UK CfD auctions: a triumph for competition?

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UK CfD auctions: a triumph for competition?
An in-depth look into the results of the inaugural UK CfD auction
UK CfD auction:
a triumph for competition?
On 26th February 2015, DECC and National Grid published the results of the
inaugural auctions for Contracts for Difference (CfDs), which will replace the
current Renewables Obligation (RO) as the primary support scheme for largescale renewable and low carbon generation in the UK.
Baringa Partners has been at the forefront of the EMR process, having worked
extensively with Government and renewables developers throughout the process.
Over the course of 2014, we have worked with numerous developers to
understand the CfD mechanism and auction processes, and provided advice on the
economics and strategy of projects which bid into this CfD auction. This Viewpoint
provides a closer look at the results from the 2014/15 auctions, and considers what
some of the major implications may be for the renewables industry.
After considering various allocation
mechanisms over the course of the
Electricity Market Reform (EMR) process
– including administrative pricing, ‘firstcome-first-served’ and ‘unconstrained’
allocation rounds – DECC sent out a
very strong signal to industry in mid2014 by finally opting for full competitive
auctions from day one of the CfD
scheme. While the UK is not the first
country in the world to introduce
competitive auctions or tenders for
renewables, the competition between
technologies under the CfD framework
is genuinely ground-breaking. And, on
first glance, the results from the first
auctions quite clearly illustrate the
benefits of driving cost reduction
through competitive tension. But can
all of the successful projects actually
deliver at the achieved strike prices, or
was there an element of strategic price-
While the UK is not the first country
in the world to introduce competitive
auctions or tenders for renewables, the
competition between technologies
under the CfD framework is genuinely
ground-breaking.
2
UK CfD auction: a triumph for competition?
taker bidding in the auction process?
Moreover, competition inevitably creates
winners and losers, and so there will
be many developers reassessing their
options after missing out on a CfD.
Where to now for these projects? What
is beyond doubt is that the landscape
for renewable investment in the UK has
now fundamentally changed.
F
ast facts
Table 1 below sets out the key statistics from the first CfD auction. Key highlights include:
just over 2.1GW of capacity, across 27 projects, was awarded a CfD contract in the 2014/15 allocation round
wind power continues to dominate the UK renewable market landscape, accounting for the majority of contracts
awarded in this round
the successful projects are comprised of fifteen onshore wind, two offshore wind, five solar PV, two energy from
waste with combined heat and power (EfW CHP), and three advanced conversion technology (ACT) projects, and
on an installed capacity basis, the two offshore wind projects account for almost 55 per cent of the total
(1162MW), onshore wind accounts for 35 per cent (749MW), with the remainder split broadly evenly between
the solar PV (72MW), ACT (62MW) and EfW CHP (95MW) projects.
Pot
Technology
2015/16
2016/17
2017/18
2018/19 Total
Onshore wind
Capacity (MW)
-
45
78
626
749
Strike price (£/MWh)
-
79.2
80.0
82.5
82.0
Project count
-
1
2
12
15
Capacity (MW)
33
39
-
-
72
Established
Table 1: Summary of capacity, strike price and project count by technology and delivery year1
Strike price (£/MWh)
50.0
79.2
-
-
65.8
Project count
2
3
-
-
5
Energy from
Capacity (MW)
-
-
-
95
95
waste with CHP Strike price (£/MWh)
-
-
-
80.0
80.0
Project count
-
-
-
2
2
Solar PV
Total
Capacity (MW)
33
84
78
721
915
established
Project count
2
4
2
14
22
Offshore wind
Capacity (MW)
-
-
714
448
1162
Strike price (£/MWh)
-
-
119.9
114.4
117.8
Less established
Project count
-
-
1
1
2
Advanced
Capacity (MW)
-
-
36
26
62
conversion
Strike price (£/MWh)
-
-
119.9
114.4
117.6
technologies
Project count
-
-
2
1
3
Total less
Capacity (MW)
-
-
750
474
1224
established
Project count
-
-
3
2
5
Combined established
Capacity (MW)
33
84
828
1195
2139
and less established
Average strike price (£/MWh) 50.0
79.2
116.2
95.0
101.8
Project count
4
5
16
27
2
1 All strike prices are expressed in real 2012 terms
UK CfD auction: a triumph for competition?
3
Figure 1: Summary of CfD volumes and clearing prices, by technology and delivery year
800
800
700
• technology cost reductions are limited
over this period (from a given starting
point)
know that creating a
• developers are We
less
willing
to bid on
customer-centric
culture
with the right skills is key
the back of unknown
future
and we workpotential
with our
clients to deliver tangible
cost reductions,changes
or and improve
colleague engagement
• a lack of liquidity in earlier years.
