The offshore wind industry is poised to develop rapidly and take a leading role in meeting the UK’s low carbon agenda.
However, this is conditional upon the Government ensuring that the right regime is created to encourage the massive commitment and investment required of the private sector.
But right now there is mounting concern that the UK’s originally bold offshore ambition might be stalling; and for a number of reasons.
Currently there are some 2.7GW (gigawatts) of offshore windfarms in operation, 1.5GW under construction, 2.3GW with consent to build and a further potential 47GW in Crown Estate licensing rounds.
In Scottish Territorial Waters there are some 21GW in the consenting process.
The UK Department of Business, Industry and Skills’ offshore wind industry strategy published during the summer projected the industry would create 30,000 jobs and generate some £7billion GVA (gross value added) per annum into the UK economy by 2020.
Delivery of the increased amount of renewable electricity on to the grid requires massive capital investment to replace and upgrade much of the UK’s electricity infrastructure.
The Westminster Government considered that to attract the necessary level of investment the electricity market should be reformed to provide a more stable platform for investors.
And it follows that the resultant Electricity Market Reform (EMR) proposed by London was promoted as an “initiative to make sure that the UK remains a leading destination for investment in low carbon electricity”.
The EMR is a package of measures designed to work together: an emissions performance standard which puts a limit on emissions from fossil fuel plants; contracts for difference – a 15-year contract which guarantees a fixed price for electricity for low carbon generators; and the capacity mechanism that is designed to back-up intermittent forms of generation such as wind.
It is also a mechanism to provide support for nuclear and carbon capture and storage (CCS).
All the proposed changes are embedded in the new Energy Bill which was put before Parliament in November last year and is expected to achieve Royal Assent by the end of this year.
A number of potentially significant changes to the support regime have been suggested but the main element of the EMR is that the current Renewable Obligation (RO) regime be replaced by a “Contracts for Difference Feed in Tariff” regime.
Under the RO generators are paid in tradable certificates (ROCs) for electricity generated.
The main differences between the RO and CfD regimes lie in the length of the revenue scheme – 20 versus 15 years; form of support payment – tradable certificates versus cash payments; protection against changes in law – none versus some; and revenue indexation – RPI versus CPI.
The Government claims that the new CfD system is better than the RO in that it reduces risk to investors.
Yet, the proposed contract terms, particularly with respect to penalties for increasing or decreasing capacity of projects from what is in the contract for difference even though this is signed early in the development process and ahead of much of the analysis, do not instil investor confidence.
The Contract for Difference Feed-in Tariffs (CfD FiTs) are intended to provide a fixed electricity revenue over a 15-year contract period and thereby make the project more attractive to investors by reducing electricity market risk.
They are viewed as being overly complex, as compared to the RO regime, in the way in which they will be implemented.
The generator will enter into a Contract for Difference contract where the payment for electricity generated will be based on the difference between a pre-defined subsidy or “strike price” and the “Reference Price”, an index that estimates the market price for electricity.
If the reference price is higher than the strike price the generator pays the difference.
The strike prices will initially be determined by government based on its view of the technology and later potentially through an auction process.
For most renewable energy technologies the strike prices reduce with time in line with a policy known as “degression” which is intended to reflect learning rates as technologies mature.
CfD contracts will be available for nuclear, Carbon Capture and Storage, and renewable technologies with the funding provided through a Levy Control Framework (LCF) that sets the limits on how much funding is available.
The details of how the LCF will operate will be revealed in December in the final EMR Delivery Plan.
The funding levels (in 2011/12 prices) have been set out on annual basis starting at £4.3billion in 2015/16 rising to £7.6billion in 2020/21.
The LCF is effectively the amount consumers will pay in higher bills.
The transition in subsidy system from the existing Renewable Obligation to the new Contracts for Difference will occur between 2014 and March 31 2017.
In this period developers have the option to apply for either the RO or CfD regime. For projects coming online after April 2017 only the CfD regime is available.
Last year, the renewables industry was reasonably optimistic about the potential changes to the support mechanism and the rates of deployment of offshore wind that the UK Government was proposing.
A year on and the greater clarity provided in the draft EMR Delivery Plan which was published in July has raised concerns in the minds of developers and investors about the financial viability of their projects.
This summer has seen the publication of a series of reports, supporting analyses and consultation documents around the EMR and its draft Delivery Plan.
This has meant a lot of serious reading and analysis for many people over the summer months in order to provide responses to the consultation that closed at the end of September.
The no doubt closely worded responses from the industry will need to be thoroughly digested by DECC (Department of Energy & Climate Change), and potentially further analyses conducted before the finalised Delivery Plan is published in December.
This will then need to be carefully managed through Parliament against a very tight timetable, particularly considering the amount of concern raised to date.
From the Government’s perspective the long-term aim is to reduce the cost to the Exchequer of subsidies for renewable energy technologies and hence the price paid to renewable generators will decline with time – the degression policy.
