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lessons from the early years of offshore wind in Europe (1)

by Jerome a Paris Sun Oct 17th, 2010 at 08:52:00 AM EST

Part of my series on Wind Power with the usual disclosure that my work (as an independent consultant) is to advise offshore wind projects find debt financing.

The main lessons from the European experience may be summarized as follows:

1) the regulatory process drives everything

As a new, capital-intensive industry requiring specific support to be economically attractive to private investors,  offshore wind requires an unusual level of regulatory effort to work:

  • first, the economics need to make sense.

    While offshore is more expensive than onshore, on a per MWh basis, it does have other advantages (proximity to load centers, availability following demand curves more closely) which do not make its cost overwhelmingly higher. However, as a capital-intensive industry requiring minimum price levels over a very long period, it is (i) poorly suited to market-pricing mechanisms based on short term marginal costs and (ii) unusually sensitive to the cost of financing.

    The regulatory framework should thus focus on providing as much stability and certainty on prices, as well as access to the grid, in order to ensure the availability of long term funding at competitive pricing. In that context, support in the form of early investment grants (to support the cost of the grid connection, for instance) or cheaper funding, have a disproportionate impact on overall cost;

  • second, the permitting process needs to be understandable and stable.

    As a new industry, offshore wind can require the input of many regulators, most of which have little or no experience with the potential issues associated with it. A centralised administrative process, where one public body takes overall responsibility for all permitting issues, and defines a comprehensive, but unique, process to follow, makes a huge difference.

    The two countries with the biggest pipeline (the UK and Germany) now both have a single body in charge of offshore wind permitting (The Crown Estate in the UK, the BSH in Germany). This allow developers to have a better grasp of the time required to get to a permitted project, as well as a better estimate of the likely cost of that process;

    If the goal is to develop an industrial supply chain, these requirements are especially important: manufacturers will commit to industrial facilities in a given market only if they see a reasonable probability that there will be stable or increasing demand for their products over several years. That means that more than a handful of projects need to make it out of the permitting process in the timeframe considered, which in turn requires that the economics are seen to work for several years in a row, and that enough projects can be expected to successfully complete the development and regulatory work. While any individual project can be hampered by a variety of internal and external factors, the likelihood of a pipeline of projects depends almost exclusively on the perceived solidity of the regulatory framework.

2) scale matters

Europe's early offshore wind projects were relatively small investments for the power industry (even if, at the time, they represented large projects for the wind industry itself) and they were built using barely adapted onshore turbines, and vessels borrowed from the marine industry on a one-off basis. Wind developers also underestimated the complexity of project management. This led to inadequate equipment, serious delays in the case of construction incidents (as there was no substitute equipment immediately available), sub-par performance of some turbines (which had to be expensively retro-fitted) and significant bills for some players.

Thankfully, these wind farms also helped the industry learn many important lessons about how to do and how not to do things, and in particular how to reduce costs through the use of specialised vessels, better designed turbines, and improved construction coordination and OM methodology.

It also became obvious that there were significant economies of scale to be gained, both on an individual project basis (where 300-500MW appears to be the optimal size today to minimize construction costs per MW) and on an industry-wide basis (with vessels specialised in the installation of certain types of foundations or certain models of turbines requiring a minimum volume of construction per annum).

Utilities, initially dragged kicking and screaming into the market by political pressure (to appear to be doing something abut climate change) are finding that multi-hundred megawatt offshore wind farms with relatively stable and predictable output are actually the kind of power plants that they like: with their size and construction risks, they are better placed than independent developers to manage the investment, while their output, in addition to fulfilling requirements to decarbonize their generation base on a scale that matters, usefully fits into their market needs and additional provides a very stable, if lowish, return on investment.

Now that the industry has reached a critical mass in Europe, it represents a significant fraction of their investment budget and it ensures that they also begin to make sure that the industrial supply chain is available in the medium and long term. Their presence also makes it quite likely that increasing improvements in operating costs will be wringed out as procedures are improved on a continued basis and on the requisite scale. In other words, having the utilities on board as willing investors makes it possible to reach the "critical mass" needed to ensure the future stability and growth of the industry.

