US offshore wind
What to make of the growing interest in US offshore wind projects given the conventional wisdom that offshore wind cannot compete in a market with no scarcity of land for onshore projects that can generate electricity more cheaply?
A panel talked about this and other questions at the Chadbourne global energy and finance conference in early June. The panelists are Laura Beane, CEO of Avangrid Renewables, Thomas Brostrøm, president, North America, of DONG Energy, Salvo Vitale, chief legal officer of US Wind Inc., Alexander Krolick, managing director, energy and infrastructure, Macquarie Group, and Christopher Hunt, partner and managing director of Riverstone Holdings. The moderator is Ben Koenigsberg with Norton Rose Fulbright in New York.
MR. KOENIGSBERG: There are five US states today that have leases for offshore wind: Massachusetts, Maryland, Virginia, New Jersey and New York. The lessor in each case is the federal government through the Bureau of Ocean Energy Management or BOEM. There has been increasing interest among these states to promote offshore wind.
US Wind and Deepwater were just awarded OREC or ocean renewable energy certificate contracts for projects off the coast of Maryland. The contracts are not just to sell renewable energy credits but also take into account the value of the electricity. They are bundled contracts.
In Massachusetts, there is a draft request for proposals out to build up to 800 megawatts of offshore wind. Ultimately, Massachusetts has plans for 1,600 megawatts, and the number is expected to increase above that. Bid are expected before year end for two to four projects with a total capacity of 800 megawatts.
Deepwater, which developed Block Island, the only offshore wind project currently operating in the United States, has a contract with the Long Island Power Authority to build a 90-megawatt project. That bid was won in a competitive market with no advantage to offshore wind.
Thomas Brostrøm, starting with you, you have a lease off Massachusetts that can accommodate up to 1,000 megawatts of offshore wind capacity. Why did Massachusetts break the 1,600 megawatts it plans to solicit into two or more bid rounds, with only 800 megawatts up for bid this year?
MR. BROSTRØM: The Massachusetts offshore wind market was stone dead two years ago. You had Cape Wind basically come to a stop. In the last two years, I think we have come a long way.
In addition to the states you mentioned, Governor Cuomo in New York is talking about 2,400 megawatts of offshore wind by 2030. Some of the candidates for governor in New Jersey are talking about 3,500 megawatts of offshore wind there by 2030. Massachusetts plans to procure 1,600 megawatts of offshore wind over the next 10 years.
From our standpoint, it is important for the market to try to move to scale rapidly. It was great to see Block Island built, but it was only a 30-megawatt project and came at a high cost. So we have been advocating strongly to go quickly to scale. You can have the same benefits we have seen in Europe where the cost has fallen to below 10¢ a KWh.
MR. KOENIGSBERG: How do you see offshore wind unfolding in the United States?
MR. BROSTRØM: Europe has paved the way. It has also taken it on the chin. Offshore wind has been highly subsidized over the last 20 to 25 years. You now have an industry that is growing by 25% a year. It is going global. It is moving from 12,000 to 15,000 megawatts of installed capacity today to about 40,000 megawatts by 2025. These volumes create competition. The supply chain is driving down costs. This has paved the way for the Massachusetts bids to offer fairly good prices and that should lead to more procurements in the future.
MR. KOENIGSBERG: Laura Beane, Avangrid also has enough area under lease off Massachusetts to build up to 1,000 megawatts. What factors do you think will influence whether the state ramps up the procurements quickly?
MS. BEANE: Price, clearly. That will be at the forefront. Market conditions will also play into it. I sense a healthy competition developing among the Northeastern states. Jobs are another factor. Massachusetts will be weighing how many direct jobs are likely to be created in the state under the different bids received.
MR. KOENIGSBERG: Do you think if the state awards the entire 800 megawatts to just one project, that will make it more difficult for the industry to take hold?
MS. BEANE: When I look at the existing players, it looks like a pretty level playing field. All of the parties expected to bid are credible. They have a lot of experience in this space in Europe. There are definitely first-mover advantages, where you will be paving the way with a regulator and establishing relationships. I assume Massachusetts wants to stagger the procurements in the hope that it will benefit over time from falling prices. The hope is the second phase will benefit not only from the knowledge and maybe some of the mistakes that are made in the first phase, but also from lower costs and a more advanced supply chain.
