A few basic truths about offshore wind

At a time when we are getting unrelenting negative headlines about offshore wind, with tales of supply chain woes, increasing costs, projects in the UK and US hading back the power purchase contracts they had obtained previously, oil&gas companies seemingly pulling back from the sector, and the stock market valuations of renewable energy companies tanking, it is worth stepping back from a minute and look at the long term prospects of the sector, focusing on a few enduring truths.

1. Offshore wind was originally a way to avoid NIMBY issues in Northern European countries blessed with the North Sea (a large area of low depth water and good wind) and was always expected to be more expensive. It was thus expected to be a side show in the energy transition

2. Thanks to what was effectively a massive bit of luck, offshore wind is the only complex infrastructure sector where banks are willing to take full construction risk without guarantees and even without EPC contracts (construction contracts where a single large contractor takes full responsibility for construction, with typically fixed costs and budgets). This happened because some of the early developers in Europe simply didn't have the money to build their projects and asked the banks: '“what will it take for you to finance us”, and in the booming 2005-2007 period, some banks said “ok, we’ll do it” (and I was part of that and claim a good chunk of the credit for that), and the rest is history. Thanks to this access to cheap (if not unconditional) funding, offshore wind has managed to become almost as cheap as onshore wind in Northern Europe, but that will not be true everywhere in the world. There are lots of places where it is likely to remain a hard-to-finance and more expensive option.

3. Offshore wind means GW-scale projects and billion-euro sized investment. They are understandable by large players (utilities and oil&gas) and are effectively the only way they can do clean generation at scale (other than in a few places where it is possible to do big onshore wind or solar projects) and where their skills at managing complex projects (and at lobbying governments) can apply. It is literally big industry.

4. There are a few places in the world where offshore wind is actually useful - or even necessary, as the alternatives are unavailable or face even tougher constraints. Places like Japan or Taiwan cannot do a lot of renewables inland due to their geography; in a number of places (like the US Northeast, California or Australia), offshore wind will be a transmission and/or system diversification play - (i) it is closer to load centers (big cities by the seaside) than any other power plant, and it is easier to build an under sea cable than an onshore cable or gas pipeline, and (ii) its production profile is nicely complementary to that of solar, which will soon dominate generation in a lot of places, and will actually be helpful to the overall system. In those places, floating wind is likely to becomes a large part of whatever gets built in the future. But in most of the world, offshore wind will remain a costly and unnecessary alternative to other renewables.

So offshore wind has become, almost unexpectedly, a significant part of the picture when future renewable energy systems are considered - at least in OECD countries. It provides diversification, opportunities to Big Energy to go green, possibly less public hostility and potentially reasonable economics. But it’s worth remembering that even in Europe, it’s just 10% of the overall wind capacity installed (and a bit more of actual generation, thanks to higher capacity factors).

The economics angle is worth discussing again as this is what ultimately will make or break the sector

1. This is and will remain a complex industry. There are no short cuts in operations and construction. Only a small number of players actually master the construction risks and are able to build projects on time and on budget. They include the core contractors (the turbine suppliers and a handful of marine contractors), and a few utilities and specialized developers like NPI. Projects with construction funded by banks providing non recourse debt do better than projects built on balance sheet. It is still an open question as to whether oil&gas companies belong to that list of competent parties as they come from a sector where the priority is not to control spending but to generate cashflow (but as they do use project finance, they should get there eventually, if they listen to the banks and their advisors)

2. The high capacity factor of the sector (now well above 50% for recent projects) can be an attractive feature on its own, as the economics of the demand associated with decarbonization of industry (like hydrogen, green steel and the like) are very sensitive to that number, and combined projects will happen. But their complexity is even worse than that of offshore wind on its own, and there will be a lot fewer projects financed and built than current announcements suggest - and they will be driven above everything by the demand side

3. It is a cost of capital play. It is capital intensive and lower cost of production of MWhs comes almost exclusively from a cheaper capital structure. Long term ownership will always end up with the cheapest capital (pension funds), unless risks are not properly mitigated. There is no money to be made for those requiring >10% IRR, except on a small scale (early development). But offshore wind does deliver cheap, fixed cost electricity over the long term (30+ years). Today’s cost increases are real, but they apply to all power generation sources and offshore wind remains competitive, relatively speaking

