining winning projects, six are ACT projects and two are dedicated biomass with CHP projects (see Figure 1).  As is the case with offshore wind, the strike prices awarded to these projects were much lower than the strike prices achieved in the first allocation round and the administrative prices set for the second allocation round: £74.75/MWh for seven of the projects, and £40/MWh for one ACT project – see Figures 3 and 4.  

Despite the fact that this is a good news story for the ACT sector, the overall CfD capacity that will be delivered by ACT projects is less than 2 per cent of the total capacity awarded, confirming the predicted shift in favour of offshore wind for this allocation round.  The other important point to note is that a low strike price, such as the £40/MWh strike price achieved by the Redruth ACT project, has a downside beyond the low level of subsidy offered: under the CfD if the reference price (being the market price of electricity) is higher than the strike price, the generator will need to pay the difference to the CfD counterparty.  

Figure 3 – ACT strike prices (with relevant delivery years noted in brackets)

Figure 4 – Dedicated biomass with CHP wind strike prices (with relevant delivery years noted in brackets)

Other technologies

No wave, tidal stream or geothermal technologies were awarded a CfD.  While there is no publicly available information about all the projects that took part in the allocation round, the developers of the Atlantis tidal stream project in northern Scotland released a public statement confirming that they participated in the allocation round but were ultimately unable to compete with the very low bids from other more established technologies such as offshore wind.  This is a familiar tale and will leave developers of/investors in these technologies to still overcome the challenge of how to commercially deploy this technology in the UK.

Implications and what next

In the March 2016 Budget, the Government announced that it would make available up to £730 million of CfD funding this Parliament (i.e. before 2020) for up to 4 GW of offshore wind and other "less established" renewables technologies, across three separate allocation rounds.  However, things have moved on since then, with a snap election taking place in June 2017, and an election commitment by the Government to undertake a "cost of energy review".  The review is being led by Professor Dieter Helm CBE and is intended to "recommend ways to keep energy prices as low as possible".  The review is expected to report at the end of October 2017, and no doubt the outcome of the second allocation round will have an impact on the review's recommendations.

From the Government's point of view, the second CfD allocation round has been a success, in procuring new capacity at a low cost to consumers.  This may act as an impetus for further allocation rounds to be brought forward, although nothing is certain pending the outcome of the cost of energy review. For developers, the second CfD allocation round sets a precedent in terms of the prices achieved, and therefore developers can expect to see much lower administrative strike prices in the future.  

There are also obvious implications for other power generation technologies.  In particular, it will add to the already existing pressure on nuclear projects to compete with the low strike prices awarded to other technologies.  To date the Government has remained committed to new nuclear, and it appears unlikely that this commitment will wane.  However, from a value for money perspective, it may be difficult for the Government to justify a repeat of the strike price of £92.50/MWh granted to the developers of the Hinkley Point C nuclear project.  The comparatively higher price of nuclear was recently examined by the National Audit Office (NAO) in its report in relation to the Hinkley Point C project.  While it may be difficult for nuclear power developers to realise the same cost savings that are possible in the offshore wind sector (particularly as nuclear technologies tend to be first of a kind for the purposes of UK deployment), it may be that, as recommended by the NAO, the Government and nuclear developers will consider options to lower the price for nuclear, such as sharing in construction risk or an even longer CfD term.  The big advantage of nuclear, of course, is that it is a baseload source of electricity, and unlike gas-fired generation which is seen as an alternative source of baseload, nuclear is low carbon.  On the other hand, gas-fired generation is more flexible so will inevitably remain a key part of the UK energy mix, particularly in providing back-up and balancing services for the national electricity grid.  

All these issues will no doubt be considered as part of the cost of energy review currently being undertaken, and hopefully the direction of the Government's energy policy will become clearer in the weeks and months that follow the publication of the outcome of the review.  What is certain, however, is the fact that the results of the second CfD allocation round are a game changer, proving that far from being an expensive whim, renewable energy can compete on price with other non-renewable sources of power.