Op-ed: Contracts for Difference – Time for something different?

The following article is an op-ed piece authored by Marine Energy Wales’ project manager Jay Sheppard, who outlined his thoughts on how the current Contracts for Difference funding mechanism for low-carbon electricity could be improved Sheppard. The article first appeared at Marine Energy Wales.

In August, the UK Government announced an extra £22 million of funding for its flagship renewable energy funding scheme, Contracts for Difference (CfD). The latest round of the auction, AR5, now offers a pot of £227 million – £190 million for established technologies such as solar and offshore wind, £37 million for emerging technologies like floating offshore wind, including a £10 million ring-fenced budget for tidal stream projects.

The CfD mechanism has been successful in driving down the cost of renewable energy over the years, to the point that other countries are now considering replicating it. The competitive nature of the scheme, which sees project developers bidding to supply the lowest price electrons in order to win a contract to produce energy to the grid, has exerted a consistent downward pressure on pricing year on year.

Whilst the recent uplift in funding for the scheme is commendable and will ultimately lead to more projects going forward in the latest allocation round, there are a number of reforms needed to ensure the scheme remains fit for purpose. As it stands, the UK is at risk of renewable energy projects failing to reach completion. Those that do, will likely see less and less economic value delivered to the UK.

First and foremost, the downward pressure on pricing coupled with the current inflationary economic climate is now making it very challenging for project developers to deliver projects at the agreed upon cost without incurring a loss.

Already we have seen projects paused due to cost concerns, such as Vattenfall’s Norfolk Boreas offshore wind project, with many other project developers raising similar concerns. Should inflationary pressures and the rising cost of manufacturing continue to be a prominent feature of the economy, we are likely to see further projects paused or halted, and a significantly slower pace in the race to reach net zero and hit government targets.

While the current state of the economy is viewed as a determining factor in the current financial risks faced by renewable project developers, it needs to be acknowledged that the very nature of the CfD mechanism is also contributing to this risk. To date, the pursuit of lowest cost electricity has driven developers to seek out cheaper supply chains overseas, rather than nurturing jobs and economic opportunities at home.

Yes, the electricity may be cheaper, but we are paying that price with lost tax revenues and spending from a homegrown supply chain. What then do we need to ensure that the CfD mechanism remains fit for purpose and delivers true value for money?

To nurture and preserve the economic opportunities associated with the UK’s growing renewable energy sector, we feel the CfD should be reformed to include enforceable local content requirements as a condition of contracts being awarded. This would ensure high-value jobs are kept in Wales and the UK, thereby maximizing the benefits associated with high energy transition.

Although this is likely to increase the price at which contracts are awarded and risk slowing the rate of cost reduction, the UK Government must consider the net benefit to the UK rather than lowest cost electricity, at any cost. We also need to see further support offered to those that have already secured contracts to ensure they can successfully progress to completion and start generating low carbon electricity – net zero delivery and energy security are matters of strategic national importance.

A recent positive step within the CfD has been the establishment of a ringfence of funding set aside specifically for tidal stream projects. Previously unable to compete on cost for funding with cheaper forms of low carbon energy, tidal stream projects now have a guaranteed route to market with government backing.

However, with the ringfence currently set at £10 million per annual auction round, approximately 4% of the total CfD budget, there is immense competition between developers to capture a portion of this relatively small pot of funding. Unless this is increased, the number of projects progressing across the country will likely be limited to around 20 MW (assuming similar strike prices to last year’s auction), and developers will be looking to cut costs any way they can to secure contracts.

To date, tidal stream projects that have progressed to deployment pre-CfD have featured incredibly high levels of UK content. One tidal turbine developer, Orbital Marine Power, rightly boasts about the fact that 80% of the jobs created and maintained within their supply chain are in the UK, whereas for offshore wind that number sits at around 10%.

What this equates to is that Gigawatt for Gigawatt, tidal stream projects can currently deliver vastly more economic value to the UK. But the current concerns around heavy competition for funding may force tidal stream down a similar pathway as offshore wind, encouraging project developers to seek out cheaper suppliers overseas. Tidal stream projects will be developed, costs will come down, but a significant economic opportunity will be missed, undermining the UK’s current world leading position with respect to tidal energy.

The current system of announcing funding annually poses an additional challenge. While ever increasing amounts of funding are welcomed by the sector, there is no visibility of future funding rounds or how they will be divided between different technologies.

This makes it hard for project developers to plan when and what to bid beyond the next immediately available opportunity. For the newly included tidal stream ringfence for example, there is no certainty that this ringfence will be maintained into the future, putting added pressure on developers to try and secure contracts as soon as possible.

Greater long-term visibility of the CfD pipeline, ideally for the next three to five years of funding allocation, would provide greater confidence to project developers, and a strong market signal to investors. The current timescales associated with political terms disincentivizes longer term decision making, but long-term planning is exactly what’s needed to optimize our approach to the energy transition. A clear forward look would allow decisions to be made about supply chain and infrastructure investment, further allowing us to better capitalize on the growth of the renewable energy industry.

Finally, a route to entry for wave energy technologies within the CfD auction would be a welcome addition. Currently wave energy projects are allowed to bid, but the pot structure is such that they are simply unable to compete with other technologies on cost to successfully win contracts. To further accelerate the development of this technology and take advantage of the UK’s abundant wave resource there needs to be a commercially viable project pathway.

A small future ringfence coupled with clear visibility of when this would become available would provide enough of a market signal to allow the industry to prepare and put forward viable projects. Ultimately wave energy needs a seat at the table alongside tidal stream, wind and solar to enable further technological development and cost reduction.

The CfD mechanism is at a serious inflection point. Now is the time for clear, long-term planning that not just sets out to reach net zero and bring costs down but helps build economic prosperity in the process.

Next week the results of the latest allocation round will be released and we at Marine Energy Wales are keenly waiting to see what this will mean for both tidal stream and floating offshore wind development in Wales. Projects are here ready to be progressed, but with CfD there is an ever-present risk of missing out to cheaper competition elsewhere, and for Wales to be left behind.

The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of Offshore Energy.

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