MR. KOENIGSBERG: Salvo Vitale, turning to Maryland, the state Public Service Commission forecasted almost 9,700 jobs and $1.8 billion in spending over 20 years because of the two projects to whom it just awarded contracts. The ORECs are worth about $130 per megawatt hour generated. The PSC has said that the average resident in Maryland will see his or her bill rise by no more than $1.40 a month. Spread out, that is not a huge number. How do you think Maryland will benefit from the two contract awards?
MR. VITALE: Maryland wants to seize first-mover advantage. Having the biggest two offshore wind farms in the United States may allow it to become a hub for offshore wind that could serve future projects from Boston to the Carolinas. I agree with Laura Beane. Future projects should end up competing more on price rather than what we had to do, which was demonstrate a big commitment to Maryland in the form of creation of new jobs and net economic benefit for the state.
I see an advantage to the state from awarding two contracts. I do not see a lot of advantages for the developers. These are two separate projects with their own timetables. We expect to have installed 248 megawatts by 2021 and the other project is expected to be in service by 2023.
MR. KOENIGSBERG: Are there any lessons learned from having gone through the bid process in Maryland?
MR. VITALE: The bidders in the next rounds will also have a high level of expertise that was earned in Europe over the past decade. The competition will probably just come down to a matter of price.
MR. KOENIGSBERG: Alex Krolick, you led the financing for Block Island and also were heavily involved with offshore wind in Europe. What have you learned about how to do offshore wind?
MR. KROLICK: Some of the lessons are obvious in hindsight. It was important that we started small. We are building an industry here. It is fragile in its early stages, and we cannot afford many failures. Thirty megawatts was the right size at that moment. It was $350 million or so in capital costs, so it was not tiny in terms of money required.
Now we have 90-, 120- and 248-megawatt PPAs. LIPA will probably do another 210 megawatts in the next few months, and then Massachusetts will award 400 to 800 megawatts. I hope we stick to this trajectory.
Offshore wind construction is hard. This is really a marine industry more than it is a wind industry, and things will go wrong. It will be important to make sure that the financing people behind you are pragmatic and experienced because the last thing that a developer wants is to have problems on top of problems. Finding a lender group that has experience institutionally with offshore wind is important. Most likely, we will have projects that are closing over some sort of litigation risk. You need to have lenders that are able to get their heads around that.
Tax equity for offshore wind is complicated. The US tax equity market is a 12-month forward market. It is hard to get tax equity providers to talk seriously if you are more than 12 months out from your project, and the offshore wind projects in the US have 24-month construction periods. As the projects increase in size, we are talking about a much larger quantum of tax equity. Raising $500 million in tax equity for a single project is a big challenge.
One of the lessons we learned on Block Island is that the ability of turbine vendors to bring tax equity as part of the turbine sale will be critical to the success of the next round of projects. Vendors can play an active role, but will not be able to cover the whole amount. So, like on Block Island, you have to come up with a structure where somebody bridges the tax equity gap. The bridge is likely to be a combination of equity and debt. Then halfway through a complex construction period, when you are 12 months away from completion, you start engaging with the tax equity. The closer the project gets to the end of construction, the less leverage there is on the sponsor side. There is a real risk of value leakage. Managing that process will be important.
MR. KOENIGSBERG: Do you want to add anything else about the financing strategy? For example, would project bonds make sense?
MR. KROLICK: For smaller projects up to 400 megawatts, the construction debt can be raised pretty easily in the commercial bank market. That is the financial sector that is most attuned to dealing with the challenges. As projects get larger, debt funds are probably going to be the next players to come in.
MR. KOENIGSBERG: Chris Hunt, Riverstone is a major backer of Pattern Energy, a successful US wind developer that has eschewed offshore wind and Riverstone has chosen not to invest directly in offshore wind developers. Why not? You have made some investments on the supply side.
Decision to Pass
MR. HUNT: We made a conscious decision not to do offshore wind. We invested several years ago in specialized rigs that that are used to build offshore wind farms. We made the investment in 2010 and for a while, we owned a fair percentage of the fleet in Europe that was constructing plants. These are rigs that have the cranes and capacity to house workers and store equipment to build offshore. Given the enormous size of the turbines, they are expensive ships. A lot of people overlook the enormous supply chain that is needed to deliver these projects. The supply chain alone will require billions of dollars in investment.
We are happy with the choice we made. The supply side turned out to be a very profitable endeavor for us, and we did well on the investment. Now that we have done full cycle — we entered and grew the business and exited — we have thought about whether we want to go back in. I think for now, we will sit on the sidelines for a few reasons.
