With less than a fortnight to go until the UK Government’s consultation on electricity market reform draws to a close, one vital question remains unanswered – will the strike prices proposed stimulate the level of renewable energy investment envisaged by the UK Government?
As we discussed in a recent Energy Voice column, UK renewables projects are currently supported under the Renewables Obligation (RO). The RO will be replaced by Contracts for Difference (CfD) as part of the implementation of Electricity Market Reform (EMR) being led by the Department of Energy and Climate Change (DECC).
To recap, the CfD is a long term contract which will pay developers the difference between the ‘reference price’ (an index which estimates the market price for electricity) and the ‘strike price’ (a fixed price per megawatt hour of electrical output). Draft strike prices were published in June in advance of the EMR Delivery Plan consultation. A selection of strike prices for 2014/15 includes:
| Technology Type | CfD Support Level/MWh |
|---|---|
| Onshore wind | £100 |
| Offshore wind | £155 |
| Wave/Tidal | £305 |
| Solar | £125 |
The strike prices have been published up to 2018/19 with most reducing over that period – a policy known as digression, which is intended to reflect learning rates as technologies mature.
The renewables industry is currently taking stock of the proposals and with the consultation closing on 25 September now is a good time to assess the merits of the strike prices that are being proposed.
The view from industry so far is mixed and suggests that some strike prices may not support future project investment, particularly in offshore wind, marine and fuel input technologies. It may be tempting to dismiss that view as the renewables industry lobbying for increased support, however it pays to look more closely at the proposals.
The methodology used by DECC to establish the draft strike prices is referred to as RO-X. Essentially, CfD strike prices should be broadly comparable to support levels under the RO. The ‘minus X’ is a reduction to reflect reduced investor hurdle rates for CfD projects based on DECC’s view that the risk profile of those projects is better than those under the RO. This view is yet to be accepted by industry. In comparing the RO and the CfD, a number of assumptions made by DECC have differential impacts on RO and CfD projects. For example, RO support lasts for 20 years and CfD for 15 years.
DECC assumes a 25-year project life, which means that it assumes capacity market payments for five and 10 years respectively. Of course the capacity market is nothing more than a proposal currently and estimating revenues generated will have a high margin of error. There is therefore a case to be made that ‘minus X’ has been set too high.
There is also the question of strike price design. For example, there is a single price for all offshore wind projects, even though a project in deeper waters further from shore will cost more to build and maintain and is higher risk.
Unless revenue generation is much higher, these projects will offer lower margins than those in shallow water and may struggle to attract investment. Why would investors choose higher risk projects with lower returns?
Consider also fuel input technologies. The strike price design is one which leaves investors with CPI linked revenues but much more variable input costs since DECC is taking the position that fuel input costs should only be varied by reference to CPI. The view that stable revenues reduce investor risk may generally be true but it is not so true if input costs are highly variable. This may not be an investible proposition.
DECC is shortly to publish a consultation on an island strike price. This recognises that connection charges for island projects are much higher, due to the costs of building new transmission capacity. The design of the island strike price of course gives rise to many questions. For example, will it be a universally applied uplift or individually considered for each technology?
DECC has chosen a contract period of 15 years because its Net Present Value (NPV) analysis shows that this offers better value for money for consumers than the current RO 20-year period. However, it does mean that projects are left without support from year 16 onwards. Generally, renewables are high capital cost, low operation cost projects but some marine and offshore wind developers are concerned that operating costs may exceed market revenues beyond year 15, raising the possibility that some projects will be decommissioned after only 15 years.
The island strike price proposal does however show that DECC is willing to try and address the shortcomings in the current design of CfD strike prices. Now is the time for the renewables industry to voice concerns on the support mechanism that will shape renewables development for years to come.
More importantly, it is the time to provide evidence and make proposals for change. If proposals for change can be tailored to be compatible with DECC’s thinking the better the chance of success, and the better the chance that the final strike prices published in December 2013, both in terms of levels and design, will be set at a level which will support future investment in the UK renewables industry.
Keith Patterson is Head of Projects, Energy & Infrastructure with Brodies
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