Offshore wind is a large and growing market segment in Europe, and utilities are the biggest owner-developers.
While the U.S. put foundations in the water for just its first 30 MW of ocean wind capacity last year, Europe commissioned 3,019 MW of new capacity — 100 times as much. That brings Europe's cumulative installed capacity to over 11 GW, according to the just-released annual industry report from the European Wind Energy Association (EWEA). Europe also has 1.9 GW in construction.
Danish public utility and power provider Dong Energy is Europe’s biggest owner-developer of offshore wind, with 15.6% of the European installations at the end of 2015. Others in Europe’s top five are German investor-owned utility E.ON, at 9.6%, Swedish public utility Vattenfall, at 8.9%, UK independent power provider RWE Innogy, at 6.4%, and Munich public utility Stadtwerke München, at 3.8%, according to EWEA.
There is every indication a U.S. breakout for the offshore wind sector is coming. The right policy and demand will come together, a recent Navigant study concluded. “It is only a matter of time.”
But will U.S. utilities be ready to use their unique leverage to seize the opportunity?
“Thresholds for achieving [investment grade (IG)] ratings for operational offshore wind projects are the same as for onshore peers,” concludes a just-released Special Report from Fitch Ratings. If developers avoid revenue and technology mistakes, “operational offshore wind projects can achieve IG ratings.”
That’s the good news. The bad news is that getting IG ratings requires overcoming “harsher stresses on availability and O&M costs and greater focus on breakeven analysis” than for onshore wind, Fitch warns.
That is one of the big reasons Europe’s offshore sector is dominated by public companies with very deep pockets. It is also why the sector offers such an important opportunity to similarly well-positioned U.S. utilities with ocean wind ambitions.
The only U.S. utility to take on the challenge to date is Dominion Virginia Power and it is still working to get its 12 MW pilot project to pencil, according to Spokesperson David B. Botkin.
For Dominion and other utilities who want to know how to seize the opportunity, the Fitch report is a user’s guide to finding and building financially successful projects.
Three kinds of risk
There are three major areas of risk an offshore wind project has to resolve, the Fitch report points out — completion risk, revenue risk, and operation risk.
Of those three, revenue risk can actually be a positive, since offshore wind facilities tend to have higher capacity factors than onshore facilities. That promises good returns — if the developer conquers the completion risk challenges.
Overcoming completion risk requires a project to be well-sited, well-assessed and to have a strong team of contractors. In the U.S., it must begin with having a solid off-take arrangement, said Fitch Sr. Director Gregory Remec.
Nothing proves his point better than the Cape Wind project.
After winning 26 legal challenges throughout the planning process, the 468 MW project was nearing construction. It had funding and was shopping for more. It had a turbine deal with Siemens and the port of New Bedford, Massachusetts, was being specifically designed for offshore wind staging.
Most importantly, power purchase agreements (PPAs) with National Grid and NSTAR, Massachusetts’ dominant utilities, were in place to cover 77.5% of the project’s output.
Then new legal challenges, funded by billionaire industrialist William Koch, imposed further delays. The financing fell through and, unexpectedly, the utilities terminated their PPAs, citing the project’s failure to meet contractual milestones.
To this day, the project remains in limbo. And though Koch's persistence in sinking the project means Cape Wind is not likely a typical offshore wind case, Remec says it still show how important the offtake agreement is.
“There has to be a credit-worthy buyer willing to pay above-market rates because a merchant offshore project is essentially not possible,” Remec said. “Market clearing prices are just too far below the kind of rates needed by an offshore facility.”
That is one of the reasons offshore wind can be such an opportunity for well-positioned utilities.
“If it is a utility, like Dominion, they are probably taking the power themselves,” Remec said.
The bids Dominion has seen for its pilot project to date “make offshore wind very expensive per MWh,” Botkin said. But bids have dropped 25% over the last year and are moving toward a competitive range.
Cost is a very serious concern because the utility would be asking its regulators for cost recovery from its customers through electric rates, Botkin added.
Completion risk factors
Assessing a project’s credit worthiness — a key factor for financers and offtakers — begins with an assessment of the site’s wind, sea conditions and seabed conditions, said Fitch Ratings Director Jelena Babajeva.
In both Europe and the U.S., governments and developers take part in siting. The U.S. Interior Department’s Bureau of Ocean Energy Management (BOEM) has been pre-qualifying Wind Energy Areas (WEAs) and leasing them to developers who do the more detailed analysis.
Fitch’s ratings analysis begins with an independent technical consultant’s report on the project site.
“The only repayment of the loan will come from the project’s cash flow,” Babajeva said. “The suitability of the site is a first concern.”
The construction package must also be “robust,” she said. “Experienced contractors are necessary.”
There is usually not a single engineering, procurement, and construction (EPC) contractor because the new sector doesn’t yet have companies ready to be responsible for an entire project. But the construction package is more likely to have four or five contractors than the seven to nine that were common a few years ago, Babajeva said.
“The financial strength and experience of the contractors is very important in understanding the risk of completion,” she added. “We combine the independent technical report and our own completion risk framework to form a conclusion.”
