Orsted – Seeking the wind
By the time DONG Energy sold its interests in fossil fuels and became Orsted, it had already tied its future to that of wind power. The company had long harboured an ambition to be the world’s biggest player in an asset class with the potential to become one of the world’s pre-eminent sources of power. It has now realised that ambition, and its dominance looks set to grow. By Solomon Teague.
In November, Orsted completed what it believes to be the biggest financing deal ever seen in the renewables sector, the divestment of 50% of the Hornsea 1 Offshore Wind Farm to Global Infrastructure Partners, for €3.5bn.
It is a fitting accolade for the Danish power company, which was once a traditional energy company but has reinvented itself as one of the leading lights in the renewable energy sector.
In the ten years to 2017, when this metamorphosis was complete and Dong Energy became Orsted, the group increased its operating profit to DKr12.7bn (US$1.93bn), from DKr9.3bn. It achieved this while reducing its CO2 emissions by 67%, to 151g/kWh, with renewable energy comprising 94% of its capital employed, up from only 16%.
Orsted’s strategic reorientation saw it sell its oil and gas business to INEOS in May 2017 for a total payment of up to US$1.3bn. Since then it has also sold its downstream business in Denmark, where it was seen as more of a traditional electricity supply business.
The sale of its power grid and residential customer businesses is expected to complete in 2019 and will give the acquirer a 19,000km grid in the Copenhagen area, north Zealand and parts of central Zealand. The residential business sells electricity to 733,000 customers and gas to 91,000 customers.
Instead, Orsted’s growth has been powered by wind. Orsted already owns more global offshore wind capacity than any other company, with 5.6GW. That puts it ahead of RWE and Vattenfall, with 3.9GW and 1.4GW respectively. But the difference becomes even more pronounced when capacity under construction and mandates awarded are taken into consideration, giving Orsted 30% of projected global capacity. That is nearly double that of RWE, in second place on 16%.
Orsted is proud of the role it has played in driving wind power forward. Being strongly associated with renewable energy gives it an edge in attracting the best talent, with prospective employees, especially from the younger generation, keen to work for a company that represents a future of clean energy. Orsted believes its attrition rate of around 6.5% to 7% gives it the perfect balance, low enough that it is not losing star performers to rivals, but high enough that it avoids stagnation, with fresh ideas always coming in.
But as much as having the best staff, being a market leader is about deals, and Orsted wants to leverage its balance sheet to maintain its market leading position. The company has set aside DKr255bn by 2025 to finance its ambitions, with its principal focus continuing to be wind power. Between 2019 and 2025 Orsted expects to have 75% to 85% of its capex allocated to offshore wind, globally. Onshore wind – principally in the US – comprises most of the remainder.
While wind currently constitutes a relatively small proportion of the global energy mix, Orsted is betting that it has a big future, and that growth will take off in coming years.
Kunal Patel, head of partnerships and structured solutions at Orsted, said: “We think the future for offshore wind is really promising. It is still a very small proportion of the global energy mix, so there is a lot of room for growth. We should (per numbers from BNEF) expect to see a 17% annual compound growth rate between 2017 and 2030. That means there will be around 129GW being generated by 2030, with that new capacity coming across the Americas, Europe and Asia.”
Orsted is under no illusions about the competitive environment this will happen in. It currently targets generation capacity of around 30GW by 2030, which would represent a decline in its current 30% market share. Its target acknowledges the near impossibility of maintaining the high win rate it currently enjoys in auctions, with a new focus from competing firms likely to lead to a more equitable distribution of deals in coming years.
Orsted is currently working on building around 1GW of capacity per year, which it expects to rise towards 2GW per year over coming years. It sees this as a sensible balance of ambition and risk management – at least for now.
While recent years have seen significant changes to the business, not least in terms of its name and how its power is generated, its financing model has been more consistent.
“We like to co-invest, but we have our own partnership model,” said Patel.
“Our preference has been for developing projects on our own and then finding a partner to take a 50% stake during the construction phase. Developing the project alone gives us maximum flexibility, which is important when you have so many deals in your pipeline and you move on to a new construction as soon as the last one is complete.
“There is always development risk in any project but we are comfortable doing this in-house,” added Patel.
But naturally there have been changes as the company has grown. Patel said: “As our balance sheet has evolved so has our investment strategy.
“The priority used to be finding investors to buy 50% of our projects as part of a capital recycling programme. But now that is less of a concern and we are comfortable with our ability to finance our pipeline of deals ourselves.
“Now other considerations, such as value creation and risk diversification, are the key drivers that will drive our approach to partnerships.”
Orsted has worked hard to develop a range of partnerships, and today it enjoys relationships with corporates and financial institutions, pension funds and insurance companies, in countries around the world, including Canada, Japan and Europe. But it is equally committed to finding local investors with which to co-invest, in both the equity and debt pieces of its deal.
Orsted continues to believe in its balance sheet financing model, which it believes is a lower risk strategy than alternatives such as project financing. Using its balance sheet helps it achieve a higher rating, which is attractive to potential partners. It means a lower returns expectation, but also lower costs from things like bank and restructuring fees.
It also offers greater flexibility, through easier access to capital in new markets, and the absence of covenants. Orsted also points out that the market for senior bonds is more stable than for project bonds.
Yet Orsted is proud of its role in the development of project bonds, an increasingly viable alternative to the bank market for financing offshore wind deals.
In some cases Orsted has had to create a project bond market for wind from scratch, and having local investors that support its vision for wind power is invaluable in helping to make that happen. Orsted traces this trend back to the Gode Wind I deal in Germany back in 2015, which is now one of four wind projects the company owns that used project financing.
