How to Create a Gold Rush in Offshore Wind
Matt Bleasdale
Offshore wind consultant
The UK has achieved a lot in the transformation of society from fossil fuels to renewables. It has the second largest deployed offshore wind portfolio (with only China, a country of 1.4bn people, having more), is the world's first major economy to present a net zero Industrial Decarbonisation Strategy, and has ambitious targets. At the same time, renewable energy supply chains have had limited success. Some component manufacturers have done well, however, no major big ticket item suppliers are based in the UK or have grown out of UK innovation. Considering the growth of supply chains in other states (e.g. turbine manufacturers in Denmark, France, Spain, Germany) the cause for the UK's lack of supply chain growth falls at the feet of policy.
The offshore wind industry is big, and is going to be huge. 2050 global capacity forecasts are 2TWs, and history from other industries shows those forecasts may significantly undershoot the mark. Current global installed capacity is 65GWs, only 3.25% of the forecasted capacity. As such the industry is still in its earliest stages and the opportunity for growth is considerable, as long as government strikes while the iron is hot.
Low carbon generation has required support and, while power prices are currently high, the industry is still wary of full market exposure. At the same time, to target support for manufacturing and create supply chain growth the mechanism is the linchpin in the process.
This article sets out why the UK has lagged behind in terms of supply chain growth and a proposal to foster it. It goes into the issues created by policy structures that have been so successful in building generation, even though the components for that have been imported from other states, and details an alternative to grow UK manufacturing and innovation.
Current Policy, the CfD
The current, interventionist, Feed-in-Tariff Contract-for-Difference (CfD) mechanism slows down development, intervenes at a point when developers have little project information, forces costs onto unsuccessful bidders (creating a lose-lose scenario in the bidding process), fails to dispatch the ideal amount of renewable generation (underspending the allocated budget and forcing up energy costs for consumers), requires significant amounts of administrative effort from all involved, excludes smaller players, and leads to a non-delivery risk that is only revealed at the last moment leaving government targets hanging in the breeze. However, worse still for UK Plc, it effectively prevents the creation of a UK based supply chain.
While the issues identified seem considerable (and they are) they are all associated with a single aspect of the support mechanism, the allocation (or auction) based nature of the CfD and its reverse (or negative) price bidding. The auction mechanism was originally thought to be desirable to introduce a competitive aspect to pricing, and thus ensure efficient use of energy consumer funds, however it created a forecast error risk that has led planners and policy makers to misjudge the amount of power that could be dispatched. While that forecast error is linked to the high energy prices caused by the Ukraine war, no matter what event would otherwise have caused price fluctuation the forecast error risk would have remained. The CfD was introduced to keep costs low through its competitive auction mechanism, however, that has shown itself to be penny wise but pound foolish.
To develop supply chains, the government implemented a requirement for projects over 300MWs to submit a Supply Chain Plan (SCP) with statements about what the projects will do in the sector and geographic area of the project. However, the SCPs have failed to build manufacturing. So in the most recent attempt to foster a supply chain, while doubling down on supporting renewable energy with the CfD, the Department for Energy Security and Net Zero (DESNZ) has set out a proposed Sustainable Industry Reward (SIR) scheme. However, it has the same flawed negative price bidding as the CfD (to which it is top-up) further exacerbating the problems, and remains a process where support is only promised for the promise of future action. Its reliance upon the CfD is throwing good money after bad.
The CfD is administratively heavy. It requires significant effort from all parties involved whether the developer, the government, National Grid as the administrator of the Allocation Rounds, or the LCCC; and that's not even touching on the supply chain providing indicative pricing information for projects that may not even secure a contract - and that's if developers can get contractors to engage given some of them will only talk to projects with a CfD!
Associated with that administrative burden is the time it takes to conduct the whole process. From start to finish the allocation of the CfD is excessively long with developers having to engage with the supply chain very early (at a stage prior to them having good project information) to get an indicative price for their project, meanwhile government is trying to calculate forecasted electricity prices and expected Bid Strike Prices to set an overall budget that will deliver the desired amount of renewable generation, developers write their SCPs, government reviews and approves those SCPs, developers then submit their Bid Strike Price, and National Grid calculates the expected amount of generation that can be dispatched within the budget based on forecasted power prices and defines the Clearing Strike Price all bids below which win a contract. After award developers have two years to enter into major contracts (make significant financial commitments) or abandon their CfD (and be excluded from the next CfD Allocation Round.) Overall the whole process can take 7+ years.
Experience from the system has shown that it has artificially kept power prices high by failing to dispatch the optimal amount of renewable electricity generation, under-utilising the allocated budget, resulting in less low-cost renewable power and leaving consumers paying for more electricity set by marginal gas generation prices. As an example, in AR1 the budget was (to 2021) £1,095m while actual cost was only £293m. Only 54% of the generation that bid into the round was contracted while only 27% of the budget has been used, so clearly a lot more generation could have been dispatched which ultimately would have saved a huge amount for consumers through lower energy prices. Meanwhile for AR2 the budget (to 2023) was £580m while actual costs have been -£144m (i.e. payments to the LCCC which were then used to subsidise energy bills, in effect renewables subsidising gas fired generation!) This time only 9.3% of the bid volume was contracted, with no use of the budget at all but 25% of it paid back by renewable generators, clearly again a huge amount more generation could have been dispatched saving consumers a vast amount in energy bills and going significantly further to meet government renewable energy targets.
In addition to the problems of it taking too long, creating a lose-lose bid dynamic, delivery risk, and failure to dispatch optimal volumes (which is fundamentally due to the inability of a single player, the government, to forecast markets), the CfD introduces other failures. For example: AR5 did not receive any offshore wind bids due to too low an Administrative Strike Price; AR4 resulted in failure to develop a significant project (Norfolk Boreas) as the Strike Price was too low (forcing cost onto projects that weren’t contracted but may have bid in at a more reasonable and successful rate); generators have a market/strike price risk as the traded volumes within the relevant markets haven’t varied since adoption of the CfD...
An Alternative, the Virtual Resource Model
Anecdotally in a gold rush the people to make all the money are the ones selling shovels. That “gold rush” strategy could easily be transferred to the renewable energy industry. The key characteristic of a gold rush (or the oil and gas industry, etc.) is that there is a resource to be extracted. As that resource is extracted it sells in the market, if more of it is extracted it sells at a slightly lower price. In order to replicate that within the renewables industry, defining a virtual resource (a budget) and giving generators a share of that dependent on their share of overall production can provide a top-up to the revenue the generator gets from its power sales, and approximates the characteristics of those other “natural” markets. The generator who is “the last into the market” (i.e. the one who builds their project last and so sets the overall total generation) sets the top-up price (share of the virtual resource) that all generators get, providing a competitive process without an interventionist mechanism. Meanwhile, the underlying market price for the power remains set by the market providing important signals such as time, season, and other metrics that the price is sensitive to.
In addition, the Virtual Resource Model (VRM) enables the government to weight metrics important to policy; e.g. differing technologies, supply chain initiatives, investment in innovation, etc. can all be prioritised through weightings. Those weightings can be reviewed from time to time to ensure efficiency and delivery of government targets. This way the VRM allows the government to reward projects based on actual delivery, after the fact, rather than promise reward for promised action, all dependent on an underlying CfD mechanism which may or may not actually deliver the generation capacity.
Most importantly, the virtual resource is available to the first who build so encourages shovel ready projects. The sooner you build, the greater the share of the resource, the more gold you get!
The #VirtualResourceModel turns ideas into reality.