Monthly Market Thoughts: A hard back-to-school for UK offshore wind

Viola Caon, Head of Content

Going back to school after summer is never easy, but it certainly was tougher than usual for the UK offshore wind sector following the government announcement of its Contract for Difference (CfD)'s fifth allocation round (AR5).

No offshore wind bids were submitted, after the five top projects – worth a total 5GW of capacity –pulled out of the process.

While this is disappointing news for the sector, it certainly came as no surprise. Wind developers and industry players had been warning the government for quite some time that inflation was having a significant impact on project financing and that it should be reflected in the auction price. But the government, seemingly, did not listen.

Government responsibilities

Why the government decided to lower the strike price by £2 to £44 (€51.4 $55.1) per MWh at the end of last year [2022] is up for debate. The reasons – like the implications of the auction's results – are probably several.

Complacency is likely to be one of them. The UK has had a strong offshore wind industry for some time now, and it is possible that the outcomes of previous auction rounds have sent the government some mixed signals.

Round 4, after all, took place not that long ago [7 July 2022]. Previous rounds also saw some of the large oil & gas majors paying a lot of money for leases. It is possible that seeing a huge injection of capital into the leasing market, the government thought that a reduction in price was justifiable.

As it turned out, however, the opposite happened. Developers have already been spending a lot of money on the auctions and cannot continue to support a downward trend in prices, it seems. On top of that, the price of raw materials, as well as competition, has gone up globally, making it even harder to make projects viable with decreasing auction prices.

The pipeline is huge - elsewhere

The offshore wind sector in the UK – or indeed, the UK government – might find some comfort in the thought that cost inflation and supply chain issues are a bane to most markets' existence at present.

However, not all markets are created equal. I was recently speaking to a lender about the matter, who told me that they are not worried as the offshore wind pipeline is huge across Europe. So they will keep busy, just not in the UK.

A legal adviser active in the sector told me that they are doing a lot of work in Australia's offshore wind and that it is no coincidence that a market that has been observed for the last 10 years has started to gain traction now. Developers across the board, from Equinor to Orsted, SSE to Iberdrola, are all trying to get first mover advantage in Australia, the adviser said.

Many of the players I spoke to about this story pointed out that when subsidy mechanisms stop working properly in established markets, it can bode well for other emerging markets, and the supply chain starts to look elsewhere. "Politicians do not always appreciate that a country is in competition with another country," one source told me.

Supply chains and failing subsidy mechanisms – A European issue?

The CfD scheme's fifth allocation round was not the only one to produce disappointing results.

Germany has been struggling with undersubscribed auctions for some time, albeit on the onshore side. So has Spain. Market players have started to wonder whether there is an issue with auction mechanisms across Europe and where the problem is.

When it comes to offshore wind in particular, there seems to have been the assumption, particularly in the UK, that the project costs were going to get cheaper when the cost of everything else was going up. Again, the UK government seem to have taken a big bet based on the huge volumes of competition in the sector.

It was an interesting bet, as the issue of rising costs has been plaguing the wind sector quite clearly in recent months, particularly in the wind turbine division. Over the summer, Siemens Gamesa announced a staggering €2.6 billion ($2.8bn £2.2bn) loss in Q3 2023, reflecting a wider trend of rising costs in turbine manufacturing across Europe that is impacting profitability.

The UK government CfD scheme AR5's result is essentially connected to a wider and persistent supply chain and cost inflation issue. "There is simply not enough supply chain in the UK offshore wind sector and prices are very tight. As China closes in, competition is also getting really high," an adviser told me.

Will the UK government listen?

The same adviser also told me: "The UK government needs to put one hand on its heart and the other in its wallet."

In the aftermath of the auction results, when it comes to offshore wind, everyone is looking at the government. And in fairness, there is room for hope. Both Conservatives and Labour are committed to offshore wind and are essentially facing two options to make the CfD mechanism work better for the sector: either replace it or set higher prices. Replacing it would be fairly complicated, time consuming and would create uncertainty in the market. So it is fair to expect that the government would indeed set higher prices for the next round.

Either way, the imperative for the UK's decarbonisation and security of supply agenda is achieving a good mix of technologies. And AR5 did a good job in that respect as it awarded a total 3.7GW across solar, onshore wind, geothermal, and tidal.

Apart from some Holdco debt and refinancing transactions, the UK offshore wind sector will not see much action in the coming months. However, confidence and appetite in the sector remain strong, and industry observers expect this result to be a blip in an otherwise strong pipeline.

Now, it is all in the government's hands.