The UK Department for Business, Energy and Industrial Strategy is expected to announce the winners of the latest renewable energy 'contracts for difference' auction on Thursday.
Awarding CFDs via these auctions has played a critical role in “stabilising revenues” for low carbon power producers, according to Dalia Majumder-Russell, a partner in the Energy & Climate Change Team at law firm CMS Cameron McKenna Nabarro Olswang.
These long-term power contracts, which were originally introduced by the UK government in 2013, have helped reduce the cost of low-carbon power in the past decade by guaranteeing producers a bottom price, known as the “strike price”.
If wholesale prices drop below that benchmark, then power producers are paid a top-up amount, but conversely, if prices rise above the strike price then they are liable to pay some of that money back.
Amid rising wholesale power prices, “a lot of renewables are paying it back”, warned Majumder-Russell, who added that the expectation is that “they will drop”.
The so-called contracts for difference auction is a sealed bid-tender for contracts lasting 15 years at fixed rates that tracks the rate of inflation.
The latest auction, which is expected to be the biggest yet, will lock in future prices for power due to be delivered between March 2024 and March 2027. Energy companies were required to submit sealed bids for the lates round between 24 May and 15 June.
Credit Suisse predicts that this latest CfD energy auction will be larger than any other to date, securing approximately 12 GW of energy capacity.
Solar and onshore wind projects were allowed to compete in the auction for the first time since 2019. The contracts they could win in the latest round, for delivery in 2024 and 2025, is capped at 4 GW.
Prices dropped to as low as £40 per megawatt in the last auction for long-term power contracts in 2019, said Majumder-Russell.
“We saw prices fall a lot... [it was] a really big drop,” she said. “There was a lot of pressure on the industry.”
Just how much lower renewable power costs can fall is now in question, as turbine manufacturers battle losses and low carbon power producers are exposed to paying money back to the government amid the high wholesale prices.
“I don’t know if we will see cheaper prices,” said Majumder-Russell, who specialises in complex process power and renewable projects. “It’s such a mature market now.”
Companies such as BP PLC (LSE:BP.) and Shell PLC (LSE:SHEL, NYSE:SHEL) that secured land under the Crown Estate and ScotWind seabed leasing rounds are also expected to be among contenders for the contracts.
“The ones competing will be [large industry players] that have won a lease in the leasing round,” said Majumder-Russell. “BP and Shell will need to compete because they had these large, leased projects.”
Credit Suisse forecast that the auction could deliver prices as low as £34 per MWh (US$41) in 2011 equivalent pricing, or from £54 per MWh in nominal terms.
The investment bank based its forecast on a combination of current turbine prices (Siemens and Gamesa’s Vestas make being the most popular), average capex costs of about £2.2mln per MW and load factors (how consistently the plant produces power) of 57%, in line with 2019 returns targeting about 7-8%.
It predicts that Denmark's Ørsted and Spain's Iberdrola could be among winners of the round, securiong contracts for the Hornsea 3 and East Anglia 3 offshore wind projects.
READ: Cornwall and Wales could soon host floating windfarms, crown estate says
“Bottom-fixed offshore wind will be tricksy to go down further,” Majumder-Russell said. “Floating offshore wind – partly new testing the waters – don’t think they will be reaching bottom prices.”
In January Shell and Scottish Power secured rights for a joint project in an auction north of the border, using technology they said will become an increasingly important part of the energy mix.
Much of the price savings renewable energy projects have made over the years rely on reductions in the cost of parts, while many manufacturers are now facing supply chain issues amid a shortage in components such as semiconductors.
“Since then [we have] seen a lot of the turbine manufacturers really struggling,” said Majumder-Russell. “[There is] only so much time [that they] can take the losses.”
Then there is the question of option fees, a new annual charge on developers in the seabed leasing rounds that have yet to secure planning permission, which she said are “definitely a factor” in whether the cost will go down.
Majumder-Russell forecasts that power producers will be able to push back on further cost reductions amid a rise in interest rates and industry borrowing costs. Corporate power purchase agreements are also more widely available, meaning they do not need to heavily rely on strike prices.
It takes a decade on average to plan for an offshore wind farm, and successful competitors will be the ones that have seabed leases and grid connection arrangements in place.
With all its problems as well as its benefits, the CfD scheme was due to end in 2027 but is currently subject to the Electricity Market Review.
The government has announced a move towards annual auctions, Majumder-Russell said, expecting them to continue not least because it is still to meet its target to deliver 40 GW of low-carbon power by 2040.