Revolutions at sea – reflecting on the cost of offshore wind

The costs of offshore wind are falling dramatically. Several European countries have now agreed to buy power from offshore wind farms at costs which challenge the notion that renewable energy must be heavily subsidised to survive.

The UK government has recently awarded contracts to offshore wind projects scheduled for the early 2020s, at prices 50-60% lower than those it handed to offshore wind projects in 2014.  Germany and the Netherlands have recently announced contracts, also for expected delivery in the early 2020s, in which offshore wind developers have agreed to receive the market price only – zero subsidy contracts.

What has caused these rapid cost reductions? Can we expect the costs of offshore wind contracts to remain at these relatively low levels, or even to reduce further?

The cost reductions are likely to have had a few contributing factors, several of which can be seen optimistically as factors that will continue to keep costs low in the future.

One such factor is an innovation relating to policy design. The payment level received by offshore wind projects is now increasingly decided not by governments, but by requesting companies to bid in for the contract, declaring the price at which they would be prepared to deliver it. Such auction-based systems allow governments to choose the lowest cost of the now revealed bids. It seems plausible that the move towards auction-based allocation systems may have helped to drive down prices by introducing price competition into the bidding process.

Technological improvement is an important factor for enabling such cost reductions. There has been a clear trend towards larger and more efficient turbines which can deliver greater amounts of energy, increasing return on investment, thereby lowering costs. The trend is set to continue, with one major company expecting the turbines they will use in 2024 to be double the current size.

However, other factors that could explain the recent low bids may give a less clear grounds for optimism that the low prices are here to stay.

It is possible that companies may currently be bidding low for strategic reasons. For some companies, a lower return may be considered worthwhile, at the present time, for the benefit of maintaining their project supply chains. If subsidies in some previous rounds were overly generous, as some have suggested, it might be that this is currently enabling some flexibility on the balance sheet for low bids. If this is part of the explanation, such strategic bidding could not be maintained in the long run.

Auction design can also incentivise companies to put in bids lower than they would ideally accept, if they believe that another project will bid in higher and set the price received by all selected bids. However, if such a strategy backfires then a company could win a contract but at a price at which it is impossible to deliver the project – sometimes called “the winner’s curse”.

Another important factor likely to be lowering costs at the present time is the relatively low cost of financing. Investors have increased familiarity with offshore wind, and the long term contracts being issued by governments help to manage uncertainty, enabling lenders to lend at lower rates of interest. However, there are also important external conditions – interest rates in general are exceptionally low at the moment. As interest rates are likely to rise again in the future, it is possible that this could add to the cost of future projects.

Costs of projects are also strongly affected by site conditions, such as distance from shore and depth of water. There is a limited number of sites close to shore and in shallow water, and if future sites are in deeper water and further from shore this could drive up costs.

It is also important to recall that not all costs associated with offshore wind farms are necessarily accounted for in the costs paid for by project developers, and thus covered by the subsidies. Important additional costs are the costs of connections to power grids, and of balancing the system, for example in the event of too much power being injected on to the grid at the wrong time and wrong place. Because wind turbines have variable output dependent on wind conditions, they can exert significant costs on the system in this way. In some countries generators must pay for, or at least make a contribution towards these kinds of costs. In other countries, generators are not required to cover their own balancing and transmission costs, as these are met by the network operator. This is an important contributing factor towards the difference in costs between offshore wind projects in different European countries. Clearly, systems that do not target transmission and balancing costs at generators to some extent create favourable conditions for offshore wind, and they certainly make achieving zero-subsidy auctions more likely. However, if not paid by generators, transmission and balancing costs still have to be covered by system operators and are ultimately paid for by consumers. Thus, there is a strong argument that to herald a ‘zero-subsidy’ auction within a system that does not direct transmission and balancing costs at generators is misleading – especially if offshore wind exerts greater than average transmission and balancing costs – as the socialisation of transmission and balancing costs is a clear subsidy. Giving generators some kind of signal as to the costs their output imposes on the network is an important part of developing a well-balanced and efficient system. While shielding offshore wind generators from these costs may have attractions in the short term, it could lead to greater costs in the longer term, if it means the system develops in a way that is harder and more expensive to balance.

Of course, the news of extremely low prices for offshore wind contracts is to be welcomed. However, rather than becoming too focussed on zero-subsidy auctions as ends in themselves, we should continue to pay attention to making policies that look robust across all market conditions: long-term policy stability; careful attention to auction design; allocating transmission and balancing costs to support rational network development and incentivise innovations in storage and flexibility; and supporting and coordinating innovation chains.

INNOPATHS takes part in European Commission’s High Level Workshop

The Council has invited the Commission to come up with a proposal for a strategy for a long term EU GHG emissions reduction, in accordance with the Paris Agreement. The intention of the Commission is to present a proposal before the COP24 to be held in Katowice in December.

On June 28th, the European Commission organized a High Level workshop in Brussels on the topic “R&I contribution to the strategy for long term EU greenhouse gas emissions.” The workshop aimed at identifying the lessons or conclusions which can be drawn from some key EU-funded R&I projects and activities. The objective was therefore to identify such lessons or conclusions and discuss them with members of DG Research, the EPSC, DG CLIMA, DG ENER, and the other Commission Services involved.

Elena Verdolini was asked to focus on the topic of decarbonization innovation, and two provide insights with respect to two key questions: what can we expect from decarbonization innovation? How can we ensure that it will come about? Three main messages emerged from the presentation. First, public policies should be designed to provide incentives for the development of a portfolio of low-carbon technologies rather than picking winners. Second, there is the need to manage the transitional costs associated with the process of decarbonization, especially for what concerns competitiveness and trade dynamics. Third, successful policy mixes are those which are tailored to the capability of a each country. For more details, please have a look at the presentation below, or feel free to send an email to: elena.verdolini@cmcc.it

180628_EV_Decarbonization_Innovation download