3) offshore costs are now understood and can only go down

In Europe, the recent buildup of offshore wind has taken place at the same time as a furious debate was raging (and is continuing) on the opportunity to extend or relaunch the nuclear power industry, in the context of a slow phasing out of the coal-fired sector, and a developing gas-fired sector.

Worries about declining domestic supplies and political risks associated with Russian or other external suppliers have added political impetus to seek alternatives, and while the debate on nuclear plants is still largely inconclusive, with no expectations of construction of more than a few reactors in the coming decade, offshore wind has quickly come of age in the meantime. Current regulations provide a firm cap to the price of offshore wind electricity (a long term option which governments, acting in the public interest, can find more valuable than private players), and the build up of the industry promises to deliver a slow but steady reduction in generation costs (indeed, Germany's regulatory framework includes a regular decrease in the tariff offered to future offshore wind projects from 2015 onwards). With economics proven by current projects, and a scale sufficient to replace a good fraction of the existing coal plants, offshore wind is fast becoming a key building block of the European power sector, which further ensures that the supply chain can be built and scaled up for the long term, and it is seen as a reasonable cost route.

While many have expressed worries about the fact that the cost of offshore wind has pretty much doubled over the past 5 years, this can be discounted for several reasons:

  • prices were driven up by the cost of commodities (steel, in particular, for offshore wind); this applied equally to other technologies, which have seen their prices move in the same direction for the same reason;

  • prices were also pushed up by turbine (and other sub-component) shortages in the onshore market; this was a sellers' market and prices (rather than costs) went up accordingly. Today, with onshore demand much weaker, prices are tumbling down for many components of the turbines. To a good extent, these cycles are linked to regulatory hiccups (the uncertainty over the US support for wind led manufacturers to under-invest in fear that the market would collapse once again; its collapse in 2009 following the bankruptcy of major players providing funding duly led to fewer orders, empty factories and lower prices).

4) jobs, jobs, jobs

Offshore wind, on the necessary scale, provides the kind of jobs that are currently craved for: typically requiring competences which already exist in industries long in decline and/or hard hit by the recent crisis (metal work, shipbuilding, mechanical and electrical manufacturing and assembly, civil works), it provides job which are structurally difficult to send elsewhere (the size of the turbines and associated equipment means that they need to be manufactured near their sites of use, as transporting them is difficult and costly; installation, operations and maintenance can naturally only be done locally).

The industry requires a large sub-contractor ecosystem to support it and its inherent complexity, and the need for very high quality equipment to withstand the tough maritime environment ensures that it creates high-quality decently paid jobs which cannot be offshored to low cost suppliers (the experience of some suppliers in subcontracting part of the work to China, getting subpar components, and needing to bear significant cost burdens to rectify the situation is well known in the industry), and most of the jobs created today are in high-wage high-tax Germany and Denmark, thanks to their early and long term policy efforts to launch and sustain the industry.

Altogether, the industry is rapidly becoming a major industrial sector of its own, spanning activities like steel bashing, mechanical and electrical manufacturing, shipbuilding, marine works and all the associated services. It is rapidly transforming from an experimental sub-sector into one of the largest infrastructure building activities in Europe, with a soon-to-be-macro impact on energy geopolitics.


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To what extent is taxation an issue?

"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Sun Oct 17th, 2010 at 09:14:14 AM EST
The industry is a normal one is every respect with regards to tax, except in countries where the support regime takes the form of tax credits:

  • in the US, you used to get PTCs (production tax credits) ie a tax credit a 2c/kWh linked to your actual production, which increases the value of the generation if you have tax bills you can deduct these credits from (thus the practice of bringing in tax investors which lent their tax capacity to projects - Lehman Brothers was the most active). This has been replaced now by ITCs - Investment Tax credits (same mechanism, but upfront and linked to the investment made) or by direct cash grants, ie a non tax pechanism

  • in several countries, renewable energy projects can do accelerated depreciation, ie write off the value of their investment faster than normal, leading to accounting losses which create tax losses which can be deducted from later profits;

Otherwise, the main tax item is going to be the yearly licensing fees that projects need to pay to get the right to harvest the resource.


Wind power
by Jerome a Paris (etg@eurotrib.com) on Sun Oct 17th, 2010 at 09:24:48 AM EST
[ Parent ]
Jerome a Paris:
Otherwise, the main tax item is going to be the yearly licensing fees that projects need to pay to get the right to harvest the resource.

