In search of a sustainable offshore wind industry

The UK government is pressing ahead with changes to the Contracts for Difference (CfD) regime that will reward developers for adopting sustainable business practices.

The proposed Sustainable Industry Reward (SIR) is the latest attempt to leverage investment into local supply chains, cleaner production methods and initiatives that benefit deprived areas – but there are still many ‘known unknowns’ about the efficacy of the policy.

The SIR, released for consultation last week, would replace the previous Supply Chain Plan (SCP) that largely failed to do this. It also represents the next step in government’s efforts to incorporate non-price factors into the CfD allocation process, as previously explored in E-FWD.

The biggest change is that the new mechanism would be funded from a dedicated pot of money within the CfD regime, rather than altering strike prices or the CfD allocation process directly to reward the desired behaviour. Also, officials are proposing that developers might be forced to meet certain sustainability criteria before being allowed to compete for a CfD at auction.

Starting from the seventh CfD allocation round (AR7) in 2025, fixed and floating offshore wind projects would be asked to submit proposals for investments that boost the environmental, economic and social sustainability of supply chains. Proposals would be ranked according to value-for-money criteria that are yet to be determined, with the highest scoring initiatives recompensed by milestone payments enshrined in the CfD contract itself.

Minimum standards, keys to entry

The Department for Energy Security and Net Zero (DESNZ) is proposing two possible types of minimum standard requirements. One would require all applicants to secure funding for at least one SIR proposal to be eligible to enter a CfD allocation round. The other would make it mandatory for all applicants to submit proposals and achieve at least a minimum standard on each SIR category to be eligible to enter the allocation round.

This represents a departure from previous proposals, whereby projects that scored highly on non-price factors would receive a boost to their CfD strike price or be re-ranked in the overall allocation process. A prerequisite to achieve minimum standards before proceeding to auction seems to be a neater and simpler solution than complex interventions in the CfD allocation rules that would be hard to understand and administer.

Projects that later fail to meet their SIR promises would be deducted some or all of their SIR payments, while those that fall below the minimum standards could see their CfD payments reduced. The worst performing applicants could also be barred from participating in future CfD auctions.

If non-price factors are judged according to cost-based metrics then there is a risk that the SIR merely transfers the same cost pressures onto the supply chain but from a different angle of approach.

Contradictions and loopholes

The SIR consultation is an invitation to industry to help design an effective mechanism, so it is by definition lacking detail. The precise criteria by against projects will be judged will be crucial to determining its success. Unless these are transparent and quantifiable from the outset, there remains the risk of confusion and legal challenges down the road as proposals are scored and implemented (or not, as the case may be).

There is also an inherent contradiction in the mooted SIR scoring methodology. Proposals would be ranked against each other “at their lowest viable price” to ensure they are “priced competitively” to “drive value for money for consumers”. A combination of a high-quality proposal and lower cost implementation will attract a higher SIR ranking, the consultation says.

The intention is laudable, but if non-price factors are judged according to cost-based metrics then there is a risk that the SIR merely transfers the same cost pressures onto the supply chain but from a different angle of approach.

Timing is (still) everything

The SIR also fails to address the elephant in the room: timing. Rewarding projects for making sustainable supply chain investments just six months before the CfD auction is arguably too late in the project development cycle. As industry sources previously told E-FWD, shoe-horning in non-price factors at this late stage leaves no time to deliver on them unless it is preceded by much earlier engagement with supply chain companies.

DESNZ argues that the proximity of the SIR assessment to the CfD allocation round allows developers time following the publication of the SIR requirements to prepare their proposals, and price them accurately. “At this stage, it is expected that developers would have narrowed down many of their project design and procurement choices and can therefore more accurately forecast the cost of delivering the proposals they submit,” the consultation states. Industry views have been invited on this key topic.

Regulation upon regulation

The SIR is an attempt to steer the offshore wind industry onto a more sustainable footing. But the wider question is, why is this even necessary?

There is something inherently perverse about a regulatory intervention designed to prod an industry into adopting sustainable business practices. If government sees the need to reward companies for doing business in a way that is in their own best interests, this is indicative of a failure of corporate governance. But in the offshore wind sector, which is already heavily regulated and subsidised, a sustainability reward also reflects the fact that existing regulations are rewarding the ‘wrong’ kind of corporate behaviour. In this sense, the SIR is a sticking-plaster that addresses design flaws in the CfD regime, rather than fixing the underlying problem.

From the outset, the CfD has rewarded projects on price and this has exerted cost pressures on the supply chain. Appending a ‘reward’ for good behaviour at the tail-end of the subsidy award process might address some of the shortcomings of the scheme, but it does not fundamentally alter the cost-based logic that determines subsidy allocation and access to market.

There is no simple solution to this conundrum. It stands to reason that those projects with the best economics are granted priority access over those that offer less value for money to consumers, who ultimately bankroll the CfD regime through their energy bills. Scrapping the entire CfD system and starting from scratch would trigger a sudden and drastic investment hiatus – a clear case of the cure being worse than the disease. And since there is no clear alternative to a cost-based allocation mechanism, it is not clear that the replacement would be anything other than a rebranded CfD.

That being the case, the SIR is perhaps the least bad mechanism for nudging offshore wind investment towards the most economically, environmentally and socially sustainable initiatives. Whether it delivers on those outcomes depends entirely on the criteria against which projects will be measured – and whether adding an incentive at the CfD allocation stage is indeed too late in the project development process to be effective.