Managing risk on low-cost offshore wind
More than 104GW of offshore wind capacity is currently operational or in the planning and development phase globally, representing an increase of over 10% on 2017. Within a very short space of time, the levellised cost of electricity (LCOE) from European offshore wind farms has dropped from above €150/MWh to around €55/MWh. By Simon Luby, global head of due diligence, K2 Management.
But what is behind this global capacity growth and LCOE drop? And how can we effectively manage risk in this new era of truly global, low-cost offshore wind?
Several factors have contributed to the industry’s recent successes, including the arrival of significantly larger turbine models – 8MW and above – supply chain optimisation, developer and operator experience allowing safe cost rationalisations, and auction-based support mechanisms causing both developers and contractors to sharpen their pencils.
These factors have, in turn, allowed greater expansion of offshore wind in new markets such as the US and Taiwan at a much more competitive and advanced level than would otherwise have been the case, through allowing these markets to capitalise on the European experience and expertise with these same factors.
As offshore wind continues to establish itself as an international, cost-competitive and mature industry, these factors will continue to develop and influence project successes and failures.
Even without the pressures of competitive government support mechanisms, capital costs on a per-MW basis have come down by around 50% by simply shifting from 5MW–6MW machines to 8MW–9MW machines, owing to the balance of plant costs remaining relatively static for a given project capacity. For example, the cost of a monopile for a Siemens 6MW machine is the same as for an 8MW variant of the same machine in the same site conditions; however the number of offshore activities has decreased, which allows further time and therefore cost savings.
Key elements of the supply chain have also reached a critical point in terms of order book size and certainty, in combination with experience, allowing cost reductions to be made safely.
Confidence in the ongoing growth of the market has allowed suppliers and contractors to make important investments with confidence and achieve economies of scale and production efficiencies, which have a direct beneficial impact on prices. The European market certainly seems to have reached a positive tipping point, providing both government support and confidence in future build-out rates continuing.
However, it’s yet to be seen if new entrants can compete at the same cost level without casualties being incurred. A somewhat Darwinian process of survival of the fittest, or smartest, has removed the less capable, or overly optimistic, elements of the European supply chain in recent years.
New entrants thinking that the relative stability and maturity of the market will allow a smart new business plan to succeed are likely to face a reality check when competing against established and trusted suppliers.
Auction-driven support mechanisms have also reduced the element of target pricing by turbine suppliers, whereby any positive changes to a support mechanism have almost always resulted in a price increase, as suppliers have modelled the potential margin within a project to identify how much of that could pass through to them, given limited competition.
Auction processes have turned that model on its head, much to the benefit of developers. However, there will be a limit to how much further prices can be brought down, while simultaneously pushing technology and scale boundaries for turbines. Profit reductions for some of the major suppliers are warning signs that financial stress points could be lurking ahead.
Auction pressures have also had an impact on pricing of turbine maintenance costs. The latest and largest machines are now around half of the price per-turbine, not per-MW, than for the older 3MW–4MW scale machines. There will be an influence from extended operational experience within the supply chain, but suppliers are clearly looking ahead to the future direction of pricing if offshore wind projects are to achieve long-term economic viability in the era of low support levels or even zero-subsidy.
Turbine technology development is one of the major drivers within the current market, particularly the increasing scale of turbines. The design, development and testing of both components and prototypes have improved significantly since the first multi-MW offshore turbines were deployed, and the significant serial defect issues experienced by almost every turbine supplier now appear to be a thing of the past.
Larger turbines make it easier for developers to over-plant certain project sites, squeezing maximum value from grid connections and providing a noticeable availability/reliability buffer. Sites originally developed with 5MW–6MW turbines in mind can now achieve significant cost optimisations for a given export limit through deploying a smaller number of larger turbines, making some previously marginal sites more attractive to investors.
