Five grand challenges of offshore wind financing in the United States

Energy Research & Social Science, Volume 107, January 2024, 103329

Another paper published this week-end - this time of a more academic bent, the result of a seminar I participated to last year at the kind invitation of Columbia University. I’m very grateful to the full team for taking me along this ride, and helping me manage the rigors of preparing a peer-reviewed academic paper!

Five grand challenges of offshore wind financing in the United States

Author:

Tyler A. Hansen, Elizabeth J. Wilson, Jeffrey P. Fitts, Malte Jansen, Philipp Beiter, Bjarne Steffen, Bolun Xu, Jérôme Guillet, Marie Münster, Lena Kitzing

Publication:

Energy Research & Social Science

Publisher:

Elsevier

Date:

January 2024

© 2023 The Authors. Published by Elsevier Ltd.

Abstract

Offshore wind energy has the potential to play a critical role in fostering a renewable energy transformation in the United States. This owes to its massive technical potential, strategic location near densely populated coastlines, and—relative to onshore wind and solar—high capacity factors and consistent production. The Biden Administration's target to build 30 GW of offshore wind capacity by 2030 (from 0.04 GW today) requires the creation and swift development of a new industry that interlinks the wind and power industries with the maritime sector. Critical to its success is financing. While financial capital is abundant, deploying it for offshore wind faces major challenges. We identify and describe five grand challenges affecting offshore wind finance in the U.S. Failing to address these challenges may put deployment targets at risk. The challenges include (1) Early years financing: navigating the complexities, timing mismatches, and high costs of projects in the development phase; (2) Policy support for project financial solvency: addressing the uncertainty and systematic transfers of tax credits away from offshore wind, characteristic of the U.S. Investment Tax Credit; (3) Workforce development: building a skilled workforce for an emerging market; (4) Transmission and integration barriers: upgrading the power grid to reliably support large scale offshore wind integration; and (5) Floating wind development: financing the development and scale-up of floating offshore wind technologies. The second challenge has already been solved to a large extent by the Inflation Reduction Act.

1. Introduction

Offshore wind (OSW) is a massive renewable energy resource, strategically situated near densely populated coastlines. Technically, OSW power is capable of supplying 11 times the world's projected electricity demand in 2040, and—relative to onshore wind and solar—OSW exhibits significantly higher capacity factors and more consistent production, providing stability for electricity transmission systems.

Within the last decade, OSW has developed from a costly decarbonization technology to an economical way to produce bulk electricity without subsidies in mature markets. From 2012 to 2021, global installed capacity increased more than 10-fold from 5 gigawatts (GW) to 53 GW. Europe had long had the highest capacity installed, but in 2022 was overtaken by Asia.

OSW's attractive characteristics and success in Europe and Asia warrant the rapidly growing interest and development in OSW power in the U.S. Indeed, the estimated technical potential of OSW in U.S. waters is 2100 GW, nearly twice the country's entire electricity capacity in 2021. In addition, coastal counties account for just 10 % of the country's landmass (excluding Alaska), but nearly 40 % of the population.

• A. Offshore Wind Development in the United States

The Biden Administration committed to increasing OSW capacity from 42 megawatts (MW) in 2022 to 30 gigawatts (GW) by 2030—enough to power 10 million homes. Achieving this target will require over $100 billion in new investments and create 80,000 full-time-equivalent jobs from 2023 to 2030. Policies in eight East Coast states—Massachusetts, New York, New Jersey, Rhode Island, Connecticut, Maryland, Virginia, and North Carolina—target developing 40 GW of OSW capacity by 2040. In August 2022, California adopted OSW capacity targets of 3–5 GW by 2030 and 25 GW by 2045. Discussions for additional OSW capacity targets are underway in Washington and Oregon, the Gulf Coast, and Great Lakes states. The pipeline of U.S. OSW projects rose to more than 40 GW by May 2022. For comparison, the country's onshore wind capacity totals 140 GW.