Are these taxes production-related?

eg Enercon PartnerKonzept interests me, of course.

Yield-oriented cost structure
The costs for the ENERCON PartnerKonzept contract are based on the annual wind turbine output. The customer pays a minimum fee depending on the respective wind turbine type and a yield-oriented surcharge. This means that the customer pays more in good wind years with good yield and less in bad wind years with less output thus stabilising annual wind turbine profit.



"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Sun Oct 17th, 2010 at 09:43:18 AM EST
[ Parent ]
licenses are usually fixed amounts, but there can be taxes/levies which are proportional to production. As Enercon notes, the main difference is linked to wind levels (or, in case of poor performance, to operational failure).

O&M (operations and maintenance) agreements can be structured as flat fees (effectively linked to nominal capacity) or proportional fees (linked to actual production) or a combination of both. Payments can also be linked to "availability" (ie the percentage of time the wind turbines are actually able to produce power, irrespective of what the wind is). The main differences are linked to whether the operator (which is typically the turbine manufacturer) takes wind risk, and to what extent it takes performance risk on its own turbines.

Nothing that hasn't been done for decades in this and other industries.

Wind power

by Jerome a Paris (etg@eurotrib.com) on Sun Oct 17th, 2010 at 09:51:09 AM EST
[ Parent ]
Do you have some nice graph or sources with data to quantify the evolution of off-shore prices your describe in point 3?

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Sun Oct 17th, 2010 at 10:45:33 AM EST

From the recent report by UKERC (see the "launch presentation" link)

Note that GBP costs look worse because of the fall in the GBP/EUR rate 2 years ago, as most of the costs for offshore are denominated in EUR (or DKK, basically the same thing)

Wind power

by Jerome a Paris (etg@eurotrib.com) on Sun Oct 17th, 2010 at 10:53:09 AM EST
[ Parent ]

So wind power prices have actually increased substantially less than that of other sources

Wind power

by Jerome a Paris (etg@eurotrib.com) on Sun Oct 17th, 2010 at 10:55:45 AM EST
[ Parent ]
Is this supposed to be a measure of production or capacity?

I'm imagining that it's the former, but......

I'm puzzled why the cost of coal fired power increased so rapidly, while combined cycle gas turbine (CCGT?) didn't?

Does this include some sort of carbon tax in the calculation?

And I'll give my consent to any government that does not deny a man a living wage-Billy Bragg

by ManfromMiddletown (manfrommiddletown at lycos dot com) on Sun Oct 17th, 2010 at 12:17:09 PM EST
[ Parent ]
The first graph (showing CAPEX = capital expenditure) is capacity, the second production. The second apparently has its origin in this Mott McDonald report, where it's clear that the cost boost arose at the EPC (engineering, procurement and construction) level. They say that the reason must be that coal power plant production is more capital and materials intensive than gas, and there were also a production bottlenecks.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Sun Oct 17th, 2010 at 12:58:25 PM EST
[ Parent ]
that the increased prices for gas-fired power and cial-fired power include higher assumptions for future prices of both gas and coal.

Wind power
by Jerome a Paris (etg@eurotrib.com) on Sun Oct 17th, 2010 at 01:04:41 PM EST
[ Parent ]
Looking at the appendixes starting on page 78 that appears to be the case.

At least with pricing carbon capture investments.  In terms of infrastructure to actually sequester the carbon, not a carbon tax.....

I'm not so sure that they've brought fuel costs into the analysis.

As you pointed out someplace else (forgot where) part of the beauty of wind farms is that the long term fuel cost is locked in, because its free.  No price volatility.

One of the things that I've noted looking at European vs US electricity markets is that there's less of a spread between residential and industrial rates.

I wonder how that plays into the expansion of the industry.

If industrial users are guaranteed a lower rate that means that they have less incentive to seek out deals that allow them to lock in costs in the long term.

And I'll give my consent to any government that does not deny a man a living wage-Billy Bragg

by ManfromMiddletown (manfrommiddletown at lycos dot com) on Sun Oct 17th, 2010 at 01:25:53 PM EST
[ Parent ]
Ooh.  Neat site

There's quite a spread as far as industrial electric prices relative to residential rates.



