INTERVIEW: UK CFD manager backs offshore wind auction changes to deliver in 2024

UK Contracts for Difference manager Low Carbon Contracts Company is ending 2023 with a positive outlook despite a disappointing result for offshore wind in this year's Allocation Round 5 (AR5) auction.

AR5 was successful if you weren't an offshore wind developer, said Adam Williams, LCCC's head of policy & development in an interview Dec. 12, noting the award of 3.7 GW of solar, onshore wind, tidal stream and geothermal contracts.

"Obviously there was disappointment in offshore wind, but for Allocation Round 6 the Department for Energy Security and Net Zero (DESNZ) has clearly taken on feedback and modified the parameters," he said.

Three main changes are to apply in next year's low carbon generation auction.

First, and most significant, is the uplift in administrative strike prices, notably for offshore wind but also for floating wind (see table).

Second, the auction moves to a three pot structure, ring fencing offshore wind from more established (solar, hydro) and less established (geothermal etc) technologies.

Finally, there is a change in delivery years, with earlier years for established technologies and later years for less established and offshore wind.

"I worked for an offshore wind developer until recently, and I can confirm that very few projects if any in the current environment could deliver a project AR5's GBP44/MWh ($55/MWh) ceiling. But GBP73/MWh in 2012 prices should be enough for even difficult projects to get a bid into the auction – it's a welcome change for the industry," Williams said.

LCCC plays an advisory role to DESNZ and is something of an intermediary between the industry and the government.

"Because we work with developers to reach their project milestones we understand what's going well, what isn't going well, and we can feed that back to DESNZ. They are generally quite receptive," said Williams.

When it comes to administrative strike prices, however, DESNZ works with external consultants.

"When you look at AR5, those ASPs would have been worked on six to nine months before they were published. The macroeconomic environment shifted significantly in that time, which has been acknowledged and rectified," he said.

Meanwhile, Williams noted that "the vast majority of AR4 projects are meeting their CFD commitments," even if some developers (including Vattenfall) had said they could not make projects profitable at the round's GBP37.53/MWh strike price for offshore wind.

Looking ahead, non-price factors, soon to be consulted on, could add new flexibility to the way developers bid their projects into future auctions.

"As of now there's no incentive to do anything else other than make your project as commercially competitive as possible, and that often means no jobs in the UK. So having additional elements that could bring jobs in, reflected in more flexible pricing, or adjustments to the auction, would be better for developers," Williams said.

Hydrogen awards imminent

LCCC's contract management role has been expanded to include new support mechanisms across a range of technologies.

"CFDs are well understood, with a track record in increasing investor confidence, providing revenue stabilization and wider protections for force majeure and changes in law," said Leo Papanikolaou, LCCC's senior head of bespoke & new schemes.

The LCCC has been named as the independent counterparty to the Dispatchable Power Agreement, which relates to carbon capture, utilization and storage (CCUS) in the power sector; to Industrial Carbon Capture (CCUS in cement, fertilizers etc); and to the Low Carbon Hydrogen Agreement, open to both green and blue hydrogen production.

In August the government announced a shortlist of 17 electrolytic projects under a first Hydrogen Allocation Round (HAR1). Contract announcements are due any day. Support is available for 250 MW of electrolysis capacity. The 17 project applications amount to 262 MW.

Negotiations on eight CCUS projects, meanwhile, are due to conclude next year with the final investment decisions anticipated in Autumn 2024.

At the same time, the government has announced the expansion of Track 1, linking more CCUS projects to the East Coast and HyNet clusters, and the selection of two more CCUS clusters under Track 2 – Acorn in Scotland and Viking in the northeast of England.

"Government is to detail the process for these expansions – which show positive ambition to ensure CCS progresses at a pace aligned with net zero achievement," Papanikolaou said.

Under the hydrogen production business model, meanwhile, negotiations with the first electrolytic projects are progressing "and our understanding is that contract awards are to be announced in the next few weeks," he said.

Establishing a reference price in contracts for a commodity that has no traded market was a challenge, Papanikolaou acknowledged.

"Projects need to [be] incentivized while offering value for money – it's a balanced position," he said.

The solution has been to use a natural gas floor price as the counterfactual fuel. "Then, under the contract, we'll be tracking the actual achieved sales price of the operator's hydrogen to relevant offtakers, with a bonus offered to projects where that price is above the natural gas price. This brings some added complexity to the contracts, but it's a good solution," Papanikolaou said.

Another unique element of 15-year hydrogen CFDs will be sliding scale support.

Although the CFD is there to support production and not offtake, nevertheless it does offer some comfort on the demand side via an increasing strike price if offtaker demand drops below a certain threshold.

The government is also looking at using the gas grid as a possible offtaker, but that idea is yet to be firmed up and would require a change in the model, Papanikolaou said. Equally, producers are not allowed to export subsidized hydrogen – offtakers must be in the UK.

"The government has strong ambitions here – 1 GW of electrolysis in operation or construction by 2025, 10 GW of electrolytic and blue hydrogen by 2030. That implies regular auctions to get there," he said.

Standards, correlation

A critical component to the hydrogen business model is the definition of low carbon production, said LCCC's Lead Contract Manager, Hydrogen, Oliver Coe.

"DESNZ's low carbon hydrogen standard takes into consideration all the emissions associated with production. Emissions must be below 20 grams CO2 per megajoule of hydrogen produced to receive support," he said.

The standard is technology agnostic.

"As long as blue H2 projects capture CO2 at appropriate levels, they will meet the standard," Papanikolaou said.

At the same time, an electrolytic project will need to use sufficiently low carbon electricity to meet the standard – grid power, depending on the mix in any half hour, will not suffice.

The UK is well advanced on the standards front, as it is on temporal correlation, Coe said.

"Electrolytic projects are going to have to evidence where their power is coming from on a half hourly basis, whether it be a PPA with a wind farm or other means whereby they can demonstrate temporal correlation with low carbon power generation," Coe said.

A certification scheme is being developed by DESNZ separately from the hydrogen production business model, based on the low carbon hydrogen standard.

This will be a critical document for hydrogen and any future certification schemes the government develops, Coe said.