Despite the U.S.'s slow start, Bloomberg New Energy Finance and 4C Offshore forecast that the U.S.'s global share in installed capacity will increase from zero in 2022 to 11 %–13 % in 2031.

Yet, creating an OSW transformation requires coordinated co-developments across technology, policy, and economic systems. With attention on OSW development rising, it is important to consider the challenges. These challenges stem from overall market and supply chain nascency, emerging workforce requirements, and regulatory, policy, and jurisdictional overlaps, among other factors.

• B. Financing Offshore Wind

All energy projects need financing, but financing plays a particularly important role for capital-intensive technologies like OSW. The largest share of OSW costs comes from upfront capital expenditures (CapEx), e.g., turbine parts, machinery, and electrical equipment. CapEx need to be financed long before revenues from energy generation are obtained through a combination of debt (loans) and equity (ownership stakes in the project), each of which comes at a cost. CapEx and the resulting financing costs account for around 80 % of a typical Western European OSW project's lifetime cost. The capital-intensive nature of OSW development makes the weighted average cost of capital (WACC)—i.e., the weighted combination of the interest rate on debt and required rate of return on equity—a highly important cost determinant of a typical OSW project. For example, at a WACC of 10 %, financing costs already account for half of the project's lifetime cost.

Historically above the WACC of onshore wind or solar PV, the WACC for typical OSW projects has come down dramatically in recent years, ranging from 3 %–6 % in nominal terms for projects financed between January 2020 and June 2022 in Western Europe, the U.S., and China. In large part, this can be attributed to a low-interest rate environment and confidence in the technology itself, as evidenced by falling risk premiums in the last decade.

With today's inflationary environment and higher interest rates, finance becomes an even more critical component for OSW project development to keep costs of energy down.

• C.Perspectives of industry experts on the challenges

We explore the challenges of an emerging OSW industry in the U.S. through the lens of finance, i.e., the sourcing of funds, the conditions under which those funds are provided, and the challenges and opportunities that surround this aspect of OSW development.

Against this backdrop, this paper addresses the following questions:

• 1. What are the challenges in the next three to five years affecting the financing of a rapid scale-up of OSW energy in the U.S. at a reasonable WACC?

• 2. Which of these challenges are grand challenges, i.e., potential showstoppers—challenges that, if unresolved, may prevent the massive and rapid scale-up from taking root?

To answer these questions, we organized an intensive, two-day exploratory consultation stakeholder workshop, bringing together academic researchers and industry practitioners active in the OSW finance space. We focused our discussions on challenges that are controllable to a large extent by government or industry actors within the offshore wind space.

• D.Macrotrends: Inflation and Interest

Since the workshop, questions of offshore wind finance have been dominated by two macrotrends: the highest inflation levels and resulting interest rate hikes that the U.S. and many other countries have seen in decades. These trends have hit OSW development particularly hard, for three reasons. First, being capital-intensive, OSW relies heavily on financing, and increasing interest rates mean increasing financing costs. Second, the combination of high inflation and fears of recession (from rising interest rates to stem inflation) steers investors towards safer investments, increasing the premium on risky investments. OSW is a nascent industry in the U.S. without an established track record and has long development timeframes. Both factors increase perceptions of risk. When combined with the general rise in material costs, OSW development in the U.S. is nearly 50 % more expensive now than in 2021. While OSW developers can mitigate inflation risk to some extent by, e.g., inflation indexing in contracts (prices automatically adjust for inflation), this does not solve the overarching problem: costs for OSW development have soared, and someone must pay for it.

Below is a brief overview of examples in four states:

Recent data, however, provide hope of price stability for the foreseeable future. U.S. inflation dropped to 3 % year-on-year in June and July 2023, and interest rate hikes have similarly slowed [40]. We acknowledge the ongoing impacts of these contextual macrotrends, which may delay OSW development. As noted above, in this paper we focus on grand challenges that are largely controllable within the OSW space, that must be overcome to finance a thriving U.S. OSW industry.