First, we are very busy with onshore projects and have plenty to do. Second, it is becoming a big balance-sheet game. Owning and building offshore wind farms requires a balance sheet and, for private equity guys like us, that is not necessarily a strength that we bring to the table. Third, this is a maritime exercise in very rough and windy seas and there are lots of things that can go wrong. It is just not a risk that we are interested in taking right now.
MR. KOENIGSBERG: If you were a balance-sheet player, do you think you would be more likely to jump into the fray?
MR. HUNT: Yes. We watched the industry grow up in Europe and, frankly, the industry if anything over delivered on expectations. Projects have been built and have delivered returns. Companies in Europe have done very well. The projects have been good not only for developers, but also for turbine suppliers and the banks. It has been a positive experience in Europe, and I think it will be a positive experience here. It is just not an industry that is for the faint of heart.
MR. KOENIGSBERG: Skeptics of the offshore wind industry point to the high cost per installed megawatt. The projects are not competitive if tested solely against that metric. Laura Beane, what do you say to the critics?
MS. BEANE: Offshore wind makes sense currently only in specific markets. The predicates for it to make sense are coming together in the Northeast. That region has huge amounts of load. It has aggressive renewable energy targets. The regulators want to make it happen. New England has huge transmission constraints. There is a lot of NIMBY resistance. Nobody wants to build additional high-voltage transmission, and it is hard to site additional power plants on land within the geographic footprint where the electricity load is located.
New England is looking at importing the power it needs from outside the region. Offshore wind feels like it is outside the state. The installed cost of offshore wind is high currently, but the cost has to be compared against the cost not only of building additional capacity on land, but also new high-voltage transmission that would have to be built alongside it.
MR. BROSTRØM: The cost has always been our Achilles heel. But look at what has happened over the last three to four years where the cost of offshore electricity has moved from something like $180 to $200 a megawatt hour to something like $60 to $70. Costs are even lower today in Europe.
Competition is picking up in the supply. Large turbine vendors like Siemens, Mitsubishi, Vestas and GE are all competing. Turbines are now eight, nine and 9 1/2 megawatts when they were only 3/4ths of a megawatt several years ago. There is big competition to supply every component of the wind farm.
A month ago, we put in a subsidy-free bid in Germany to supply offshore wind at the prevailing wholesale market price. We said we plan to install 13- to 15-megawatt turbines to make it work.
I agree with Laura Beane that a lot of things are coming together in New England. It is a big advantage to be able to put an offshore wind farm just 20 miles from Boston where you cannot see it, but the project is close enough to feed the electricity straight in.
MR. KOENIGSBERG: Alex Krolick, Europe used feed-in tariffs to develop a renewable energy industry. We use tax credits. Raising tax equity for offshore wind is challenging for the reasons you said. Do you think these projects can get done without tax credits?
MR. KROLICK: Oy! Tax equity is undeniably a big contributor of value. Keith Martin said the typical capital stack for an onshore wind farm is 50% to 60% tax equity. Maybe it is 40% to 50% for offshore wind because of value leakage. You lose value on fees, transaction costs, increased debt costs because of the structural complexities, but the tax credits are still value. Without tax credits, the electricity will be more expensive. The issue is whether that price is palatable.
As Laura and Tom said, offshore wind is starting to take hold in Goldilocks locations in premium constrained markets where offshore wind is a competitive solution for delivering megawatts. I think you can see this happening eventually without tax equity. With the tax credits already phasing out, I think we may be there sooner rather than later.
MR. KOENIGSBERG: Salvo Vitale and Chris Hunt, where do you think US offshore wind will be in five years?
MR. VITALE: We expect confidence in the sector to grow over the next five years. Turbines will increase in size, making the projects more competitive. This is an industry that still needs political support to prosper. Hopefully the need for political support will diminish over time.
MR. HUNT: I don’t mean to sound negative, but I think things are going to take longer and go slower than the industry expects. Europe has had a boom in building and it has been a great experience, but people forget that most of the projects that were built were 10 to 15 years in gestation. It takes a long time to get the supply chain up and functioning. Some of that is transferable from Europe to the United States, but not all. For example, you can’t use a construction vessel that has been operating in the North Sea because US law does not allow the vessel to be used here. It takes time to build new vessels and train people to use them.
