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). 

lower cost wind

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. 

georg obert

Georg Obert: “There are ample opportunities for institutional investors to provide equity at reduced risk levels compared with five years ago”

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. 

Tech evolution a cause of performance risk

Improving technology in renewables is lowering costs for consumers and raising investment risks for investors

Razak Baba

Technological advances in renewable energy could create winners and losers among investors. Research from JP Morgan Asset Management (JPMAM) suggests that infrastructure investors should look to core assets to reduce performance variations caused by new technology.

“If the ongoing decline in the cost of renewable energy and battery storage proceeds faster than expected, infrastructure investment performance may vary considerably,” according to the research.

In the report by Serkan Bahçeci, head of infrastructure research, and infrastructure analyst Stephen Leh, JPMAM said: “We believe that core infrastructure investments are relatively less vulnerable to disruption because they are grounded in long-life physical assets that provide essential services.”

Technological progress over the past decade has lowered the price of renewable power so much that in many places it is now cost-competitive with coal and natural gas, even when renewables are not supported by government subsidies, and “we expect the cost of installing renewable energy projects to continue falling over the next decade, while renewables’ role in the supply stack grows”, the report says.

But judging the pace and timing of technological advances is “highly challenging”, the analysts write, and some sectors of the infrastructure market are likely to benefit from lower-cost renewable energy and batteries, while other sectors are vulnerable to those trends.

In general, investments in power projects with long-term contracts with creditworthy counterparties should be “relatively insulated”, while merchant power projects – those exposed to spot-market pricing – will be “under stress” and likely to see their value fall as the growing capacity in renewable plants that operate at zero marginal cost reduces the average cost of power.

The researchers believe existing wind and solar projects would be “most vulnerable” because “new renewable projects compete for potentially limited transmission capacity, and drive down prices by producing power at similar times”.

Cheaper new installations “could also mean that long-term contracts are no longer necessary to incentivise construction, limiting investors’ ability to recycle capital into new core projects”.

Gas-fired peaker plants designed to generate power quickly when demand rises are likely to benefit from the falling cost of renewable energy. 

But peakers are vulnerable to disruption from batteries, which compete directly with peaker plants by storing energy produced when prices are low and releasing it when demand rises or when renewable generation dips due to low wind or reduced sunlight.

This suggests that “renewable energy installations and gas-fired peaker plants may be complementary investments, with each performing better under different downside scenarios,” the report states.

Low-cost batteries could change power-market dynamics by enabling renewable power projects to store energy until prices rise, the research notes. 

“Without an economical way to store electricity, renewables projects are forced to sell their power irrespective of the market price. When the wind is strong, for example, all nearby wind farms generate power at the same time, resulting in low prices or outright curtailment,” and while solar generation sources are less volatile, a similar logic applies.

“Low-cost battery storage technology is probably more than a decade away, and we expect the costs will decline gradually, as wind and solar technology costs did.”

But batteries are already being used to mitigate the intermit risk of wind and solar generation, pushing the price of power from hybrid renewable solutions to record lows in some major markets.

According to a report by Matt Gray, an analyst at the Carbon Tracker Initiative, Xcel Energy’s 2017 Colorado filing shows the median bid price for wind plus storage was $21 (€17)/MWh and for solar plus storage was $36/MWh.

“As far as we know, these are the lowest renewables plus storage bids in the US to date,” Gray wrote.

The bids highlight the difficulty investors face when trying to project the pace of change in energy technology. “Crucially, the amount of storage is currently unknown,” Gray wrote of the Colorado bids. 

The combination of renewables plus storage bids is $3-7/MWh higher than standalone wind and solar bids, he noted, “suggesting a limited amount of storage”.

However, he added, “These changes highlight the dramatic declines in storage costs.”

As technological innovation accelerates, infrastructure investors will need to consider “the potential for disruptive changes in every underwriting”, the JPMAM research states, “constantly assess new risks, and diversify to mitigate volatility”.