Energy Transition

Why we can’t rebuild trust in the energy transition without reforming the auction process

The energy transition is ready to be supercharged

The energy transition is ready to be supercharged Image: Photo by Abby Anaday on Unsplash

Henrik Andersen
Chief Executive Officer of Vestas Wind Systems A/S and Chair, Electricity Industry Action Group
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Energy Transition

This article is part of: World Economic Forum Annual Meeting
  • Across the world, offshore wind is slow to ramp up due to cancelled PPAs and avoidable pressure on the wind energy supply chain.
  • Fixated on driving down energy costs, many governments have spurred unsustainable industry mechanics, leading to a race to the bottom in bidding wars, an arms race for turbine platforms and speculative bidding.
  • Wind energy auctions should be reformed to focus on what wind energy can deliver – from lower power prices to more resilient energy systems - and not just what it costs.

In an attempt to galvanise a teetering COP28 summit, UN secretary general, Antonio Guterres, urged nations to move beyond their "entrenched positions." Not forty-eight hours later, Dubai taught us with a global climate dialogue, we can reach a deal.

A deal, however, does not guarantee action. And, in a moment where the cost of keeping our lights on supersedes any thought for what powers them, why should the energy transition matter at all? With many economies and wallets, still reeling under a cost-of-living crisis, political commitments do nothing to bring down the cost of energy. Nor do they help the industry behind the promises gain any real footing in our global energy landscape.

The trouble is that our energy systems are still very much entrenched. Spooked by the prospect of change – and what it could mean for revenue streams or votes – many governments have been running the allocation of wind energy projects with an outdated mindset, under conditions that don’t align with the reality faced by societies and the energy industry.

This year will see the largest volume of offshore wind up for auction in the history of global energy. With wind project plans becoming more ambitious, how can we ensure that they materialize into real projects - projects that can deliver on both lofty political commitments, and more affordable energy for worried consumers?

The gap between promises and projects

Fixated with driving down the cost of energy, many governments have spurred unsustainable industry mechanics. This has, in turn, driven developers to extreme measures to maintain their stake in the business. These measures include a race to the bottom in bidding wars, an arms race for ever-larger turbine platforms and speculative bidding that leads to unrealistic project commitments.

The result? Unviable project economics that cannot sustain what is now – with just six years until the global deadline to peak carbon emissions – a critical industry. Unable to uphold pre-COVID-19 agreements last year, several developers were forced to cancel projects across the USA and Europe. With a bid ceiling too low to support a viable business case, the UK’s CfD5 auction last September did not attract any investment.

The time between when a project is awarded, and when it’s delivered is also far too long. As the cost of delivering projects has been driven up by inflation, climbing interest rates and supply chain disruption, auctions are locking developers into conditions that are completely misaligned with their business environment at the time of delivery.

From squeezing value, to infusing it

So, how can we fix our auction systems? In many markets, adjusting the bid ceiling to account for market fluctuations is a critical first step. Following its unsuccessful auction round, the UK increased its CFD6 ceiling price by 66%. While the increase still pitches below the market price of electricity - meaning that developer margins remain squeezed in a moment when electricity is persistently expensive for the consumer – the adjustment marks a positive step towards a more sustainable business case for wind energy in the UK.

A higher ceiling means that developers can achieve a strike price that reflects the current cost of energy - which has increased significantly with inflation and rising interest rates. France and Germany have introduced similar adjustments to the bid ceiling. In the USA, policy support through the Inflation Reduction Act has trailblazed a significant acceleration of new wind energy projects. Local authorities in New York recently fast-tracked a process through which developers can negotiate higher prices. For a successful transition to green energy, more markets need to follow suit.

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In place of a subsidy, the UK’s 2-sided CfD model also supports a sustainable business case. Over the lifetime of a wind project, the model ensures that both the developer and the government can secure a stable revenue.

This marks a departure from the alternative, where many governments attempt to secure a revenue stream from wind energy by squeezing value from the industry that must deliver it. Wind energy is a relatively young industry, with the value chain behind it working to build scalability. Every promise of a bigger turbine calls for a bigger shipping vessel, a bigger turbine foundation and more manufacturing capacity in a market environment that grows increasingly uncertain. For a successful energy transition, auctions need to infuse value into renewable, not extract it.

Finally, revenue-sharing mechanisms are a powerful tool to incentivize a more sustainable business environment for offshore wind. Replacing uncapped negative bidding and concession-based systems – where developers are forced to pay exorbitant fees upfront – with revenue-sharing mechanisms, can incentivize project completion and support healthier project economics.

More wind energy can lower power prices

During a cost-of-living crisis, the temptation to have the offshore wind industry cover the cost of its entry into our energy systems might seem valid. But the facts suggest otherwise. In Europe, more wind energy in the system has steadily driven down the price of electricity in power markets since 2021. Following 2022’s historic highs, the average price of electricity in Europe has been driven down by 8% – all due to the displacement of more expensive power sources. Preventing the entry of wind to save money, could, in the long run, have the opposite effect.

While the relationship between wholesale power prices and lower consumer bills is not linear, it does present a clear opportunity for governments. Adding wind energy capacity, combined with the necessary system adjustments, such as grid buildout and flexibility solutions, represents a pathway to lower energy bills. Not to mention, energy systems that are less vulnerable to the volatility of imports and geopolitics through strengthened energy independence.

Overall, it’s time to focus on what wind energy will deliver – if granted a less hostile business environment - and not just what it costs. If governments really want to lower power prices and build resilient energy systems, it’s time for action. This means entering a new era of reformed auctions. A route towards more affordable energy is now clearly outlined. We can remain entrenched or we can choose to uproot. With stability and prosperity on the horizon, what would you choose?

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Energy TransitionNature and BiodiversityForum Institutional
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