"Green" policies are destroying this country
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Big Read: Ill wind of inflation is blowing through the offshore energy sector
With major projects being scrapped and others becoming unviable, the offshore wind energy sector is at crisis point
- LORCAN ALLEN 01:00
Between 2010 and 2021, offshore wind development costs plunged 60 per cent but now a surge in financing costs has seen developers back out of contracts
Mads Nipper is long enough working in the energy sector to know the signs when storm clouds are gathering on the horizon.
Unfortunately for the chief executive of Orsted, the Danish offshore renewable energy giant, the current storm building won’t help generate cheap, clean wind energy.
Instead, Nipper is facing a desperate fight to hold on to his job as Orsted grapples with a mounting crisis over the viability of its project pipeline. Last month, the energy company, which is majority-owned by the Danish state, was forced to book a €3.8 billion impairment charge after it abandoned two offshore wind farms in the US due to soaring costs.
The company, along with a raft of other energy giants, had begged the state of New York to increase subsidies for its Ocean Wind 1 and 2 projects but the proposal was turned down. Orsted said it was left with “no choice” but to stop work.
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The decision is the clearest sign to date that the offshore wind industry is at a turning point. Governments all over the world are desperately hoping wind energy can decarbonise their fossil fuel dependent systems, but the sector is flagging.
And as the world’s largest developer of these projects, Orsted is at the very centre of the crisis driven by higher interest rates pushing up the cost of capital, double-digit cost inflation and lengthy delays in the planning system.
The chief executive of Orsted Mads Nipper
Since taking over as chief executive in January 2021, Nipper has watched as shares in Orsted have plummeted by almost 80 per cent, which has resulted in an eye-watering €56 billion in shareholder equity being destroyed to leave the company with a current valuation of just over €17 billion.
In a bid to convince investors that a plan is in place, Nipper dismissed two of his most senior executives in recent weeks, but whether it’s enough to placate investors remains to be seen.
The crisis playing out at Orsted is symptomatic of some major stresses that have appeared in the global offshore wind industry over the last year, which up to recently had seen a dramatic drop in costs year after year.
Between 2010 and 2021, offshore wind development costs plunged 60 per cent fuelled by ultra low interest rates and significant advances in turbine technology. But now a surge in financing costs due to rising interest rates, along with higher prices for key materials used to build turbines, has seen a notable uptick in developers backing out of contracts or subsidy deals for offshore wind projects, mainly in the US and Britain. But pressure is mounting in other markets too.
Target
In Ireland, the government has set a target for 5,000 megawatts (MW) of offshore wind capacity to be installed by 2030.
So Eamon Ryan, the climate minister, and the rest of the government should be worried about the problems developers are running into in other countries.
“Offshore wind energy is going to struggle to hit its 2030 targets,” Kevin O’Donovan, managing director of the Irish arm of Statkraft, the Norwegian state-owned energy company, told the Business Post.
“The economics of offshore wind are certainly challenging right now. The sole focus of governments to date has been around securing the best price for the consumer in these auctions. But it can’t be just about that anymore. It has to be about projects that can deliver.”
Kevin O’Donovan: ‘The sole focus of governments to date has been around securing the best price for the consumer in these auctions’. Picture: John Allen
O’Donovan admitted that in the past “the offshore wind industry and developers probably over-committed to policymakers in terms of what they could deliver. It became a race to the bottom in a way. But everyone can now see that won’t work anymore.”
Earlier this year, four developers, including Statkraft, were successful in securing state-backed contracts in Ireland’s first-ever offshore renewable energy subsidy auction, known as O-RESS 1.
The four projects have committed to deliver over 3,000 MW of offshore wind capacity at an average price of €86 per megawatt-hour (MWhr), which was far lower than industry expectations at the time.
While the government initially lauded the auction price as a success, there is now mounting concern about the economic viability of this first phase. It also means any bids into the government’s second O-RESS auction due to take place next year will likely be significantly higher.
Peter Lefroy, head of offshore development in Ireland for RWE Renewables, the German energy giant, said his company was really pleased to win a contract in O-RESS 1 for its 834 MW capacity Dublin Array project off the coast of Dublin and Wicklow.
