CfD Indexation Is A Rip Off
By Paul Homewood
We have been looking at indexation of CfD strike prices. So let’s look at an example of how it works in practice.
Beatrice is an offshore wind farm off the Scottish coast. It has been operational since 2019.
Their first three years of full accounts show:
https://find-and-update.company-information.service.gov.uk/company/SC350248/filing-history
Profits increased by £53 million between 2021 and 2022, despite lower output, on the back of higher revenue, mainly due to indexation of 8.1% on strike prices.
Finance costs fell as debt began to be repaid. Most of the debt is spread over 15 years, on floating interest rates. As with most businesses with large capital expenditures, Beatrice has covered all of its long term debt with interest rate swaps, meaning the interest rate it pays is fixed for the full maturity of the loans.
The only real risk to the business profitability therefore is the actual output of the wind farm.
In the y/e March 2023, Beatrice received another uplift in strike prices of 8.1%, and a further 6.1% was added last month. Together these will increase revenue by another £55 million, assuming output remains the same.
It was grossly negligent and a misuse of public money for Ed Davey to have drawn up contracts guaranteeing full indexation of strike prices. I know of no private business which would have offered such generous terms.
It is plainly evident that his only concern was to get as many wind farms built as he could, regardless of the cost to the public.
It has been suggested that offshore wind farms simply would not have been viable without such generous terms. If so, it gives the lie to the claim that wind power is as cheap as advertised.
Comments are closed.
NOT A LOT OF PEOPLE KNOW THAT 
Also if wind power is so cheap why is my Octopus electricity five time more expensive than gas per GWhr?!
I emailed Greg@Octopus the CEO and asked that question 18mths ago and was told they didn’t control the prices of electricity it was the way marginal cost pricing works. Ummm
Octopus Energy serves the public well – by exposing the (lack of) worth of “Which?” as an independent assessor of goods and services whose decision in the case of Octopus is highly dubious; I asked, several times, for the precise methodology behind their OFGEM mandated checking of customers’ regular payments. 6 + times I asked the question and they provided some detail each time, sometimes repeating themselves, but not the nitty gritty. However, they did send several emails to say they have dealt with my query – so “process” trumps outcomes which to me is a sure sign of a business failing to do what they say they do…and “Which?” was either conned or connived in some way.
Which? is fully-signed-up to the nonsense. The “letter of the month” is nearly always another green virtue-brag.
John Ruskin taught, soon after Adam Smith, that there are two economies:-
One is the mercantile economy in which Merchants fight to maximise their profit every day, week, month by extracting as much money as possible from the proletariat with no responsibility for the consequence but with the expectation of power over the poor.
Two is the Political Economy meaning that commercial and taxation process that arranges the maximum benefit for the proletariat (us) like fair law, health care, social benefits, all those kinds of things.
We live in a time when the Merchants have the upper hand and increasingly. In the Business Schools and University PPE courses they teach profit first. So do not be surprised by any of this. See today’s BP profits.
(Do not confuse Socialism with the Political Economy, the difference is huge.)
The proletariat has been free to decide not to buy at least some goods: merchants cannot force them to consume their wares. Other “goods and services” are forced upon them by state spending and laws. Merchants do not fight to maximise their profits. They are beholden to the diktats and favours doled out by political elites for the most part. Where the political elites make bad choices (which may enrich them personally) they may find that they become beholden to some merchants to bale them out to avoid riot and revolution later. That is why BP has made profits this year (in sharp contrast with the losses forced on it by the politicians in 2020, whose effects in underinvestment have come home to roost).
Fair law, health care and social benefits are not arranged for the maximum benefit of the proletariat. They are being made poorer by the value destroying actions of the political elite.
Ruskin had no concept of the world of today. HG Wells, Aldous Huxley, Eric Blair, Ayn Rand were all much more prescient.
Ayn Rand illustrates my point exactly.
Eric Blair, imho, especially prescient.
Then ol’ Johnny wasn’t very smart.
“by extracting as much money as possible from the proletariat”
They charge what the market will bear. From EVERYBODY.
“with no responsibility for the consequence”
Wut? They charge what the market will bear.
“but with the expectation of power over the poor.”
Wut?
Do not confuse Socialism with Ruskin’s communist pablum.
And Ruskin was completely wrong. Money isn’t “extracted” nor does “money” matter. I swap my production for somebody else’s production. “Money” just helps me do that in clever and efficient ways. When a merchant sells me a product, I cannot get poorer, so long as I choose to buy it in a free, fair market. I swap money (which cannot feed, clothe or entertain me) for a product I value at least as highly as the alternatives I could buy for the same amount. I thus get richer. Merchants exchange their production for my production – “extraction” is simply fallacious.
