The game has changed

Monday’s CfD auction winners’ announcement revealed that two new offshore wind farms, with a capacity of 2336MW between them, would be able to generate energy at a strike price (the price that Government will guarantee to pay) of just £57.50 per MWh. To put this into perspective, DONG Energy’s Hornsea 1 project was awarded a contract with a strike price £140 per MWh in 2014. Just three years later, its Hornsea 2 project’s strike price is just 41% of that.

There was talk before the announcements of strike prices in the £80s or, perhaps with some divine intervention, in the £70s but nobody expected £57.50. With the price now so close to the £40 MWh wholesale energy price and distinctly less than the £92.50 MWh Hinkley Point C strike price, this will spur a new technology development race.

Offshore wind will not be the only energy source in the UK’s future but it has now established itself as the de facto large scale generator. This means that there will now be a strong push to tackle its weaknesses, namely that its production is not very predictable so storage and a high capacity demand side response network are essential. Next-generation 15 MW turbines are in the works and these will further highlight the new literal weak link in the energy network – transmission and distribution. Low capacity, leaky cables (the UK loses approximately 7.5% of energy generated during transmission and distribution) will no longer suffice. This is partially because energy security still remains an issue so every megawatt counts, and partially because the cheapest and easiest way for the UK to meet its carbon reduction targets is to simply waste less energy.

Government has already progressed its thinking in this area. Policy officials at the Department of Business Energy and Industrial Strategy (BEIS) are increasingly focused on innovation in the sector, particularly in energy storage, and this pressure is being felt by Ofgem and in turn influencing its policies.

Battery storage has fallen in price just as dramatically as wind generation, but the amount of storage required to support a system based on intermittent renewables would still be vastly expensive. While BEIS has shown great interest in storage, it is an area that it is driving primarily with its industrial strategy hat on, having identified another potential arrow for UK plc’s quiver of exportable technologies. It is telling that BEIS did not pursue a battery storage CfD, but rather announced a £246m Innovate UK fund for storage technology development.

So we can expect Government to start to turn towards the other means of managing peak consumption. In fact we don’t need to expect this as it already has. The joint BEIS/Ofgem Smart Systems and Flexibility Plan sets out Government’s ambitious yet pragmatic approach to drag the energy sector into the 21st century. It means making use of new demand side response technologies to smooth demand peaks and reduce the amount of new grid infrastructure required.

The next CfD auction

So what does this all mean for the next CfD? It goes without saying that Government is going to expect very low strike prices, almost certainly below the current £40 per MWh wholesale energy price. As energy generation becomes more affordable, the other costs and issues in the network will become more salient – transmission and distribution costs, and real-time or near real-time matching of supply and demand. Beyond this the Government might also start considering the potential that projects have to create jobs and new export opportunities, and further reduce carbon emissions.

That last point is worth reflecting on. There were two biomass and six advanced conversion technology projects awarded contracts on Monday, but together they only represented 4.7% of the capacity of the winners. The other 95.3% was awarded to three large offshore wind farms. As the Government seeks to meet its Paris carbon reduction targets, it is difficult to envision it awarding any large contracts to fuel burning projects.

The current CfD process has a rather limited set of criteria with the primary considerations being the delivery time and strike price, but there’s nothing to say the next auction will be anything like a CfD as we know it.  The first question is whether there will actually be an auction at all. The Government made a commitment in 2015 to allocate of up to £700m of CfD funding for these auctions but this was conspicuously absent from the 2017 manifesto.

On balance it is more than likely that there will be a long term programme of auctions of some sort. There is recognition in Government and industry that the CfD process is largely successful and the UK needs new energy sources to come on stream, even before considering its plans for electric vehicles. But, it now needs to develop the process for energy that will come on stream beyond 2023.

Forward thinking companies are already engaging with Government to shape the process, no doubt all keen to ensure Government funds are allocated to the areas with the biggest potential benefit. This however, will inevitably be skewed by the fact that each organisation will likely know more about the future potential of its own technology than others. As is often the case, the organisations that are most effective at communicating their vision with Government are likely to play a key role in shaping the future of CfDs. And with the potential for a radical shift in the CfD scoring criteria, this role will be more important than in past years.

As an aside, I don’t think anyone needs to actually say this out loud, but the £57.50 strike prices achieved by two of the offshore wind farms clearly puts a great deal of pressure on Hinkley Point C. I’d be willing to put my head above the parapet and say that Hickey will be the last large scale nuclear power plant to be awarded a contract in the UK. That being said, at this point I wouldn’t be willing to bet on it actually being built.