Three of the four winning bids in the recent German offshore wind auction for projects coming on line in 2025 were for subsidy-free power, rejecting even the comfort of a minimum reference price (MRP). By contracting to deliver energy without any MRP, the wind farm developers must be expecting to make a better return from the wholesale market price than they could under a subsidy regime.

The developers must have calculated that their levelised cost of energy (LCOE) from the projects will be considerably less than their forecasts of wholesale electricity price in Germany from 2025 onwards. This strategy means that the developer teams forecasting future market prices will have at least equal billing with those forecasting technology and LCOE. Here at BVG Associates, we have calculated the LCOE of these wind farms, taking into account their characteristics, our own expectations of technology and costs from 2025, published information and statements from the winning bidders Dong Energy and EnBW. The key site characteristics are:

30-40-metre water depths
Average wind speeds of 10.7-11.5 metres per second
70-115km distances to port
5-16km distances to grid connection at an offshore hub
30-year project lifetime
13MW turbines

The use of much larger turbines (13MW or more) was implied by both bidders. This is in line with our expectations that such technology will just be coming available by the time these projects are being built.

Treating the two neighbouring Dong sites (OWP West and Borkum Rifgrund 2 West) as a single site, we calculate that an average LCOE (in today’s terms) of just over €51 ($55.60) per MWh would generate a 6% project return rate (real, pre-tax weighted average cost of capital)).

Our calculations suggest that if the generated electricity were to be sold at an average price just under €31/MWh, the project return rate will be 0%. If it could be sold at €60/MWh (our estimate of the LCOE including carbon pricing of combined-cycle gas generation — the likely lowest available option for new non-renewable generation), then returns increase to 8%.

Relying solely on market prices does pose some particular problems for wind-powered electricity generation. At times of higher wind, the supply of electricity increases, reducing the market price (as demand is largely unaffected by wind speed). Indeed, in the current market in Germany, we have seen instances of electricity prices turning negative for short periods in 2015, 2016 and 2017. Storage and interconnection can mitigate these effects, but even so, it is likely that to be competitive, offshore wind farms will have to achieve an LCOE of significantly below €60/MWh.

The refusal of a government-backed MRP does appear to make the commercial viability of these wind farms, as standalone projects, riskier. The time horizon for them to come on line further complicates that risk. Those risks and timescales present an interesting dilemma for all stakeholders in this project. If they turn out to be optimistic on LCOE and/or overly pessimistic on the wholesale price, will the developers still want to proceed with a potentially loss-making project? In the converse situation, will consumers and governments accept what could look like excessive profiteering?

Of course, as electricity suppliers with other generating and energy-storage assets in their portfolios, both Dong and EnBW are taking a wider view of their supply mix and could be using wind to hedge against higher-than-expected future prices of natural gas and CO_2.

The German results also present the wider industry with a dilemma. On one hand, the results represent a huge step forward as offshore wind is now apparently cost-competitive on the open market, paving the way for a booming pipeline of activity. On the other hand, projects with less benign oceanography, legislative and market conditions might see subsidies vastly reduced as authorities use the German example as their benchmark, effectively destroying growth.

Overall, these results add an unwelcome ambiguity to an already complex picture, especially as this auction process is only an interim system for this year and next.

A combination of contracts for difference — in which the project owner receives a set price for energy, with the government topping up the market price when necessary — and a project completion date within five years of the auction would seem a better way forward. This would give the industry a less risky profile, consumers more security over prices and governments more confidence in likely supply.

Giles Hundelby is a director of UK-based renewable-energy consultants BVG Associates

Wind

Germany's zero-subsidy offshore wind could generate at €31/MWh: BVG