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Offshore wind faces changing risk, S&P Global Ratings says


According to Market Intelligence, December 2022


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Offshore wind faces changing risk, S&P Global Ratings says

Offshore wind projects in Europe and in the U.S. are facing a "changing sea of risk," according to a report recently released by credit rating agency S&P Global Ratings.

As costs for offshore wind development have been declining in Europe and a number of new projects have been proposed in the U.S., where only one offshore facility is operational, S&P Global Ratings said it is gaining a better understanding of the sector's key risks.

"Projects face significant construction risk, with cost and schedule overruns just two examples," the S&P Global Ratings report titled "Offshore Wind: A Changing Sea Of Risk" said. There are risks associated with how contractors, subcontractors and equipment suppliers interact, and with the technology used. There is even resource risk surrounding the variability of wind resources.

With the trend toward bigger turbines and foundations to increase manufacturing and production efficiency, combined with greater distances to shore and harsher sea conditions, technology risk will remain an important factor, the report said.

"This risk is accentuated when a difference exists between the technologies proposed at the bidding stage and the ones that are actually feasible at the time of construction."

However, as the industry matures and participants have a better understanding of the risks, along with a more robust supply chain, the rating agency said it believes that construction risk will abate.

Backing up its claim that costs for offshore wind are coming down, the rating agency's analysts pointed to three winning bids in the United Kingdom's Sept. 11 contracts for difference auction. "Offshore wind projects saw a drop in offered tariff prices of 50% on average since the last competitive auction in 2015."

The report noted that Denmark's DONG Energy which recently announced a plan to change its name to Ørsted, and the EDP Renováveis/Engie consortium bid a strike price of £57.5/MWh, or $75.92/MWh, for delivery in 2022/2023, and $98.70/MWh for the offshore wind project from a joint venture between innogy SE and Statkraft AS for delivery in 2021/2022. This compared to $190.14 in previous auctions in the U.K. "only 30 months ago," the report said.

In 2016, offshore operators connected 1,600 MW of new offshore wind power capacity to the grid in Europe, which was roughly 70% of all offshore wind installed globally in 2016.

Investment in the offshore wind industry in Europe has grown at an annual average of 30% over the past five years and by 2020, could total 24,600 MW, the report said.

974 MW proposed in US

What has delayed offshore wind in the U.S. is its cost, the lack of demand and ultimately, the absence of willing investors. The paucity of projects to date has left cost analysis somewhat opaque.

Deepwater Wind's 30-MW Block Island Offshore Wind facility began delivering power to the New England grid in May. It is the first and only operational offshore wind project in the U.S. and cost an estimated $290 million to build. It was backed by DeepWater majority shareholder, hedge fund D.E. Shaw & Co. Holdings LP, which reportedly received a 30% investment tax credit on the project.

For the first year of a 20-year supply deal, Block Island is selling its power to Rhode Island's regulated utility National Grid plc for an estimated 24.4 cents/kWh. There is a 3.5% annual escalator written into the supply deal that, if unchanged, could eventually push the price of Block Island power to close to 50 cents/kWh.

Over the past year, there have been six offshore wind projects with combined capacity of 974 MW that have been promoted by Atlantic coast states. Most of the proposed projects have won federal lease auctions and are at varying stages of the permitting and approval process.

Merchant risk increases in Europe

The S&P Global Ratings report said offshore wind assets have most often been financed via project finance on a nonrecourse basis, which the rating agency said "is critical, given the heavy investment requirement and the large quantities of debt needed to finance such transactions — while offering a decent equity return to the sponsors in a very competitive environment."

However, in Europe, recent auction bids have "ushered in a new era for the sector," as companies have bid at zero, "meaning no subsidies, just market prices," the analysts said.

The European market is moving to pool prices from contract pricing, with merchant risk increasing, they said.

Merchant prices are volatile and can be close to zero on very windy days. This can impact a company's ability to service its debt and be the difference between an investment-grade and a speculative-grade credit rating, they said

The analysts said that for projects with massive upfront capital costs, a power purchase agreement or feed-in tariff that fixes revenues for a period of time is a typical feature for investment-grade projects, and these contracts have often included rates that well exceed market power rates. But while these contracts may be lucrative in the project's early years, they may not cover the entire life of the asset or even the debt tenor, the analysts said.

There is little to no market risk during the contracted phase, but there could be during the subsequent merchant phase, the analysts said. "Our assessment first determines how significantly cash flow would decline in a once-in-20-year market stress to power prices."

Jeffrey Reyser is a reporter for S&P Global Platts. S&P Global Market Intelligence, S&P Global Platts and S&P Global Ratings are owned by S&P Global Inc.