Within the first few days of being elected, the new UK government will face a critical decision which will determine the number of wind, solar and tidal energy projects that go ahead this year. They will finalise the budget for ‘Contracts for Difference Allocation Round 6’, this year’s clean power auction.
This blog explains how these CfD auctions work, how they benefit consumers, why the budget matters and what it measures, and what needs to happen next to maximise investment.
What is the CfD scheme and AR6?
The Contracts for Difference (CfD) scheme is the government’s main mechanism for unlocking investment in low-carbon electricity generation. It’s essentially an auction for power contracts between generators and government. Since its introduction in 2014, the CfD scheme has been hugely successful in supporting the expansion of homegrown clean energy, driving down costs to consumers whilst empowering technological innovation.
The 15-year contracts awarded via the auction are between a low carbon electricity generator and the government-owned Low Carbon Contracts Company (LCCC). Importantly for billpayers, each contract secures a fixed price for every MWh of electricity a renewable energy project generates.
Allocation Round 6 (AR6) refers to the sixth allocation round of the CfD scheme, which will take place this summer.
How do CfDs benefit consumers?
The electricity market is highly volatile and the market price can change dramatically, so a mechanism to ensure stability is desirable to both protect consumers and provide a stable revenue stream for investors. CfD contracts address this by being agreed at a certain ‘strike price’, which represents the price the project will receive for each MWh of electricity it generates during the contracted period.
An index of the market price based on government forecasts, known as the ‘reference price’, is tracked against the strike price for the duration of the contract. When the market price is higher than the strike price, the developer pays back the difference to the government. When it is lower, the government tops it up to ensure the developer receives the agreed strike price.
For example, during the energy price crisis in 2021, renewable energy was significantly cheaper than fossil fuels and saved consumers over £6.1 billion (equivalent to £221 per household) by displacing imported and volatile gas. Without energy generation from renewables, the UK would have had to import an additional £12.5bn of gas the following year in 2022.
By fixing prices, CfDs also reduce the risk investors are exposed to, thereby reducing the costs of financing projects by enabling capital to be borrowed on more favourable terms, making wind farms cheaper than they would be otherwise. Furthermore, recent analysis has found that a future UK electricity system powered by offshore wind is lower cost for billpayers than alternatives, including unabated gas.
How does the CfD auction and budget work?
CfD contracts are awarded through annual auctions or ‘Allocation Rounds’. To enter the auction, developers need to satisfy the eligibility requirements and confirm the size of their project, the year it will start delivering power, and a bid for how much they want to be paid for each MWh of electricity it produces – the strike price. The government caps the maximum a project can bid by setting the highest price it is willing to offer, known as the ‘Administrative Strike Price’ (ASP), which a developer cannot bid above.
Critically, the government outlines a ‘budget’ for the auction, as a means of controlling the total number of projects that can secure contracts within it. Confusingly for the public, the budget is not a reflection of how much the projects will actually cost over their lifetime, the impact of the projects on public spending, or the total impact on consumer bills.
The budget is rather an estimate of the annual cost of supporting renewable energy projects, based on their first four years of power generation, and therefore the annual level of financial support billpayers could contribute during this period, disregarding that figures will vary and the projects will actually pay back to consumers in times of high electricity prices.
For illustration, imagine there are eight ‘shovel-ready’ offshore wind farms that will pay back hundreds of millions of pounds to billpayers during periods of high wholesale prices over their 15-year contracts, but billpayers are forecast to cumulatively pay a total of £20 million to each project to account for the first years of generation when wholesale electricity prices are particularly low. The ‘budget’ requirement for each wind farm would therefore be £20m. Now imagine that the government has only allocated a budget of £80m for a given offshore wind CfD auction – this would mean that only four of the eight wind farms could secure a contract.
This, in essence, is the current situation. The government has set a provisional budget which is too low and consequently the auction is only set to unlock investment for a fraction of shovel-ready renewable energy projects that could be brought forward with a higher budget.
