How will UK lease prices affect winners, the unsuccessful and the global market?

The unexpected pricing coming from the latest UK offshore leasing round signals some challenges for both the lease winners and for those that missed out. But there are also wider impacts that will be felt across the domestic and global marketplaces.

Already last week, the Crown Estate Scotland announced that it will delay the ScotWind Leasing process, in light of the UK results and it’s unlikely to be the only player reviewing its position.

What implications does the UK leasing results have for everyone involved?

Lease winners

8GW is a sizable auction, however, allowing a 1.5GW maximum capacity per lease has led to only a few companies winning leases. The demanding pre-qualification conditions with respect to the financial strength of bidders acted as a deterrent for small/medium sized developers and IPPs – barriers to entry were high.

Having said that, these steep (the highest observed thus far in the sector) upfront development costs will have a non-negligible effect on the eventual profitability of the required investments. CfD auctions in the UK have been very competitive with strike prices decreasing in each round.

How can the lease winners ensure an adequate risk/return equation on their investment going forward?

Lease owners will need to scrutinise every element of their project to optimize revenue opportunities and to continue the ongoing focus on cost reduction.

• Next gen tech - Improvements on existing technology will not be enough, so lease owners will be looking at the next generation of technology to lower the LCOEs. Prediction of future technology for a project expected to be built in 8-10 years, is critical. How will turbines sizes ranging between 12 to 15 MWs evolve in this time horizon? How can efficiencies of scale in the supply chain and digitalisation reduce cost structures?
  
  
• Stretching useful asset life – While it is becoming usual for investors to consider 35 years as standard life for offshore assets, corresponding certification process need to evolve to keep up. Assumptions related to asset performance over such a long period will have to be matched by corresponding investments over the lifecycle.
  
  With a guaranteed 60-year lease after a maximum 10-year agreement for lease, repowering could be an interesting option to consider in which case permitting constraints will need to be anticipated and mitigated.
  
  
• Sharing the burden by farming out – Bringing in new partners to share costs of development is an alternative that will be considered. The timing of this will depend on premiums acceptable to new investors, which in turn, will depend on the advancement of development activity.
  
  
• Revenue considerations – In tandem with increased useful asset life, lease owner will have to carefully consider the revenue options that could be available to them over this time frame i.e. contracted versus merchant revenues. This will have an impact on bankability of the business case and leverage that the projects can achieve. The current evolution of the corporate PPA market is encouraging in this respect.

Those who missed out

The well-known players that missed out on leases this time are likely turn their attention to other markets e.g. in Eastern/Central Europe, Taiwan, USA, Japan and Korea. Falling equity yields in traditional offshore wind markets have already started this trend and it will witness acceleration. It will also enhance developer / investor interest in floating wind which is already being noticed.

Auction schemes across the globe

Markets that are a few steps behind the UK in terms of maturity will get a glimpse into what their future might look like, and markets like the USA which already proved over heated may have more fuel on the fire in its next round of State led lease auction.

Markets that have already had their first successful rounds may be looking to change their bidding structure to realise more revenue from leasing than what they achieved previously. While this is a tempting path for regulators and sovereigns to take, adjustments would need to be weighed against developer appetite and risk frameworks to ensure that these projects eventually move forward in a profitable manner.

After this curveball, what does the CfD of the future look like?

With a stable and low risk market like the UK, it is not surprising that competition for limited available capacity has driven bidders to react in this way. But the sustainability of this trend will depend on regulatory stability.

Will the current CfD auction structure be maintained over time? How will the corporate PPA market evolve – we seem to be getting there in terms of volume, but can time horizons required be matched? How can the commodity markets step up to the plate to provide price/volume hedging mechanisms? Will the current liquidity in the lending market continue and be able to absorb the future requirements? Will interest rate regimes continue to be benevolent as they are now?

Whatever the future may hold, we live in very interesting times and success will depend on innovation, pragmatic development and forward-looking insights backed by a solid rationale.