Contracts For Difference

The latest CFD allocation round closed for applications recently, and everyone (well ok, not everyone) is excited to see the results.

But really, EVERYONE should be excited.  Because we are in a climate emergency.  I don’t believe that’s scaremongering, it’s the reality.  Our kids / grand kids are in trouble if we don’t dramatically slow down the damage we are doing to the environment.

CFD is the process where Developers building offshore wind farms in the UK get a subsidy.  For this round projects being constructed in 2022-23 and 2023-24 are eligible.  The Government are allocating up to £65million of subsidy per year for 15 years, and will support up to 6GW of capacity.  It’s a complicated process, but essentially a Developer states what price (Strike Price) they will require for their electricity.  This would then be guaranteed (the Contract), and the subsidy would be the difference between the actual wholesale cost of energy, and the price the developer contracted.  If the wholesale price goes higher than their strike price, then the Developer pays back the difference.  I find examples with real numbers help in these situations:

The wholesale price varies all the time, which, without the CFD mechanism would mean that investing in Offshore Wind would be a bit of an unknown as you wouldn’t know what price you would get, so investors wouldn’t know what return they were going to get.  With construction of offshore wind being so risky, projects simply wouldn’t happen without the security of knowing what return you will get.

So, what levels of subsidy do we expect in this round?  It’s worth looking at where we have been previously in the UK:

So through two allocation rounds, and three construction phases the strike price has halved.  For comparison, Hinckley Point (the new Nuclear power station) has a strike price of £92/MWh.

Now remember, the subsidy is only the difference between the strike price and the wholesale price.  So in 2018 a subsidy of around £60/MWh was being paid, and in 2023 this is predicted to be only £4/MWh.

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So, the big question is……. What strike prices will be bid in this allocation round – could we see zero subsidy bids? I hope so, but I doubt it. Not yet. But I think we will see bids of only £2 over the estimated wholesale price. I also think none of the projects will be built in the first delivery year, choosing to delay for a year to take advantage of an improved predicted wholesale price.
The likely projects bidding for CFDs this time around are:
East Anglia 3 (Iberdrola)
Dogger Bank (Equinor & SSE)
Sofia (Innogy)
Seagreen Alpha (SSE)
Inch Cape (Red Rock)

I think only Inch Cape could meet the earlier delivery year.

The other “complication” is that remote island onshore wind is included. This considers projects such as Viking Energy, a windfarm on Shetland, being developed by SSE. This is tied into a new interconnector between the Scottish mainland and Shetland – so a really interesting (and challenging) project.

Anyway, it’s going to be really interesting, and it’s a great time to be working in the industry. Legal challenges and appeals could slow the process, but all should be revealed by the Autumn.

My prediction – Strike Price of £52.50 will be secured in this round – that would be a subsidy of £1.60/MWh.  On that basis, the 6GW cap will be reached before the financial limit.  I’m beginning to get my head around the reason for the capacity cap – it’s to do with the intermittent nature of offshore wind.  I still feel a capacity cap isn’t the answer, just push us into exploring battery storage and other ways of solving the intermittent issue.

Note – I wrote the above before the French Government announced the result of their auction for Dunkirk, they’ve granted a subsidy of €44 to EDF.  The subsidy mechanisms are a bit different across the Channel, but that’s a huge slashing of costs compared with subsidies granted in the first French round.  Exciting times across Europe.

 

Disclaimer: I am not involved in any project competing in this allocation round.  I have no access to any inside information.  The above has been written using information in the public domain.  I’m by no means an expert in any of the above, and this just represents my personal thoughts.  Feel free to comment.