Gavin Smart, ORE Catapult’s Head of Insights, gives his initial analysis of yesterday’s Contracts for Difference Round 2 auction results.

This is part two in a series of blogs analysing the UK Government’s Contracts for Difference Round 2 auction, the results of which were announced on Monday 11 September. Part one in this series is here.

The results for successful offshore wind projects announced in yesterday (Monday 11 September)’s Contracts for Difference allocation round 2 results are stunning.

There will be 3.2GW of offshore wind capacity built commencing 2021/22 at a weighted average 15-year strike price of £62.14. I was pleased to see that my prediction of £75 for 2021/22 was very close to the money. But I was even more pleased to see that my (what I thought was bullish) prediction of £70 for 2022/23 was blown out of the water. The prices and capacities awarded are as shown in Table 1.

Table 1: Allocation Round 2 offshore wind results summary

Table 1: Allocation Round 2 offshore wind results summary

My first reaction was that the answer to the question everyone asks after each European auction result – “What is the difference driving costs so low on the continent compared to the UK, apart from grid costs?” – is now clear. It would seem all we were missing in the UK was a recent auction. But more on this later.

Analysis

In the run up to the announcement, we illustrated a few points around strike prices, LCOE and affordable capacity. So how did this analysis compare to the actual results?

Administrative Price Ceilings

As expected, the strike prices awarded came in significantly lower than the administrative price ceilings – 29% and 43% lower to be precise. This is shown in Figure 1.

Figure 1: Selected offshore wind bid prices vs administrative price ceilings

Figure 1: Selected offshore wind bid prices vs administrative price ceilings

LCOE Reduction

We also looked at what the LCOE trend from the CRMF 2016 study might suggest about the forthcoming projects. Figure 2 shows that our estimates for the LCOE associated with the strike prices awarded is almost completely in line with this trend. So perhaps we (OK, I really mean “I”) shouldn’t have been surprised by the prices announced today.

Figure 2: LCOE trends over time from CRMF results

Figure 2: LCOE trends over time from CRMF results

This is striking enough, but becomes even more so when considering on more of a like-for-like basis with European projects. Figure 3 shows the estimated LCOE in £/MWh for selected UK and European projects. The LCOE has been estimated based on the bid price and taking account of the duration of support and whether the support mechanism is index-linked (as in the UK) or flat in nominal terms (as in key European markets) as these, together with wholesale power price expectations, are key drivers of the difference between a strike price and LCOE. Three data points are shown for each project:

  • solid blue circles are headline bid prices;
  • solid orange diamonds are LCOE including grid costs;
  • purple outline-only diamonds are LCOE net of grid costs.

The same adjustment is made to add grid costs to European projects and to remove it from UK projects – in reality, these costs are highly project-specific.

This shows that we estimate LCOE for UK projects commissioning in 2022/23 to be broadly in line with LCOE for European projects on a like-for-like basis.

Figure 3: Headline bid prices and LCOE compared

Figure 3: Headline bid prices and LCOE compared

Affordable Capacity

We also illustrated the amount of capacity affordable at different strike prices. In the original, we only showed affordable capacity at strike prices as low as £65. Figure 3 shows the same graph extended to a strike price of £60 and highlights the MW-weighted average strike price awarded. So, in theory, this level of pricing could afford in excess of 6GW. The government’s results show that the maximum budget draw in the affordability calculation is £176m in 2023/24, which bears out that only around 60% of the budget is expected to be utilised.

Figure 4: Affordable capacity as a function of strike price (other assumptions held constant)

Figure 4: Affordable capacity as a function of strike price (other assumptions held constant)

In addition to the affordable capacity according to the budget affordability calculation, we highlighted how, in practice, the capacity affordable will vary with strike prices and capacity factors. An amended version of the chart is shown in Figure 4. The strike price lines shown are those awarded (£74.75 and £57.50) and the MW-weighted average of £62.14. Again, the dotted “capacity factor border” line is illustrative, but is re-drawn here together with the original from last week shown as the purple dotted line. As mentioned last week, this border line would move up if we can assume lower returns and/or lower costs. As outlined already, it is fair to say that both have reduced significantly. So, while a capacity factor of 45% may previously have required a bid price of £74.75 to make an economic project, with reductions in capex, opex and cost of capital, a strike price of £62.14 will provide the economic return required. As stated, these strike price / capacity factor combinations are illustrative, rather than an absolute guide to project economics.

Figure 5: Affordable capacity as a function of strike price and capacity factor

Figure 5: Affordable capacity as a function of strike price and capacity factor

Conclusions

The strike prices awarded in today’s auction results are a clear sign of intent from the UK offshore wind industry. Together with the hugely encouraging news on UK content published by Renewable UK on Friday 8 September, this makes a compelling case for continued support from both the public and private sectors.

The cost reductions required will take a combination of key technology innovation and continued reductions to the cost of capital. In future Analysis & Insight papers and blog articles, we will be looking at the challenges both in general terms and specific to the successful projects.