Surging power prices may be tempting more European renewable energy generators into taking merchant risk by selling electricity into the spot market or agreeing power-purchase agreements (PPAs). But for many operators, the long-term price certainty offered by government-backed subsidy schemes such as contracts for difference (CfD) remains hard to beat.

In the UK, spot day-ahead power prices averaged £370/MWh ($427/MWh) in August, the highest month on record and ten times the level of August 2020. Prices are expected to rise even higher, with futures contracts for this winter settling at over £680/MWh this week as the European energy crisis sparked by Russia’s invasion of Ukraine deepens.

£680/MWh – Power futures prices for this winter

This is a boon for renewable power operators with exposure to market prices, including those under the UK’s old Renewable Obligation (RO) scheme.

Operators in the UK can lock in PPAs for £300-500/MWh “for the next year or couple of years”, says Robert Ogden, CEO of UK-based PPA marketplace Renewable Exchange.

Newer UK projects with CfDs should in theory be indifferent to the market, as they must pay back the difference between the power price and their CfD strike price, which has gone as low as £40/MWh in recent auctions.

But some newly operational projects are delaying full commissioning and the start of their CfDs to gain exposure to market prices. An offshore windfarm can commission anywhere within a three-year window under current regulation, according to UK-based consultancy Cornwall Insight.

A silver lining to this loophole is that developers are incentivised to generate much-needed power as soon as possible. France has even moved to allow new developers to go merchant for 18 months, releasing them from CfD obligations, says Ryan Alexander, research lead for European power at UK-based consultancy Aurora Energy Research.

Going merchant

More developers are considering the merchant option as a result of the high prices. “We are seeing a huge push for long-term PPAs, especially if developers can lock in ten-year fixes at £100/MWh without the rigidity and bureaucracy of the CfD system,” says Ogden. Ten-year PPA prices have more than doubled in the past two years, says Alexander.

Some developers are also looking at securing a CfD for some of their capacity and selling the rest on the market, according to Ogden.

Still, the CfD route remains attractive for most UK developers, Ogden says. Strike prices are much higher than they seem, because they are in 2012 money and rise with inflation. The certainty of an inflation-hedged fixed price for 15 years helps with financing.

“Developers would struggle to raise as much debt and use leverage on merchant projects,” Ogden says. In any case, “lead times for projects mean you might come online after prices have stabilised and miss all the good stuff”.

A CfD also shelters operators from risks of government intervention in markets. The European Commission's plans to potentially decouple the power and gas markets caused an initial drop of around 25pc to the forward price of power, says Ogden. “It is clear that there is a point at which there is political will to limit the upside to the wholesale price of these critical commodities."

“Developers would struggle to raise as much debt and use leverage on merchant projects” Ogden, Renewable Exchange

Industry association EnergyUK is backing a scheme, proposed by independent thinktank UK Energy Research, to offer voluntary CfDs to older RO generators and nuclear plants to reduce energy bills this winter. It believes the longer-term price stability will lure generators away from the wholesale market.

For all the talk of corporate PPAs, where generators sell directly to corporate consumers, as an alternative route to market, the UK is still dominated by utility PPAs, where the buyer of the power is an energy utility or trader. “Corporate buyers are less interested, or are still looking to pay 2021 prices,” says Ogden. But Aurora believes the high prices will “supercharge the nascent corporate PPA market in countries such as Poland”.

Outlook

High prices may have only a marginal impact on the future renewables pipeline. "Ultimately, most projects across Europe are being held up by lengthy permitting and grid connection processes, no matter how high their projected IRRs are,” says Alexander.

Older assets dropping out of subsidy schemes, such as Germany’s first feed-in-tariff generators, will benefit from surging market prices. “But this doesn’t materially change our outlook as they would have gone merchant anyway,” says Alexander.

And high prices may even delay the repowering of old projects. Repowering makes sense “if it can be done quickly”, Ogden says but, in today’s market clients tell him they prefer to “oil the blades and keep the turbines running” as long as possible.