UK to reveal renewables auction results with inflation as backdrop

The UK government is set to reveal the results of its latest renewable energy auction this week, with the industry bracing for the very real prospect of an underwhelming outcome due to ongoing inflationary pressure.

Rising project costs provide an uncertain backdrop to the country's fifth contracts for difference (CFD) auction, known as Allocation Round 5 (AR5), in which developers compete for 15-year fixed-price power deals.

The government is under pressure to continue the trend of downward prices and higher awarded capacity witnessed in every CFD auction since 2015, with companies and commentators arguing that AR5's maximum bid levels have been set too low.

That fear deepened in July when Swedish utility Vattenfall decided to shelve its 1.8-GW Norfolk Boreas offshore wind project, citing cost increases of 40%.

Vattenfall was awarded a CFD in 2022's Allocation Round 4 (AR4) worth GBP37.35/MWh in 2012 prices, only slightly below the GBP44/MWh ($55/MWh) bid ceiling set for offshore wind in AR5.

Danish wind giant Orsted is among those to have spoken out, saying it may need tax breaks to make its 2.85-GW Hornsea 3 project economically viable. Hornsea 3 has a CFD at the same level as Norfolk Boreas.

'Bit of a gamble'

The government responded to the price pressure by increasing AR5's funding pot by 11%, or GBP22 million per year. Yet industry players maintain that the overall budget remains too low -- and the bid ceilings too tight -- to get anywhere close to matching the 10.8 GW of renewables capacity awarded CFDs in AR4.

"The stage is set for an absolutely fascinating set of events," said Adam Bell, head of policy at consultancy Stonehaven. "This auction ... to a degree represents a bit of a gamble for the [government]."

In particular, the decision to abandon the ringfenced budget for offshore wind and make the technology compete for CFDs against onshore wind and solar "creates some interesting dynamics," Bell said in an interview.

Of the more than 26 GW of UK renewables capacity awarded CFDs to-date, more than 20 GW has gone to offshore wind -- the country's flagship clean technology that it wants to ramp up to 50 GW by 2030.

In previous auctions with ringfenced budgets, offshore wind developers could tailor their bids according to what they know is in the development pipeline -- typically a small number given the size of projects. That approach is now complicated by the fact companies will be going up against potentially dozens of smaller onshore wind and solar projects.

"Your ability to game the auction is a lot more challenging," Bell said.

Uncertain outcome

Bidding strategies in AR5 will ultimately be determined by the extent to which developers think the inflationary pressure will subside before their projects need to be delivered, Bell said.

In AR5, projects must come online between 2025 and 2028, depending on the technology.

There is also a risk that companies view their CFD awards as options, bidding beneath the GBP44/MWh ceiling and paying the required penalties for non-delivery if they cannot make their business case stack up.

"The actual outcome of this will shake down in a couple of years' time," Bell said, adding that an underwhelming result in AR5 would force the government to take another look at its methodology for calculating maximum bid prices.

Another possibility is that offshore wind is pushed out entirely by onshore wind and solar. UK Prime Minister Rishi Sunak is said to be under pressure to overturn the UK's ban on building new onshore wind projects, according to a Sept. 3 report by The Telegraph newspaper.

At least 4 GW of offshore wind farms are eligible to bid in AR5 (see table).

New parameters

The Low Carbon Contracts Company (LCCC), the government agency that administers the CFD program, anticipates announcing the AR5 results on Sept. 8.

In a March interview, the LCCC underlined improvements in AR5 versus previous rounds, including a new annual cadence for auctions and a reduced award processing period.

Annual auctions allow for peaks and troughs in bidder interest without unduly disrupting predictability, while a faster results process -- six months instead of nine -- helps developers facing volatile costs, officials said.

One change that will not be welcomed by investors, however, is the removal of the 'merchant nose' opportunity, where operational projects delay the triggering of their CFDs in order to benefit from high market prices.

From AR5 onward, the LCCC will use new parameters to identify when a project has commenced operation and, if need be, require commencement of a CFD.