Lessons from the early years of offshore wind in Europe
As I keep on being extremely busy at work and with little time for blogging, the only thing I can find the time to write about is precisely what I'm working on, namely offshore wind and its financing. There was a conference on the subject last week in Atlantic City which I attended, and which generated a lot of attention (with over 1,500 attendees) and during which the federal lease for Cape Wind was signed.
While no turbine has been built in the US yet, there are high hopes that there will be some in the near future, and one of the ways to make that happen faster is to absorb the lessons from the European experience, where close to 2,500 MW have been built already. So here's my take on what can be usefully learnt.
Part of my series on Wind Power with the usual disclosure that my work (as an independent consultant) is to advise offshore wind projects find debt financing.
the regulatory process drives everything
As a new, capital-intensive industry requiring specific support to be economically attractive to private investors, offshore wind requires an unusual level of regulatory effort to work:
While offshore is more expensive than onshore, on a per MWh basis, it does have other advantages (proximity to load centers, availability following demand curves more closely) which do not make its cost overwhelmingly higher. However, as a capital-intensive industry requiring minimum price levels over a very long period, it is (i) poorly suited to market-pricing mechanisms based on short term marginal costs and (ii) unusually sensitive to the cost of financing (see my article on the cost of wind, the price of wind, the value of wind).
The regulatory framework should thus focus on providing as much stability and certainty on prices, as well as access to the grid, in order to ensure the availability of long term funding at competitive pricing. In that context, support in the form of early investment grants (to support the cost of the grid connection, for instance) or cheaper funding, have a disproportionate impact on overall cost;
Experience in this sector and others show that the simplest and cheapest way to get a working support regime is what's called "feed-in tariffs" which provide a guaranteed access to the grid and a fixed price to wind producers, but that route is seen as too "dirigiste" in the US, and indirect (and cumbersome) routes like PTCs (tax credits) or RPSs (renewable portfolio standards, obliging regulated utilities to purchase power from renewable sources) have been used in the US. And, as they go through direct subsidies (tax credits) or power purchase agreements with apparently high prices, they are also politically contentious, so progress on that front has been slow;
As a new industry, offshore wind can require the input of many regulators, most of which have little or no experience with the potential issues associated with it. A centralised administrative process, where one public body takes overall responsibility for all permitting issues, and defines a comprehensive, but unique, process to follow, makes a huge difference.
The two countries with the biggest pipeline (the UK and Germany) now both have a single body in charge of offshore wind permitting (The Crown Estate in the UK, the BSH in Germany). This allows developers to have a better grasp of the time required to get to a permitted project, as well as a better estimate of the likely cost of that process;
If the goal is to develop an industrial supply chain, these requirements are especially important: manufacturers will commit to industrial facilities in a given market only if they see a reasonable probability that there will be stable or increasing demand for their products over several years. That means that more than a handful of projects need to make it out of the permitting process in the timeframe considered, which in turn requires that the economics are seen to work for several years in a row, and that enough projects can be expected to successfully complete the development and regulatory work. While any individual project can be hampered by a variety of internal and external factors, the likelihood of a pipeline of projects depends almost exclusively on the perceived solidity of the regulatory framework.
This has been the biggest obstacle in the US: the instability created by the PTC mechanism, which needs to be extended every year or couple of years, is well documented and has led to under-investment in US factories by manufacturers, who fear that the market will disappear on them every now on them (as is happening - again - this year);
Europe's early offshore wind projects were relatively small investments for the power industry (even if, at the time, they represented large projects for the wind industry itself) and they were built using barely adapted onshore turbines, and vessels borrowed from the marine industry on a one-off basis. Wind developers also underestimated the complexity of project management. This led to inadequate equipment, serious delays in the case of construction incidents (as there was no substitute equipment immediately available), sub-par performance of some turbines (which had to be expensively retro-fitted) and significant bills for some players.
Thankfully, these wind farms also helped the industry learn many important lessons about how to do and how not to do things, and in particular how to reduce costs through the use of specialised vessels, better designed turbines, and improved construction coordination and O&M methodology.
It also became obvious that there were significant economies of scale to be gained, both on an individual project basis (where 300-500MW appears to be the optimal size today to minimize construction costs per MW) and on an industry-wide basis (with vessels specialised in the installation of certain types of foundations or certain models of turbines requiring a minimum volume of construction per annum).
