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Key takeaways
- While the UK offshore wind industry is expected to grow in the coming years, it is also facing immense challenges.
- Rising inflation, interest rates and wider supply chain issues create concurrent uncertainty for this established market.
The UK is a global leader in offshore wind, boasting roughly 20 per cent of global offshore wind capacity, with 13.7GW fully operational in 2022. The Offshore Wind Sector Deal,1 signed in 2019, targeted 30GW by 2030. However, the government soon thereafter increased the ambition to 50GW by 2030 in order to meet the target for net-zero greenhouse gas emissions by 2050 pursuant to the Climate Change Act 2008. The world’s four largest operational wind farms are based in the UK, while just last year the UK installed 300 new offshore wind turbines, with Contracts for Difference (CfD) contributing towards 29GW of total wind capacity (both offshore and onshore), powering the equivalent of around 24 million homes.
What is a CfD?
In this context, a CfD is a long-term contract between a low-carbon electricity generator and the government-owned CfD counterparty, the Low Carbon Contracts Company. A CfD sets a fixed price, known as the strike price, for the electricity produced by the generator. The generator sells the electricity in the wholesale market. When the market price is below strike price, the generator receives a top-up payment (premium) from the CfD counterparty. When the market price is above strike price, the generator must pay back the difference to the CfD counterparty.
The CfD auctions are fundamental for the UK electricity sector’s decarbonization policy and were introduced as part of the government’s 2013 Electricity Market Reform. CfD auctions were launched in 2014, ensuring that projects receive a guaranteed price from the government for the electricity they generate, providing developers (and, critically, banks and others providing developers with the significant amount of capital needed to build these projects) with revenue certainty and, as a result, confidence to invest in the UK. CfDs are awarded through a series of competitive auctions rounds, where the lowest price bids are successful.
CfD allocation round 5
Ahead of this year’s new round of CfD allocation (AR5), the results of which were published in September, industry had for some months been warning the government that CfD strike prices for offshore wind do not yet reflect the realities of their costs. However, few would have predicted the total absence of offshore wind bids from the UK’s latest AR5 in September. A combination of UK-specific challenges and macro-economic factors led to these results for offshore wind, putting the UK’s renewable capacity ambitions for 2030 in doubt. The main reason, as explained by industry representatives, was that the strike price for offshore wind at £44/MWh (including cost of the grid connection) was too low to be financially viable. Indeed, in July 2023, Vattenfall (which had obtained a CfD for its 1.4GW Boreas offshore wind farm as part of AR4) announced that it was halting development over cost concerns.
What’s next?
In light of the recent AR5 results and the success of the previous round’s (AR4) results being at risk, serious government intervention is required to (re)create investor confidence and meet the ambitious offshore wind capacity targets. The government's focus on the next CfD allocation round 6 (AR6), which is expected to launch in spring 2024, is crucial for the future of the UK's offshore wind market. Additionally, the integration of offshore wind with multi-purpose interconnectors in CfD allocation rounds can further enhance the sector's sustainability and reliability.
Conclusion
While the UK's offshore wind industry offers significant opportunities for economic growth, addressing the challenges related to costs, supply chain issues and competitive pricing will be essential to ensure the continued success of the sector and its contribution to the UK's decarbonisation targets. With a general election on the horizon in the UK, it will be interesting to see how the -potentially shifting political landscape will affect the approach to AR6.
Client Alert 2023-230
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