Should we give up on OFTO to achieve the Government’s target of 50GW of offshore wind by 2030?

Considering the future of the OFTO regime  

Achieving the Government’s target of 50GW of offshore wind by 2030 will require a massive development in the offshore network. We will need to ensure that every new windfarm secures a timely and cost-efficient connection to the main transmission network.

Since 2009, wind generators have designed and built the assets necessary to connect their windfarm to the main network, through what is widely called a “radial connection”. Generators then hand over the assets to another party through a competitive tender process. In part, this is to comply with legislation requiring separation between generation and network assets. This tender regime is commonly referred to as the “OFTO regime” and is administered by Ofgem.

23 OFTO tenders have been completed to date, for a total OFTO investment of around £6.4bn in offshore transmission networks. Current Tender Rounds six, seven and eight could add another £2.5bn.

From the outset, the OFTO regime has encouraged innovation and attracted new sources of technical expertise and finance, whilst ensuring that grid connections are delivered efficiently and effectively. Ofgem estimates that combined savings from Tender Rounds one, two and three are between £672m and £1.218bn (2014/15 prices) compared to a range of merchant and regulated counterfactuals[1].

Nonetheless, the OFTO regime was created in 2009 for a nascent sector and when industry expectations were that offshore capacity might only amount to 10GW by 2030. In the context of increasingly ambitious targets for offshore wind, it is widely believed that it no longer makes sense to construct radial connections, or individual point-to-point connections for each offshore wind farm. There are also concerns this could become a major barrier to delivery given the considerable environmental and local impacts.

Considering the pressing need to expand offshore generation capacity, the OFTO regime will be a key enabler to the development of the offshore wind industry - alternative approaches are not practical. We therefore consider options to incrementally reform the OFTO regime to attract private investment and support competition and coordination.

OFTO is a key enabler to the development of the offshore wind industry

We can expect OFTO to play a key role in attracting private investments in the offshore wind industry, and in driving increased coordination in the sector.

The OFTO regime offers strong protection, and makes investment in offshore connection assets attractive to investors. This is crucial in the context of strong competition for private investments in renewable power.

It is anticipated that the OFTO regime will support greater coordination by allowing several windfarms to connect to the main network with the same connection assets, i.e. through “non-radial connections”. In these circumstances, an OFTO party can helpfully act as a third party that is independent from generators and network operators. This is likely to reassure generators that they will have a fair and non-discriminatory access to the network. For example, where the connection assets are designed and delivered by the OFTO party rather than the generator (“OFTO-build model”), the OFTO party could consider the needs of several (current and future) generators when designing the connection assets. This contrasts with the current situation when generators typically design and deliver connection assets focusing on their own needs.

Alternatives to the OFTO regime are not practical in the short to medium term

One alternative to the OFTO regime would be to require onshore transmission operators to design, build, own and operate offshore transmission connection assets. However, the evidence does not give confidence that this approach will be successful. The onshore transmission operators already have a very substantial programme of work.   The onshore operators estimate they will need to invest £21.7bn to deliver the necessary additional onshore network capacity to accommodate the growth of renewable generation. Many will question whether they have the capacity to take on offshore connections as well, given the scale of the task ahead.

These concerns are reinforced by the fact that onshore transmission operators have not been successful in winning an OFTO tender to date.

Another alternative would be to relax the requirement to separate generation and transmission activities and allow generators to own and operate the assets to which their windfarms are connected. This is not currently possible because the UK applies European legislation requiring separation between generation and network assets. This solution could be appropriate for radial connections, but would not make sense for non-radial connections where generators are likely to value the role of an independent third party that can balance the interests of several generators. 

We can see strong reasons to retain the OFTO regime. 

The OFTO regime can be improved to support the delivery of the Government’s target

First, the tender process remains time-consuming and costly. It is not clear to us that re-tendering the connection assets at the end of the initial Tender Revenue Stream (TRS) to extend the life of the connection assets is beneficial. It is unclear how this tender process could deliver benefits over and above its costs, given that it is unlikely that a competitor could submit a more competitive bid than the incumbent. It also creates unnecessary uncertainty for the OFTO party and the windfarm currently connected to the assets. 

The length of the TRS could also be increased. From Tender Round 6 onwards, the maximum revenue period has been extended from twenty to twenty-five years. Ofgem could go further than this and align the duration of the TRS with the expected life of the generation assets. This would provide greater certainty to the OFTO investor, and to the generator who would know that the transmission assets would be available to operate its windfarm. 

Secondly, we wonder if more could be done to create opportunities for new entrants to bid. It seems that the same three organisations were shortlisted for Tender Rounds seven, eight and nine:  Diamond Transmission Partners, Equitix TEPSO Consortium and Transmission Capital Partners. Diamond Transmission Partners and Transmission Capital Partners have won the majority of OFTO licences awarded since the fifth Tender Round.

As the market and potential for private investment in offshore wind assets grows, we wonder if Ofgem should take steps to ensure that there are no barriers to new entrants entering the market. This is likely to mean exploring opportunities to reduce bid costs for new entrants as well as to appropriately promote the investment opportunities to international investors.

Last, but not least, more could be done to ensure that the OFTO regime better supports coordination. Ofgem has recently decided to allow anticipatory investments for a wider range of projects, and to maintain a late competition OFTO-build model for non-radial assets rather than just a generator-build model.

While all these developments are positive, we wonder if they go far enough. There have so far been no OFTO-build projects. This suggests that keeping the OFTO-build model as an option is not sufficient by itself. There is a need to understand and address the reasons why OFTO parties have been reluctant to design and build connection assets while actively promoting the OFTO-build model.

In addition, we question whether a late competition OFTO-build model will maximise the benefits of coordination. Arguably, as an independent party, an OFTO party would be better placed to balance the interests of several (current and future) generators when designing assets, increasing the chances that the connection could serve several generators. Generators may find this challenging - they tend to prefer controlling the design of the assets to which they will connect. One option could then be to require the Future System Operator to sign off on the design of the assets proposed by generators.

Finally, other countries are going even further and have adopted a holistic approach, a single competitive process which encompasses both the leasing of the seabed and the determination of government support. We explore this in our next post “What can the UK learn from other auction processes for offshore wind?”. 

[1] Ofgem, 18 March 2016, Evaluation of OFTO Tender Round 2 and 3 Benefits

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