Alternative Energy: How offshore wind farms can come out of the doldrums

An energy business recently touted as the next big thing hits a wall, with projects getting canceled, major developers pulling out, and investors questioning whether it will ever turn a profit.

That might sound like a description of the offshore wind industry in 2023. Turbine farms being built by Iberdrola SA, Orsted A/S and Vattenfall AB were all canceled last week as rising costs buffet the industry. Yet it’s equally applicable to the US shale petroleum sector three years ago, when it was on the brink of emerging from a decade of red ink to its current lucrative state.

There’s a lesson for renewables in the way an upstart fossil fuel sector cycled from boom, to bust, to maturity. All shale needed to do to solve its profitability problem was to move away from a phase of explosive growth with every cent of earnings spent on new investment. A similar stage in offshore wind’s evolution may be just around the corner. The main challenge for governments will be making sure that incumbents, currently in a state of crisis, don’t get too comfortable as they adapt to the new environment.

Right now, an industry built to harness the turbulent conditions of the high seas is being hit by a perfect storm. The global pulse of post-pandemic inflation has seen equipment costs for blades, turbines, switchgear, transmission cables and foundations rise after years of decline.

Central banks, looking to quell such price rises, have put up interest rates, making wind projects still more expensive. Expenditure on fuel-free renewables is all incurred upfront, meaning such generation is highly exposed to the price of debt: One study last month estimated that a 3.2 percentage point increase in the cost of capital would raise the price of German offshore wind by 26 percent.

On top of that, the most important investors in the sector have been reconsidering their allocations. Thanks to the high cost and complexity of offshore wind, many of its biggest developers have been oil and gas companies and utilities able to finance giant projects, rather than smaller-scale specialists. With petroleum companies refocusing on their higher-return core businesses and utilities hit by ill-considered windfall taxes, the pool of cash available has shrunk.

The good news is that some of these problems are already fixing themselves. Equipment prices are easing for the first time in several years, with the average cost of new orders to manufacturer Vestas Wind Systems A/S slumping 23 percent in the first quarter to $877,990 per megawatt. The interest-rate cycle appears to be peaking, too, meaning capital costs may switch from a headwind for developers into a tailwind, with cheaper funds opening up scope for profitable refinancing.

The danger is that a more comfortable offshore sector is a smaller one. Wind is already falling behind a booming solar industry. Further stagnation could be fatal for plans to decarbonise grids: Offshore wind’s high productivity will only become more valuable as renewables take up a larger share of generation. More investment will also be needed to make floating turbines in deeper waters a reality, extending wind’s reach from a handful of locations in Europe, China and North America to areas such as Southeast Asia.

Some modest reforms pioneered in Europe should be applied more broadly. Germany this month saw highly competitive bidding in a seabed auction, with units of BP Plc and TotalEnergies SE paying €12.6 billion ($13.9 billion) for the rights to develop 7 gigawatts of unsubsidised sites. That’s the highest per-megawatt price ever paid for offshore development, according to BloombergNEF.

Characteristics of Germany’s regulation may have made the tender more attractive, based on analysis by BloombergNEF’s Chelsea Jean-Michel. Transmission costs from site to shore are borne by the grid operator, a contrast with the US and UK where the developer pays. That gives certainty to bidders and avoids duplication of one of the most costly pieces of equipment.

The revenue structure also helps, with developers in Germany being allowed to spread their payments over the life of a project rather than having to pay every cent upfront. That means projects that will be producing electricity for decades don’t need to be benchmarked against 2023’s elevated cost of finance.

Streamlined permitting will also help. Construction typically only takes up about two years of the average nine-year development period for offshore wind, according to the Global Wind Energy Council. Most of the remainder is spent mired in red tape. Changes on that front are already under way in Europe and the US.

The last change that’s needed is to diversify the investment pool to unleash more animal spirits. Infrastructure funds have done well weathering the storm of rising rates. If more of them can be persuaded to buy the debt and equity in established offshore projects from developers and banks, that will free up significant funds for new generation. A period of easing rates is precisely when such transactions will look most attractive.

Things appear dark for the world’s offshore industry right now. Dawn may be just around the corner.

David Fickling is a Bloomberg Opinion columnist covering commodities, as well as industrial and consumer companies. Views are personal, and do not represent the stand of this publication.