With the Scottish Government’s target to generate 31% of Scotland’s electricity demand from renewable sources by 2011 and 50% by 2020, there will be many opportunities to capitalise on the oil&gas industry’s offshore experience.
The European Commission has demonstrated strong policy leadership to commit the EU27 members to produce 20% of their energy needs from renewable energy sources by 2020.
Given that renewables meet 7% of EU energy needs today across the heat, transport and power sectors, and that both the heat and transport sectors have limited scope to meet their 20% target by 2020, the renewable energy power sector is expected to deliver a significant proportion of these targets.
Offshore wind power generation, which offers the largest potential for scale deployment, is expected to be the main contributor to these targets, under supportive national energy policies.
Some 60GW (gigawatts) of new production capacity is due to be rolled out across the North Sea over the next decade or so. With the Crown Estate’s Round Three announcement of early-January 2010, the UK has now put in place the most ambitious offshore wind programme in the world, alongside Germany.
Some 75GW of new generation capacity is envisaged across these two markets alone.
The scale of this infrastructure deployment – often compared with that of the oil&gas sector in the North Sea – feels biblical when assessed from the perspective of what is, by and large, a maturing manufacturing and service sector.
But is it realistic to expect, as the European Wind Energy Association suggests, that offshore wind could ultimately satisfy 10% of European power demand, given the challenges ahead?
In 2009, Ernst & Young conducted an analysis of the economics of offshore wind projects for the Department of Energy and Climate Change (DECC) in the UK.
That analysis concluded that costs had significantly increased in recent years (actually, they doubled over a five-year period) for a number of reasons.
These include an increase in the price of raw materials needed in the fabrication of the turbines (such as steel, copper) and a significant increase in the pricing of the supply of equipment and construction services in a maturing market characterised by a tight supply chain. Some argue it is more akin to a monopolistic environment.
More recently, project economics have been further affected by a poor pound-euro exchange rate (80% or so of capital costs are euro denominated).
As a consequence, the Department of Energy and Climate has had no choice but to drive a revision of the regulatory support for offshore wind, allowing it to benefit from twice as much support as onshore wind for projects commissioned by April 2014.
The Ernst & Young analysis indicated that project returns could now be expected to generate returns in the region of 10-12%; arguably, just enough to attract the construction finance required to deliver this infrastructure.
It will be of no surprise to most that constructing and operating infrastructure assets at sea is challenging. Experience to date has demonstrated that construction costs and timetables have often been underestimated and that availability issues with turbine technology and foundation engineering remain. In practice, reliability issues occur more often at times of bad weather, when access is an issue.
A great deal of work is currently being undertaken by the sector to understand these risks and to develop solutions to mitigate them in a cost-efficient manner. This will be critical to provide investors with the right risk/reward profile, and thus access to capital.
In confirming its support for the offshore wind sector, the UK Government has demonstrated strong political leadership and sent a positive signal to the private sector.
This has already borne fruit, with some 1,000MW (megawatts) due to be under construction in the UK in 2010 – nearly twice as much as was built in 2009 – all financed on the balance sheet of large utilities and other oil&gas majors.
Significant investments have been made in the supply chain. It is often seen as a growth area for the North Sea oil&gas industry, which can leverage skills and expertise which current offshore wind developers might lack.
A number of private-equity houses have spotted opportunities in the financing of cable and construction vessels; others are intensively looking at service companies specialising in the provision of operation and maintenance services.
This signals that growth capital is available to entrepreneurs seeking to exploit such opportunities.
Centrica’s refinancing of the Boreas portfolio, announced early-November 2009, is a very significant and encouraging milestone for the sector, demonstrating appetite from both project-finance debt providers and infrastructure funds for investments in an operating portfolio – a first in the UK.
Going forward, this means an increasing awareness and understanding by credit committees to deal with and structure funding around long-term warranty and assurances, possibly drawing on existing oil&gas experience.
In addition, the industry has seen, and continues to expect, a great deal of support from the European Investment Bank, which can facilitate the financing of such projects.
Securing capital is now a key priority for the sector; for those who need it, this will require a great deal of professionalism, entrepreneurship and innovation. For those who are interested in investing, it will require a good understanding of the sector, and its risks and value drivers.
Financial institutions (banks and other infra players) need to spend time to understand the market, assess the risks and opportunities, and play their role in delivering this infrastructure.
Technology and service providers need to improve the reliability, contractual terms and pricing of their solutions to ensure their bankability. Only then can this great potential be unlocked.
Arnaud Bouillé is director in Ernst & Young’s energy and environmental infrastructure advisory team
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