The shifting investment climate for clean energy in the UK

Over the last year, we have seen a deterioration in the investment climate in the UK, against a backdrop of increased global competition for investment in clean energy. 

The 2023 Contracts for Difference Allocation Round 5 resulted in no contracts for offshore wind, sending warning signs across the energy sector that, unless there are market-reflective assumptions in place within the auction mechanism, offshore wind, a cornerstone of our low carbon energy system and vanguard of our net zero ambitions, is at risk of significant future under-deployment.

The critical role of Contracts for Difference in the UK's renewable energy strategy

We need decisive action from government to ensure the UK remains one of the most attractive places to invest in clean energy. Getting AR6 right will be pivotal to this - ensuring the UK doesn’t fall behind in the global renewables race and offshore in particular. 

The CfD is the critical tool for delivering much of the UK’s future renewables pipeline. The contract itself provides security and investor certainty, and ensures cheaper capital is attracted to project investments. In recent years the CfD has also become a vital hedge for consumers against price spikes and should continue to do so in future as global energy markets become increasingly volatile.

Responding to the challenge: The importance of AR6 for future investments

The material importance of the scheme therefore means the failure of Allocation Round 5 (AR5), in which no offshore projects were awarded CfDs due to the ceiling prices (known as Administrative Strike Prices or ASPs) being set too low, was a significant blow to investor confidence and the UK government’s wider ambitions. 

Government responded, and we very much welcomed the core parameters for AR6 that were released by DESNZ in November. A more reflective administrative strike price, plus a separate pot for offshore wind is critical for investor certainty and also allows for higher levels of onshore wind and solar PV to clear more efficiently in a different pot.

The pitfalls of current CfD budget setting practices

There is still much uncertainty for developers heading into AR6, as there is still no view on the size of the CfD budget, and hence the potential megawatts that could be secured. Ultimately, the CfD budget – and its ability to procure in line with Net Zero targets - is the true measure of the UK government’s seriousness about offshore wind and wider renewables deployment. AR6 budgets are therefore critical in setting the future direction of renewables investment in the UK.

With a “catch up” required for offshore wind following AR5, alongside a need for rising deployment of onshore wind and solar PV, procurement levels for AR6 have to be higher than ever before. To reach the government’s ambition for 50GW offshore wind by 2030, it is estimated that over 8GW needs to be procured annually over the next three auctions to 2026. 

However, the ability of the CfD to procure at these levels is being undermined by the current approach to setting CfD budgets, which needs a significant and urgent rethink.

A path forward: Embracing market-reflective assumptions

As things stand, the current approach seriously overestimates the cost of each megawatt of renewables on consumer bills. The forecasts of future market prices that are being used in CfD auctions (and which are used to assess the amount of “top-up” needed for CfD payments) are very low compared to prevailing market views. In addition, the estimate for the load factors for offshore wind are significantly higher than we see in practice. 

This means there is an assumption that every megawatt bought in the auction requires a higher level of “top-up” than the markets consider to be reasonable. This results in a more rapid depletion of the auction budgets, leading to fewer megawatts procured than would be the case if market-reflective assumptions for future power prices and more realistic load factors were used. 

In a nutshell, for every pound budgeted in CfD auctions, fewer MWs are procured.

The need for a strategic shift: Towards realistic renewable energy procurement

We believe there is a clear, simple and well-evidenced solution to this problem. 

By using market-reflective assumptions for future power prices, which are available from independent market forecasters, and evidenced historic load factors rather than the current assumptions being used to set CfD budgets, the CfD auction could procure MWs at a cheaper, more realistic price. 

This gives government more flexibility to procure the MWs needed to make up for the failure of AR5, and deliver a very successful AR6 whilst reducing the budget required for this success by potentially billions of pounds per year. 

Fundamentally, we see this as a required shift in mindset from government to a more market reflective and realistic approach of value maximisation, continuing its already demonstrated willingness to increase CfD administrative strike prices in line with current market pressures.

A call to action for government realignment

We urge a rapid rethink and realignment on future power price assumptions – and load factors for offshore wind - that we believe will ensure the CfD will be able to procure the volumes needed to meet stretching renewables targets, whilst also increasing energy independence and ultimately ensuring the wider economic benefits of the renewables industry are seen by UK consumers.