The UK government has opened the purse strings for the upcoming sixth Contracts for Difference allocation round (AR6) in an attempt to atone for last year’s disastrous CfD auction and put the offshore wind industry back on track to hit its 2030 target of 60 GW.

The AR6 budget received an unprecedented 52% uplift to £1.5 billion per year (in 2012 money).

The lion’s share of £1.1 billion will go to seabed-mounted offshore wind in Pot 3, followed by £270 million for emerging technologies (floating offshore wind and tidal) in Pot 2, and £185 million for established technologies (solar PV, onshore wind, and remote island wind) in Pot 1.

*The sixth allocation round budget is significantly higher than previous CfD auctions. Chart: Low Carbon Contracts Company*

Administrative strike prices, the maximum permitted bid price, were increased in March and are unchanged as follows (all in 2012 money):

offshore wind £73/MWh
onshore wind £64/MWh
solar £61/MWh
floating offshore wind £176/MWh
geothermal £157/MWh
tidal £261/MWh

With the key auction parameters now known, analysts are estimating AR6 will contract somewhere between 5 GW and 6 GW of offshore wind capacity – well above the 3 GW to 4 GW previously anticipated.

This still falls short of what’s needed to hit the 2030 goal, however. The UK needs to contract 35 GW in aggregate across the next four CfD allocation rounds to get on track for 2030. That’s 8.8 GW per auction – but AR6 simply won’t get there.

In theory, the record £1.1 billion budget for fixed-bottom offshore wind could contract as much as 13 GW, according to the Offshore Renewable Energy Catapult. However, there’s only 10.7 GW of projects eligible to participate.

Moreover, the AR6 clearing price would need to fall to £40/MWh to contract this much capacity. Supply chains are still grappling with the lingering effects of post-Covid, post-Ukraine cost inflation and are unlikely to be able to deliver projects for much below £60/MWh.

For 6 GW of capacity to clear the auction, the strike price would need to fall to £58/MWh assuming the budget is fully used up. In reality, there’s always a portion of unused budget due to the large size of projects.

The upshot is that future allocation rounds from AR7 onwards will need to contract even more capacity than AR6 to raise the deployment trajectory towards what’s needed to hit the 60 GW target.

*The inverse relationship between CfD capacity and strike prices (assumes budget is fully used). Chart: ORE Catapult*

‘Permitted reduction’ curveball

A complicating factor is the allowance for so-called Permitted Reduction projects to re-bid into AR6.

Offshore wind projects that won a CfD in the fourth allocation round are allowed to rebid up to 25% of their capacity in AR6 to secure a higher strike price.

The Department for Energy Security and Net Zero (DESNZ) made this allowance to shore up the economics of projects that warned of delivery risk due to the very low clearing price of £37/MWh in AR4.

There is believed to be 1.3 GW of Permitted Reduction capacity eligible to rebid into AR6.

“These projects may bid in at lower prices than other projects, the impact of which is not entirely clear,” said Tom Quinn, head of analysis and insights at ORE Catapult.

While this would put these projects on a firmer economic footing, it means some of the AR6 budget will be used up on projects that already hold a CfD.

The rebid capacity might out-compete other projects seeking their first CfD, while also pushing back their own commissioning further – all of which could undermine efforts to speed up deployment.

Fighting off the cannibals

The CfD pays generators the difference between the strike price and the market reference price. The higher the reference price, the lower the CfD payment – and vice-versa.

The reference price for offshore wind CfDs is the wholesale power price, which nobody can predict with 100% accuracy. As such, ministers must make an informed guess as to what future prices might be and set auction parameters accordingly.

In a nutshell, assuming a higher reference price gives ministers more ‘bang’ for each ‘buck’ of CfD budget. The opposite is also true: if wholesale prices are assumed to be low, then more budget must be set aside to procure the same amount of capacity, all else being equal.

Offshore wind turbines off the coast of Great Yarmouth. Credit Shutterstock — *Offshore wind turbines off the coast of Great Yarmouth. Credit: Shutterstock*

However, DESNZ reduced the reference price for AR6 to reflect the deflationary impact of greater renewables penetration on wholesale market prices.

Wholesale prices are expected to fall as more wind comes onto the system – a phenomenon known as price cannibalisation. DESNZ is working on the assumption that more budget must be set aside to counteract the cannibalisation effect.

Trade group Regen said the government is using a “flawed” methodology based on a “worst-case scenario that future wholesale prices … will be exceptionally low”. “Labour has room to support more projects for the same budget if they choose to review the methodology for future allocation rounds,” Regen said in a note.

FLOW of momentum

The 2030 target includes 5 GW of floating offshore wind (FLOW), and the AR6 budget uplift goes some way towards achieving that.

FLOW projects are competing alongside tidal stream in Pot 2, for which the budget was hiked from £105 million to £270 million. Tidal has £15 million ring-fenced, leaving £255 million for FLOW if that allowance is exhausted. However, tidal performed well in AR4 and AR5, so “there are not many projects in the pipeline for this round,” Regen said.

There are four FLOW projects eligible for AR6: Pentland (100 MW), Blyth 2 (58 MW), Erebus (100 MW), and Greenvolt (300 MW). For all four to get a CfD, the auction would need to clear at a strike price of ~£122/MWh, well below the administrative price of £176/MWh, ORE Catapult said.

The impact of the budget uplift on likely FLOW capacity procurement is substantial. Under the previous parameters, the strike price would have needed to drop as low as £90/MWh to contract just 300 MW of FLOW capacity.

The more generous allowance opens the door to potentially all four demonstration projects clearing at an ambitious but not unrealistic strike price. This “signal[s] to the supply chain the opportunity is there to invest in,” Quinn said.

*With only 558 MW of FLOW capacity eligible for AR6, the Pot 2 clearing price is unlikely to fall below £120/MWh. Chart: ORE Catapult*

Cost of capital cut

The Bank of England cut interest rates from 5.25% to 5% on 1 August, its first drop since the onset of the pandemic in March 2020.

This is likely to lead to lower borrowing costs for AR6 projects, which might mean a more competitive auction with slightly lower clearing prices.

Gareth Miller, Regen associate and ex-CEO of Cornwall Insight, said the rate cut “will be welcome news for those looking at bidding into CfD AR6 auction”.

The timing was opportune. Due to one or more potential bidders lodging an appeal over their eligibility to participate in AR6, the date for submission of sealed bids was pushed back until 5-9 August while appeals were heard.

“The fact that the sealed bid window was delayed by appeals on qualifying bid decisions, will now run over the next couple of weeks, and thus bidders can take into account the change in interest rates is a happy stroke of luck for government (though I imagine has financial modellers busy reworking investment papers!)” Miller posted on LinkedIn.

However, he cautioned that financing costs generally are “unlikely to be materially different to where they were during the challenging AR5 application window in 2023”. Still, the timing and profile of further interest rate reductions will be “a massive driver of the overall investment cost of the 2030 mission”.

The AR6 allocation process is expected to be run over 12-28 August, followed by further deliberations and audits by DESNZ, National Grid ESO and other bodies. Applicants will be notified of auction results on 3 or 4 September 2024.

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