Getting these deals done has involved a lot of work. Part of that has been with rating agencies, ensuring projects achieve the investment-grade rating necessary to bring institutional investors on board. Another is educating institutional investors about the characteristics of renewable energy and specifically wind, and the implications of investing in this kind of infrastructure.
Many institutions have never invested in offshore wind projects before and need a lot of hand-holding in order to make them comfortable with the risks specific to these assets.
Financing terms have had to be adjusted to overcome the regulatory constraints under which large institutional investors operate, such as Solvency II for insurers. But for every investor that has been convinced, it should be easier to bring them back for future deals, meaning there should be more project financings of offshore wind deals in the future.
Orsted has also proved itself happy to provide construction wraps in its deals to provide a greater level of comfort to investors feeling their way into a new asset class.
Patel said: “We are happy to provide construction wraps in our deals, they make a lot of sense to us. They mean we take on a significant portion of the construction risk ourselves, but we believe we are the best people to take that risk. This is our core business and we have developed a long track record of doing it, so we believe this allocation of risk creates value for us as well as our partners.”
While Orsted’s expansion has seen its focus sharpen in terms of the assets it invests in, it has broadened in terms of its geographical reach. Its main markets remain in Europe, particularly Denmark, Germany and the UK. Recent months have seen the company expand its horizons beyond its home continent, but Europe itself remains a growth market, not only in those three core countries, but in places such as the Netherlands, where wind is also growing.
But a company with Orsted’s ambitions for wind cannot confine itself to Europe, and the company has been expanding both eastwards and westwards, with the US and Taiwan the key markets with significant pipelines of deals under consideration.
Orsted is keen to continue building up its business outside Europe, in both the Americas and Asia, in any markets where there is demand for offshore wind, and where governments and regulators have done the work to make that possible.
Its growth expectations differ between markets: the US is a strong market for onshore wind, given the vast space available, but in Europe, especially Northern Europe, “Nimbyism” makes onshore wind a tougher proposition, with offshore wind having much greater potential.
Patel said: “We want to invest where there is demand for offshore wind and where the work has been done to make that possible. We are a strategic investor, not an opportunistic one – we want to invest long term. So there needs to be a framework in place to support the industry. Part of that might be a subsidy but there is much more to it than that; it’s also the regulatory environment and the market fundamentals.”
Subsidies can help make projects particularly attractive and Orsted’s returns expectations are heavily influenced by the presence of a CFD or a feed-in tariff, which influence returns expectations and open the door to investments where there is no appetite for merchant risk.
But other factors are also important, said Patel. “First the market conditions have to be favourable. The regulation has to be right, and there are many elements to that. It is about having a supportive government with the right energy mix, as well as a favourable legal regime. If those conditions are met we will do a detailed assessment of project sites. It is only when both those site and market conditions marry up that we can consider making serious investments,” he said.
Those serious investments begin long before financing is arranged for wind turbines. “Being a global player requires investing in local people on the ground in your target markets, who understand the culture, the business environment and in particular the regulatory requirements in the power markets,” said Patel.
Orsted’s increasing presence in Taiwan illustrates these considerations. The company is developing projects that should bring around 2.4GW of offshore wind power to the Taiwanese market, with 1.8GW already allocated grid connection. But a lot of ground work was done over a number of years to get into a position to make that a reality.
Orsted opened its office in Taipei years before it was awarded any mandates or grid connection in the country. Its staff grew from a handful on day one to more than 40 people, with considerable time spent familiarising itself with the relevant regulations and supply chains. Equally important was familiarising its Taiwanese staff with the health and safety standards and culture of Orsted.
Such an investment in time and resources only makes sense from the perspective of a long-term, strategic investor, committed to building multiple projects in that market. Not every player in wind will be in a position to make such a commitment. Orsted’s capex costs in Taiwan are projected to be twice the levels of European projects, covering the costs of its investments in things such as building up supply chains in this new market, and additional time spent on installation.
So although the feed-in tariffs in Taiwan are likely to be very generous, they will be eaten up by the expense of establishing itself in this new market. Orsted has its eyes on a longer-term prize, pointing out that it will not need to spend the same amount of money preparing the ground for subsequent Taiwanese wind farms, on things such as developing supply chains. That means future profitability will be higher.
There are many variables in play, and for a global player in the wind market, the willingness to take on merchant risk will vary between markets.
Patel said: “Merchant risk is easier to take in some markets. We have projects that take on merchant risk in Germany that – subject to our final investment decision – will be built by 2024, which will use new technology to bring down the cost of offshore wind as well as benefit from clustering with other projects of ours in the region.
“It has already come down – I think plummeted is a fair word to describe it – as the capex, the opex and all the other expenses associated with it have fallen and investors have got more comfortable with the sector.”
In other markets there will need to be greater incentives. But one thing that remains constant is Orsted’s global commitment to wind power. It is bullish on power prices in coming years, and on its own prospects and profitability.
It acknowledges new renewable projects and improving technology, such as increasingly efficient turbines in its windfarms, will increase supply and weigh on prices. But this is more than offset by thermal power being phased out, and increases in the cost of fossil fuels such as coal and gas, and of CO2.
Demand for power is also likely to rise, it says, which underpins its growth expectations for years to come. In the long-term future, Orsted accepts energy prices could crash as production costs fall dramatically. But it does not expect that to happen until after 2050.
In the meantime, it wants to lead the way in delivering the clean, renewable energy that could ultimately prove so transformational to the power markets. A lot of wind turbines will need to be installed before people can expect ubiquitous, low cost energy. Its hope is that many of them will be put there by Orsted.