Welcome to the next little crisis in the UK energy world: the offshore windfarm industry is being blown off course. No, not because of the cost of leasing seabed plots from the crown estate. Rather, an inflationary gale is blowing through supply chains, upsetting the old and comforting notion that the cost of getting the turbines spinning always falls in real terms.
The decision by Vattenfall to halt work on a big project off the coast of Norfolk is significant for what it says about how far the economics of new wind development have shifted in the space of a year. The state-owned Swedish company calculates that it is better to take a financial hit of 5.5bn Swedish krona (£415m), covering the work it has done so far on the Norfolk Boreas development, than plough on.
The contract for the electricity to be generated from Boreas was priced at £37.35 a megawatt hour (in 2012 prices) when set in last year’s auction for renewables capacity. The price needs to be significantly higher to make the project financially worthwhile, says Vattenfall’s chief executive, Anna Borg.
If this sounds like a plea for more subsidies – which it is – there is sadly little point in telling Vattenfall and other victors in last year’s auction that it’s their own damn fault for bidding so aggressively. Winning an auction brings the right to build a windfarm but not an obligation to do so. The government cannot simply order companies to get on with the job.
Since it can take two years to lock down contracts with suppliers, one can see precisely why cost increases of “up to 40%” in a year, according to Borg, have undermined financial incentives to build. The higher cost of borrowing, as well as the higher cost of steel, will be a factor.
Nor will the change in the economics be unique to Boreas. This year’s auction round is already in progress and all developers will also be pricing in higher costs. It is an open question whether the government’s maximum strike price of £44 a megawatt hour (again in 2012 prices because of the industry’s odd yardstick) will bring forth bidders in anything like the desired number.
What’s to be done? One way or another, the government – which means all of us, via our energy bills – will have to pay more for the next crop of windfarms. If not, construction will only slow further and the dream of being “the Saudi Arabia of wind” will be lost in a North Sea haze.
Giving up on the ambition of having 50GW of capacity by 2030 would surely be the worst outcome – a false economy. Offshore wind, even at slightly higher strike prices to reflect higher construction costs, still represents a significantly cheaper source of energy than gas – at least, according to medium-term projections of gas prices. The bottom line is that developers hold a strong hand here. Offshore wind is still a relatively cheap technology – just not as cheap as it was.
One solution would be to reprice the 15-year contracts agreed last year – in other words, be more generous to the winning bidders. The problem with that idea is that it would bypass the competitive contracts-for-difference regime that, until now, has been highly successful in driving down the cost for consumers and ensuring the government isn’t given the runaround. It would be more sensible just to re-run the auction and invite new bids. As for this year’s auction, that cap of £44 a megawatt hour will surely have to be raised a notch or two.
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“The UK offshore wind sector needs to see higher tariffs/more policy support to incentivise investments,” says the Jefferies analyst Ahmed Farman. Yes, unfortunately that is the state of play. The crisis rumbles on.