700
119.9
600
114.4
500
500
79.2
400
300
600
80.0
82.5
400
300
50.0
200
200
100
100
0
Strike pirce (£/MWh, real 2012)
As illustrated in Figure 1, the successful projects were predominantly for the
2017/18 and 2018/19 delivery
years. While the clearing price in the
less established pot declines in the later
delivery year, there is no such reduction
in strike prices observed in the established
pot over time. This may be due to a
number of reasons:
Capacity awarded (MW)
Whilst our own work is
based on a data led
approach, using it to inform
what’s important, and
ensure clear line of sight to
benefits, we hep clients
establish this as their own
‘modus operandi’
0
2015/16
2016/17
2017/18
2018/19
Established
2015/16
2016/17
2017/18
2018/19
Less established
Energy from waste with CHP
Onshore wind
Solar PV
Offshore wind
Advanced conversion technologies
Strike Price
Note: The administrative strike price of £80/MWh was awarded to the two EfW CHP projects in 2018/19
A
tale of two schemes
An obvious comparison to make in light
of these CfD results is to compare
them to the all-in compensation that
projects might have received under the
Renewable Obligation (RO) scheme.
This comparison is particularly pertinent given that many project developers have rushed to accredit under the
RO, mainly to avoid uncertainty over
allocation, but perhaps partly due to a
perception that the scheme may offer
greater rewards than the CfD. Table
2 provides a summary of the relative
levels of all-in compensation across
the two schemes, using current power
prices and assuming a ROC value of
£41/MWh (real 2012).
With the exception of solar PV, using
current power prices the compensation
available under the two schemes is very
similar. The renewables industry will
be relieved that there does not appear
to be a strong basis for a short-notice
review of RO banding levels, which
may have been a risk had the auctions
shown costs to be significantly less than
those assumed in existing RO bandings.
4
UK CfD auction: a triumph for competition?
However, a full comparison is not quite so
straightforward, for the following reasons:
• support under the RO lasts for 20
years, versus 15 under the CfD
• intermittent generators are exposed
under the RO to long term power price
risk, short term price risk (cannibalisation)
and imbalance, in contrast to the CfD
which removes long-term price risk
and leaves only imbalance risk, and
• during development, projects targeting
CfDs are exposed to increased
allocation risk compared to the RO.
The removal of long-term power price
risk under the CfD is perhaps the key
difference with the RO from an investor
perspective, and was a key driver of the
design of the CfD mechanism. Wholesale
price rises would represent upside for RO
developers (and vice versa), assuming
that the rising prices are not counteracted
by the effects of cannibalisation. Under
the CfD, project returns are stabilised
at the strike price, and consumers are
protected from rising prices. The relative
support levels under the RO and CfD
mechanisms are illustrated in Figure 2.
W
J
w
Table 2: Compensation under RO and CfD schemes by technology, real 2012
Technology
RO banding
(2016/17)
Approx. ROC
support
(£/MWh)
Approx. price of
base load power
(£/MWh)1
All-in
compensation
under RO (£/MWh)
Average CfD
clearing price
(£/MWh)
Onshore wind
0.9
37
43
80
82
Solar PV
1.2
49
43
92
792
EfW CHP
1.0
41
43
84
80
Offshore wind
1.8
74
43
117
118
117
118
800
ACT
1.8
74
800
43
700
2
This Source: Platts Cal16 Baseload (accessed 2nd March 2015)
119.9
600figure excludes the two solar projects that cleared the auction at a strike price of £50/MWh
This
114.4
600
500
500
79.2
400
300
82.5
80.0
400
Strike pirce (£/MWh, real 2012)
1
700
The renewables industry will be relieved that there
does not appear to be a strong basis for a short-notice
review of RO banding levels, which may have been a
risk had the auctions shown costs to be significantly
less than those assumed in existing RO bandings.
300
50.0
200
200
100
100
0
2015/16
2016/17
2017/18
2018/19
2015/16
2016/17
Established
0
2017/18
2018/19
1%
1%
2%
1%
Less established
Energy from waste with CHP
Onshore wind
Solar PV
Off shore wind
Advanced conversion technologies
Strike Price
44%
4%
97%
13%
97%
Figure 2: Relative support levels under RO v CfD mechanisms
39%
90
l
ai
Em
fs
er
(s
el
ph
o
ne
e
50
Te
le
ep
ho
n
60
vi
ce
)
)
ag
en
t
(li
ve
70
Te
l
Effective subsidy (£/MWh, real 2012)
80
40
Use today
30
Will imp
within
months
20
10
0
2015/16
2016/17
Established
2017/18
Less established
2018/19
0.9 x ROC
2019/20
2020/21
1.8 x ROC
UK CfD auction: a triumph for competition?
