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One of the most significant energy policy decisions in years was made by the UK government this month, when it confirmed plans to rule out zonal pricing for the GB electricity market. Instead, government will progress to “reformed national pricing” – which means sticking with the current wholesale market structure and pursuing evolutionary changes, namely to network charges and the ancillary markets (e.g., the Balancing Mechanism, and Capacity Market). It also means that the strategy for centralised infrastructure plans will take on greater importance.
For a deeper look at how electricity market reform has evolved including the government’s position on zonal pricing and investor implications - read our analysis here
While the prospect of major reform to the electricity market is now much reduced, a quiet revolution has been taking place in the background. A sequence of layered decisions on the next Contracts for Difference (CfD) allocation round – AR7 – now add up to a major shift in approach to securing the new clean power supplies needed to achieve the government’s 2030 goal.
This blog explores some of the decisions that make AR7 so different to the rounds that have gone before it, and the implications for consumers and investors alike.
The success of AR7 will be judged on how much new offshore wind capacity it secures in some months from now. If we are to reach the minimum 43GW of installed capacity needed in 2030 to achieve the clean power goal, around 15GW of new offshore wind needs to be approved over the next two auction rounds (AR7 and AR8). It is clear that the collective decisions on AR7 have been made to de-risk investment and secure 7-8GW needed to keep the target within reach. These changes include:
Government has made the significant step of allowing unconsented fixed offshore wind to compete in AR7. There are some heavy restrictions (e.g., projects need to have submitted planning applications at least 12 months prior to the start of the auction). This should help secure more capacity and improve the competitive dynamics within the round. While the end result may only benefit a few unconsented projects, it sets a precedent for future rounds that will be hard to unwind.
Awarding CfDs to unconsented projects naturally introduces a higher level of risk that the capacity fails to materialise. But government clearly considers this a risk worth taking, particularly if it is combined with speedier decisions from UK and Scottish Ministers on consenting outcomes.
Government has also decided to effectively split AR7 into two separate allocation rounds, one for offshore wind (fixed and floating), and one for everything else. This is designed to insulate the offshore wind pots from being delayed by any eligibility challenges, which could have delayed the whole process if they were still combined.
Government has made some other critical changes to bring forward as much new capacity as possible. For example, this is the first CfD round to allow repowered onshore wind projects to compete.
But there is a more fundamental change that might help unlock capacity across different technologies. DESNZ has updated its internal modelling used to inform decisions on the budget and cost impact of each CfD round. For AR7, government has reduced load factors for many technologies, and by quite a significant margin, with onshore wind down from 45% to 36%, and offshore wind down from 62% to 49%. A simplified example demonstrates the impact: a 500MW fixed offshore wind project bidding in at the published AR7 strike price would receive an annual revenue of £242.5m/yr but if using the previous net load factors the revenue would be £306.9m/yr (for ease of comparison, this calculation does not include changes that relate to indexation and different market reference prices). By reducing the load factors – a measure of the proportion of time that a renewable generator actually produces power – DESNZ can sign-off more capacity under the auction budget.
Of course, if net output is higher than modelled by those load factors, then the result could be higher cumulative policy costs, which will be passed on to consumer bills.
One of the criticisms of the CP2030 goal is that moving faster comes with a cost premium from accelerating new infrastructure build. Ultimately, we will only know whether government has been able to get this balance right when we see the results some months from now. One of the major changes at this round is the increase in CfD length for offshore wind, onshore wind and solar from 15 to 20 years. This should lead to a lower strike price than under a 15-year contract. This may well benefit consumers later this decade, but government has admitted that it could also result in higher cumulative costs for billpayers in the long term.
There has been an increase in the Administrative Strike Prices (ASPs) set by DESNZ for each technology. To some, this is a sign of higher risk premiums feeding through. DESNZ has explained that the higher ASPs are a direct result of their changes to modelled load factors, and does not indicate any “real-world” changes in generation costs. However, a high set of ASPs removes one of the limiting factors on participating in the auction, a lesson learned the hard way at AR5 when no offshore wind was successful.
It reflects the reality for project developers bidding into AR7 who are dealing with significant uncertainties. International supply chain pressures, an unpredictable global tariff and trade environment create macro challenges. While at the domestic level, headwinds include the live grid connections queue re-ordering, major uncertainty on Ofgem’s network charging reforms, and concerns about the fracturing of the political consensus on net zero, including Reform UK’s threat to strike down AR7 contracts. These headwinds are significant, which makes the outcome of AR7 – including the value for money for consumers – harder to predict. Ultimately, it shows that the CP2030 target rules over others, and government is having to think through ways to ensure this does not drive higher prices.
Zonal pricing may be dead, but there is a significant change to AR7 that means location matters. Without any public consultation, DESNZ has confirmed plans to have separate clearing prices for offshore wind projects, depending on whether or not they fall on the Scottish side of the GB transmission (TNUoS) charging zones. This move is a response to the ongoing challenge of rising TNUoS prices and increased volatility, particularly in Scotland. Having separate clearing prices should mean that Scottish offshore wind farms secure higher CfD prices, but without lifting the price of the whole pot.
This sets a precedent for using CfD parameters to embed locational investment signals. We already know that NESO’s Strategic Spatial Energy Plan (SSEP) and Ofgem’s review of network charging will now be the critical drivers behind the development of our clean power system. By using ‘Maxima’ for specific TNUoS charging zones, DESNZ has created a new tool – effectively a locational CfD – that could be used in conjunction with the SSEP and reforms to charging to create the locational signals needed for an efficient system.
Locational pricing and energy system planning are also shaping infrastructure investment strategies more broadly; including the critical role of grid access and planning reform. Read more here:
With our annual sequence of CfD allocation rounds, thinking in government will quickly turn to plans for AR8 and how that can also lock-in the clean power needed to make CP2030 possible. The autumn will be an important time for influencing government’s thinking, and aligning short-term solutions with the longer-term approach to the electricity market development that we are due to see in the upcoming Reformed National Pricing Delivery Plan.
This blog was written by Directors James Diggle and Jeremy Adams. They both provide support to Flint clients on energy policy and regulatory issues. James supports clean power projects seeking government support and financing. Jeremy brings a regulatory perspective, supporting clients’ interaction with Ofgem and regulatory reforms. Please get in touch if you would like to discuss further.