Why is AR6 so critical?
The most recent CfD auction (AR5) took place in September 2023 and was largely unsuccessful due to the ASP being set at a level that did not reflect rising costs for developers caused by inflation and increases to interest rates.
As a result, there were a lack of willing investors and the number of bids fell dramatically. Only 3.7 GW of new renewable energy was procured overall, compared to 10.8GW in 2021, with no new offshore wind farms at all.
This meant valuable time was lost, with a larger number of households continuing to rely on costly imported gas to generate their electricity. Future auctions now need to procure a greater amount of new renewable energy to ensure government targets remain on track to be met.
Luckily there is over 10GW of fixed offshore wind, alongside 658MW of floating offshore wind and around 2GW of onshore wind, all of which is either shovel-ready or eligible to enter the auction this year.
Besides providing lower-cost clean electricity, a successful AR6 that maximises investment in renewable energy projects can bring many wider benefits to the UK, including:
New jobs across the country - renewable energy projects create jobs across the UK in hubs such as Grimsby, the Solent, East Anglia, Aberdeenshire, the Humber and North Wales, while floating offshore wind opens up opportunities in areas across North-East England, the Celtic Sea, North Scotland and Irish waters. If the UK achieves its offshore wind targets through strong allocation rounds, it is estimated that offshore wind could employ an additional 70,000 jobs by 2030, with the onshore wind sector supporting over 27,000 jobs.
A boost to the economy - a strong pipeline of renewable energy projects through AR6 will trigger billions in private investment and support new investments in the UK's domestic manufacturing and supply chain. A strong project pipeline is critical to seizing the offshore wind industrial opportunity - trebling the UK’s offshore wind manufacturing base and adding a further £25bn to the UK economy between now and 2035.
Greater energy security - maximising investment in AR6 will reduce our reliance on international gas. The eligible offshore wind projects could provide electricity for 16.5 million homes and maximising procurement and investment could reduce the UK’s current gas imports by around a quarter if the projects come online from 2027.
Reduced costs for floating offshore wind - floating offshore wind is essential to achieving our net zero targets, as it allows us to reach higher wind speeds in deeper waters. Investing in these smaller projects provides an opportunity for the sector to innovate and learn how to reduce costs in subsequent, larger projects, ultimately to the benefit of billpayers. The UK has the opportunity to Invest comparatively small sums today, in order to secure significant savings in the coming years, whilst helping ensure that the country remains a leader in this space, which could lead to further export opportunities.
What needs to happen next?
Despite there being over 12GW of renewable energy projects able to enter the AR6 auction, with many projects carried over from 2023, the current budget set by the Secretary of State means that only a fraction of these projects will be able to receive investment.
The budget for AR6 therefore needs to be uplifted to maximise investment in these shovel-ready projects, ensuring confidence is restored and benefits are unlocked. It is currently £800m for the offshore wind auction, £105m for floating wind, and £120m for onshore wind and solar. To increase investment in shovel-ready offshore wind projects this year, unlocking capital investment and lowering average household bills, the government should raise this to £1.5bn. If it wants to unlock investment in all four floating wind projects, the budget should be raised to £464m, and we would also advise raising the onshore wind and solar budget by £200m to enable more shovel-ready projects to come forward.
A greater volume of contracts awarded means more investment in offshore wind, onshore wind and solar projects, resulting in lower bills for consumers and greater energy security, whilst ensuring supply chains strengthen and grow, creating high-quality and well-paid jobs that are distributed across the whole country.
There is now a crucial opportunity for the Secretary of State to revise and increase the budget between Friday 26 July and Thursday 1 August. The bidding window will then follow from Monday 5 to Friday 9 August, and the industry will be watching closely as the results of AR6 are announced on either Tuesday 3 or Wednesday 4 September.
By Nick Hibberd, Policy Analyst, Markets and Economics, RenewableUK