Your seemingly erudite explanation is very interesting; by swapping your money for “a product” its value can be determined in different ways. You state that you get richer in such an exchange when you exercise judgment to determine relative worth.
What happens, directly after you have swapped money for product, should you decide you do not need “it”, if you were to act as the merchant did with you, and you were to place the now superfluous product in a free and fair market? What is the chance you could recoup your money swapped in the first place?
If you do not recoup your originally swapped money, you are most definitely poorer than you were before your free and fair exchange….and you are thereby an example of the free and fair market extraction mechanism you say is fallacious.
To the several friends who commented on my reflection about Ruskin I do not choose to disagree verbally, you have your views.
I would just like to point out, you cannot have a market which is simultaneously both free and fair. One or the other. In a genuinely free market the buyer/seller relationship is always biased in favour of the seller, she/he is the only one one who knows all the facts about how much the product actually cost.
Also our site master Paul in this thread is illustrating all my points exactly: the price which we are forced, repeat, forced, to pay to the power merchants is not negotiable, it is pay or go away and therefore they have the advantage. That is neither free nor fair!
I would encourage you to read all Adam Smith’s “Wealth of Nations” ( most people miss books 4&5) but particularly Ruskin’s “Unto this last” which is intellectually challenging partly because of its firmly 19th C language but also because it is highly original even today.
Just thoughts, but I accept the possibility that I might be wrong. Maybe.
Malcolm
Value is subjective. Price paid is objective. If you find you no longer place the same value you did when you bought something, then the best you can do is to find the person who values the item most and sell it to them. You may have quite legitimate reasons for your change in valuation, but when you make the purchase you take that risk. There is no extraction involved. You might also have a change in circumstances that leads you to value a purchase more highly. Break your leg, and your bike will seem less use, but perhaps suddenly the books you bought but never read take on a new attraction and may delight you more than you had anticipated.
“In a genuinely free market the buyer/seller relationship is always biased in favour of the seller”
No. In a free market, it is a question of who has the greatest bargaining power.
If demand is less than total supply, sellers are forced to compete for limited demand and price can be driven down towards marginal cost of supply. This can last for a period until the more expensive suppliers drop out of the market because they don’t recover total cost. This was the condition of the power market for several years at the turn of the century, after NETA (resulting in bragging from the Labour government and Ofgem about how they had done the consumer a favour).
If demand exceeds limited supply (shortage), price can increase to the point of lowest value of demand. This happened after supply contraction after the period mentioned above when power prices spiked up (starting in July, so it was nothing to do with demand). It is also what we are seeing today because of limited power supplies, in part due to over-dependence on gas as the dominant primary fuel supply today. The positive price signal should encourage increase in supply from the most competitive producers – this could be coal fired generation today (diversifying primary fuel supply), except the Government is blocking this.
The above adjustments to balance supply and demand can take years to play out. There is no “fair” about it – supply contraction is tough for some, demand rationing is tough for others.
A (free market) question we have to ask ourselves is: why should demand be secured to a standard of security measure in levels of a loss of load expectation down to a small number of hours per year for power supplies?
This is a level of demand security which can only be delivered by maintaining a substantial supply margin over demand. History suggests about 23% seems to be the point for high security of supply. However this means bargaining power of a free market would always sit in the hands of consumers, resulting in depressed prices and economic pressure for supply to contract.
The answer is that secure energy is necessary for a modern economy. We cannot have efficient and continuous production of basic feedstock materials (e.g. aluminium), and other essentials if energy supply is intermittent.
Sorry to say, but the energy industry (and this is more a reference to power) depends on some form of intervention for security.
‘I would just like to point out, you cannot have a market which is simultaneously both free and fair.’
Not your job, Malcolm. The buyer and seller will decide what is fair. You can mind your own damn business. Stay out of other people’s business. YOU CANNOT IMPROVE THEIR BUSINESS. You can only screw it up. It making you feel better is of no value. You seem to think you can help the buyer. The buyer says STFU.
And the idea the state can organise what you claim is simply false. The Knowledge Problem means it cannot. No government official can know how I value anything, let alone all the relative values I have as I choose what to consume. To do as you claim, a handful of officials would need to know every value of everything we can consume for every person at every moment – because our values change. And know how we will value the things about to be invented that we don’t know about yet. If those officials cannot do that, then they cannot maximise anything. And they clearly cannot, so we are inevitably made poorer by them trying.
