US Offshore Wind Projects Move Toward Financing; Google, Good Energies and Marubeni betting on the sector

US Offshore Wind Projects Move Toward Financing; Google, Good Energies and Marubeni betting on the sector

June 11, 2011 | By Keith Martin in Washington, DC

The US offshore wind industry is gaining momentum. The first US projects are already in the market seeking financing. How is the market likely to respond? The experience with offshore wind projects in Europe provides some useful insights.

More than a thousand offshore wind turbines have been installed in Europe and the second offshore wind farm is under construction in China, but offshore wind development in the United States has been frustratingly slow. Not a single commercial turbine has been installed in US coastal waters despite exceptional offshore wind resources and deep onshore wind experience.

Significant breakthroughs in 2010 are finally giving the industry momentum. Federal and state governments are encouraging offshore development. Google, Good Energies and Marubeni bet on the sector by backing a 6,000-megawatt transmission line that Trans-Elect proposes to build off the mid-Atlantic coast.

Smart From the Start

One of the obstacles to offshore wind development in the United States has been a confusing regulatory landscape. The unveiling of the “Smart From The Start” program by the Obama administration late in 2010 will help. The program, which is be managed by the newly-renamed (after the BP oil spill) Bureau of Ocean Energy Management, Regulation and Enforcement, or “BOE,” streamlines the permitting and leasing of offshore sites for new projects in federal waters, with a near-term focus on the Atlantic coast. Federal waters start three miles off the coast.

The BOE is supposed to work with the “Atlantic Offshore Wind Energy Consortium,” a group of representatives appointed by the governors of 10 eastern states, to identify areas that are best suited for offshore wind projects. So far, BOE has identified such areas off of the coasts Massachusetts, Rhode Island, Delaware, Maryland, New Jersey and Virginia, and it is expected to designate others off the coasts of Maine, South Carolina, North Carolina and Georgia.

Once an area is designated, then BOE issues a request for proposals from developers interested in building projects in the areas. This triggers an environmental assessment. If the environmental assessment comes back clean, then leases will be issued. The streamlined program has already led to NRG Bluewater Wind being offered a lease for its project off the Delaware coast.

There are two types of leases available: a commercial lease and a limited lease.

A commercial lease grants all the rights necessary to conduct studies and construct and operate the wind farm. Such leases have a term of 30 years, and come with a price tag that could approach $100,000 annually prior to production. A developer can terminate the lease if it abandons a project and cut off the obligation to continue making lease payments. Nothing already paid would be refunded.

A limited lease only allows a developer to study the particular area, and the term is five years or less. Since the lease does not automatically roll over into a commercial lease, a developer will have to re-apply if it decides to move forward with a project. The limited lease, a number of which have been granted, may appeal to smaller developers that do not want the commitment and cost of a commercial lease.

While Smart From The Start relieves a lot of complexity, it does not eliminate all. A number of federal and state agencies still have permitting authority over various aspects of development and will need to be engaged during the development process. Projects built in federal waters will have to cross state waters (zero to three miles from shore) to an onshore interconnection point, implicating state permitting and regulatory regimes. Further, developers will still have to contend with the Endangered Species Act, Coastal Zone Management Act, Clean Water Act, Clean Air Act and other federal statutes.

State Incentives Gaining Traction

Many states are becoming enthusiastic supporters of offshore wind.

New Jersey is leading the way. More than 1,000 megawatts of projects have been proposed off the New Jersey coast by such developers as Fishermen’s Energy, Deepwater Wind and NRG Bluewater Wind.

New Jersey enacted an Offshore Wind Development Act in August 2010 that creates offshore renewable energy credits — called ORECs — and requires New Jersey utilities to buy enough ORECs to support the development of 1,100 megawatts of offshore wind capacity. The law also authorizes the New Jersey Economic Development Authority to provide up to $100 million in tax credits to offshore wind projects that are built in designated wind energy zones and interconnect in New Jersey.

In Maryland, the governor, Martin O’Malley, is urging the state legislature to pass an ambitious bill that would require Maryland utilities to sign a total of 600 megawatts in long-term power purchase agreements with offshore wind projects. The bill is currently stalled in the legislature but has a fairly good chance of passing in the next session.

A similar bill was introduced recently in North Carolina that would require utilities to enter long-term power purchase agreements with offshore wind projects for a total of 2,500 megawatts. The outlook for the bill in the state legislature is unclear.

In Virginia, utilities get triple credit for renewable energy credits purchased from offshore wind projects for the purposes of compliance with the state renewable portfolio standard. In Delaware, the state decided that a 350% multiplier would apply to each renewable energy credit purchased from the NRG Bluewater Wind project.

Other states have formed committees to develop policies supporting offshore wind. Only time will tell whether conversation turns into prescription, but there seems to be a genuine interest on the east coast and throughout the Great Lakes to advance policy measures in support of offshore wind.

Financing Challenges

Europe has had a significant head start on working out financing structures.

Early offshore wind projects were financed primarily on the balance sheets of utilities. Lenders and investors largely steered clear because of the unknown risks in permitting, construction and operation.

In 2006, non-recourse project financing emerged as an alternative to balance-sheet financing. A syndicate of banks joined forces to finance the Prince Amalia wind farm, a 120-megawatt wind farm off the coast of the Netherlands. Shortly thereafter, in 2007, the C-Power Thornton Bank wind farm, a 30-megawatt wind farm off the coast of Belgium, secured project financing from a syndicate of banks.

