HC 517 The Economics of Wind Power

Memorandum submitted The Crown Estate (WIND 70)

1. The Crown Estate is pleased to submit evidence to this inquiry on the economics of wind power – in our role as programme managers of UK offshore wind. A representative from The Crown Estate would be available to provide oral evidence to the committee on July 10th.

Summary:

· Offshore wind has the potential to be a cost-competitive form of low carbon energy and make a significant contribution towards the achievement of the 2020 renewables targets.

· Offshore wind has the potential to generate significant economic benefits in the form of UK based green jobs.

· Official evidence suggests that the impact of renewables subsidies on energy bills is small.

· Investment in this sector relies on certainty; which can be undermined if government policy is arrived at as a result of political pressure rather than robust evidence.

· There are issues with the established evidence base for the costs of offshore wind, which need to be addressed going forward - particularly if, as suggested in the draft Energy Bill, a similar approach is to be used in the setting of CfD strike prices.

The need for evidence-based policymaking

2. We agree with the sentiment of the call for evidence – that government energy policy should be based on sound evidence, rather than political pressure.

3. The Renewables Obligation Banding consultation (October 2011) outlined a series of proposals which would see the banding for both onshore wind and offshore wind reduce slightly over the period 2013-2017. The proposals were generally understood and accepted by the wind industry, and provide a sufficient level of support and rate of return in order to make most projects viable.

4. Recent rumours of a reduction in the ROC banding for onshore wind appears to have damaged confidence in the market, and led to a hiatus in investment – both by developers and also the supply chain, and across both the onshore wind and offshore wind markets (due to the close integration of the two). There are several offshore wind turbine manufacturers at advanced stages of considering investment into UK-based manufacturing sites. In order to finalise their investments (which could typically be around £200m for a turbine plant), they require reasonable certainty and visibility of their future market for a period of say 10-15 years. The uncertainty created by the rumoured changes to ROC bandings appears to have damaged their confidence in this market and led to a hiatus in investment.

5. We support the use of evidence of costs of technologies to determine ROC Bandings and future CfD strike prices – however this evidence needs to be robust and credible in order to arrive at the correct decisions. This paper provides a critique of the existing evidence base on the cost of offshore wind energy (see Appendix for a summary of key recent studies), including the Arup (2011) report which formed the evidence base for the RO Banding review in October 2011.

Cost of offshore wind power (including transmission connections)

6. Over the last few years there has been a considerable amount of research into the cost of low carbon technologies including wind. In our opinion, some of this is useful, but there is also a fair degree of misinformation surrounding the costs of offshore wind energy – particularly the likely cost of future (Round 3) projects.

7. It is often difficult to establish the true cost of energy, since there is limited transparency in contract prices; and energy yields, reliability, and operations and maintenance costs can only be known ex-post once a plant has been up and running for a number of years. It is also difficult to compare costs across technologies, as there are differences in the costs they face and the profile of expenditure and returns. The metric often used by policymakers to compare across technologies is the ‘Levelised Cost of Energy’ (LCOE) which provides an estimate of the lifetime cost per unit of energy. We support the use of this for policymaking, although it should be noted that developers take a slightly different approach in assessing project viability – assessing lifetime costs and revenues, and comparing the corresponding return against their ‘hurdle rate’. Therefore we recommend that this inquiry considers a range of metrics for the cost of energy (i.e. not just LCOE).

8. The Crown Estate (2012) recently undertook a significant piece of research to identify cost reduction pathways for offshore wind – providing evidence to the Cost Reduction Taskforce. This work was based on consultation, data, and validation from just over 100 companies across the entire offshore wind value chain. As part of this work, we estimated a baseline LCOE at around £140-144/MWh for the types of offshore wind projects currently being deployed (i.e. relatively close to shore and with a water depth of up to 30-40m). This figure includes all costs faced by the developer/generator, including transmission charges associated with the offshore connection and wider transmission costs, plus the seabed rent charged by The Crown Estate. It does not include system balancing charges as these are not faced by the generator directly – rather they are ‘smeared’ across all generators.

9. The report provides four scenarios or pathways for the future cost of offshore wind energy. It demonstrates that provided there is a market of 17-18GW+ operating capacity in the UK by 2020, [1] and provided there is commitment from government and industry, the cost of offshore wind could reduce to £100/MWh or below by 2020 [2] . This would make offshore wind cost-competitive with other large scale forms of low carbon energy such as nuclear [3] and CCS. [4]

10. One of the interesting findings from this work is that there is relatively little variation in LCOE between different site types (i.e. defined by water depth and distance to shore). Previous studies on cost including the Arup (2011) report, have concluded that the cost of Round 3 projects, in deeper water and further from shore, would be much higher than current projects. Our work shows that whilst the move to more challenging sites may increase capital and operating costs, this is balanced by higher wind speeds which result in a higher ‘capacity factor’. This means that in LCOE terms, Round 3 sites are broadly equivalent in cost to current projects.

