By Aneesh Prabhu
While Europe has seen profitability and investor interest increase significantly over recent years, its U.S. counterpart has yet to provide an economic case. With an ocean between them, yet similar goals, how exactly do their approaches differ?
To date, offshore wind has been a largely European endeavor, with the region accounting for roughly 80 percent of the world’s offshore capacity at the end of 2018. Large European utilities dominate the offshore market, providing an important advantage with regard to project and supply chain management. In stark contrast, the U.S. currently has only one offshore wind farm in operation. Additionally, offshore has yet to demonstrate its profitability on this side of the Atlantic. This could be about to change, however, thanks to increasing investor interest that suggest sector growth is in the cards.
From strength to strength
While offshore wind still accounts for just 1 percent of the European energy mix – amounting to 20GW installed by the end of 2019 – the past decade has seen significant growth. Favorable pricing mechanisms, lower costs of capital, and excellent operator execution have kept costs markedly low, while significant increases in capacity are on the horizon. Recently updated national energy policies and government commitments, across several different countries, reveal a total of 90GW in planned offshore capacity in Europe – with the lion’s share coming from the U.K and Germany.
Of course, European power prices have declined dramatically in 2020, as the coronavirus lockdown and a historically mild winter came together to reduce power demand. Though the pandemic has dampened demand as we head towards a global recession, offshore wind is, so far, proving resilient from a credit perspective. The big European players have all seen their credit ratings affirmed, with extra support from the EU’s commitment to a greener COVID-19 recovery (via the European Green Deal).
It’s not all good news for offshore developers, though. Traditionally, projects have been supported by feed-in tariffs or other supporting pricing mechanisms, leading to enviable equity returns. Nevertheless, as the technology matures and costs fall, governments are adopting more advanced, market-based ways of supporting development. It has now become commonplace to award contracts for offshore-wind projects through reverse auctions in which bidders compete by accepting lower subsidies. So, while the evolving situation may ultimately lead to the end of double-digit returns in the sector, the development of cheaper and more efficient technology will see the sector continue to move forward.
U.S. still catching up
On the other side of the pond, the economics are less favorable. The infrastructure-related risks of venturing into deeper waters are considerable. But they are not the only obstacles; levelized costs of energy (LCOE) remain significantly higher for offshore than for competing renewables technologies, and lack of a track-record means operations and maintenance (O&M) costs remain significantly higher than they do in Europe.
Yet investor interest in U.S. offshore has grown. Certainly, the aggregate pipeline of more than 26 GW in offshore wind capacity in federal lease areas has given impetus to investors, with a boost from the potential for further cost declines. According to the International Energy Agency (IEA), global average overnight capital costs (including transmission) are projected to decline to US$2,500/kW by 2030, from US$4,350/kW in 2018. Roughly half of the savings will come from efficiency gains achieved through fewer and larger turbines. Efficiency gains are contributing to offshore wind’s claim to being more reliable than other renewable sources. Offshore wind already enjoys higher capacity factors than its onshore equivalent, and more stable hourly variability when compared to solar power.
There are overlaps, too, between existing onshore and offshore infrastructure that have the potential to drive costs down. As such, it’s unsurprising that some oil majors are also offshore wind developers. The IEA estimates that about 40 percent of full lifetime costs of an offshore wind project have synergies with the oil and gas sector.
Offshore wind is making waves on both sides of the Atlantic. Although the U.S. is clearly lagging behind its European counterpart, the challenges facing global power markets – whether from the pandemic or from volatile prices – could very well give added impetus to the energy transition. While Europe looks to make offshore wind a key component of its energy mix, it’s still unknown whether the U.S. can surmount the considerable challenges that currently render offshore uneconomical against alternative sources.
Aneesh Prabhu is Senior Director, Infrastructure North America for S&P Global Ratings, a credit rating agency that publishes financial research and analysis on stocks, bonds, and commodities.