In both cases, the construction contractor assumed substantial risk. Both projects were supported by long-term power purchase agreements and contracted sales of the associated green attributes.

In 2007, the non-recourse model appeared to be the future for financing offshore wind projects. Then the credit crisis hit in late 2008 and made it difficult to secure project financing for any type of project. Quasi-governmental entities stepped in to fill the gap in order to push projects to financial close.

The Belwind project, a 165-megawatt wind farm off the coast of Belgium, was the first project to obtain project financing post-recession in 2009. While commercial banks participated, the European Investment Bank, a bank formed to support European Union policy objectives, and Eksport Kredit Fonden, a Danish export credit agency, took on most of the risk. The EIB contributed approximately  300 million of the credit facility, and the commercial banks contributed the remaining  182.5 million of which half was guaranteed by EKB.

Subsequent financings followed a similar model. In 2010, C-Power secured a  1.16 billion loan for the balance of the Thornton Bank project, consisting again of a significant EIB debt contribution, a syndicate of commercial banks contributing smaller amounts, and guarantees from the EKF as well as Euler Hermes, the German export credit agency.

The participation of the EIB and other national institutions has lured banks to the offshore wind sector, providing a bridge to commercial bank-driven financings in the future.

Financing in the States

The US can learn from the experience in Europe.

Financing for any wind farm in the United States is a challenge. It is usually impossible to find the entire capital cost from one source. Chief financial officers at wind companies stack capital from cheapest to most expensive by tapping
multiple sources.

None of the large-scale US offshore projects appears far enough along to be able to tap a Treasury cash grant for 30%
of the project cost, as it requires starting construction by December 2011.

The next cheapest capital is debt guaranteed by the US government or by an export credit agency that is supporting the turbine sale. The high capital cost of offshore projects per installed megawatt makes some form of government loan guarantee or export credit agency support almost essential.

In the absence of such debt, the experience in Europe suggests that early projects are likely to require a balance sheet. Prior to the Prince Amalia wind farm financing off Holland in 2006, all European offshore wind projects were financed “on balance sheet.” Even now, utilities dominate the sector.

In the United States, utilities have shown little appetite to own offshore wind farms. While they have supported the sector in concept and backed some pilot projects, none has an advanced commercial-scale project on its balance sheet. This leaves independent developers to drive growth, and since they are unable to self finance their projects, they must turn to banks to bring them on line.

No borrowing is possible without a bankable power purchase agreement, and such contracts have been elusive even for onshore projects. Of the dozen or so projects in the pipeline, only three have lined up offtakers.

The NRG Bluewater project off Delaware has a 25-year contract to sell its output to Delmarva Power.

In November 2010, the Massachusetts Department of Utilities approved the PPA between Cape Wind and National Grid. However, National Grid has only committed to purchasing half of the project’s output, with the remaining output still uncommitted. The developers plan to build the project in phases.

Deepwater Wind secured a PPA for the entire output of its Block Island project, but that has come with some popular and legal resistance because of the high prices. Under the 20-year PPA, National Grid will purchase all of the project’s output at 24.4¢ per kilowatt hour (increasing annually).

Some states are designing their renewable portfolio standards to encourage utilities to sign PPAs with offshore wind projects. New Jersey, Delaware, Maryland, and North Carolina are examples of states moving in this direction. With relatively weak solar and onshore wind resources, offshore wind offers Atlantic coast states a path to achieving their ambitious RPS targets.

Offshore projects are likely to need more true equity than onshore projects to be financed. In a typical onshore project financing, equity can account for up to 20% of the total project investment. Offshore projects in the US will probably follow the European example where equity accounted for 30% or more of the total project investment.

Public entities have played a critical role in bringing offshore projects in Europe through financing. They have provided the bulk of the debt, as well as the credit enhancements to satisfy commercial banks.

The Department of Energy loan guarantee program, which could prove critical for early offshore wind projects in the United States, may end up being of limited help. The window has already effectively closed on new applications. The recent budget deal that President Obama reached with the Republicans in the House to keep the US government operating eliminated what money there was to write new loan guarantees for projects that are not already in the queue for loan guarantees. The projects that are in the queue have until September 30 this year to close on the financing, with one exception. The budget deal made $1.183 billion in additional loan guarantee authority available for projects that are currently in the queue but that miss the September 30 deadline. The potential claims on this $1.183 billion are expected to be several times the amount.

The irony is that lack of such support may lead developers to use foreign-made turbines in order to benefit from financing from foreign governments through their export credit agencies.

An offshore wind coalition is urging Congress to extend the deadlines to qualify for a 30% investment tax credit or production tax credits of 2.2¢ a kilowatt hour on the first 10 years of electricity output. These credits are available currently only for projects completed by December 2012. The coalition argues that offshore wind is an early-stage technology like solar and needs the same ramp-up period as solar. Solar projects have until December 2016 to finish construction and qualify for tax subsidies. The tax subsidies, once accelerated depreciation is added to the tax credits, amount to at least 56% of the capital cost of a project. If they could then be converted into current capital in the tax equity market, that would fill in a significant piece of the permanent capital structure for US projects.