11. Related to this, our research demonstrates that one of the main sources of future improvements in LCOE will be due to improvements in capacity factor. The capacity factor for all existing operating offshore wind plant currently stands at around 31% [5] . We estimate that projects being deployed today could achieve a capacity factor of around 40-42%, increasing to up to 50% by 2020; due to the progressive move to windier sites, combined with improvements in technology (including larger turbines) and reliability. In contrast to this, previous studies have assumed lower capacity factors, for example the Arup (2011) report assumes a flat 38% load factor for all sites, both today and into the future. This is one of the principal reasons why, in our view, previous studies have over-estimated the LCOE for offshore wind (especially for Round 3 sites).

12. Whilst we cannot comment in detail on system balancing costs and backup capacity, it is interesting to note that a 50% capacity factor for future offshore wind would be higher than that of existing coal stations (46%), challenging the notion that offshore wind is significantly less ‘reliable’ than other forms of energy. This is one area where offshore wind differs markedly to onshore wind – which currently has a much lower capacity factor of 26%. [6]

13. Another key consideration in calculating the cost of energy is the cost of capital. Our analysis shows that up front capital expenditure accounts for around 70% of the LCOE of an offshore wind farm, and a one percentage point change in the cost of capital results in around a 6% change in LCOE. We estimate the cost of capital at 9.2% (pre-tax real basis) - a result which has been validated by PWC through both a bottom up assessment of risk and through benchmarking with industry. By comparison, previous studies have used much a much higher cost of capital – for example the Arup (2011) study estimates the cost of capital at 11.6% for Round 2 sites (or 13.2% for Round 3 sites) – which all else being equal results in LCOE values around 10-15% higher than The Crown Estate analysis.

14. Overall our conclusions on the cost of offshore wind are somewhat different to previous studies, and this requires further consideration in order to achieve a robust and credible evidence-based for policymaking; particularly if as suggested in the draft Energy Bill, the setting of CfD strike prices will follow a similar methodology to the RO.

Support provided to offshore wind versus other renewables, and the impact on energy bills

15. The support currently available to offshore wind (i.e. 2 ROCs per MWh) is commensurate with the costs involved and the returns required by investors. Assuming a modest cost reduction to 2017, as outlined in our recent report, the ROC bandings proposed in the October 2011 consultation are sufficient to maintain the viability of most projects. On this basis, offshore wind is towards the top end in terms of the support received by other renewables – however as demonstrated in the RO Banding Impact Assessment, this is what is required in order to maintain progress towards the 2020 renewables targets. Our recent research shows that beyond 2017 it may be possible to reduce the level of support as the LCOE of offshore wind reduces.

16. The public debate on the impact of renewables on energy bills is complex and multi-faceted. DECC (2011) estimates that public policies (including subsidies to renewables) comprised 7% of consumer bills in 2011. The Committee on Climate Change (2011) predicts that the average household electricity bill could increase by 33% by 2020; with around two-thirds of this increase due to increasing fossil fuel prices, and the remaining third due to subsidies to all renewables. Thus whilst support to renewables clearly contributes to energy bills and energy bill increases, it is not the main cause.

17. These official estimates of impact have done little to quell a tide of criticism by the media and several think tanks on the high costs of renewables subsidies. However, as highlighted by Gross (2011), the public discourse around policies and consumer bill impacts is often poorly substantiated and misleading.

Wider economic benefits of offshore wind

18. In addition to considering wind power economics at a project level, it is important to consider some of the wider economic and societal benefits. There have been many attempts to quantify the socio-economic benefits of offshore wind. Renewable UK (2011) estimates that by 2022, the UK offshore wind industry could generate £60 billion of Gross Value Added, supporting up to 45,000 jobs. More recently, CEBR (2012) identified that by 2020 the UK offshore wind sector could support 0.4% of UK GDP and employ 97,000 people.

19. Clearly, the achievement of these benefits depends on the level of UK content in offshore wind projects. In order to maximise this, UK businesses need to increase their capabilities to compete in this sector, and the UK must attract inward investment for production to be established in the UK. Relating this back to earlier comments, it is clear that the extent of inward investment (and therefore the level of UK content) is dependent on the confidence in the UK market; which in turn requires predictable and evidence-based policy-making.

Appendix: Comparison of Offshore Wind cost estimates from recent studies

Estimates of current costs (for projects reaching Final Investment Decision at or around 2010)

Study

Date of costings

LCOE (£/MWh)

CAPEX (£m/MW)

OPEX (£000s/MW p.a.)