As turbine design has evolved, balance of plant elements have also kept pace. Monopile sizes and weights needed for turbines of 6MW and above have been optimised, allowing cost reductions to be safely made through design and production savings.
The use of 66kV array cables is becoming more common, providing electrical efficiency gains as access to suppliers of offshore cables of this rating increases, and installation experience grows.
Substation design and export cable ratings are also the subject of ongoing development, improvement and optimisation. Together, modest improvements across the balance of plant elements of a project can provide a significant aggregate saving on capital and maintenance costs for new projects.
Offshore wind markets outside of Europe can exploit these technology developments almost immediately, avoiding an unnecessary need to begin their own deployment of offshore wind using yesterday’s technology.
The ability to capitalise on European improvements may be linked to local content rules and local supply chain capabilities, and certainly to local developer expertise and experience, but with more developers becoming active in multiple geographic areas, it’s also becoming easier for local developers to find experienced and reliable partners.
Wishful-thinking or wisdom
As knowledge and experience have grown, cost certainty for construction has been easier to achieve. Investors are subsequently able to consider and accept the lower returns that are inherent within the latest generation of offshore wind farms.
However, it is yet to be seen whether the current price levels offered by OEMs, or assumed by developers undertaking a self-maintain model, can be sustained long-term. With total turbine maintenance costs on some of the low-price European projects assuming very high and consistent reliability levels across much of the operating life, it is likely that some contractors and developers will feel pain on a certain number of individual wind farms. In the longer term, an adjustment to lifetime OpEx assumptions and long-term maintenance agreement pricing is likely in some markets.
While some developers invest considerable time and money in the work needed to fully optimise and de-risk their projects, others may succumb to the pressure to win at all costs by reverting back to the earlier days in the wind industry, where a P50 was a variable was used to justify a decision or project value, rather than a critical parameter determined by extensive technical and analytical effort to ensure accuracy.
It’s also worth noting that the low LCOEs achieved by some of the most recent European projects are often coming from developers with their own internal electricity supply business or internal demand.
These developers can de-risk the low electricity price by using it to supply another part of their business with large volumes of cheap power, or through long-term and reliable offtake agreements with strategic partners. This strategic thinking and “vertical” integration provides a good level of confidence to the companies adopting such an approach as the project economics are only part of a wider business case for them.
However, investors need to tread carefully, be robust in their due diligence and not get caught up in the “win at all costs” attitude when such projects sell down to new partners. The tight financial and safety margins on these lowest-cost projects are likely to mean that even a relatively small change in production, OpEx or electricity price (if merchant risk is brought into the equation) are going to hit investors hard.
Experience is the ultimate arbiter
Ultimately, the current success of offshore wind in bringing down costs and allowing many projects to be completed on time and on budget is down to one key factor – experience. Without the hard-won experience of the developers, operators, maintenance providers, suppliers and installation contractors the industry would not have had the knowledge or confidence to make such rapid improvements and gains within a short space of time.
The industry is right to be optimistic about the future, provided that growth continues to be consistent and all parties can plan several years ahead with a fair amount of certainty.
Where new markets are concerned, care is needed to ensure that developers do not try to achieve the same gains as seen in Europe too quickly or in a short-term manner. Local supply chain factors as well as financing and electricity market influences make it unlikely that the latest European costs can be safely achieved during operation, rather than just achieved on paper.
Current assumptions that long-term maintenance costs and availability levels do not have to be wrong by very much to cause several projects to come unstuck over the next 10 years. Expect to see another round of Darwinian-like filtering between the developers who got it right and have achieved financially sustainable long-term operations, and those who did not and see their projects become unviable as the reality differs from their optimistic pre-bid assumptions.
In the race to the bottom on pricing, investors and developers have financial and technical risks at the forefront of their minds as the offshore wind boom really takes off around the world. Although different considerations apply between mature, low LCOE markets and new but less certain emerging markets, managing and correctly understanding risks means the difference between sustained long-term success for all parties, or short-lived growth.