With the project expected to cost up to €2 billion to develop, Lefroy said inflation is a real concern in the supply chain right now.
“We’ve seen the cost of certain components increase in the order of 30 to 40 per cent. So really very significant inflation. The O-RESS 1 contracts do have indexation built into them meaning prices are linked to general inflation, so that will soften the blow. But it certainly won’t cover all of the cost inflation by any means,” he said.
“Right now, we think the inflation is manageable. We think the price we agreed is a price that is deliverable. In saying that, there’s very little fat built into those O-RESS 1 prices. The nature of the competition meant we had to work very hard to strip out costs. I don’t think any developer would say they’re in a comfortable position. These are big projects and a shift in costs by one or two percentage points can make a big difference in terms of what your margin looks like.”
Striking
What’s striking about the viability challenges mounting in the offshore wind industry is that no company is immune. All of the biggest energy companies in the world are encountering similar problems where projects that looked attractive 18 months ago are suddenly uncertain.
In Britain, which has been a world leader in offshore wind development, the most recent state support auction failed to attract a single bid from developers after the government set a price cap which equated to around £65 per MWhr (€75 per MWhr). Developers had repeatedly warned the British government in the lead-up to the auction that the price cap was far too low to offset rising costs.
Anja-Isabel Dotzenrath: ‘The way the policy works, the supply chain, the permitting, is not catching up with the growth of this sector’
Anja-Isabel Dotzenrath, executive vice-president for gas and low-carbon energy at BP, the British energy giant that has slowly begun to invest in renewables, recently described the offshore wind industry as “fundamentally broken”.
She blamed government-run auction processes for failing to keep up with changing market dynamics such as inflation, while also hitting out at the delays in the planning system for large-scale renewable energy projects.
“The way the policy works, the supply chain, the permitting, is not catching up with the growth of this sector,” Dotzenrath told an energy conference in London last month.
“There’s a fundamental reset needed,” she said.
Philip Cole, director of industrial affairs at Wind Europe, a trade association representing over 500 companies, said the supply chain is at breaking point with the constant drive for lower prices at a time when inflation is driving up raw material costs.
“I think the focus on pricing has got us to the point where, when you add in inflation and other issues, we're now starting to see some developers starting to say they’re not sure they can build this wind farm now,” he said.
To understand the viability challenges in offshore wind right now, a quick scan of the financial performance of some of the main players is quite revealing.
Siemens Energy, the German clean energy company, reported a net loss of €4.6 billion last month, primarily due to its struggling wind business, and was forced to accept a €15 billion government-backed bailout,
General Electric’s renewable energy division, a major manufacturer of turbines, is on course to report a loss of close to €1.5 billion for this year, while Vestas, the Danish turbine manufacturer, is hopeful of merely breaking even this year after posting a €1.7 billion loss in 2022.
Inflation
The recent inflation in supply chain and turbine costs is not the only challenge facing the offshore wind industry right now. Rising interest rates are also having a very significant impact in two ways. Firstly, higher rates drive up the cost of capital for developers, which again acts as a headwind against project viability.
Secondly, and perhaps more significantly, the higher rate environment has seen investor capital move away from high-risk renewable energy projects towards safe-haven investments such as government bonds.
Russell Smyth, head of KPMG Ireland’s sustainable futures team and an expert on renewable energy project finance, said the offshore wind industry is now facing significant liquidity challenges on top of everything else.
“Without question, the offshore wind industry is in a pretty depressed place right now. Until 18 months ago, there was a wall of capital looking to invest in the sector. In fact, there was more capital than there were projects. But what we’re seeing now is there’s more projects than there is capital,” he said.
He added that the biggest challenge for Ireland is that it’s competing for funds with 100 other countries that are all seeking to mobilise renewable energy capacity at the same time.
“It’s a bad time to see a liquidity shrinkage. The challenge for Ireland is that it needs to position itself and demonstrate to global investors why it should be a recipient of international capital as opposed to everywhere else,” Smyth said.
“The key piece is consistency of policy and deliverability. The O-RESS 1 auction has generally been well-received in the market. The challenge is those four projects still do not have planning consent. So the question becomes how quickly can the state mobilise the functions needed to move these projects on from where they are today to the point where they’re making a final investment decision and raising capital?”
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