Offshore optimism after stormy year

In hindsight, 2013 is likely to be viewed as a key year for offshore wind.

Developers, suppliers and investors have shown strong commitment to the sector, not least in the leading markets, the UK and Germany.

Four large projects came on line off the English coast. Greater Gabbard, Gunfleet Sands 3, Sheringham Shoal and the world’s biggest offshore wind farm, the 630MW London Array, took national installed capacity from 1.86GW to 3.32GW. They have helped cement Britain’s position as a world leader in offshore wind, which is attracting investment from a widening group of participants.

With continued government support, the UK is likely to remain the largest offshore wind producer for the foreseeable future.

On the other side of the North Sea, Germany was no laggard either. The 288MW Butendiek reached financial close in 2013, with Siemens Financial Services, the Marguerite Fund and two Danish pension funds investing equity along with the developer, WPD. Equity and debt financing amounted to €1.3bn ($2.12bn).

That said, German offshore has been hampered by changing political attitudes, as well as a failure to connect wind farms to the grid on schedule and a number of developer bankruptcies. Nonetheless, significant progress is being made with planned projects such as Dong Energy’s Gode Wind 1 and 2.

The challenges the sector faced in 2013, especially in Germany, are unlikely to disappear. Germany’s nervousness is due to the need to rebalance its energy system as it abandons nuclear. In Europe’s biggest economy, this presents complex challenges and will take time.

The UK’s Electricity Market Reform proposals, published in July, initially heightened investor uncertainty. The proposals involved changing the pricing mechanism from the Renewables Obligation Contract system to Contract for Difference, to improve transparency and fair price-setting. This led to concerns that the suggested level of the “strike price” could deter future investment.

Furthermore, RWE pulled the plug on its 1.2GW, £4bn ($6.52bn) Atlantic Array off southwest England in November, causing alarm among investors and the supply chain. ScottishPower Renewables then announced that it was walking away from the Argyll Array, a development of up to 1.8GW. However, the UK government heeded the industry’s call for more financial support and raised the strike price, sending positive signals to potential investors that backing for offshore wind was firm. This sort of recognition of the industry’s successes and potential is essential to build investor confidence.

Three models have been established for financing offshore projects.

The first is the utility equity model, in which the utility finances the project entirely on its balance sheet. Until recently, offshore wind was mainly funded in this manner.

Then there’s the developer model, used most successfully by Dong. The company develops, builds and finances a project itself, thereby retaining the construction risk, before selling a minority stake to institutional investors.

In the project finance/developer model, construction risks are passed to commercial bank lenders. This third model offers the most potential for bringing the required liquidity to the sector, perhaps mixed with the expansion of institutional appetite for debt and equity investments. That said, if we are to see a significant increase in the number of large offshore projects, bank financing capacity may eventually become constrained.

These debt capacity concerns are most acute in funding the construction phase, meaning the industry will have to develop structures that appeal to other investor classes, such as institutional investors, to attract capital. Fortunately, that is what appears to be happening as bank lending and institutional investor confidence are rising. There is optimism and willingness to continue investing, thanks in part to a better understanding of the risks, as well as the greater political commitment.

Despite the choppy waters of 2013, the industry weathered the storms, producing several notable success stories. With the UK’s renewed commitment to offshore, the industry can look forward to a year of building momentum for a technology that is likely to become the leading renewables sector in the energy mix.

Kirk Edelman is head of energy finance at Siemens Financial Services

This piece was published as part of the Thought Leaders series. Recharge’s Thought Leaders Club brings together leading thinkers and participants from the renewable-energy sector to examine the key challenges facing our industry