As Prime Minister David Cameron has being saying of late, his desire is not to pay for wind energy any longer than is absolutely necessary.
The Government’s green agenda appears to be one of meeting obligations at least cost and there is debate in some quarters as to whether there should be a continuing acceptance of the renewable energy targets, and hence obligations, set by Europe. All this debate around renewable energy and the costs to the consumer is just adding to the uncertainty that the EMR is supposed to be designed to allay.
For offshore windfarms generating from 2014/15 and 2015/16 the proposed draft strike price is £155/MWh of electricity generated over a 15-year contract.
The strike price would then fall to £150/MWh for projects starting in 2016/17 and then to £135/MWh by 2018/19.
The rapid cost reduction (£15/MWh over 4 years) implicit in this decline is posited on the findings of two key studies undertaken last year – the Crown Estates Offshore Wind Cost Reduction Pathways Study (CPRS) and the Offshore Renewables Cost Reduction Task Force.
Both demonstrated that costs could be reduced based on the level of deployment, economies of scale and learning by doing, rather than time per se. And the industry is keen to drive costs down and improve financial viability for their projects.
The view of the CPRS report was that in order to achieve these significant cost reductions there needs to be a UK market growing by at least 2GW per year from 2015 to 2025.
This seems reasonable as it fits well with industry forecasts of 8GW installed by 2016, growing to 18GW by 2020.
The CPRS notes that in a 12GW scenario, there is “limited cost reduction potential prior to a final investment decision in 2017, as the limited scale and stop-start nature of the market deters investment in technology or supply chain”.
The UK Government’s 2011 Renewable Energy Roadmap indicates some 11-18GW by 2020. These levels of deployment will provide confidence in the supply chain, competition driving prices down and a high level of experience of operating in the environment leading to lower costs.
However, the draft Delivery Plan only projected as little as 8GW of offshore wind by 2020.
This accounts for existing projects and those already in the pipeline. But it excludes the new series of offshore windfarms planned for The Crown Estates’ Round 3 and those in Scottish Territorial Waters.
It is these large-scale projects in deeper waters and far from shore that would have delivered the very cost reductions that government expects.
These points about degression in strike price and level of deployment have been recognised by the Committee on Climate Change, an independent statutory body established under the Climate Change Act of 2008 to advise Government and Devolved Administrations on emissions targets and report to Parliament on progress in greenhouse gas reductions.
They conclude that the degression rates for strike prices for offshore wind proposed in the draft Delivery Plan will not be achievable with the lower levels of deployment projected to 2020.
They go further and suggest that a degression rate closer to £5/MWh (rather than £15/MWh) between 2016/17 and 2018/19 “is more likely to be appropriate” and sent this in an open letter to Ed Davey, the secretary of state at DECC. In a similar vein the industry is calling for higher strike prices and/or lower degression rates.
A further issue causing uncertainty amongst developers and investors is that the draft Delivery Plan scenarios suggest offshore wind deployment as low as 9GW in 2030.
This would seem to imply no further investment beyond 2020.
No targets have been proposed beyond 2020 and Government appears at the moment not minded to set 2030 carbon reduction targets.
It is difficult to see how this sends a positive signal to industry.
Indeed Scottish Renewables in its submission to the consultation stated that it “believes the proposed reductions in strike prices, and the lack of clear ambition for significant further growth in offshore wind capacity, up to and beyond 2020, could profoundly limit the growth of the UK offshore industry and its supply chain”.
Such a low level of projected deployment creates market uncertainty, the very point that EMR is supposed to be addressing and could slow the development of the supply chain to the point that the UK loses out on front runner status, the market is too small to attract manufacturers of equipment and the industry will not be in a strong position to capitalise on the export market.
So, where does this leave us?
We have an offshore wind industry which is poised to expand but which is now concerned that the level of strike prices suggested and potential rates of deployment mean that anticipated cost reductions will be difficult to achieve and hence call into question the economic viability of its industry.
The EMR team in DECC will now be considering what one can only imagine to be strongly worded critiques of the draft EMR Delivery Plan.
There is much to consider.
The Government is concerned about the costs of meeting the low carbon targets particularly in the current debate about energy bills and the industry and the climate change committee are indicating that the rates of degression in strike price are not commensurate with rates of deployment being proposed.
No doubt there will be much lobbying in the interim. But if offshore wind is to make the level of contribution to the low carbon targets signalled in the Renewable Energy Roadmap some concessions by Government will need to be made.
For instance, a clear statement of ambition for offshore wind towards 16 rather than 8GW and a reduction in the rate of strike price degression. We await with interest the final version when it appears in December.
Professor Paul Mitchell is the director of the Offshore Renewables Institute, a new joint venture between the Universities of Aberdeen, Dundee and Robert Gordon focusing on the deployment of offshore wind.
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