Offshore wind has no time to fail, analysts say as huge UK project is scrapped

Swedish utility Vattenfall AB's decision to scrap its 1.8-GW Norfolk Boreas offshore wind farm in the UK has cast a wider shadow of doubt on projects globally, which may also face a profitability squeeze.

Vattenfall cited a 40% cost hike as making the project unprofitable to deliver. If more dominoes fall, the UK risks missing its energy transition goals, analysts warned.

The company had secured a contract for difference (CFD) for Norfolk Boreas in 2022 at a price of £37.35/MWh.

UK CFDs are given in 2012 currency and linked to the consumer price index, an inflation gauge, meaning Vattenfall's contract is equivalent to £45.37/MWh in today's money. But this still is not enough to compensate for recent price hikes, according to Mike Blanch, associate director at advisory firm BVG Associates.

Four other offshore wind projects were awarded £37.35/MWh contracts in the UK's fourth CFD auction. Of those, only the 882-MW Moray West project, owned by Ocean Winds SL, has reached a final investment decision (FID).

That might be at least partly because Moray West's lowball CFD makes up a smaller share of the project's total capacity compared to the rest. Its CFD covers just one-third of its output, with more than half instead being sold via corporate power purchase agreements (PPAs), including to Google LLC.

Of the other projects, the largest is the 2.8-GW Hornsea 3 being developed by Denmark's Ørsted A/S, whose executives have talked in recent months about trying to achieve the "needed robustness" in the project's business case, and potentially needing tax breaks, in order to make it to FID.

An Ørsted spokesperson said, "We note the news from Vattenfall about its Norfolk Boreas project but we continue to progress Hornsea 3 and expect to take final investment decision during 2023."

Iberdrola SA's Scottish Power Ltd. is also yet to take FID on its 1.4-GW East Anglia 3 project, while Chinese-owned Red Rock Power Ltd. and Ireland's Electricity Supply Board are together developing the 1.1-GW Inch Cape wind farm.

'Borrowed time'

It is unclear how expensive the development of Norfolk Boreas would have been and if other projects will be able to deliver more profitably, Blanch said in a July 20 email.

"The immediate concern is whether the developers … are not wanting to pursue any of them," the consultant said.

In normal industrial settings, revocations of contracts just lead to disruption, renegotiations and legal fees, according to Alon Carmel, renewable energy expert at PA Consulting.

"In this situation, the problem is we don't have enough time. We're on borrowed time to meet energy transition targets and climate targets," Carmel said in a July 21 interview.

Vattenfall executives noted that part of the reason for the withdrawal was a key supplier reneging on their commitments. It is not clear who the supplier was, but troubles in the wind supply chain are well known, and Carmel said other developers will be facing similar challenges with equipment providers.

Meanwhile, the price pressure in the UK offshore wind sector is only set to continue as the market awaits the outcome of the fifth CFD auction. Despite the inflationary backdrop, the government is continuing to push on prices, setting a bid ceiling for offshore wind of £44/MWh in 2012 prices.

CFD auctions at odds with reality

Three of the UK's major energy lobby groups said this month that the price-only focus of CFD auctions is damaging supply chains and jeopardizing deployment targets and is at odds with the reality of project costs.

RenewableUK, Energy UK and Scottish Renewables called for an increased budget in this summer's auction, as well as a clear schedule with auction parameters, budgets and capacity targets outlined for future CFD rounds.

A spokesperson for the UK Department for Energy Security and Net-Zero acknowledged the supply chain pressure on the offshore sector globally and said the government is "listening to companies' concerns."

They also pointed to a consultation to introduce nonprice factors into the auction regime, such as supply chain sustainability, addressing skills gaps, and enabling system and grid flexibility and operability.

Still, nonprice criteria would not directly help boost suppliers' margins, according to Blanch.

"If the nonprice mechanisms are tied to increasing the proportion of local content then they will introduce the need for more local investment, requiring more short-term spend not less," Blanch said. "I wonder if some form of local price indexing is the way forward."

Despite cost increases, governments need to realize quickly that offshore wind "is still more competitive than traditional energy sources, and has a huge role to play in the electricity markets in this and next decades," said Adrian Bucica, senior adviser at offshore wind consultancy Green Ducklings.

To enable this role, market design in the coming years should allow higher prices, PPAs and merchant flexibility in addition to revenue stabilization, Bucica said in a July 21 email.

Market design also ought to cap the seabed lease fees payable in auctions and increase the volumes available, as well as support the supply chain to increase capacity, Bucica added.

Industry in transition

The UK is not alone in experiencing troubles with offshore wind projects.

In the US, Iberdrola-owned Avangrid Inc. recently agreed to pay $48 million to not have to deliver on PPAs from its Commonwealth wind farm project in Massachusetts.

The UK CFD model has been a victim of its own success in consistently delivering fully subscribed contests and falling prices, according to Julio Dal Poz, managing director at FTI Consulting. "The biggest challenge was the short space of time in which the cost increase happened," Dal Poz said in an interview July 21.

The consultant does not see the sector in crisis, but rather in transition into an environment of higher prices. "Obviously there are projects that are being challenged but there is optimism that this is specific to this cohort," Dal Poz said.

Vattenfall's withdrawal from Norfolk Boreas comes in the same month as oil majors BP PLC and TotalEnergies SE paid €12.6 billion for seabed rights off the coast of Germany for wind projects set for completion by 2030.

"It's contradictory on the face of it," Carmel said, adding that part of the explanation is time horizons.

"Norfolk Boreas is having to sign contracts now, and the supply chain inflation is at its maximum peak at the moment," Carmel said. "So BP and TotalEnergies, when they are evaluating a wind farm, will have taken a forward view on the cost pressures, and hopefully we're at a peak at the moment and things will have resolved themselves by then."

Meanwhile, Dal Poz pointed out that, unlike the UK, Germany also still has a deep pool of corporate buyers for PPAs and is set to be a major consumption hub for green hydrogen, which should support the profitability of offshore wind projects.

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