I hesitate to guess how many megawatts actually get developed in the next five years. Europe is biting the bullet and experimenting with 10- to 15-megawatt turbines that are astonishingly large and experimenting with floating platforms and different base technology that will reduce the installation cost. A lot of what happens in the US is going to depend in part how the Petri dish projects in Europe perform.
MR. KOENIGSBERG: Thomas Brostrøm and Laura Beane, with the size of your balance sheets, you do not really need to use project finance.
MR. BROSTRØM: In Europe, we used our balance sheet to issue bonds at the corporate level. We take construction risk. Once the project is built, we have looked to sell 50% of the equity to financial investors who are looking for long-term stable cash flows.
That model has worked well in Europe. We may start with it here, but the US is a different market when it comes to debt and equity investors. Then you add tax equity structures, which add another layer of complexity that we are still trying to get our heads around. The balance sheet gives us flexibility.
MS. BEANE: My answer is nearly identical, but ultimately, it is too soon to tell. A lot can happen between now and when projects go into the construction phase. We will evaluate the environment at that time and make the most economic choice.
MR. KOENIGSBERG: Are there any audience questions?
MR. EBER: John Eber, J.P. Morgan. Is the $60 to $70 megawatt hour projection current pricing or are you looking down the road a few years, and does it assume an ability to monetize the tax benefits?
MR. BROSTRØM: I think if Salvo and Laura would talk about what their price expectations are, I will tell them what mine are. [Laughter] Let me put it this way. The wind conditions or wind speeds off New England are on par with what we know in the North Sea. Give and take. We should be able to tap into the same cost reduction curve.
I don’t think prices will start out as low here as in Europe for the reasons that Chris Hunt mentioned. It has taken 25 years to get to that point in Europe with now mature markets.
MR. MURPHY: Drew Murphy with Edison International. My recollection, having been involved in the effort to do the first round of US offshore wind projects eight to 10 years ago, is that the environmental and permitting issues were significant challenges. Has that situation improved?
MR. VITALE: I was not here 10 years ago, but we are in the advanced stages of permitting our Maryland project. The process seems fairly streamlined. Maybe it’s because I am coming from Italy where everything is a huge mess, but I was impressed by the precision, by the timing of the delivery of every permit so the US authorities must have done a lot in the last 10 years to improve the process.
MR. VOLPE: Tony Volpe with Falck Renewables. Do you foresee a time when the levelized cost of energy for offshore wind will be systematically below onshore? Do you see that coming in Europe sooner than in the United States, if ever? Part B of the question is how do you plan to finance subsidy-free projects?
MR. BROSTRØM: We are close in Europe to being on a par with onshore wind. I do not think we can do that anytime soon in the United States if you include wind prices in the US interior because you are looking currently at $18 to $20 a megawatt hour in the Midwest. It is easier to be competitive in Scandinavia, the UK, Germany, the Netherlands where there is only limited room for additional onshore wind.
You are basically capped at turbines of three to four megawatts in size on land. Not so offshore.
MR. HUNT: I am actually bullish on the cost projection. One turn of the rotor of the larger offshore wind turbines in the United Kingdom can power a home for an entire day. Do not underestimate the enormous benefit of increasing the size. If Europe can prove some of these giant wind turbines, we will see a dramatic reduction in levelized cost of energy. It will take time, but I am bullish about getting there.
MS. BEANE: MHI Vestas unveiled a 9.5-megawatt turbine. People used to talk about a future with 10-megawatt turbines. We are pretty much there.
MR. MARTIN: A member of the audience wanted the following question to be asked anonymously. How do the developers on the panel plan to qualify for tax credits for the Massachusetts and Maryland projects that seem important to the project economics?
MR. BROSTRØM: The US tax credits were really not designed for offshore wind given the long lead times required to develop such projects. We are looking at all the options for starting construction to qualify. It is a little out of our hands because we have no control over the permitting process and, therefore, how soon we will be able to be in the water doing actual construction and, therefore, how long the projects will take to finish.
MS. BEANE: Same answer for us. Occasionally, through our policy group, I see news of new proposals in Congress to provide tax credits specifically for offshore wind. Hopefully something like that will be enacted and make it a clearer picture for all of us.
MR. KROLICK: There is an arbitrage that needs to be thought through on the part of the developer because you can lock in tax credits by procuring equipment, but that means you are locking into today’s technology in a market with rapid improvements in things like turbine size and blades. It is a gamble unless you can lock in with equipment that is not tied to the turbine.