The growth of the offshore wind sector has become an increasingly well-known industrial success story. Its massive expansion has driven rapid the development of technology and supply chain competition and as a result the industry has delivered spectacular cost savings, with its levelised cost of energy having halved in the last four years. As costs have fallen, governments have moved to reduce support for the sector, leading to more than 2.5GW of zero-subsidy capacity – where projects will sell their electricity at the wholesale price – now having been bid into European offshore markets.
But now comes the inconvenient truth. Zero-subsidy tenders remove that security the industry has grown up with and expose it to the full variability and merchant risk of the open market. To continue growing, offshore wind needs to figure out how to attract finance in a subsidy-free world. And with the first zero-subsidy project, Hollandse Kust Zuid in the Netherlands, due to be built by 2022, this remains very much an open question.
Probably the most common solution will be the corporate power purchase agreement (PPAs). PPAs are already familiar in the industry, with well over 5GW of wind power bought to-date in Europe by corporates , according to figures from industry advocacy body WindEurope. Yet, in a zero-subsidy world, the PPA must evolve to provide the bankability necessary for investor confidence in project finance. To set the level of a PPA in the first place however, a consensus on future power price evolution is needed. This will have to take in considerations including whether a PPA will run for the project’s lifetime, as it ideally would, and how to manage the fact that current low wholesale prices and the long-term impact of the low marginal cost of renewables will increase pressure on PPA pricing levels.
Current PPAs are typically short- to medium-term arrangements, lasting perhaps anywhere from 2-15 years. Without subsidies, PPAs will need to run for the project’s lifetime – 25-30 years or more. Forecasting wholesale power prices is a complicated business and depends on a huge number of influencing factors. Today’s indexed PPAs may be very good instruments in these volatile and uncertain environments. Yet future market dynamics – influenced by the advent of new technologies, the impact of government policies, trends in demand for energy, and so on – will likely be correlated with the renewable energy production generated. And as weather risks are correlated across the system, individual renewable projects in the future will not be regarded as purely price-following.
So, the dynamics need to be included in a smarter way, while considering profile factor – such as the price difference between average market price and asset capture price – and imbalance risk. Long-term PPAs need more fundamental market analysis. Negotiating such long-term agreements will be more complex and require more effort and expertise than developers and buyers are used to deploying. However, as the PPA model matures, we can expect to see today’s case-by-case discussions replaced by more standardised terms.
Even with the remarkable cost reduction seen to-date, zero-subsidy projects won’t be a universal phenomenon – at least not yet. They can only be viable where there are good wind resources and where projects can be developed, built and operated cheaply. The success of early subsidy-free projects will depend on advantageous market conditions, such as government-funded development of sites and transmission structure, as is the case in the Netherlands, and, critically, the development of a strong local supply chain. Competition will also play a key role by encouraging the innovation and new technologies that make further cost reductions possible.
For these reasons, as offshore wind continues to expand around the world, different regions will move towards low- and zero-subsidy projects at different speeds. It is natural that investors will favour those regions that still offer subsidies to minimise their risk. To maintain growth in mature zero-subsidy markets, the regional offshore wind industry must do all it can to reassure financiers that they can still guarantee a good return on investment without subsidies. That means ensuring the transition to zero-subsidy moves forward at a pace the finance world is comfortable with and that mature, fit-for-purpose PPAs are in place.
· Simon Cox is DNV GL - Energy’s UK offshore head of section. DNV GL’srecent report, Offshore Wind: the Power to Progress, can be downloaded here.