The force awakens

It had been a few glorious years. Supported by generous subsidy schemes and buoyed by dwindling costs, early renewable assets have lived through the last 10 years by growing stronger in number and returning good money to their investors.

But then the empire struck back. The first salvo came from Spain, in the form of retroactive cuts to solar photovoltaic tariffs. The well-documented offensive was followed by a similar move in Italy and soon became the harbinger of a much broader trend across Europe. “There’s been a paradigm shift,” notes Martin Neubert, head of commercial transactions and market development at Danish developer Dong Energy. 

Not only are subsidies for the most established technologies like onshore wind and solar being considerably reduced, but renewable energy projects are now awarded through competitive auctions – rather than on a first come first served basis – as governments place security of supply and affordability higher on their energy agenda.

As COP21 recently underlined, that doesn’t mean the EU is suddenly turning its back on clean energy. But it does mean that emerging fields investors previously feared to tread on are the ones now enjoying the kind of support that established technologies used to benefit from.

Chief among them is offshore wind. Along with natural gas and nuclear energy, offshore wind has been singled out as a pillar of the revamped energy policy put forward by the UK Conservative government, which, since being elected in May, has cut subsidies for established technologies like onshore wind and solar. 

Amber Rudd, Secretary of State for Energy and Climate Change (DECC), recently hinted in a speech that up to three tenders of between 500 and 1,000 megawatts (MW) were in the cards for the period running until 2020, with a first one likely to happen in the second half of 2016. The government is targeting 10 gigawatts in new capacity in the decade to 2030.

The Netherlands is also sailing high on the trend, with 750MW worth of offshore wind farms planned annually over the next five years. Germany has plans in the field and France recently awarded a spate of tenders to utilities, which should yield good opportunities for investors further down the line.

PROPELLED FORWARD

This wouldn’t be possible without government support. Offshore wind farms are very large projects with significant lead times to completion. Whopping sums of money are needed upfront and the electricity produced is still too expensive to compete on an equal footing with more established renewable sources, let alone natural gas or coal. 

Fortunately, notes Dirk Hovers, senior portfolio manager at Dutch pension administrator APG Asset Management, European governments seem committed to backing the sector, with no flip-flopping expected anytime soon. There is good visibility up to 2020, he says, and the pipeline in the decade to 2030 is shaping up well. Crucially, he doesn’t expect the currently favourable climate to suddenly cloud.

This is not being lost on institutional investors, with blue-chip infrastructure names getting involved in high-profile projects last year. Germany’s 330MW Gode 1 Wind Farm, developed by Dong, counts Global Infrastructure Partners as shareholder and a club of German insurers as debt providers, while Macquarie Capital and the Green Investment Bank restarted construction of the UK’s £1.5 billion (€2.0 billion; $2.2 billion) Galloper wind farm in November. 

“The industry has matured faster than many believed,” says Neubert. “There’s rising appetite from both equity and debt investors for these projects”. 

Three years ago, notes Mark Dooley, head of infrastructure, utilities and renewables at Macquarie Capital, institutions were wary of investing in offshore wind, which was perceived as too young and risky a technology. “Many institutions simply didn’t want to be first,” agrees Hovers. But they now have good reasons to head out into the deep blue sea.

A track record of large-scale projects delivered on time and on budget, for a start, gives them greater confidence in the sector. Offshore wind farms also offer the opportunity to write very large cheques – some projects currently in market have equity requirements of more than £1 billion – at a time when similar opportunities in the core infrastructure space are harder to come by.

COUNTER-CURRENTS

Prospective investors in new build infrastructure will also like the sector’s scalability. Previously some infra investors weren’t so interested in greenfield because the cheques were too small. With no yield through construction phase, often it simply wasn’t worth it,” Dooley recalls.

It helps that the technology has greatly progressed. Many problems observed in the last decade have been ironed out and today’s turbines have grown stronger, more reliable and more intelligent.

But therein lies a key challenge for would-be offshore wind investors – fast-evolving offshore technology requires them to remain nimble when analysing projects. “Offshore wind is an arms race. It’s not [about who’s got] the biggest weapon, it’s who’s got the biggest and most efficient turbines,” says Dooley. “Capital providers have to get their head around evolved technology pretty much with each project.” 

He notes that while Macquarie invested in a project with 3.6MW turbines this year, Galloper is equipped with 6MW units. “Now there are people speaking about the inevitability of 10MW turbines.”

This reliance on ever-powerful kit also creates dependence on the companies that build it, engineering potential hidden costs in the process. An adviser with expertise in the field says dominant market players, like Siemens, sell turbines relatively cheap only to jack up operation and maintenance fees further down the line, on the back of what is effectively a quasi-monopolistic position. 

This relationship is unlikely to change anytime soon in a context where governments are pushing for more cost savings. They are a large part of what will convince UK leaders to follow on this year’s tenders with future ones, for instance. Market sources reckon the DECC wants to see costs come down to about £100 per megawatt/hour (MW/hour) within the next few years and eventually get them closer to the costs of nuclear, which stands at £92.5 per MW/hour. 

HARD-WIRED COMMITMENT

Other challenges are dotted along the supply chain, from bid risks during the development phase to weather patterns during construction. There’s also a larger question: with a rising wave of institutional capital targeting a lumpy pipeline – and the pressure on returns that is bound to ensue – could the window to invest in offshore wind profitably be closing soon?

Few insiders think so. For one, offshore wind offers the possibility to enter projects at various stages of the deployment cycle, allowing investors with different risk/return profiles to consider getting involved. ‘Big-ticket’ institutions tend to be attracted to operational assets, which typically command single-digit returns, while more hands-on capital providers will be able to earn a premium by getting involved during the construction phase.

Various innovative financing structures also allow investors to tailor cashflows to their needs. “We’re very flexible,” says Hovers. Some projects are financed on an all-equity basis, while others would typically include 70 percent leverage. Private debt providers could also add more options to the mix.

Importantly, offshore wind also seems to supersede its onshore cousin in another respect: reliability of output. Studies have shown that while onshore wind farms have recently underperformed projections by a meaningful margin – and displayed greater volatility – offshore plants are closer to the consistency displayed by baseload sources. There’s an intuitive reason for that: “The sea is more or less flat,” explains Dooley. “There are no hills, forests or other obstructions to diminish the airflow reaching your turbines.”

European leaders have other reasons to like the sector. It doesn’t need any fuel input, at a time when energy independence is a priority. And crucially, offshore projects often give a boost to the local economy with construction, which typically lasts two to three years, helping to re-industrialise parts of a country, argues Neubert.
Offshore wind won’t be enough to curb global warming to below two degrees Celsius. But as the fight against climate change gains a new urgency, it certainly looks like a valuable ally.