Moray (East) Wind Farm has come under scrutiny from a new report for the significant drop in their Contract for Difference (CfD) strike price from the first to second phase of the CfD auctions.
The report, entitled Offshore Wind Strike Prices: Behind the Headlines, has been put together by economics professor Gordon Hughes, a former advisor to World Bank, Dr Capell Aris, a fellow of the IET, and Dr John Constable of the Global Warming Policy Forum.
The document claims that ‘it has been widely assumed that the underlying costs of offshore wind are falling and that the CfD prices indicate a sudden paradigm for the technology’.
Yet, the report points to statistical analysis of the data, covering 86 wind farms, which suggests that the capital cost of offshore wind (£/MWh installed) is not in actual fact falling, but actually rising as a consequence of companies moving into deeper and deeper waters.
The report challenges some difficult assumed realities concerning the viability and cost of offshore wind and believes the industry has also taken the media along for the ride.
One major indictment is that the industry doesn’t mean what it says when it comes to the second round of bidding for contracts and that there are few penalties for such duplicity.
On the issue of lower than expected strike rates for the second round, the report claims that ‘because the contract is easily broken once the wind farm cannot be built, they regard the price as a minimum and not a ceiling…the low CfD prices are commercial speculation, not the dawn of a new age for offshore wind and renewables.’
For example, Moray East Wind Farm in the first round of the CfD auction process tabled a first round price based above or expected a future market level of £140/MWh, yet recently put in a second round bid of £57.50/MWh.
While these auctions are designed and intended to drive down price to get a better deal for the consumer, this new report is claiming that these estimations are much too low, and potentially critical for future development.
The report’s concern is that the offshore wind industry is making unrealistic assumptions around the overall costs of development in the future. That though costs may be being reduced in some areas, such as supply chain and technology, these will be offset by the growing costs of moving into deeper waters.
One author of the report and professor of economics at the University of Edinburgh, Gordon Hughes, looks at this concern over offshore wind contracts as a different variant of a traditional oil well development deal.
He said: “Under the right circumstances, drilling an oil well can lead you to finding a gusher and finding a huge amount of oil and making a lot of money, or it may turn out to be dry and you lose the money that you put into the geological work and the drilling and so forth.
“Building a wind farm is something of the same nature, in that you were engaged in a gamble where you put up a certain amount of money upfront, but there is always the option of pulling out if looks like it might not work out.”
While Professor Hughes doesn’t believe that developers are being wilfully deceitful, he does believe they are under a strong misapprehension that they can provide wind energy at the second round stake price by which they won the contract on.
Yet, he believes that there is a situation within the offshore wind industry where companies are willing to make bids where there is only a mild to fair chance that they can deliver, effectively kicking the can down the road and hoping market forces will alter in their favour down the line.
Prof Hughes said: “In the oil business and actually this is part of the economics of auctions generally, there is a phenomenon known as ‘the winner’s curse’, it’s a very well-known phenomenon and actually it’s a trap that bidders time after time fall into. The winner’s curse is essentially: you win only because you got it wrong. In other words, only the most optimistic and most likely to be wrong bidders bid a price which will win the bid, but is almost certainly too low [to deliver].
“There are just lots of examples around where businesses make mistakes, and in this case the cost of a mistake is low. In other words, they have the option to pull out. In many ways, they are not committed to spending the £3billion, £4billion that would be necessary at current prices to build Moray East.”
The concern from those looking at the current CfD auction process is that, in the event of a default, and unlike the situations with Holyrood and the Edinburgh tram system, the cost doesn’t then fall on the taxpayer or the closest last bid in the CfD process to take over the development, it falls apart entirely. If Moray East Wind Farm can’t be delivered for the proposed price of £57.50/MWh the UK loses out on a huge amount of energy simply through a competition induced miscalculation.
Moray East Wind Farm is certain that they can provide the development at the price quoted in the second round of the CfD auction. While they are aware of what the industry calls ‘kamikaze bids’, they see themselves as an industry leader who has put so much time, effort and money into this particular development that it would be a travesty to lose it all on what would essentially be a delayed poker bluff.
A Moray East spokesperson refuted the allegation that they can’t deliver, and that they would never table a bid that might tarnish their reputation, they said: “It goes beyond that, it goes beyond reputation. To be eligible to bid in such a process it costs money, it costs a lot of money. We’ve had a highly skilled staff in Edinburgh for eight years, not just to the stage of having a project with consent but in parallel with that having a project that has gone through the consenting process and gone through the engineering process and gone through a contracting process.”
“Why on earth would you spend £100million or so getting a project ready and eligible to participate in a CfD auction and then lose the whole thing because you put in a bid that – although you won it – would incur an extra years staffing costs to keep the project on but you couldn’t actually build it? There are market economics that work to mitigate against that circumstance.”
While strongly against any suggestion that Moray East can’t deliver on its proposed second round strike price, the spokesperson for the North Sea wind project would concede that the Contract for Difference (CfD) process was far from the finished product. While they believe their bid to be achievable, they’re aware that it’s possible for developers to knowingly put in lower bids to win contracts knowing that they will be removed in the future.
Moray East’s spokesperson said: “You wouldn’t find a project like Moray East arguing against an improvement to the auction process that made it unattractive to bid in a way in that allowed a win but couldn’t construct. We would be comfortable for the government to take action to prevent, or to make it unattractive for a company to make that type of bid.”
Professor Hughes believes he has a better idea. One that would make absolutely sure every offshore wind farm bid is genuinely achievable. He suggests the introduction of a performance bond, something which he claims are usually standard practice in these types of deals. He also believes that by not having them in place it evidences a form of government approval in a knowingly flawed process.
He said: “Basically, you have to put up along with your auction bid a commitment that if you do not deliver on time, in accordance with the specification of your bid, you will lose some percentage of the overall value of the bid. You will lose that money, just ‘bang’, that’s it gone.
“That very seriously changes the nature of the bidding process. It’s simply amazing that the government has chosen to go ahead with these Contracts for Difference auctions without posting a requirement for a performance bond. They’re just colluding, in my view, in overly optimistic assumptions. What the government has done is to allow these bids and hope that something will turn up.”