5
1. Establishing the Vision
Figure 3: Comparison of CfD administrative strike prices with auction clearing prices, by technology
140
120
100
80
60
40
Onshore wind
Solar PV
EfW CHP
The other obvious comparison to make
is between the clearing prices and the
CfD Administrative Strike Prices (ASP).
These were calculated by DECC for each
technology to provide a reasonable
return to investors, based on estimates
of costs and other relevant data at the
time. Figure 3 above details the ASP by
technology and delivery year versus the
CfD auction clearing prices.
Using the ASP as a benchmark, the
competitive auctions appear to have
delivered impressive savings for
consumers. However, we note that
the ASPs may have been set too high,
based on unrealistic or outdated costs
or hurdle rate assumptions.
6
2018/19
2017/18
2015/16
2018/19
2016/17
ACT
Less established
Auction clearing price
The ASPs were used in early CfD contracts
awarded to just over 3GW of offshore
wind projects (plus a number of
biomass projects) in April 2014 under
the Final Investment Decision enabling
scheme (FIDer). DECC’s stated justification
for the scheme was to prevent a hiatus
in investment while the CfD mechanism
design was finalised and legislated. But
the evidence from these first CfD
auctions suggests that these initial
FIDer contracts were overpriced, which
may prompt concerns over efficiency
when contracts are awarded via a less
competitive or indeed a bilateral
negotiation process.
UK CfD auction: a triumph for competition?
2017/18
Offshore wind
Established
Administrative strike price
2016/17
2015/16
2018/19
2017/18
2016/17
2015/16
2018/19
2017/18
2016/17
2015/16
2018/19
2017/18
0
2016/17
20
2015/16
Strike price (£/MWh, real 2012)
160
Using the ASP as
a benchmark, the
competitive auctions
appear to have
delivered impressive
savings for consumers
ame on in the
G
established pot
Onshore wind
This auction marks a significant
downward recalibration in the cost of
developing an onshore wind project in
the UK. It could be argued that a new
benchmark of around £80/MWh is
now an appropriate value to quote in a
policy context, compared to the previous
benchmark of £90/MWh; the value
used as the administrative strike price
in the auction. We can identify three
principal drivers for this reduction:
1) The price discovery attributes of the
competitive allocation process have
revealed the true cost of delivering an
onshore wind project; a cost that was
less transparent in the RO banding
process. Moreover, the allocation
uncertainty under CfDs may have
incentivised developers to more thoroughly
interrogate underlying project and
development costs and identify genuine
savings, which may not have otherwise
occurred with administrative pricing
under the ROC scheme.
played a role, although this could take
effect more fully over time.
2) Long term price risk is removed
under the CfD mechanism (as discussed
above), which may enable the project to
attract greater leverage thereby reducing
the required hurdle rate.
Projects under both the RO and CfDs
are predominantly developed in Scotland,
where the best wind resources can be
3) Only the best and most competitive
projects are developed in a constrained
funding allocation model. There is
greater likelihood that projects with
the optimum balance of size, wind
resource, TNUoS charge, individual
site considerations and cost of capital
will be developed, in contrast to the
relatively indiscriminate nature of the
ROC scheme.
found. Although we can continue to
expect a distribution weighted toward
Scotland, the competitive CfD allocation
process should better tease out the
locational trade-off between superior
wind resources of the north and lower
TNUoS charges of the south.
The first two of these drivers may have
featured strongly in this first allocation
round. The third driver may have also
This auction marks a significant downward
recalibration in the cost of delivering an onshore
wind project in the UK.
Only the best and most competitive projects are
developed in a constrained funding allocation model.
UK CfD auction: a triumph for competition?