Net Capacity Factor

Weighted Average Cost of Capital (pre-tax, real, %)

The Crown Estate (2012)

FID 2011

140-144

2.6 - 2.9

(ex transmission)

164-167

(inc transmission)

40-42%

9.2%

Arup (2011)

FID 2010 –

Round 1/2/STW project

169

(range 149-191)

2.7

(ex transmission, range 2.3 - 3.2)

166

(inc transmission, range 117 – 184)

38%

11.6%

Ernst & Young (2009)

FID Jan 2009

144

3.2

(inc transmission)

79

(ex transmission)

38%

12%

Committee on Climate Change (2011) / Mott MacDonald (2011)

FID 2010

169

(range 140-180)

3.1

(inc transmission, range 2.4 - 3.4)

110

(ex transmission, range 97-121)

37%

(range 34%-41%)

12%

(range 10% - 14%)

Estimates of future costs (for projects reaching Final Investment Decision in 2020 or beyond)

Study

Date of costings

LCOE (£/MWh)

CAPEX (£m/MW)

OPEX (£000s/MW p.a.)

Net Capacity Factor

Weighted Average Cost of Capital (pre-tax, real, %)

The Crown Estate (2012)

FID 2020 –

Round 1/2/STW project

94 [1]

(range 81 -113)

2.1

(ex transmission, range 1.9 – 2.6)

142

(inc transmission, range 128-151)

46%

(range 42% - 51%)

7.9%

(range 7.8 – 8.5%)

FID 2020 –

Round 3 project

97

(range 93 -124)

2.2

(ex transmission, range 2.0 – 2.6)

196

(inc transmission, range 131-213)

50%

(range 46% - 52%)

8.4%

(range 8.3 – 8.6%)

Arup (2011)

FID 2020 –

Round 1/2/STW project

107

(range 95 -121)

2.1

(ex transmission, range 1.8 – 2.4)

148

(inc transmission, range 104 – 175)

38%

9.6%

FID 2020 –

Round 3 project

145

(range 127-170)

2.2

(ex transmission, range 1.8 - 2.9)

132

(inc transmission, range 81 – 185)

38%

9.6%

UKERC (2010)

2025

116

(range 95 -185)

2.8

(inc transmission, range 2.4 – 3.8)

87

(ex transmission, range 59 - 99)

43%

(range 35%-45%)

12%

Committee on Climate Change (2011) / Mott MacDonald (2011)

2020

103-114

2.6

(inc transmission, range 2.0 - 3.0)

106

(ex transmission, range 93-117)

39%

(range 35%-43%)

10.5%

(range 7.3%-14%)

Notes: Transmission can be treated either as CAPEX or OPEX in an LCOE model. The baseline costing from The Crown Estate (2012) report is a CAPEX of £550,000/MW, which equates to an OPEX charge of £63,000 per annum over the lifetime of the asset. STW = Scottish Territorial Waters.

Bibliography

Arup (2011) Review of the generation costs and deployment potential of renewable electricity technologies in the UK

CEBR (2012) The macroeconomic benefits of investment in offshore wind

Committee on Climate Change (2011) Renewable Energy Review

DECC (Oct 2011) Estimated Impacts of energy and climate change policies on energy prices and bills

Ernst & Young (2009) Cost of and financial support for offshore wind

Gross, R (2012) Nonsense on stilts? Investigating the discourse around policies and consumer bills

Mott MacDonald (2011) Costs of low carbon generation technologies

Renewable UK (2011) Offshore Wind: Forecasts of future costs and benefits

The Crown Estate (2012) Offshore Wind Cost Reduction Pathways Study. Available from: http://www.thecrownestate.co.uk/energy/offshore-wind-energy/working-with-us/strategic-workstreams/cost-reduction-study/

UKERC (2010) Great Expectations: The cost of offshore wind in UK waters

June 2012

Footnotes:


[1] Also assumes a similar size of market in the rest of Europe

[2] This represents the cost of the ‘average’ project reaching Final Investment Decision in 2020.

[3] Recent cost estimates of £14bn for the Hinkley C nuclear project equate to a LCOE of around £166/ MWh (Source: Reuters, 8 th May 2012 – quote from Peter Atherton of Citibank).

[4] Cost of CCS in 2020 is estimated at £60-150/ MWh (Source: Committee on Climate Change, 2011, ‘Renewable Energy Review’).

[5] DECC (2011) Digest of UK Energy Statistics. Average load factor over the period 2006-2010.

[6] Capacity factors for all technologies from UK Digest of Energy Statistics (2011). Average for the period 2006-2010.

[1] Central case figures relate to Scenario 3 – Supply Chain Efficiency.

Prepared 10th July 2012