UK auction failure a double-edged sword for offshore wind, industry says

The UK's failure to award even a single contract to an offshore wind project in its latest renewable energy auction will make it hard for the country to reach its 50-GW offshore wind target by 2030 but will drive home the fact that companies are not willing to pursue development at all costs, industry observers said on the back of the Sept. 8 results.

The fifth contracts for difference (CFD) auction yielded no bids from offshore wind, with developers such as Iberdrola SA, Vattenfall AB and SSE PLC sitting out of the process because the bid ceiling was too low to make their projects viable.

Keith Anderson, CEO of Scottish Power Ltd., Iberdrola's UK subsidiary, said the economics "simply did not stand up this time around." Up to 5 GW of offshore capacity was eligible to bid in the auction, known as Allocation Round 5 (AR5), with projects now having to wait for the next CFD round in 2024 or pursue other routes to market.

The result raises significant questions about the UK's ability to meet its ambitious 50-GW offshore wind target by 2030. Only about 27 GW of that has been secured to date, according to lobby group RenewableUK, with future CFD auctions needing to support between 4.5 GW and 5.8 GW per year to get back on track.

At the same time, analysts said the lack of offshore wind bids demonstrates developers' capital discipline and, after COVID-19 and Russia's war in Ukraine, serves as a strong signal to the government about the industry's new economic realities.

"The consequence of such challenges is that capital-intensive renewables projects now cost more than they did two years ago and therefore need better support," Jochen Eickholt, CEO of wind-turbine maker Siemens Gamesa Renewable Energy SA, said in a Sept. 11 post on LinkedIn.

Investors 'a bit spooked'

While the causes and ramifications of offshore wind's no-show will continue to be debated, the industry is in agreement that the result did not come as a total surprise.

Companies and commentators had warned for months that offshore wind's bid ceiling in AR5 was going to be tough for projects — something that was brought into sharp focus when Vattenfall decided to cancel the development of its 1.8-GW Norfolk Boreas wind farm in July, citing a 40% increase in project costs.

There is a risk that investors "become a bit spooked" by recent developments in the UK, according to Alon Carmel, renewable energy expert at PA Consulting.

"There will be increasing numbers of international investors who question whether the UK is as attractive as it has been," Carmel said in an interview. "I'm hoping that it's not going to deter them and they conclude it's just a bump in the road rather than a different course."

At the same time, investors ought to be reassured that the outcome of AR5 will force the government to set prices that better reflect offshore wind development costs, CreditSights analysts said in a Sept. 8 note.

"There is no shortage of companies wanting to develop UK projects, but returns need to be adequate," the analysts wrote. "In our view the UK government will need to increase the CFD prices for offshore wind if it wants to meet its targets, and that will be positive for those wanting to build UK offshore wind projects."

With CFD auctions now on an annual cadence, the UK government is under pressure to rethink its parameters ahead of Allocation Round 6 in 2024.

Industry players noted that AR5 was the first time that UK CFD prices increased from one auction to the next, mirroring a trend in several other European renewables auctions in the last year amid inflationary pressures.

About 1.5 GW of onshore wind and 1.9 GW of solar was awarded CFDs in AR5. Onshore wind's contract price of £52.29/MWh represents a 23% increase from the previous auction while solar prices rose a little over 2% to £47.00/MWh.

The bid ceiling for both technologies was kept the same from the previous auction, while offshore wind's dropped to £44/MWh from £46/MWh. All CFD prices are given in 2012 currency for comparison purposes.

"Realistically, an administrative strike price of £44/MWh — 4% lower than Allocation Round 4 — was never going to be feasible for developers facing cost increases upwards of 25% over the past 18 months," said Ashutosh Padelkar, senior research associate for the British power market at Aurora Energy Research.

For Allocation Round 6, offshore wind developers would want a 20% increase in the technology's strike price to make their returns attractive again, according to Julio Dal Poz, managing director at FTI Consulting.

That would increase £44/MWh to £74/MWh when also accounting for inflation, bringing UK CFD prices more in line with those seen in Ireland's recent offshore wind auction as well as with corporate power purchase agreements (PPAs) for offshore wind projects in Germany, the consultant noted in an email.

That said, the UK government is a stronger counterparty than some corporates, and UK CFDs are fully inflation-indexed, meaning the uplift "could be less than 20% and still motivate developers to come forward," Dal Poz added. "I would not expect anything less than [a] 10% increase if the government is going to do a serious effort to bring the industry back."

New financing strategies

AR5's failure to bring forward new offshore wind capacity also sparked discussion in the industry around alternative routes to market, namely corporate PPAs and merchant strategies.

SSE's 1,075-MW Seagreen wind farm and Ocean Winds SL's 882-MW Moray West project have CFDs in place for a portion of their total capacity. However, both plan to supplement that government contract with private PPAs with corporates like Google LLC and utilities like Statkraft AS.

While this might be an option for those projects that opted to sit out of AR5, "the clear lack of interest in [the auction] demonstrates that successfully financing projects in today's high-interest, high-cost environment is increasingly challenging," Padelkar said.

Indeed, five offshore wind projects were awarded £37.35/MWh CFDs in 2022's auction, one of which — Norfolk Boreas — is no longer being developed. Of the rest, only Moray West has reached a final investment decision.

Even the world's largest offshore wind developer, Denmark's Ørsted A/S, is finding conditions tough. The company plans to confirm its investment in its 2.8-GW Hornsea 3 wind farm by the end of 2023, with executives talking in recent months about trying to achieve the "needed robustness" in the project's business case.

"I think there will be a resurgence of interest [in PPAs and merchant strategies] and people will start to be creative about how they structure their revenue models," Carmel said, adding, however, that it would be a "big innovation and probably quite difficult" for a large project to make a final investment decision without securing a CFD for at least a portion of its capacity.

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