The impact of inflation on the offshore wind industry is being felt globally. With markets recalibrating to factor in supply chain costs, we look at how and why investment has been interrupted, and when it will begin to flow again.
In the UK, the lack of offshore wind projects bidding for the Contracts for Difference (CfDs) Auction Round 5 (AR5) exemplifies the impact of rising costs, while in the US, Reuters recently reported that many companies are cancelling offtake agreements.
Energy Intelligence has reported that “In the last year, four projects with a total generation capacity of some 7.5 gigawatts in US east coast waters — equal to roughly 25% of US President Joe Biden’s 30 gigawatt by 2030 target — have run into trouble because of cost inflation.”
Today Solar Media is hosting the Wind Power Finance and Investment Summit, which is likely to be dominated by the problem of inflation and rising supply chain costs. Speakers from ABN AMRO, NTR, Octopus Energy Generation and Santander will discuss the impact of inflation on investor returns and strategies.
Anthony Doherty, chief investment officer at NTR, a Dublin-based, European renewable energy company, said Auction Round 5 was “no great surprise in terms of the results which had been well flagged in terms of the price point. It is actually a perfect example of where we’re seeing quite significant inflation in terms of supply chain costs and a need to react to that.”
NTR has been a developer, owner, operator and recycler of assets who have helped build around 3GW of clean energy assets so far, according to Doherty. In 2015 they pivoted to concentrate on asset management for institutional investors. The company has investors in Euro and Sterling denominated assets.
Doherty said he assumed that the issue caused by a too low strike price for offshore wind would be fixed in the next auction round, because it was unlikely that the industry would see a strong downward trend in wind turbine pricing.
If the UK government plans to meet its target of 50GW of offshore wind by 2030, Doherty says that “I definitely think you’d need CFDs to help meet the targets… an interesting approach is a mixture, some CFD and then some PPA.” This will require the government to take into account supply chain cost inflation and raise the strike price in future auctions.
In July, Vattenfall announced a halt to its Norfolk Boreas windfarm, citing a 40% rise in the costs of production. Orsted has also warned that its Hornsea 3 project is under threat without more government support.
The Bank of England has a target of 2% inflation by 2025, while Ernst & Young projects that inflation in the UK is due to fall to 3.4% in 2024. Given these projections, it is understandable that investors may be holding off on further offshore investments until financing becomes less costly.
The investment environment in the UK has also been dampened by the incentives offered by the Inflation Reduction Act (IRA) in the US, while “the EU has reacted by adapting its State Aid rules and the legislative proposals of the Green Deal Industrial Plan… it also relies upon the Recovery and Resilience Facility’s dedicated climate subsidies to offset the IRA’s effects on the EU economy,” according to EU parliament analysis.
Doherty says that there is also a “Sterling-Euro deviation” occurring. Sterling currently has a higher base rate than the Euro, “meaning the discount rate for Sterling-based assets is higher from an investor perspective than the Euro. So that does create a competitive piece between Sterling-denominated assets and Euro-denominated assets”.
The UK government also introduced an Electricity Generator Levy on 1 January 2023 to capture some of the increased profits from renewable energy generation, and this has also influenced some investors, Doherty said.
The Irish government did also impose a price cap on electricity generation, but at a higher level. At the time, Pinsent Masons said that the price cap would have an effect on investment in the UK, as it defined ‘extraordinary returns’ as “the aggregate revenue that generators make in a period from in-scope generation at an average output price above £75/MWh”. Ireland’s similar price cap was at €120 (£103) per MWh for wind and solar.
“The tool was probably not unexpected, it was the calibration in terms of the level of price cap that was probably the piece that was not fully expected,” Doherty said.
Going forward, Bank of England base rates will continue to be the main driver of investment. The Evening Standard reports that inflation for August remained high at 7.1%, which means that there is an expectation that the Bank will raise interest rates again from 5.25% to 5.5% when it meets this week.
Ironically, the main driver for continued inflation is the price of oil, with Russia and Saudi Arabia cutting production in August.
“The complexity on inflation and interest rates isn’t necessarily whether they are high or low, it’s that they’re volatile,” says Bart White, managing director, European head of energy structured finance at Santander.
“If you’re looking at a renewable energy asset, typically you’re getting your money back from that investment over a relatively long period of time,” White says. “It’s very sensitive to the cash flow generation and cost. So you need a relatively accurate forecasting to determine and ensure that you get the right level of return over the long term. In the context of stable inputs, it’s easier to get an expected output.”
Even if a renewable project has its returns inflation-linked, for example to the Consumer Price Index of inflation, this won’t protect investors from big increases in materials costs, White says.
“If you’re building something that’s made out of steel and your steel goes up twice in price, and that’s passed through to the project owner, CPI doesn’t necessarily move up twice. So effectively the underlying mix of your costs may not be the same as the indexation of your revenue.”
Alex Brierley, co-head of Octopus Energy Generation’s fund management team, told Current± that: “We need to do everything we possibly can to quickly shift to a cheaper, cleaner and more secure energy system. Globally trillions of dollars are required to invest in renewable energy projects, highlighting the massive scale of the investment opportunity to help meet net zero. Investors, especially institutional investors like pension funds, can tap into this and make a positive impact with their money.”
Brierley says that, “while some investors have identified the opportunity to earn more income from bonds than had been possible in previous years, companies building new renewable energy projects offer investors more than just income, as they offer capital growth alongside the positive impact, so there’s tremendous value in this for investors.”
Supply chain costs for offshore wind are currently impacting that part of the renewable industry especially badly, but other parts of the industry are much more competitive, with increased solar PV supply from Asia bringing down materials costs in that sector.
“In addition to funding traditional renewable energy sources like wind and solar, we’re also seeing a growing range of opportunities to back companies developing green technologies also needed for a 100% renewable economy,” Brierly told Current±. “From energy storage sites, to green hydrogen for big industry, heat pumps for heating homes and businesses, to electric vehicle charge point infrastructure to enable clean transport, and much more.”
“Ultimately we need a market that works for all participants. And the best way to reduce the impact of gas price spikes is to reduce our dependence on fossil fuels by building more renewables, more quickly.”
Anthony Doherty says we should not be too gloomy about investment in offshore wind. “Investment hasn’t dried up,” he says. “Capital raising went through its toughest period in 10 years earlier in 2023. A large part of that was rebasing, because as base rates went up, discount rates ticked up for investors, so therefore they were looking for higher returns where possible. At the same time we did see a dip in public equity pricing which, as industry observers point to, had this denominator effect which meant that people couldn’t invest as much in private equities.”
This dynamic is changing a little, Doherty says, and “investing has continued because there has been quite a considerable amount of dry powder raised pre-2023. So there are still plenty of projects getting invested in, maybe the valuations that sellers thought they would get are not where they were. So we’re in a little bit of a period of dislocation in the market.”
Once the market adjusts itself, this recalibration will see capital start flowing more consistently, even for offshore wind. Fundamentally, many countries need to create more offshore wind, and this delay as the market recalibrates should eventually give way to further investment which will help reduce exposure to oil price-caused inflation.