7
Figure 4: Regional distribution of CfD projects
Zone 1
£25.5/kW
4 projects
32.4%
Zone 2
£21.1/kW
1 project
32.4%
North Sea
OFTO
1 project
37.7%
Zone 2
£21.1/kW
1 project Zone
32.4%
10
£15.8/kW
5 projects
Zone 1
North28.7%
Sea
£25.5/kW
OFTO
4 projects
1 project
32.4%
37.7%
Zone 16
£4.9/kW
Zone 2
2 projects
£21.1/kW
26.5%
1 project
Zone 13
£8.6/kW
1 project
25.9%
Zone 26
Zone 16
£-3.9/kW
£4.9/kW
Zone 24
2 projects
2 projects
£-0.7/kW
11.5% 26.5%
1 project
Zone 15
£6.3/kW
1 project
Zone 16
£4.9/kW
2 projects
26.5%
Zone 21
£3.3/kW
2 projects
26.5%
Zone 2
£21.1/kW
1 project
32.4%
North Sea
OFTO
1 project
37.7%
East Anglia
OFTO
1 project
37.7%
32.4%
Zone 10
£15.8/kW
5 projects
28.7%
Zone 18
£2.1/kW
6 projects
25.9%
10.0%
Zone 15
£6.3/kW
1 project
Zone 13
£8.6/kW
1 project
25.9%
North Sea
Zone 21
OFTO
East Anglia
1 project
£3.3/kW
OFTO
37.7%
2 projects
1 project
37.7%26.5%
Zone 15
£6.3/kW
1 project
Zone 13
£8.6/kW
1 project
25.9% Zone
Zone 13
£8.6/kW
1 project
25.9%
East Anglia
OFTO
1 project
37.7%
Onshore wind
Solar PV
Capacity (MW)
Zone 21
£3.3/kW
2 projects
26.5%
Zone 26
£-3.9/kW
2 projects
11.5%
Zone 18
£2.1/kW
6 projects
25.9%
10.0%
16
Zone 24
£-0.7/kW
1 project
Technology
Capacity (MW)
Technology
16
Advanced conversion technologies
Energy from waste with CHP
Offshore wind
Onshore wind
Solar PV
Capacity (MW)
16
200
400
8
Capa
Advanced conversion technologies
Energy from waste with CHP
Offshore wind
Onshore wind
Solar PV
200
400
Zone 18
East Anglia
600
£2.1/kW
OFTO
714
6 projects
1 project
25.9%
37.7%
Legend 10.0%
2015/16 TNUoS charge (nominal)
Projects cleared
Typical load factor by technology
Zone 24
£-0.7/kW
1 project
A
E
O
O
S
Zone 24
£-0.7/kW
1 project
18
£2.1/kW
Advanced conversion technologies 6 projects
25.9%
Energy from waste with CHP
Offshore wind
10.0%
Technology
600
UK CfD auction: a triumph for competition?
714
Legend
Tech
200
400
600
714
Legend
2015/16 TNUoS charge (nominal)
Projects cleared
Typical load factor by technology
Lege
2
P
T
A potential point of distinction that can
be drawn is with respect to the size
of projects developed. At present, the
average onshore wind farm generating
ROCs is only 12MW in size. This is in
comparison to an average size of 50MW
for CfD-awarded onshore wind projects,
with only two of the fifteen projects
falling under 12MW. This is a first
indication that there are likely to be
economies of scale in larger individual
projects making them more competitive.
Solar
Although it could be said that this auction
equally marks a significant reduction in
the benchmark costs for solar PV, there
are two reasons for caution:
1) A relatively small amount of solar
capacity was awarded a contract, with
only 72MW across five projects. If solar
PV was truly able to develop at ~£80/
MWh, we could have expected more
contracts awarded, particularly given its
faster deployment attributes vis-à-vis
onshore wind.
2) The two projects awarded a
contract in 2015 for £50/MWh likely
indicate strategic price-taker bidding
behaviour rather than bids reflective of
true costs.
Some strategic bidding on the part
of solar PV was widely anticipated by
industry, in particular considering the
lack of a direct financial penalty for
non-delivery. While we would attach
a low probability to the deliverability
of the two projects at a strike price of
£50/MWh, Government and industry
alike will be taking note of whether
the projects at ~£80/MWh are capable
of delivering. If they are, then we will
have a new benchmark for solar PV –
one that promises head-to-head
competition with onshore wind in
future allocation rounds.
Implied all-in cost of a solar PV project
Using our levelised cost model and adopting some assumptions for fixed
operating and maintenance costs (FO&M), hurdle rate, load factor and a
merchant tail bid adjustment, we can derive a broad estimate for the all-in
cost of developing a solar PV project implied by a strike price of £80/MWh:
FO&M: £22/kW (inclusive of land use and use of system charges)
Hurdle rate: 4.5% (pre-tax real)
Load factor: 11%
Bid adjustment: +£5/MWh
Implied all-in cost:£745/kW (inclusive of development costs and grid
connection charges)
DECC low estimate,
Dec 2013:
£882/kW
Note: All values are real 2012
However, at this early stage, it appears
as if the accelerated transition out of
the RO and into CfDs may have brought
the large-scale solar PV sector to a
temporary standstill. With less than
100MW coming forward following the
recent period of GW-levels of annual
investment, Government should hope
that there is not a consequent flight
of solar PV investors out of the UK.
