The UK government has committed to boosting the clean energy sector with £205m for the latest round of the Contracts for Difference (CfD) scheme, which is seen as the main way ahead for supporting renewables. It has already supported almost 27GW of low carbon generation projects and the fifth allocation round is expected to further encourage green industries and jobs, including £170m set aside for established technologies such as offshore wind, as well as a £10m allocation for tidal stream technologies.
However, there are economic issues with the overall CfD programme. RenewableUK’s Economics and Markets Manager Michael Chesser said: ‘Unfortunately, in the light of global inflationary pressures, the budget and parameters set for this year’s CfD auction are currently too low and too tight to unlock all the potential investment in wind, solar and tidal stream projects which the industry could deliver’. The still continuing lack of support for significant onshore wind in England is a glaring example.
Moreover, the UK Energy Research Centre says it could get worse, with the rapid CfD-led progress on other renewables also faltering due to reduced investment support and increased investment risk. Although it notes that the CfDs ‘provide a fixed price for renewables, shielding investors from these risks, helping to minimise the cost of capital for these projects during this critical build-phase of the transition’, it warns that ‘now that renewables are so cheap, some commentators are questioning whether they need the continued government support, arguing that markets might be able deliver decarbonised power more efficiently without the provision of these long-term contracts’.
While it is reasonable to phase out renewable subsidies over time, in its recent report on energy transition costs, the UKERC says that exposing projects fully to what it calls ‘the transition risk’ at this stage could increase the cost of transition by at least a third, from £15bn to around £18-£20bn per year for offshore wind alone. Fortunately though, the UKERC says that a number of market design options that provide an alternative to CfDs, or variations of them, to address this ‘price cannibalisation’ may become feasible and attractive in the longer-term, once the risk characteristics of the decarbonised system are better understood.
It says that the argument for a new approach, for example with just a low carbon obligation on suppliers, is that, although CfDs make investment less risky, ‘they also largely remove any incentive for renewable generators to respond to the short-term price signals that reflect the value of electricity in particular locations or at particular times of the day or year.’ But, it is sometimes argued that ‘if renewable projects were more exposed to wholesale price movements over time and in different locations, renewable generators could be incentivised to generate more when demand is high and not to generate when demand is low’. That, it says, is also linked to a wider set of arguments associated with incentives for demand response and provision of flexibility.
The UKERC says that ‘evidence in favour of this approach is that the market is now delivering wind projects outside of current policy support mechanisms. Currently, however, these remain a low proportion of the total market, below 1 GW out of a total of 48 GW. The extent to which these could be reliably scaled to cover the bulk of the wind power needed over the next 10-15 years remains untested’ .
It does seem a bit premature to expect a lot of that to happen quickly. As the UKECC says, it can be argued that ‘we have only just started to deliver the massive shift in the country’s power infrastructure needed for decarbonisation of the electricity system by 2035, and electrification of other sectors in order to meet net zero’ . Moreover, it has been claimed that ‘at least some of the dynamic efficiencies of the market can be replicated through design changes to the CfD, and that this would be a more efficient approach to delivering investment than fully exposing plant to wholesale price risk.’ But it’s all rather debatable - and depends on what your aim is.
The government is thinking about all this- but it has problems. Given the cost of living crisis, it obviously wants energy cost reductions, although it seems to be going about that a bid oddly- pushing for expensive nuclear projects and as yet untested Carbon Capture systems. Given the widespread public support for renewables, cutting/revamping their CfD funding so as to be able to support these other less popular options might not be wise- or publicly acceptable.
Clearly the government does not want to enter any new nuclear plants into the CfD- last time it did that (for Hinkley Point C) it ended up with a very high price contract, much more than for renewables. It has now settled on the Regulated Asset Base (RAB) financing system for the proposed Sizewell C nuclear plant. That allows the capital costs to be charged direct to consumers ahead of construction, which should certainly cut cost of borrowing capital for the developers, while presumably leaving the consumers and taxpayers to face the risk of any cost escalation or delays. Is that’s really what’s needed?
The UKERC says ‘since renewable power generation will form the bulk of total electricity system costs in the future, the primary policy objective should be to maintain as low a cost of capital as possible during the build-out phase’. Well, rather than going for high cost nuclear (and fossil CCS), why not apply the RAB to renewables? Or is that only meant for hard-to-support expensive projects?
The UKERC doesn’t explore that issue- its focus is mainly on possible variations to the CfD, although it does also look at other approaches to finance and energy markets as adopted elsewhere in the world, including corporate Power Purchase Agreements. It doesn’t come to any hard and fast conclusions from this comparison, although CfDs do seem to be quite well placed, if suitably modified. But what comes across strongly is the wide range of impacts that different policy options on the cost of capital across the market can have. In the case of an 80GW offshore wind programme, using a conservative estimate of risk premium range of up to 5 percentage points, the UKERC notes that ‘every percentage point increase in the cost of capital implies an additional £1 bn to the cost of delivering the full fleet of offshore wind expected to be needed. A 5 %-point increase in the discount rate represents a third extra in capital costs’. So it’s important to get it right.
However, it’s not easy, given the various policy and technology uncertainties. As the UKERC says ‘uncertainty over which technology pathway will prevail is itself largely a result of uncertainty over the evolution of technology costs.’ Yep. With nuclear being a case in point, although the UKERC doesn’t go into to that much, apart from saying that it, along with CCS, ‘appear to need additional support, or more action by government to de-risk investment’. Quite so. It seems nuclear always does! But then, to be fair, so do renewables, for awhile..
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