Renewables: Look beyond the shore

Offshore wind is on the brink of delivering energy at the costs of conventional power. Georg Obert explains what this means for investors 

While the Paris agreement is still awaiting political action across the western hemisphere, in Europe newly installed capacity for onshore wind farms and commercial photovoltaics is slowing down significantly. Even Germany, the poster boy of energy transition, is failing to meet its CO₂ targets by 2020 due to cheap coal and ever cheaper emission rights.

The gap between the required acceleration and a de facto slowdown is mostly a result of growing resistance from lobby groups and discouragement from local governments. Appropriate locations have become increasingly hard to find, planning has been too little and too late, and regulators and power grid providers have faced growing resistance from local communities.

Furthermore, the growing use of regulated auctions has rendered permitted projects useless as they no longer fulfil the required criteria or they have become uneconomic. While a step in the right direction, the auction approach has proven problematic. Tenders have been postponed as rules have been contested. Some projects have not been completed – early auctions in Italy, for instance – as some bidders participated without an obligation to see them through. Loopholes have been used to derail governments’ local participation rules. In Germany, for instance, corporates participated in large numbers as community projects because of a favourable rule interpretation.

As a result of all this, France will probably be the only country in the EU producing reliable levels of newly installed capacity in coming years. The situation will probably improve over time in other countries as rules change, a power purchase agreement (PPA) market develops, and ageing facilities leads to a rise in dismantling and repowering. Wind developments need time for realisation, though, and existing permits are only valid for a limited time, so a stable industry depends on rather quick changes to the current system. 

Offshore wind developement, on the other hand, is accelerating, helped by sufficiently high tariffs. Scale, advances in technology, standardisation, widely available equipment– such as installation ships and cable laying equipment – and skilled people from an idle oil and gas industry have brought down costs. As a result, offshore wind is now able to compete with newly built conventional power plants.

Latest auction results in the UK, which came in at £65 (€74) per MWh produced, shows earlier expectations have been exceeded and we have now undercut the 2025 levellised cost of energy (LCOE) target as the technology neutral indicator (figure 1). 

Putting to one side the much discussed Hinkley Point nuclear powerplant (as it has far higher LCOE), offshore wind is now coming close to combined-cycle gas powerplants in relation to forward gas prices and a low cost for emissions.  

These days, many European countries determine the tariff level by means of competitive auctions. Successful tenders face a simple tariff system, which helps finance increasingly larger projects. A departure from the renewable obligation certificate (ROC) system in the UK, for example, was definitely a move in the right direction, as the contracts-for-difference (CfD) system has far fewer uncertainties over time. More so, systems in the UK, Netherlands, Belgium and Denmark are budgeted, so that governments do not run the risk of overspending or being surprised by the level of newly installed capacities. A sharp decrease in prices also makes room for further projects in the government budgets. Falling prices, in turn, make it easier to place the costs of clean and sustainable energy with consumers and lowers the risk of budget cuts or government interventions significantly.

This makes offshore wind a more secure long-term investment for investors who are comfortable with the overall country risk of an asset’s location. That said, a new trend has emerged at recent auctions whereby utility companies have secured an option to build a project at a zero tariff. Consequently, a long-term PPA – bearing credit risk and thus requiring additional security – is needed to finance these projects. 

A large part of European offshore wind projects are located in the UK. Uncertainty  about the outcome of Brexit means less price competition from continental European investors in the UK, potentially increasing the cost of capital for future projects.   

Looking at the pipeline to 2030 (figure 2), we can see that it does not ease any time soon, as significant amounts of offshore wind capacity come online in the UK over the coming years. 

On the upside, this growth path supports the required volumes for further advances in the industry, with larger turbines requiring fewer foundations or even floating foundation structures, which could be deployed in a wider area, including outside European waters,where sea beds are too deep for fixed structures.

Widely differing developers’ risks, as a cost factor during the permitting process, and the burden to cover grid connection costs are also progressing in favour of more stable investments. Many countries are now changing their auction processes to a system of pre-consented projects including grid connection, bearing fewer risks to completion. 

Detailed planning and risk management is key to a successful construction process. Today it is customary to model several hundred risk factors via a Monte-Carlo-simulation to determine impacts to timing, resources and financials. These processes are important and a good eye for detail is required by the developer or investor during due diligence to identify processes that could have knock-on effects in the value chain. 

Much has been achieved here by applying customised solutions from the oil and gas industry. Widely available infrastructure, standardised technical solutions such as J-Tubes (used to funnel the cables into the foundations) cable trenching robots or specialised bridges for transferring personnel from vessels to turbine, speed up processes and bring down costs and risks. This increasing level of professionalism has borne fruit and most projects finish with little or no use of contingency plans.

Looking forward, increasingly bigger machines mean fewer foundations, more and larger weather windows and hence reduced construction time per wind farm, as many costs are tight to bringing personnel to and from the site in a short time. Maximising capacity factors of new generation wind turbines remains key here; size in itself does not suffice on the quest to lower costs. 

Wind generation levels have proven to be less of a concern to offshore wind project owners than onshore wind owners. A number of projects have performed over the P50 level (the level of generation forecast to be exceeded 50% of the year) and reserves were factored in more generously than elsewhere. While this may change as margins tighten, it is generally accepted that the lower complexity of the surroundings make the models easier to handle than in hilly terrain and hence delivers reliable results. The focus is therefore on operational costs, according to industry experts. Again, increasing sizes, shrinking distances between wind farms and better applications to deploy service personnel will help to bring down the cost of dedicated resources in a given area. 

With over 11 gigawatts of installed capacity online and an expected two to four gigawatts per annum of newly installed capacity coming online over the next years, there are ample opportunities for institutional investors to provide equity at reduced risk levels compared with five years ago. Now is the time to look at projects with the right risk-return characteristics, especially because few investors have found the means to identify the right opportunities, so competition is lower than in, say, onshore wind or real estate. Tariff details, project execution and contractual concepts for construction and operation need to be reviewed with the necessary expertise and from an equity perspective, as banks still have enough downside protection over equity in their modelling. 

We realise that the financial performance of an asset class is paramount, as it remains difficult to find the right investments in this low-interest environment. We also see different progress levels on ESG-compliant portfolio constructions in different countries. The recent move away from financing coal-related investments is a welcome departure from passive strategies, which focused on minimum criteria. The interesting part is that investors at the forefront of ESG development seem to achieve better returns in their overall portfolio, be it the result of more active portfolio management or the refusal to sacrifice long-term values for short-term goals. 

ESG aside, offshore wind has the properties of a regulated infrastructure asset, which is uncorrelated to stock markets and real estate, and in some countries offers protection from inflation via an indexed tariff. In every portfolio this is a value that should be considered by itself.