22 Apr 13 News England

Reducing cost of offshore wind in the UK

There are two strategies for reducing the cost of offshore wind in the UK.  Easy to state and, in fact, easy to implement.  They are:

1.    Short term:  introduce a transparent simply calculated support price for offshore wind
2.    Build lots of offshore wind;  watch the supply chain build up and see how scale and experience work as they have worked in every industry up to now to bring costs down

The reason why simple support prices work is that they remove risk from the price of electricity delivered from offshore wind (or anything else that requires large capital spend).  The key to cheapness is to get as much debt as possible into projects at the lowest interest rate.  Banks, pension funds, in fact each class of lender loves visibility of the stream of cash-flows coming from the project.  If the cash flow is not dependent on anything except the quantity of electricity delivered, then the bank can concentrate on what that quantity is.  They don’t have to worry about balancing costs, basis price risk, negative pricing, counterparty risk or anything that impinges on price.

In fact an unambiguous fixed price makes for plentiful Project Finance.  That is what IPPs bring to the generation game.  A project funded by Project Finance has recourse to the assets of the project, only, and the simpler the stream of cash flows, the more debt can be allocated to the project.  It has been pointed out elsewhere that Utilities do not have the balance sheets to build all the new plant needed in this transition to sustainability.  Policy makers need to ease the path for Project Finance.

We have seen how Germany, Denmark and Spain organised their support schemes around the so called REFIT,  The Renewable Energy Feed In Tarriff.
Easy for risk averse bankers to understand and calculate, the REFIT works like a charm.

In the second last blog post we showed how the proposed UK CFD could be made to behave exactly like a refit.  This involved the creation of a Green Auctioning mechanism.  Perhaps the strongest part of the green auctioning mechanism is that it subjects the Balancing Charges, much touted by the utilities, to a market test.

Under the Green Power Auction Market (GPAM), utilities would bid for power over the coming 6 month period.  They would do this at each six month interval for the duration of the Contract for Difference.  Their bid would be reduced by the amount they thought they had to pay for balancing.  Of course the clever utility would realise that this cost was near zero, and would succeed in achieving very nice fixed priced wind, on its portfolio for the coming time period.

The really clever utility would be lobbying the DECC to be able to buy wind, at a fixed price for 20 years.  This way they would change their risk of exposure to variable fossil fuel prices, and make more profits.