‘You cannot build an energy system if nobody makes a return in doing so.’
Ministers cheered last summer as wind farm developers competed to plant new turbines in UK waters, at ever cheaper rates.
Danish giant Orsted was among the energy giants who agreed to build new wind-farms that would generate state-backed revenues well below wholesale prices at the time.
“The more power we generate within our own borders, the better protected we will be from volatile gas prices that are pushing up bills,” Kwasi Kwarteng, then business secretary, said.
Less than a year later, however, and that optimism has all but evaporated, with developers warning that rising costs are making planned new projects unviable.
Orsted warned last week that its £8bn Hornsea Three development was no longer viable under the terms agreed with the Government and threatened to mothball the project without tax breaks to offset rising costs.
It comes as clean energy investors are being lured to the US by a $216bn (£178bn) package of tax breaks. The huge giveaway is putting pressure on Chancellor Jeremy Hunt to respond.
He now faces a balancing act as he tries to encourage investment in an industry critical for the Government’s push to net zero, while keeping a lid on state spending and household bills amid a cost of living crisis.
“I think there’s a bit of a game of jeopardy at the moment [with the Government] – who blinks first,” says Phil Grant, a partner specialising in energy at the consultancy Baringa.
Makers of wind turbines have been feeling the squeeze from rising costs in their supply chain for more than a year.
Henrik Anderson, chief executive of Vestas, the world’s largest turbine maker, warned in January 2022 of a “troubling and challenging” market, as lockdowns in China disrupted manufacturing, and the cost of steel, copper and other components rose.
Russia’s invasion of Ukraine in February 2022 added to the turmoil, with Vestas ending the year €1.7bn in the red and raising the average selling price of its turbines by more than one-third to €1.15m per megawatt (MW).
Jochen Eickholt, chief executive of rival Siemens Gamesa, warned in October that rising costs and supply chain disruption “could jeopardize the energy transition”.
Wind farm developers face higher costs for turbines as well as for the ships and labour required to install them. Slow timelines for planning permission and grid connections all add to the pressure given some prices are rising month-to-month.
Nonetheless, in June last year, wind-farm developers including Orsted, Vattenfall and Scottish Power competed to build new farms at record low revenues, in an auction for government subsidised contracts.
Under the Government’s “contracts for difference” (CfD) subsidy scheme, developers are guaranteed a fixed price of electricity for 15 years. If the wider market wholesale price turns out to be higher, they get the difference via a levy on consumer bills. If it is lower, they have to pay back the difference.
The scheme is key for offshore wind projects as it gives developers certainty over revenues, which helps them raise cash. It has helped the offshore wind industry grow from a standing start in the year 2000 to producing more than 11.5pc of the nation’s electricity in 2021.
In the CfD auction in June, developers agreed to build a massive 11GW of projects by 2027 at a guaranteed price of £37.35 per MWh. That was 70pc cheaper than contracts accepted by developers in 2012 and well below today’s wholesale rates of around £150 per MWh.
(The guaranteed price is in 2012 money, and is indexed to inflation, so would be about £49.96 per MWh if the projects were online today.)
However, industry leaders now fear that the price is too low, with cost increases outpacing inflation and higher interest rates also damaging investment cases.
Energy UK, the trade body, claims that overall costs for new low carbon developments have climbed by 20pc-30pc in recent months.
“There are immediate concerns whether AR4 [projects bid for in June 2022] will go ahead,” Energy UK, warned in a report this month.
“Losing the major projects would cause immediate and possibly irreparable damage to the pipeline of 135GW new capacity needed by 2035,” it added.
Rob Anderson, project director for Vattenfall’s two planned giant wind farms off the Norfolk coast, says the company is “ready to press the button” but rising costs make the decision “difficult”.
“This is a multi-billion pound deployment,” he added. “It’s going to be one of the largest infrastructure projects and one of the biggest decisions this company has made.”
Energy UK and fellow trade body RenewableUK have presented the Chancellor with a string of requests ahead of the Budget on March 15.
They range from tax breaks on investments to raising the cap on electricity prices in the next auction round for government-subsidised contracts.
“The US and the EU are in a race to offer incentives to clean energy investors, and the UK cannot take its leadership position for granted,” Ana Musat, executive director for RenewableUK, has said.
Despite the importance of the industry, the Chancellor is said to be sceptical. Concerns have been raised about “shroud-waving” by the industry.
“These generators bid into an auction in June. They knew the costs pretty well then,” says Mr Grant at Baringa.
“I think we have to be careful – to what extent they are worried about a genuine change in costs, versus exerting pressure on government at a time when government is quite vulnerable with regards to long-term energy security, the decarbonisation agenda, and the threat from the Inflation Reduction Act [America’s package of tax breaks] on capital flowing out of Europe?”
The Treasury says the Government has already taken “significant” action to support the sector, with about £6bn paid to renewable developers under the CfD scheme so far.
Its policy of indexing CfD rates to inflation is “more generous” than other countries, it added, and should lead to a “significant increase” in prices for developers in coming years.
However, rising interest rates have cut the expected profitability of future sales of stakes in projects once up and running.
Mr Grant says: “Therefore they are now having to look at their project economics and recover more in the upfront period.”
Industry sources say developers were also expecting to be able to make up for rising costs by delaying the start of their CfD contracts, meaning they could rake in surging wholesale prices. However, revenues from this strategy have been curbed by new windfall taxes, and developers have also been criticised by the Government for this tactic.
Energy UK argues the increase in interest rates since the “mini-Budget” in September has pushed up costs and dampened investors’ enthusiasm for the sector.
Pressure from the offshore wind industry comes at a critical time for UK energy policy, with the Government trying to ramp up clean energy capacity and keep bills down.
One City analyst warned: “There is a tension – you cannot build an energy system if nobody makes a return in doing so.”
A Treasury spokesman said: “We are taking significant action to encourage investment in renewable generation, including committing £30bn to support the domestic green industrial revolution.
“Our Contracts for Difference auctions have been hugely successful, contracting record capacity of almost 11GW of clean energy just last year.”
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