The offshore wind market is becoming an increasingly attractive investment option as it grows and matures. Michael Ferguson looks at the recent project Meerwind
Offshore wind is one of the fastest growing energy sectors in Europe. Indeed, over 11,000 megawatts (MW) of capacity have already been installed. As costs come down, efficiency improves and governments seek low-carbon sources of power, this growth is unlikely to slow. It is no surprise, therefore, that offshore wind projects are gaining interest from institutional investors.
Yet the development of offshore wind farms comes with considerable risks, often distinct from those of their onshore cousins. Construction, for one, is more costly and complex, while operations and maintenance at sea are inherently risky. Wind farms rely on variables such as wind resources and technological performance to remain profitable. Furthermore, exposed to volatile power prices, investors usually demand specialised, comprehensive contracts, or subsidies, to mitigate market risks.
With many risks to consider, increasing transparency will be crucial to whetting investor appetite for offshore assets. With this in mind, we can look to S&P’s first rated offshore wind project – a 288 MW farm, known as Meerwind, off the German coast in the North Sea – to understand where the risks exist and, ultimately, how to mitigate them.
Power generation from offshore wind turbines is increasing its presence in Europe’s energy grids. In fact, in 2015 over 3,000 MW of capacity was built in Europe, and a similar amount of new capacity is expected this year. The European Wind Energy Association estimates that, in total, around 26 gigawatts (GW) of new capacity could be built over the next decade. Notably, the UK, Germany and Denmark are making great strides – responsible for roughly 46%, 30% and 12% of the current offshore market capacity respectively.
Clearly, a key driver of this increasing capacity is Europe’s growing demand for low-carbon, renewable energy, as it moves away from fossil fuel-intensive power generation. This will ultimately help to reduce greenhouse gas emissions and support countries in the global fight against climate change.
Private investors also stand to benefit from offshore wind development. With advances in turbine technology, reduced equipment costs and increased tax incentives, offshore wind is increasingly regarded as an attractive asset, which can yield stable, long-term returns. As such, we issued an investment-grade rating of BBB- with a stable outlook to the Meerwind project.
“Power generation from offshore wind turbines is increasing its presence in Europe’s energy grids. In fact, in 2015 over 3,000 MW of capacity was built in Europe”
Yet if investors are to reap the rewards of offshore wind investment, they need to be able to navigate the various inherent risks.
While Meerwind was rated post-construction, construction risk is an important risk that investors must consider in the early stages of development. This risk is considerable given the complexity associated with the building of wind farms in the open water, with hefty sums of capital demanded at the initial stages. Indeed, this is a much more challenging process than for similar assets on land.
In fact, offshore wind assets are often financed on a non-recourse project basis – meaning the lender cannot claim compensation if the project defaults. In addition, should construction of the farm stall, the value of the collateral (in this case, the wind farm’s materials and equipment) may not cover an investor’s initial loan, especially if building conditions prove to be more challenging than initially thought.
In light of such risk in the early stages, we find that project sponsors often prefer to keep offshore developments off their balance sheet until construction is complete.
Even after construction, offshore wind farms pose considerable risk to their investors – especially when compared to their onshore equivalents at the same stage. Given the remoteness of the projects, the costs of maintenance can be more significant and subject to variability.
Furthermore, to earn all revenues due on their contracts, offshore wind farms must maintain high availability, which is no small task. Operational challenges are inherently more difficult and time consuming to mitigate, but shrewd developers have found ways to offset this risk. For instance, in the case of Meerwind, its dual transformers can each transmit full capacity to the mainland, while a ‘looped cable array’ ensures single turbine failures do not become contagious.
Encouragingly, Europe’s offshore market is now maturing, meaning operational costs are stabilising. This aids us as we attempt to forecast operational expenses during the life of these projects, which can exceed twenty years.
What is more, investors can help to mitigate operational risk by looking for a strong operations and maintenance contract that guarantees power availability and protects against cost overruns. Meerwind provides a case in point, where Siemens provided security contracts that guarantee 95% power availability as part of a service contract lasting five years. The participation of Siemens is no accident – because Siemens both designed and installed the turbines, it has a huge financial and reputational stake in the project.
Of course, the performance and productivity of offshore farms relies on adequacy of wind resources, something investors must be able to properly assess before committing capital to a project. Despite a lower degree of variability in wind levels at sea (compared to inland), there is less data available regarding offshore wind farms. With less insight, the risk is higher.
As well as accounting for resource availability, investors need to understand exactly how the data is collected. By looking at measurements taken over a long period of time, from a point close to the project’s site, and at the optimum height of a turbine – known as the ‘hub height’ – investors can gain the strongest insight into the likely wind levels.
The Meerwind project, for instance, benefited from data collected over four years, at a hub height of 1km from the project site, as well as other analysis of the wider region taken over two decades. What is more, while many developers assess the average energy likely to be harnessed from a wind project over a year – using what is known as a P50 analysis – in rating Meerwind we used a more conservative one-year ‘P90’ regime, which accounts for the energy generation likely to be exceeded in 90% of years.
Getting a wind farm up and running is only half the challenge – to be a reliable asset, the power it generates must be able to compete with other energy generators and weather volatile prices.
Governments can be key to mitigating exposure to this market volatility – issuing regulation friendly to renewable power to help meet low-carbon targets. In this way, the UK, Germany and Denmark, in particular, have supported the growth of offshore assets by establishing purchase agreements or feed-in tariff subsidies. These secure revenues to investors by offering a fixed price for power generated and channelled to the grid.
For example, Meerwind secured a profitable feed-in tariff of €154 per megawatt-hour from the German government, which significantly outpaces the market power rate. With a considerable debt to pay off to investors, the project thus gained vital financial stability.
Certainly, the success of any project depends on the support of its key counterparties, from raw materials and equipment suppliers, to companies involved in construction, and those responsible for operations and maintenance. In this respect, offshore wind farms are no different.
Developers, for their part, are committed to ensuring their technology’s reliability. When evaluating Meerwind, we found the involvement of Siemens to be advantageous to the rating outcome.
Clearly, Europe’s offshore wind sector is taking great strides forward and will no doubt continue to grow. With a comprehensive awareness of the key risks – and insights into how to mitigate them – investors can tap into this growth and benefit from Europe’s offshore progress.
Michael Ferguson is a director at Standard & Poor’s
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