4. The sensitivity to the cost of capital means merchant price risk (the variability of spot prices for electricity) is difficult to bear, as it requires expensive capital. In a sector where short term prices and spot markets are still the norm (and also have practical value when you need to balance demand and supply at all times) this will always be an issue and that means that the industry will always be highly sensitive to the regulatory environment. That means that fixed price auctions for CfDs and similar mechanisms to mitigate long term price risk will remain indispensable even if the industry is cost-competitive on average (I actually have written, with colleagues, a peer-reviewed academic paper on that topic published soon, watch this space).

5. In that context, the size of turbines is actually not that relevant - the push for ever larger turbines has been painful for the supply chain, who are supposed to develop new turbines even before the previous ones are fully vetted and profitable, but the costs per MW do not seem very correlated to turbine size. Sure, there are fewer foundations to install, but the foundations, turbines, blades, etc are bigger and require bigger factories, vessels and cranes, and it’s getting obvious that it’s not cheaper to race for ever larger turbines than to work with existing models and tools a bit longer. Maybe it’s the financier thinking that everything revolves around money, but in this case, the cost of money is actually more important than the cost of turbines…

6. One project requires the regulatory framework to be right once. A supply chain requires the regulatory framework to be right several years in a row (so that enough projects that use that supply chain get built, and justify the investment in the supply chain). The supply chain always comes to countries that have a stable framework and where projects happen with regularity. This is not an industry that tolerates policy tinkering very well

And yet, this is a highly scrutinized industry, and it has become a political proxy of sorts for larger fights.

1. First of all, scrutiny is now coming from equity analysts looking at Ørsted and Vestas, whose values briefly reached front-page-headline-worthy levels, before falling back. The increased focus on short term numbers is not helpful to an industry that is predicated on long term performance (including statistical variability of the underlying resource) and whose business model is entirely underpinned by the accessibility and cost of long term capital . The day to day attention given to industry news brings with it a lot of noise. Noise creates uncertainty, and uncertainty has a price, in terms of cost of capital.

2. It is a PR magnet (everybody puts wind turbines on their annual reports or ads, even Apple, to sell iPads) , and as such can easily be taken hostage by opportunistic politicians and corporations. In fact, wind has now become a larger tribal issue, politically speaking: being pro-oil (or pro-nuclear, the useful idiots of the fossil fuels industry), and anti-wind, is now largely correlated to being anti-woke and anti-establishment (even if the combination of being pro-oil and anti-establishment does boggle the mind).

   

3. Let’s say it bluntly - the recent tale of the industry’s fall from grace is pushed by the fossil fuel industry, who are seeing resurgent stock market values and think they can continue to dominate the energy sector by embracing ‘old energy’ - but this is just temporary luck. The war in Ukraine (and the less discussed, but probably more significant, temporary but large fall in French nuclear production at the exact same time) caused a massive supply shock that triggered large energy price rises. That is highly likely to be a short term effect, and it is hiding the continuing move towards increasingly decarbonised energy systems, whether through renewable energy, electric vehicles, smart grids or energy efficiency. But public announcements by the oil majors are given disproportionate importance, which ignores the fact that renewable energy is a very decentralized sector where the big players command a much smaller slice of the market, and as these announcements are currently negative, the overall impression is one of doom - just like their bullish moves a few years back generated over-the-top excitement about the sector. Given that, it would seem that now is a good time to buy offshore wind assets currently dumped by the majors - and of course to have the option to sell them back to them at a steep markup in a couple of years, when offshore wind becomes fashionable again…

Overall, this is an industry that has an amazing track record of delivering what it promised to, often against the odds. But it’s not a silver bullet, it’s a meaningful but still relatively small part of the overall transition. Less obviously, given how public debate (and lobbying) seem dominated by the largest energy companies, it is actually a sector where most of the progress has been brought by the smaller players, and that needs to be preserved. So don’t forget to look behind the headlines!