In such an event, future CfD auctions
may not be able to reap the full benefit
of the rapid downward cost trajectory
of solar panels, as well as the benefits
from sustained competitive pressure on
the onshore wind industry.
Some strategic bidding on the part of solar
PV was widely anticipated by industry, in
particular considering the lack of a direct
financial penalty for non-delivery.
UK CfD auction: a triumph for competition?
9
C
an we really deliver
offshore wind at
these prices?
Perhaps the most encouraging result
from a consumer perspective is the far
lower than anticipated strike prices for
the two offshore wind projects awarded
CfDs in the first auction. At up to £25/
MWh below the administrative strike
price, Government will feel somewhat
vindicated in their policy to support
the development of a UK offshore wind
industry. However, the true test will be
whether these projects can achieve
financial close off the back of these low
prices and successfully construct the
projects on time. If we directly compare the new wind benchmarks – £80/
MWh for onshore wind and £120/MWh
for offshore wind – investors will need
comfort that this difference of £40/
MWh is high enough to account for high
OFTO charges and the multitude of
complexities in erecting pylons off the
coast, in water depths up to 50m with
individually designed foundations.
On the margin
While we do not have detail on unsuccessful CfD bids, we can form a view
of which projects were ‘in the mix’ based on consent and grid timings, as
well as market intelligence on supply chain and project backing.
With this caveat on the available public information, we found the results
somewhat surprising. For example, based on a couple of indicators such as wind
speed1 and consented turbine size2 (and anecdotally there are other differences),
by most accounts the Moray Firth project could be considered more cost
competitive than the Neart na Gaoithe project. This then begs the question why
Neart na Gaoithe was successful in the auction and came in cheapest. Perhaps
the results simply reveal a difference in auction strategy, with Moray Firth bidding
closer to cost, while Neart na Gaoithe may have submitted a lower strategic bid.
In this scenario, can Neart na Gaoithe deliver at this strike price?
Failure of any of these projects to reach financial close may leave DECC in
deep water and could prompt a re-examination of the penalties for nondelivery and the direction of funds.
If indeed £120/MWh is the new
benchmark for offshore wind, the
outlook would appear negative for the
other higher cost technologies competing in the less established pot, including
marine technologies such as wave and
tidal, and the Scottish Isles onshore
wind projects. We may expect a greater
use of carve-outs such as through
‘minimas’ in the 2015/16 auction, to
enable these immature technologies to
develop.
1 http://www.4coffshore.com/windfarms/windspeeds.aspx
2 For Neart na Goithe, see maximum turbine size defined in Annex 1 of the S36 consent (http://www.gov.scot/Resource/0046/00460581.pdf); and for Moray Firth, see the Project Brochure
10
UK CfD auction: a triumph for competition?
W
hat comes next?
The results of the first CfD auctions are
understandably being heralded by
DECC as a significant win for consumers.
On first glance we would tend to agree,
but the reality is that we will not be
able to qualify this until projects
successfully finance and then deliver
under the new scheme.
Looking forward, these results leave us
with a number of significant questions
that the UK renewables industry will
need to tackle over the coming months
and years, including:
• Can the successful offshore wind
projects deliver at the strike prices
achieved? If so, is the stated ambition
of reducing the cost of offshore wind
to £100/MWh by 2020 now less
fanciful than it once seemed? What
will this mean for the more immature
of the less established technologies?
• What does the future hold for onshore
wind in the UK? Will affordability
concerns lead to a rebalancing of the
political debate in favour of onshore
wind? In the immediate term, has the
potential temptation to launch an
emergency ROC re-banding receded?
• How long will the hiatus be for largescale solar deployment in the UK?
Can projects really deliver at a price of
£80/MWh, and if so, does this imply
even stronger competition in future
auctions for established technologies?
• What are the key risks that need to be
understood in order to get financing
of these projects over the line in a CfD
world? Is an understanding of key risks
such as imbalance and negative prices
of equal or even greater importance
than a wholesale power price curve?
• Will this allocation mechanism provide
a blueprint for Europe, and what are
the key lessons to be learned?
• Looking to the long term, in this
world of increased allocation risk
and squeezed returns, will the CfD
mechanism attract the desired level
of new investment in the sector? And
is the UK now more or less likely to
hit its 2020 renewable targets?
If you have further interest in understanding more
about the future of low carbon development in the
UK and Europe, then don’t hesitate to contact a
member of the Baringa team.
UK CfD auction: a triumph for competition?
11
For more information please contact:
Peter Sherry, Energy Advisory +44 (0) 7903 181 454
Andrew Stiel, Energy Advisory +44 (0) 7530 589 302
[email protected]
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