UK renewables payments per MWh dwindle, as 2021 power price rally drives profitability

Rising power market prices have seen the gap between strike and market prices in the UK's Contract for Difference (CfD) scheme hit historic lows in 2021.

In October 2014, the UK established CfD to deliver cost-effective large-scale renewable projects; an auction system now common across Europe.

Payments to producers are contingent on the difference between a strike price and the market price, with the former being agreed via the Low Carbon Contract Company (LCCC), a UK government set-up. To ensure an efficient strike price, the LCCC holds allocation rounds every two years, with costs minimized through competition between projects.

Once the renewable installation is online, if market prices are below the strike price then generators receive the difference as a payment from the LCCC, which is ultimately passed on to consumers through their power bills.

However, if market prices climb above the strike price then generators pay back the difference to the LCCC and bills are reconciled. Renewable producers agree to this deal as it underwrites risk on renewable returns, thus promoting greater institutional investor interest.

Bullish power prices

The difference between the strike and market price has persisted at an all-time low throughout 2021, averaging GBP30 lower than the historical average. Wind and solar producers even had to pay the LCCC back for a three-day period in mid-January when a myriad of bullish factors pushed UK spot power prices to record highs.

This is despite the strike price of installed capacity having remained relatively stable, with most online projects still coming from the first allocation round in 2015, when bids were at their highest. The average-weighted strike price for wind and solar producers currently stands at GBP151/MWh as of July 2021, with over 6 GW of renewable capacity allocated under the scheme already installed.

The decline in the strike-market gap has been driven by 2021's bullish power price environment, with both spot and forward prices trading at significant highs on the back of unprecedented gains in European carbon and global gas prices. The UK baseload day-ahead contract averaged GBP92.63/MWh during July, with prices even hitting GBP123/MWh on August 2, the highest for a summer month since September 2016.

Strike prices set to fall further

Overall, CfD has signed up nearly 19GW of zero-carbon generation (renewables and nuclear). During this period average strike prices have dipped from GBP138/MWh in the first round, to GBP43/MWh by the third, meaning payments per a generating unit could sink further as projects come online by the mid-2020s.

The third allocation round in September 2019 signed up 5.8 GW of mainly offshore wind capacity, with 2.6 GW of offshore capacity awarded at GBP39.65/MWh for delivery in 2023/24, and a further 2.85 GW at GBP41.611/MWh for delivery in 2024/2025.

According to the BEIS, these prices were significantly below the administrative strike prices for each successful technology. "For the first time renewables are expected to come online below market prices and without additional subsidy on bills, meaning a better deal for consumers".

Fourth auction round

As strike prices and corresponding payments per MWh decline, this will significantly reduce the burden of renewables on consumers, with green levies currently accounting for around 30% of consumer bills.

The Interim Levy Rate, which funds CfDs and is paid by generators, currently stands at GBP6.4/MWh for Q4 2021. Any falls would directly filter into consumer bills, with Platts Analytics expecting wholesale UK power prices to fall by about 60% (in real terms) between 2022 and 2030. Albeit, this is expected to be primarily driven by falling commodity costs as well as diminishing renewable capture prices, and therefore in fact could rewiden the strike-market gap.

With CfDs it is even possible that renewable projects could regularly pay consumers when generating electricity. In this case, an interesting dynamic will have been created, with renewable revenues significantly higher than generators initially expected.

In essence, this would mean renewable producers would have found it more profitable to take a merchant route exposed to market volatility, rather the CfD route with guaranteed payments. This would be a symbolic milestone, marking the first time that renewables can profitably be mass developed without significant state support in the UK.

A fourth allocation round of CfD will open in late December 2021, with the BEIS aiming to expand to 12GW of renewable. The number of technologies will also be increased from previous years, with solar and onshore wind projects being able to compete for the first time since 2015.

Despite the increasing profitability of renewables without subsidies, the fourth allocation is still expected to be fully subscribed, as producers look to underwrite the risk of high levels of wind and solar eroding their own capture price in the future. A recent SSE report warned that wind generation will continue to require subsidy support, as high generation days could drive the market to economically unviable prices.

Trend across Europe

Increasing renewable profitability is set to be mirrored across Europe, with over 40 GW of capacity being auctioned during 2021.

In January, Spain allocated 3 GW at an average price of Eur24.47/MWh, a significant drop compared to the prices awarded in their previous auction in 2017. Meanwhile, the German government has even signaled that by 2027 it wants to advance the timeline for a plan to cease renewable funding entirely.