Utilities, initially dragged kicking and screaming into the market by political pressure (to appear to be doing something abut climate change) are finding that multi-hundred megawatt offshore wind farms with relatively stable and predictable output are actually the kind of power plants that they like: with their size and construction risks, they are better placed than independent developers to manage the investment, while their output, in addition to fulfilling requirements to decarbonize their generation base on a scale that matters, usefully fits into their market needs and additional provides a very stable, if lowish, return on investment.
Now that the industry has reached a critical mass in Europe, it represents a significant fraction of their investment budget and it ensures that they also begin to make sure that the industrial supply chain is available in the medium and long term. Their presence also makes it quite likely that increasing improvements in operating costs will be wringed out as procedures are improved on a continued basis and on the requisite scale. In other words, having the utilities on board as willing investors makes it possible to reach the "critical mass" needed to ensure the future stability and growth of the industry.
In the US, it's not obvious yet how that scale effect will be reached, especially if individual states race against each other to win factories rather than work together to build an industry. This is an ongoing process, and the industry will not take off if this is not resolved.
offshore costs are now understood and can only go down
In Europe, the recent buildup of offshore wind has taken place at the same time as a furious debate was raging (and is continuing) on the opportunity to extend or relaunch the nuclear power industry, in the context of a slow phasing out of the coal-fired sector, and a developing gas-fired sector.
Worries about declining domestic supplies and political risks associated with Russian or other external suppliers have added political impetus to seek alternatives, and while the debate on nuclear plants is still largely inconclusive, with no expectations of construction of more than a few reactors in the coming decade, offshore wind has quickly come of age in the meantime. Current regulations provide a firm cap to the price of offshore wind electricity (a long term option which governments, acting in the public interest, can find more valuable than private players), and the build up of the industry promises to deliver a slow but steady reduction in generation costs (indeed, Germany's regulatory framework includes a regular decrease in the tariff offered to future offshore wind projects from 2015 onwards). With economics proven by current projects, and a scale sufficient to replace a good fraction of the existing coal plants, offshore wind is fast becoming a key building block of the European power sector, which further ensures that the supply chain can be built and scaled up for the long term, and it is seen as a reasonable cost route.
While many have expressed worries about the fact that the cost of offshore wind has pretty much doubled over the past 5 years, this can be discounted for several reasons:
- prices were driven up by the cost of commodities (steel, in particular, for offshore wind); this applied equally to other technologies, which have seen their prices move in the same direction even more for the same reason;
- prices in the biggest market for offshore today, the UK, were driven up by the collapse of the pound against the euro, as most turbine components were imported from Denmark and Germany;
- prices were also pushed up by turbine (and other sub-component) shortages in the onshore market; this was a sellers' market and prices (rather than costs) went up accordingly. Today, with onshore demand much weaker, prices are tumbling down for many components of the turbines. To a good extent, these cycles are linked to regulatory hiccups (the uncertainty over the US support for wind led manufacturers to under-invest in fear that the market would collapse once again; its collapse in 2009 following the bankruptcy of major players providing funding duly led to fewer orders, empty factories and lower prices).
jobs, jobs, jobs
Offshore wind, on the necessary scale, provides the kind of jobs that are currently craved for: typically requiring competences which already exist in industries long in decline and/or hard hit by the recent crisis (metal work, shipbuilding, mechanical and electrical manufacturing and assembly, civil works), it provides job which are structurally difficult to send elsewhere (the size of the turbines and associated equipment means that they need to be manufactured near their sites of use, as transporting them is difficult and costly; installation, operations and maintenance can naturally only be done locally).
The industry requires a large sub-contractor ecosystem to support it and its inherent complexity, and the need for very high quality equipment to withstand the tough maritime environment ensures that it creates high-quality decently paid jobs which cannot be offshored to low cost suppliers (the experience of some suppliers in subcontracting part of the work to China, getting subpar components, and needing to bear significant cost burdens to rectify the situation is well known in the industry), and most of the jobs created today are in high-wage high-tax Germany and Denmark, thanks to their early and long term policy efforts to launch and sustain the industry.
Altogether, the industry is rapidly becoming a major industrial sector of its own, spanning activities like steel bashing, mechanical and electrical manufacturing, shipbuilding, marine works and all the associated services. It is rapidly transforming from an experimental sub-sector into one of the largest infrastructure building activities in Europe, with a soon-to-be-macro impact on energy geopolitics.