• E. Five Grand Challenges

We found that, while financial capital is abundant and investors are seeking opportunities in OSW, successfully employing that capital in the U.S. faces at least five grand challenges:

• 1. Navigating the timing mismatches, high costs, and jurisdictional complexities of the development phase (i.e., all of the processes, such as siting and permitting and securing financing, prior to construction).

• 2. Addressing the uncertainty and systematic transfers of tax credits away from OSW built in to the U.S. Investment Tax Credit (ITC).

• 3. Developing a skilled workforce capable of navigating and problem-solving the harsh conditions offshore.

• 4. Building a transmission network that supports OSW expansion.

• 5. Financing and scaling up early-stage floating OSW technologies, which are needed to realize the full potential of OSW in the U.S.

The second grand challenge (inadequacies of the ITC) has been addressed to a significant extent by the Inflation Reduction Act (IRA) and is discussed in detail in Section 3.

The grand challenges, in general, imply the need for structural change, alignment across policy and regulatory environments, as well as development of the OSW electricity transmission grid. They also imply a future of growing pains experienced by any new industry. The U.S. is an emerging OSW market with its first utility-scale OSW farm scheduled to come into operation in 2023.

This paper is organized as follows: Section 2 outlines the methodology, Section 3 presents the grand challenges, and Section 4 concludes with a discussion on the implications of the grand challenges for OSW development in the U.S. and future research.

[you can go read the full sections 2 &3 here]

4. Discussion and conclusions

Current macrotrends aside, conditions in the U.S. are favorable for a rapid scale-up of OSW energy, but successfully deploying hundreds of billions of dollars in investments in the U.S. OSW sector requires overcoming five grand challenges: (1) Early years financing; (2) Policy support for project financial solvency; (3) Workforce development; (4) Transmission and integration barriers; and (5) Floating wind technology development. Challenge (2) has already been solved to a large extent by the IRA.

These challenges point to structural shifts in policy and regulatory environments, the workforce, and the physical infrastructure in electricity transmission systems. They also point towards growing pains in a new industry. The U.S. currently hosts just seven operating OSW turbines. Scaling up OSW development in a nascent market at an unprecedented pace is risky for financial actors and presents major logistical challenges for developers and regulators.

We also appreciate that these grand challenges are not the only major challenges facing OSW finance. Recent reporting, for example, highlights efforts—funded in part by fossil fuel interests—to undermine social acceptance and political support for OSW projects [59,60]. Such efforts—even with moderate success—can increase project risk and cost of capital.

The grand challenges suggest future research directions. Domain-specific research topics such as OSW design and deployments, transmission system planning, and financing models, will continue to be critical. Interdisciplinary research detailing the evolving infrastructure, economic, regulatory, policy, and social environments will help policymakers, regulators, and developers develop coordinated solutions. Specific research topics include:

• 1. Analyzing policy impacts on financing and cost of capital in general.⁷

• 2. Identifying regulatory and policy solutions to streamline and reduce risk of OSW development.

• 3. Assessing the impacts of inflation and high interest rates on OSW and other capital-intensive technologies.

• 4. Mapping and analyzing the stakeholders of OSW, their influence, and the political-economic relations between them.

• 5. Exploring how coordinated planning of transmission (power and hydrogen) and storage build-outs affect and can improve OSW profitability.

• 6. Further specifying the near-term workforce challenge and potential solutions, drawing on existing resources and past experience.

Researchers are also well-positioned to discern and analyze longer-term challenges, including:

• 1. Domestic workforce development to support long-term OSW capacity targets.

• 2. OSW integration solutions, e.g., demand response, electricity storage, and sector coupling (electrifying transport, coupling the power and heating sectors, and using power to generate green fuels, known as Power-to-X [62,63]).

• 3. Supply chain constraints in light of global energy transitions and the effect of local content requirements on project costs and critical bottlenecks.

Our work presented in this paper provides context for creating solutions for OSW development. We are hopeful that collaborations between researchers, practitioners, policymakers, and regulators can support the development of solutions and enable rapid decarbonization of the energy sector in the U.S.