Ørsted abandoning Hornsea 4 is shameful and should be punished

Energy auctions should not be free options for utilities

Ørsted just announced their decision to stop work on the Hornsea 4 project, despite having won a CfD revenue contract only last year in AR6. I would like to say unequivocally that this is the kind of outrageous behavior that the UK government should not tolerate and should punish harshly.

Ørsted claims that the project is no longer economically viable, but that does not make any sense, given that they bid the price they needed to build only last year after all the market turmoil in 2022-23, so they should have known better, and have really no excuse this time.

To explain this: the usual behavior of utilities in these price auctions had been to get detailed quotes from contractors in order to determine their construction costs and thus their bidding price, and then, once they have actually won, to go back to the contractors and say "now we have won and have an actual project to build, give us your best quote" and squeeze them for an additional rebate. With construction prices steadily going down over the years, this was a logical approach to auctions, and a profitable one. It even made sense in auctions where construction could not start very quickly after winning the auction because of permitting or grid constraints - the likely gains outweighed the uncertainty.

But the market turmoil of 2022-23, with supply chain shocks, increased interest rates and volatility in power prices, caused havoc in the business model of the sector and caused a general increase in the cost of generating electricity from new projects. So those parties that had obtained tariff before 2022 and not locked in construction and financing costs at the time found themselves with suddenly very unattractive business cases, and many projects were abandoned, in particular in the US and the UK . The cost of doing so was relatively low, in particular compared to the cost of building the projects with now-weakened economics.

The companies could, barely, argue that these circumstances were truly exceptional (after Covid and the war in Ukraine, both impossible to predict in the relevant timelines) and that they deserved some flexibility. This could hold in the US where they had to bid for PPA contract prices long before they had all their permits, but was always flimsy in the UK, where you need to have all your permits and your grid connection to be allowed to bid for a CfD, and know that you will be able (and indeed are supposed) to build your project quickly after CfD award. With short timelines, it is possible to lock in your contract prices and financing already when you bid - which is what projects using bank finance for construction do, as banks will not take the risk of costs changing after the bid, and impose that all terms be nailed down in advance. It is even possible lock down interest rates in advance, for instance with instruments called contingent hedges where you don't pay money upfront but pay a slightly higher, but known, rate only if you do go ahead with the project.

Northland Power, which won a tender for tariffs in Taiwan in 2019 and was allocated a tariff in Poland before 2022, managed to debt-finance both projects in 2023 without abandoning their original tariffs, despite all the market havoc.

Utilities choose to not fix their contractual prices when bidding; it is their right, but it is a commercial decision on their part (effectively a bet that construction costs and cost of capital will go down) and they should be held accountable for it, and asked to honor their contractual commitment to build a wind farm, given the effort that the public body makes to ensure that it is economic for them to do so.

The fact that Ørsted is again abandonding a project in 2025 after having bid for a CfD less than a year earlier shows that they have learnt nothing, and are still taking the government (and ratepayers who support their projects) for fools. They should be punished. Currently, the main penalty in the UK for giving back a CfD is that you are not allowed to bid in the next two rounds. This is much too weak - they should be forced to build the project or stripped of their licence on the zone and forced to pay a penalty equal to a substantial fraction of that investment cost. That amount could be used to incentivize replacement bidders. I'd even go as far as banning failing developers from getting any offshore licence for multiple years.

The fact that such behavior effectively goes unpunished creates continuing perverse incentives, where utilities can bid unrealistic prices to win auctions, with the option to either abandon the project or whine for subsidies if the bet does not work (given how visible and politically sensitive these projects are, governments are highly sensitive to blackmail). This gets fewer projects to be built and terms to be generally less favorable to ratepayers in the end.

At the very least, governments need to impose very high bid bonds on any price auction, to ensure that these bids are realistic and projects get built at the offered price. The bonds would be drawn only if projects are not build within a reasonable, pre-set timeframe, with limited allowances for extensions for factors genuinely beyond the developers’ control (a delay in the grid, or something like a critical vessel sinking, say).

As another reform, governments should move away from auction rules that favor the biggest players only (such as large balance sheet requirements, or a track record or building GW previously, or similar hurdles that exclude non-utility players, and even often exclude large financial players like specialized infrastructure funds). Small players in offshore wind have a distinguished record of getting projects not only built, but built on time and on budget. They are definitely better than the utilities on that front - the main reason for that being that these small players rely on bank finance i ntheform of non recourse debt for construction, and lenders in the sector have done a good job of understanding construction and operation risks, and ensuring that they are mitigated properly, and there is a large ecosystem of competent contractors and consultants that have shared experience and a large body of common knowledge to work from. (Project financiers have a market share of 50%, as opposed to the 10-15% or less of Ørsted or other large utilises who think they have the most experience…)

As an aside, bank-financed deals tend to offer smarter contracts to the supply chain instead of squeezing them for the lowest price like the utilities tend to do - contractors take more risk, but it is risk they understand, and they get paid fairly (ie better) for it. Developers get cheap debt, and the resulting lower cost of capital makes their bids competitive. So you get a healthier supply chain, in Europe (banks tend not to like Chinese contractors) as an added bonus.

Smaller players can also actually afford large bid bonds linked to construction (as for banks it's a risk they are already taking), so this would not be penalising for them.

The signal given by Ørsted (and other utilities that abandoned projects before) is detestable, and their behavior actively detrimental to ratepayers and to public policies to decarbonize. They need to be punished harshly, otherwise this will happen again - indeed, they are already doing this AGAIN, after getting better terms last year after already doing it in 2023.