The Blog - Wind energy market analysis

Posted 25/10/2018

Frances Salter

    

The economics of wind energy: are competitive auctions the way forward?

The Carbon Trust is an independent, expert partner of leading organisations around the world, helping them contribute to and benefit from a more sustainable future through carbon reduction, resource efficiency strategies and commercialising low carbon technologies. Meet the Carbon Trust’s experts, Rhodri James and Megan Smith, at A Word About Wind’s Financing Wind Europe conference on 1st November. 

are competitive auctions the way forward_

Europe has been the trailblazer for offshore wind for many years; the UK and Germany lead the global ranks for deployment of projects, whilst Netherlands and Denmark have hit the headlines around the world with the strike prices achieved in recent auctions.

With costs falling, other European countries are waking up to the potential benefits of offshore wind in helping to decarbonise and secure their electricity supplies. This wave of increased interest has seen the likes of Belgium, Poland and Turkey setting their sights on the enormous potential of this technology.

So how should new renewable energy projects be financed?

These relative newcomers now face an important decision – what is the right level of support to provide new offshore wind projects? How do you balance the low costs achieved in other countries with the reality of a less mature supply chain and infrastructure? Should these nascent markets adopt the auction mechanisms driving these low cost results, or adapt the approach as the market matures?

The Carbon Trust has carried out analysis to show that fixed off-take mechanisms were very successful in establishing a market, but came at the cost of a much higher level of subsidy per MW.

Once a market is established and the necessary infrastructure and supply chain have been secured, a move to a competitive auction approach can deliver real value for governments and maintain a healthy pipeline of projects. Both the UK and Germany were successful in making sure any changes to policies were introduced gradually, ensuring a smooth transition (notwithstanding some initial apprehension).

In addition to intelligent support mechanism design, both countries also ensured a consistent flow of sites were made available to developers and were initially more lenient on local content requirements to accelerate the industry in the preliminary phases.

How competitive auctions benefit the UK wind market

The UK’s Renewables Obligation Certificate (ROC) mechanism (fixed off-take[1]) saw 6.6 GW of offshore wind projects supported over a 16-year period (the final ROC supported project, Galloper was commissioned in September 2018).

This solid grounding enabled a move to the Contracts for Difference (CfD), a market premium mechanism[2]. Whilst initially developers were competing for a fixed price set by the government (CfD FIDeR), it provided greater potential to reduce the UK Government’s overall spend on support through an eventual transition to a competitive auction mechanism after a couple of years.

The Carbon Trust’s analysis shows that since the first round of CfDs in 2016, an additional 7.5 GW of projects have secured contracts. It also shows that the subsidy per MW has been steadily reducing. The early ROC offshore wind projects were delivered at a calculated value of around £6 million per MW from the UK Government, which has tumbled to around £0.5 million per MW for the most recent winners of the CfD auction in 2017 (Hornsea Two and Moray East).

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Figure 1 - Subsidy per MW for offshore wind in the UK since 2000. Source: Carbon Trust Analysis

Auctions in German wind: a success story

In Germany, the story differs but results in a very similar conclusion. The first few offshore wind projects in Germany were built under fixed Feed-in-Tariffs paid on-top of the market price, but the real increase in deployment came through the introduction of a market premium mechanism (non-competitive) in 2014 under which nearly 7 GW of projects have been or will be built.

The success of this mechanism in invigorating the market has led Germany to adapt its approach to a competitive auction mechanism, which has already awarded contracts to 3.1 GW of offshore wind projects from 2021 onwards.

 A similar pattern emerges when the Carbon Trust analysed the relative subsidy per MW being, or expected to be, paid by the German government. The nearly 7 GW under the non-competitive market premium is predicted to be delivered for just over €5 million per MW, whilst the auction results indicate the latest round of projects should see this slide to just €1 million per MW.

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Figure 2 - Subsidy per MW for offshore wind in Germany since 2004. Source - Carbon Trust Analysis

What does this mean for the future of wind energy projects?

The offshore wind industry is very different now to when these mechanisms were first introduced. European supply chains are more mature and developers are now highly experienced in the construction and operation of offshore wind farms. Nevertheless, there are some key lessons to be learned and the Carbon Trust’s analysis clearly demonstrates the benefits of a grounded fixed revenue support mechanism at an early stage, with competitive auctions offering benefits once a market is established.

It may be that this shift to competitive auctions can be accelerated in the new wave of emerging offshore wind markets, but these countries should proceed with caution before seeing the headlines and jumping straight into a mechanism that may not be fit for purpose.

Meet the Carbon Trust’s experts, Rhodri James and Megan Smith, at A Word About Wind’s Financing Wind Conference on 1st November. To find out more about the conference, click below...

Visit the conference website


[1] Fixed off-take mechanisms are non-competitive. They provide the generator with a fixed subsidy on top of the wholesale price of electricity. This subsidy can take the form of either a cash payment per MWh generated (e.g Fixed Feed-In-Tariff) or something else of value such as a certificate that can be traded to electricity suppliers on a market in return for cash (e.g. Renewables Obligation Certificates).


[2] A market premium mechanism provides offshore wind farm owners with a fixed price per MWh of electricity generated (a strike price) inclusive of the wholesale electricity price – the total level of subsidy is then calculated by subtracting the wholesale cost of the electricity exported from the strike price. If the wholesale cost of electricity is greater than the strike price then the wind farm owner pays back the difference. Variations on this basic principle exist, including a cap to the floor and ceiling of subsidy paid out, the timeframe subsidy is available etc.

 

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