I did see BP’s profit and I have a big smile on my face although I don’t get my cut until the end of June. You see you are able to share in the profits of the merchants, not only as an individual but there will be who knows how many thousands getting a share of the BP profits via their pension funds. Would you rather the government stole the profits in a windfall tax and pissed it up the wall, or the money go to ordinary people?
Milton Friedman. “Underlying most arguments against the free market is a lack of belief in freedom itself.”
Malcolm is a typical communist: he thinks freedom is BAD!!!
Perhaps some of the proponent politicians are (sane) Russian agents?
Interesting that output in GWh has fallen by about 10% at the same time as the profits increased
Indeed, it would be interesting to know why it fell by 10%. Less wind? Turbine failures? Corrosion of blades? Or perhaps wake loss from a more recent farm?
‘Long-Range Wake Losses Offshore Much Greater Than Expected, New Study Shows’ [August 2022]:
https://www.offshorewind.biz/2022/08/18/long-range-wake-losses-offshore-much-greater-than-expected-new-study-shows/
In 2021 winds were much less. In 2022 Beatrice discovered curtailment income.
And the price per MWh jumped from £160 in 2020 and 2021 to over £188 per MWh in 2022….must still be 9x times cheaper than gas, eh?
Perhaps there are Russian agents among the
poIticos pusshing all this terribly damaging nonsense-no kidding.
I looked at THANET OFFSHORE WIND LIMITED which is on ROC basis and in 2020 ROC income was 102m with 33m from leccy sales off 861MWh. In 2021 ROC income was about same at 103m but leccy sales had jumped upto 94m off 1036MWh. Curious that ROC income wasn’t higher?
Apologies electricity production is back to front above that explains why ROC income didn’t increase!! but the rate per MWh certainly did!!
Thanet gets 2 ROCs/MWh, currently worth over £120/MWh in subsidy. ROC values are index linked to RPI (not CPI).
https://www.ofgem.gov.uk/publications/renewables-obligation-ro-buy-out-price-mutualisation-threshold-and-mutualisation-ceilings-2023-24
The formal buyout price is £59.01/ROC, but that excludes the recycle value which is the result of the engineered shortage of ROCs that lead to cash buyout purchases that are allocated pro rata to ROCs from actual production. We won’t know the final value of current ROCs until late 2024, but it is likely to be around £65/ROC.
Thanet should also be picking up a handy income in REGOs (renewable energy guarantee of origin, quite separate form ROCs) now trading comfortably at almost £7/MWh. Of course, they may have sold them forward much cheaper. But they are a little bit of bunce for any wind farm now that they are trading for rather more than the few pence per MWh they ran to in earlier years.
I think we can say that ROC indexation is also a ripoff.
I found a copy of the standard CfD terms for AR4 on the EMR portal (which is not easy to use). From a quick squint, the strike price is inflated using CPI as the measure of general inflation in the UK, and January values are used to determine the indexation applicable to each year.
The CPI(all items) index can be found at the following link, and from the data provided there:
CPI Jan22 = 114.9
CPI Jan23 = 126.9
https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/d7bt/mm23
Going with this as a yardstick for the value of the £ in your pocket, £1 in Jan23 has dropped in value by (114.9/126.9) = 0.905. The £ in your pocket in Jan23 has the same spending power as 90.5 pence had in Jan22.
An adjustment of (126.9/114.9) = 1.104 (10.4% increase) would compensate this fall in value, leaving you no better or worse off.
The above post complains about a 6.1% increase last month, so there is more going on than I have managed to pick up from a quick squint at a contract. Perhaps others will be able to clarify.
However if the value of each £1 has fallen by 10.4% according to the above inflation index, how could an increase of 6.1% be anything other than a real terms price reduction against that index?
Put another way, if it is asserted to be a £55M increase in revenue (for same output), which measure of inflation supports such a claim?
I posted links to the detailed methodology and calculations on the previous thread.
Inflation indexes measure average inflation for a basket of goods usually either for the whole economy (GDP deflator) or for various groups of consumers (CPI, RPI, CPIH etc.). Different baskets of goods are used to produce different inflation measures that are supposed to be more relevant to particular groups. No index is produced that reflects the real inflation faced by wind farms. The Beatrice accounts show that their operating costs were essentially flat between 2021 and 2022, while their financing cost fell because they repaid loans early. A tailor made inflation index for their costs would show falling prices. Yet they are being granted a revenue increase based on consumer costs.
