Thank you for Subscribing to Energy Business Review Weekly Brief
From 2008 to 2016, Europe experienced successive crises that affected the offshore wind sector in different ways. The 2008-2009 global financial crisis and the 2010-2012 sovereign debt crisis made financing conditions challenging. Electrical utilities faced pressure to improve their balance sheets and many chose to reduce offshore wind development expenditures, often by delaying the development of their offshore wind projects. A few utilities went as far as divesting a large portion of their portfolio (e.g., Innogy) at arguably very attractive conditions (in retrospect). The offshore wind industry was still moving forward, albeit at a slower pace.
The 2014-2015 commodity price crisis (oil prices plunged largely due to shale gas production in the US) reduced demand for traditional oil and gas (O&G) offshore engineering and construction services. The O&G offshore service suppliers increasingly looked to the offshore wind sector and often accepted lower returns (some to the point of near bankruptcy, if not bankruptcy). This resulted in a reduction of offshore wind project costs: CAPEX and OPEX for offshore wind substantially declined just as the industry was becoming more effective at building offshore wind projects. Between 2015 to 2019, all the winning conditions converged. Access to capital ubiquitously improved, and attractive auction compensation schemes dominated Europe and Taiwan. Under this new favorable context, offshore wind projects built between 2015 to 2019 were financed and structured, expecting very high returns on equity. This period is what we refer to as the bonanza or a heyday period for the offshore wind industry. From our view, it will be an unlikely feat for current US offshore wind projects to achieve similar returns as they had in the past, at least in the foreseeable future. Today’s Cost Drivers for the US Offshore Wind Industry It’s against the 2015-2019 backdrop that the first major BOEM auctions in the US took place. The US market has since witnessed a large influx of potential investors, from oil majors, infrastructure, and investment funds to pension funds. Most of these investors are relying on two premises: costs will indubitably go down, just as it had during the bonanza period, simply because “it has to,”; and the supply chain will ramp up to ensure any scale of demand is met.As the world is now more aware of the reality of climate change, it may be time for a difficult and transparent social conversation around the cost of the energy transition
2. Industry’s financial health
3. Oil and gas prices
4. Cost of capital
5. Scale of projects
6. Other commodities LCOE (per MWh ) for Empire Wind in 2020 was estimated to be $75, and the LCOE for a typical offshore wind project in 2022 is around $78, which is below or not far from LCOEs observed during the bonanza period even as inflationary pressure is still being felt. Despite the current reality of the market, the Department of Energy expects LCOE to be around $60 by 2030. Offshore wind still has a long way to go before it can reach parity with onshore wind, let alone solar energy. Considering the fundamentals above, what gives? Regarding 1, if we assume that local content consists in large part of labor (particularly unions), it is difficult to fathom the workforce accepting lower salaries in the future than they are today, particularly in the current inflationary context and the training that is and will be needed in the local workforce. Moreover, the expectation is for more local content in the future, not less . Regarding 2, the offshore wind supply chain is arguably less healthy than it was in the bonanza period. OEMs are experiencing severe operational issues (e.g., Siemens X models), and these problems will have repercussions on the offshore wind supply chain, eventually, as investors will aim to recoup their losses or hedge against such issues in the future, or perhaps as some articles suggest “refocus on quality.” Regarding 3, it can be argued that the oil majors will be cautious in their investment going forward so as to not suffer the negative prices experienced during the onset of COVID. It is difficult to imagine oil prices going significantly down unless there is a major economic crisis such as in 2008. While oil majors have less control over demand, they exert substantial control on the supply (as do trading houses) and will certainly adjust it accordingly if prices drop drastically. From our perspective, 4, 5, and 6 are the remaining factors that have the potential to positively affect forward LCOE, but it is highly uncertain as to what extent they can do so unless there is a significant economic crisis on the horizon. The Green Energy Transition is Essential, but it will not be Free It is our view that offshore wind remains driven by government policies and will continue to rely on subsidies, directly or indirectly, particularly if the States are primarily motivated to create local value. In that context, market forces alone are unlikely to offer a sustainable path for the industry. New Jersey’s recent decision to return its tax credits to Orsted (worth around 30% of the total CAPEX of the project) seems to support this view. As the world is now more aware of the reality of climate change (particularly after this summer’s extreme heart), it may be time for a difficult and transparent social conversation around the cost of energy transition. Electricity prices will need to go up in the coming decade to realize offshore wind targets and for project sponsors to realize adequate returns. The bonanza might be over, but a new era of resiliency is about to begin.
