UK offshore wind still has room to grow, despite failed auction

UK offshore wind is still seen as an opportunity for asset owners investing in renewable infrastructure, despite the government's recent failed auction.

The UK government had auctioned new wind energy projects in September which had the potential to deliver up to five gigawatts worth of energy but failed to attract investment from offshore wind energy developers. 

But the auction is only a short-term setback, sources said.

A misreading of extra inflation-related costs and supply chain issues led the government to set the maximum "strike price" too low for developers.

The UK's Contracts for Difference scheme enables renewable project developers to compete in sealed-bid auctions to win 15-year contracts to sell electricity at a guaranteed inflation-adjusted “strike price”.

Prior to the failed auction, offshore wind had been held up as a flagship UK net zero policy success, with government price support unlocking low-cost capital, accelerating investment and encouraging rapid innovation. This led to an installed capacity boom and strike prices to fall to less than a third of the initial price set in 2015.

In November 2022, EY’s Renewable Energy Country Attractiveness Index ranked the UK first for offshore wind based on investment attractiveness.

Still room to grow

“We definitely still see room for UK off-shore wind to grow, and are actively looking for new opportunities via our renewables fund manager, Octopus,” said Katharina Lindmeier, senior responsible investment manager at Nest.

Nest, in a joint venture with GLIL, already holds a 12.5% stake in Hornsea One, one of the world’s largest off-shore wind farms.

Meeting the UK’s target of 50 gigawatts of offshore wind energy by 2030 requires an increase of 265% relative to current output, according to technology company ABB.

This would require the installation of a further 24 wind farms with an average capacity of 1.5GW over the next seven years. If implemented successfully, the share of offshore wind in the UK’s energy mix would jump from 18% to 62%.

Inflation and supply chain costs: a short term blip?

Lindmeier isn’t particularly concerned about a single failed auction, though she does hope the error won’t repeat itself.

She also expects inflation and supply chain pressures to ease in the near future. This would reduce construction costs and encourage developers to take on new projects. “The Russia-Ukraine war and high inflation environment came as shock to many businesses, not just those involved in renewable infrastructure,” she said. “However, we don’t see these extra inflation-related costs and supply chain issues as factors that dampen the long-term prospects of UK off-shore wind.”

Chris Lewis, EY’s global infrastructure leader, noted that some of the developers that secured contracts in the fourth auction (the failed auction was the fifth) have since pulled out of their commitments, citing extra inflation-related costs. The bidding for the fourth auction took place in a low inflationary environment and didn’t factor in the extra costs.

“The big question is how the government goes about attracting private infrastructure investment,” said Lewis. “There is a lot of money waiting for the right opportunities but obviously the risk-return profile has to be right. This wasn’t the case in the most recent auction.”

While consumer inflation ran at 10% last year, input inflation – the real costs faced by these projects – was closer to 25%, he added.

Inflation, supply chain issues, delayed grid connection timeline

It will take at least two years before these costs resume a downward trend, according to a recent EY survey. The survey also showed that the current cost levels represent a significant challenge for investors looking to achieve the final investment decision (FID) in the next two years.

In addition to inflation and supply chain challenges, other significant risks include delayed grid connection timelines, and issues with the Development Consent Order, according to the survey. None of these challenges have easy solutions. 

Lewis said the auction failure resulted from the mistaken belief that renewables will “keep on getting cheaper and cheaper”. A higher strike price might have yielded a different result.

“When it comes to a country’s energy supply, governments face the trilemma of affordability, security of supply, and green goals,” Lewis said. “This last auction was weighted too much towards affordability.”

Like Lindmeier, Lewis said he expected off-shore wind to continue to grow in the long term. The UK is still the fourth most attractive country in the world for renewables investors, behind China, Germany, and the US, according to EY’s renewable energy country attractiveness index.

The UK’s flagship “Contracts for Difference” scheme accounts for a large part of the country’s success in attracting renewable investment. "UK offshore wind contracts will be attractive so long as the price reflects recent inflation and the grid connections are resolved", Lewis said.

Reaching netzero requires more than doubling the amount of investment in energy systems, according to a recent FIDIC/EY report.

“If you're building a gas fired asset now, you're pretty unlikely to be operating it much beyond 2050,” said Lewis. “It makes sense to build renewables and the UK has a long track record of being a good place to invest.”

Why is offshore wind a safe bet?

Wind and solar energy are still seen as the safest renewable bets for institutional investors, mostly because they are proven technologies with predictable investment outcomes.

Opportunities in other proven technologies, such as hydropower, tend to be limited, according to Nest. Even nuclear still has some “technological” uncertainties. For example, the new Hinkley Point power station is currently testing a new reactor. This uncertainty creates an “unacceptable” level of risk for pension funds.

“There are currently around eighty small modular reactor technologies under development, but only a few are proven technologies and actually operating,” said Lewis.

Small modular reactors (SMRs) are advanced nuclear reactors that have a power capacity of up to 300 MW(e) per unit, which is about one-third of the generating capacity of traditional nuclear power reactors, according to the International Atomic Energy Agency.

When investors look at renewable infrastructure opportunities, they often make the classic “TECOP” assessment – analysis of “technical, economic, commercial, operational, and political” risks.

Solar and wind still top the TECOP assessments for renewables, according to Lewis.

Constant improvement

Constant technological improvements may also contribute to the continued growth of off-shore wind.

“The wind turbines of today are very different to those of 15 years ago,” Lindmeier said. “The trend of rapidly advancing technologies looks set to continue. The turbines keep on getting larger and more efficient.”

Floating wind-farms – which don’t require shallow waters for construction – will vastly increase the amount of potential sea space available to off-shore wind farms.

Nest has already invested in a company looking to develop floating wind farm opportunities in the Irish sea.

Even without the new “floating” technology, UK waters still has plenty of room for ordinary wind-farms, according to Nest. The government’s 50 gigawatts target is based on existing construction potential and does not include the extra potential that floating wind farms would create.