A complete misunderstanding of inflation. Inflation is not somehow contained by what you decide to put in an index. Ot is a systemic problem that affects every area. That some costs appear to fall is NET of inflation. The idea offshore windfarns are immune to say energy price inflation is absurd. And pretty much every contractor they employ will be exposed to inflation in all sorts of areas from steel for repairs to the coffee they provide the people crewing the maintenance boats.
Of course their maintenance bills are subject to wage inflation in the general economy, and perhaps higher rates if their spares become more expensive because of rising raw materials prices. All I pointed out was that on the evidence of their accounts their operating costs were essentially the same for the two years, which did not suggest they were affected by rising prices between 2021 and 2022. Perhaps they were, and failed to do as much work. Perhaps they have a fixed price deal for now. We cannot know. They were not short of cash if they needed to do more work.
The accounts show a substantial decrease in payments under the CfD – from £256m to £30m. Sales of renewable energy goes from £88m to £363m so I’m unclear what we are comparing. Given the spit, just comparing total revenue doesn’t seem correct but it might be.
When market prices are low they provide limited revenue. However the CFD tops that up to the CFD strike price, paid out by the LCCC and charged back to retailers and hence you and me. When market prices are high the amount of top up needed from the LCCC reduces (and may even go negative).
Market prices do not affect net revenues, which are determined by the prevailing indexed strike price. That’s what the CFD does.
Not quite a fair analysis. Cost of sales increased by around £15m, partially offset by a decrease in Other Operating Costs. What happened with costs is obviously a key part of the analysis but we have no information. Finance costs are lower because they sold an asset for £450m and the proceeds were applied to debt. You need to adjust for that to do a like for like comparison. There is a massive shift in revenue from CfD payments which means we are not comparing strike prices. Finally dividends paid are halved.
It’s also simply not true to claim that most large scale projects hedge all their floating rate exposure.
Do you have any evidence for your last claim? In many years of dealing with project finance it has long been the case that banks will demand two skims if profit. First on tombstombing and syndication of debt. Then on derivatives to remove the risk exposure of FRNs.
Every set of accounts for wind farms I’ve looked at shows floating rate interest exposure is hedged. In a ZIRP environment it would be criminal not to: the risk is one sided that ZIRP would end. It has been the pension funds invested in leveraged debt instruments who have borne the risk of the end of ZIRP. Banks just make money out of each turn.
I am guessing, but I suspect that “Cost of Sales” mainly reflects Balancing Mechanism charges, while operating costs definitely includes ~£90m of depreciation, which being on a straight line basis is not fundamentally variable from year to year.
Yes depn is £90m
The water regulator, Ofwat, allows the same or very similar treatment of capital expenditure. You end up paying for it in perpetuity.
https://www.msn.com/en-gb/money/other/a-green-price-to-pay-why-offshore-wind-s-rising-costs-pose-a-challenge-for-renewables/ar-AA1aF86A?cvid=9193a2825cf345c1c4292eec49aa30e2&ocid=winp2fptaskbarhover&ei=7
“Ana Musat, executive director of policy and engagement at Renewable UK, criticised the government’s £205m funding pledge for the latest CfD round– deeming it too low to ease pressure on energy firms.
“She argued that if the cost of renewable energy generation kept rising, without government support this would make projects more expensive – jeopardising the UK’s push to reach its net zero and energy security goals.
“There was also the prospect of fewer bids, with underwhelming auction rounds in Europe – including no winning bids in Spain’s allocation window last November.”
Then there’s this:
“Zoisa North-Bond, chief executive of Octopus Energy Generation, said: “Renewable energy prices have completely plummeted over the last decade – and consistently far below what was ever expected. It’s clear prices will only continue to come down even more in the long run as the technologies scale further. This will ultimately accelerate the drive to a low cost and more secure energy system for Britain, and lowering energy bills as a result.””
I suppose it depends on whether you’re buying or selling!
Well the Octopus energy person – Zoisa??? – is talking bollocks. Scale won’t decrease the price as the demand for materials will drive the commodities prices higher same as for battery cars. And adding more unreliable generation is not going to provide us with a more secure energy system or reduce prices as grid management costs have rocketed.
Octopus are the crazies planning to invest in Moroccan solar plus an interconnector all the way to the UK. A project with nuclear levels of cost and massive risks. Government should offer them no subsidies or financing.
Are solar plants resistant to sonic boom?