And I'll give my consent to any government that does not deny a man a living wage-Billy Bragg

by ManfromMiddletown (manfrommiddletown at lycos dot com) on Sun Oct 17th, 2010 at 01:44:55 PM EST
[ Parent ]
Yes, they say so on pages 56-57 (73-74 in the pdf), but even in the high case, they expect coal well below the 2008 prices. EPC prices however tripled, check diagrams on page 10 (pdf 27) and the text on the following pages.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Sun Oct 17th, 2010 at 01:33:05 PM EST
[ Parent ]
A belated thanks for those; and do you perhaps have something similar for Germany? (It would be an interesting comparison with feed-in rates.)

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Sun Oct 17th, 2010 at 01:40:48 PM EST
[ Parent ]
on dKos (including comments on the US situation)

Wind power
by Jerome a Paris (etg@eurotrib.com) on Sun Oct 17th, 2010 at 11:47:38 AM EST
... that's to say the Energy Return on Energy Invested in offshore wind and the associated changes to the grid network?  Has anyone being doing the energy accounting in parallel with the financial accounting?

A very informative post - thank you.

by Pope Epopt on Tue Oct 19th, 2010 at 09:00:37 AM EST
On a drive through the midwest to Chicago I came upon a large number of windmills near Lafayette in Indiana.  I don't remember them from my trip last year, though I can't swear that I took the same route.  Nice to see them there in the midwest.

"I said, 'Wait a minute, Chester, You know I'm a peaceful man...'" Robbie Robertson
by NearlyNormal on Wed Oct 20th, 2010 at 06:58:43 PM EST
Those windmills in Indiana have aviation warning lights on their tops that flash at night in spookily synchronized fashion.
by asdf on Wed Oct 20th, 2010 at 11:53:28 PM EST
[ Parent ]
Did you drive up US-52 to Chicago to avoid the traffic?  

There's a large wind farm in Benton county northwest of Lafayette, near the city of Fowler.

They've been there since the summer of 2008. I saw them on the way to Chicago for a conference in the spring of 2009.  Fowler Ridge Wind Farm is the fifth largest in the country.  

That area has a good wind resource, and the line to take the power out of state.

Indiana still lacks a feed in tariff or renewables mandate.  For the moment, this power is going out of state where those do exist.

And I'll give my consent to any government that does not deny a man a living wage-Billy Bragg

by ManfromMiddletown (manfrommiddletown at lycos dot com) on Thu Oct 21st, 2010 at 01:19:54 PM EST
[ Parent ]
I just drive West on 26 from Fairmount to Lafayette then go north.  Sometimes I get bored and take off cross country through the backroads.

"I said, 'Wait a minute, Chester, You know I'm a peaceful man...'" Robbie Robertson
by NearlyNormal on Thu Oct 21st, 2010 at 05:44:59 PM EST
[ Parent ]
I always found that the 69-465-65 route was the easiest. A good 30 minutes quicker than going crosscountry on 26. Of course I always did about 80-85mph on the highway.

And I'll give my consent to any government that does not deny a man a living wage-Billy Bragg
by ManfromMiddletown (manfrommiddletown at lycos dot com) on Fri Oct 22nd, 2010 at 08:45:42 AM EST
[ Parent ]
I'll try it next year.  Are you still in "Middletown"?

"I said, 'Wait a minute, Chester, You know I'm a peaceful man...'" Robbie Robertson
by NearlyNormal on Fri Oct 22nd, 2010 at 12:45:25 PM EST
[ Parent ]
I'm near Cincinnati at this point.  I do my PhD exams this week, and then I'm on to writing the dissertation.

And I'll give my consent to any government that does not deny a man a living wage-Billy Bragg
by ManfromMiddletown (manfrommiddletown at lycos dot com) on Sat Oct 23rd, 2010 at 04:23:16 PM EST
[ Parent ]
Good luck, I was often in Cincinnati when I was a kid, my family came from Milan and my grandpa drove a truck into the city carrying milk from the farms to the creamery.

"I said, 'Wait a minute, Chester, You know I'm a peaceful man...'" Robbie Robertson
by NearlyNormal on Mon Oct 25th, 2010 at 04:10:08 PM EST
[ Parent ]


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