Revenue risk factors
Fitch found offshore wind project capacity factors to range “from 39% to as high as 52% with the average of 45%,” the paper reports. Onshore project capacity factors “range from 21% to 51% with an average of 33%.”
Better capacity factors mean greater project output and economics that can justify investment. For that reason, the site’s wind is carefully assessed “before construction to justify construction,” Babajeva said.
“Gross production estimates are adjusted for several loss factors,” the paper adds. Wake losses and turbine unavailability are the biggest of those. Uncertainty of production for offshore wind is 8.5% to 12.8%, however, while onshore uncertainty is 11% to 21% and averages 15%.
Operation risk factors
The EPC contractors turn over operations and maintenance (O&M) when the project is commissioned, often to the manufacturers of the project’s turbines, Babajeva said. “Given the nascent nature of the sector, the manufacturers are probably best positioned.”
Fitch’s credit assessment covers a wide set of O&M considerations. It begins with the experience of the contractor, what kind of maintenance the contract covers, whether it is fixed-price or cost-plus, and whether it covers the significant cost of vessels necessary to service the project.
Fitch also assesses turbine and foundation technologies. Siemens had 60% of the 2015 offshore turbine manufacturing market, followed by Adwen, at 18.2%, Vestas, at 12.9%, and Senvion, at 8.9%. Though the industry standard turbine nameplate capacity is still 3.6 MW and 4 MW, new projects are now installing turbines of from 6 MW to 8 MW, Babajeva said.
EEW had 41.1% of the 2015 foundation market, followed by Sif, at 34.1%, Bladt, at 21.6%, and Smulders, at 3.8%. The industry standards are monopile and jacket foundations, Babajeva added.
Innovative technologies such as larger turbines and floating foundations “would require a very robust technical opinion to be considered credit-worthy,” she said.
Fitch’s final consideration for a project’s credit worthiness is its interconnection with the onshore transmission system. That becomes more important as projects are built farther offshore and the cost of the cabling rises.
In Europe, the cost may be covered by the national utility. In the U.S., it is likely to be a project cost and increase the price of the delivered electricity.
Lessons for U.S. utilities
The U.S. is beginning to show real market potential, said Nancy Sopko, federal legislative affiars manager at the American Wind Energy Association (AWEA), pointing to the interest European developers like Dong and Italy's Renexia have shown in U.S. offshore leases and development plans.
State and federal policies must still be aligned, but recent renewables mandate carve-out requirements for offshore wind like those in Maryland. Rhode Island, and New Jersey are pointing the way, she said.
“Massachusetts lawmakers are said to now be preparing for as much as 2,000 MW of offshore wind capacity,” Sopko added.
While designed with the European market in mind, the Fitch credit-worthiness criteria apply equally to U.S. offshore wind projects, Remec said.
Though there is no real market yet, the key rating factors for proposed projects are likely to be those described in the paper, he said.
To date, renewables are generally economic only in limited geographic regions where the resource is especially strong and other economic and policy factors support growth, Remec said.
The first questions a utility CEO thinking about offshore wind must answer, he said, are "How does it fit into your overall generation profile? And what void is it filling?"
“Then there has to be some need for renewables and some level of need for offshore wind that cannot be met by less expensive renewables,” Remec said. “And there has to be a willingness from ratepayers and the load the utility is serving to accommodate above market prices.”
Offshore wind is more successful in Europe because Europe is more space constrained and power prices are higher, Remec said. "The price of offshore wind is above-market but there is the willingness to pay the higher cost.”
The mandate carve-outs for offshore wind now emerging in the U.S. will help create that willingness, Remec believes.
A utility CEO thinking about meeting those mandates with offshore wind must pursue the best site, the best EPCs, the best construction package of technologies, the best O&M contractors, and a cost-effective interconnection.
If the utility is going to pursue the project on its own balance sheet, it will go to its regulators and ask for its projected cost to be applied to rates and passed through to the ratepayers, he said. In that case, the utility and its ratepayers face the risk of cost overruns.
“The other option is buying offshore wind through a PPA and transferring the risk to the independent power producer,” Remec said. “The utility gets the output at a fixed and certain price and knows what its exposure is. The cost would probably be higher than if the utility builds the project on its balance sheet because there is a profit for the IPP, but the risk is reduced.”
An offshore wind market will happen in the U.S., though probably not before 2020, Remec believes.
As in Europe, early projects will be more expensive than later projects. But the difference will not be as great because the experience and efficiencies from Europe will inform the industry, he added.
“There is no reason the technology improvements and learning curves from Europe are not transferrable to the U.S., because it would probably be many of the same players," he said. “There is no captive intelligence in Europe that can’t be transferred to the U.S. market.”
Utilities in the U.S. are well-positioned to take advantage of the opportunity offshore wind offers, Sopko said. “It is a large-scale reliable source of clean energy adjacent to population centers where it is needed most.”
“It is like putting a man on the moon,” Dominion’s Botkin said. “It seemed at one time like it was not doable but, as with all big ideas, it is about taking baby steps. We are making progress.”