Tom Harries, Partner, answers questions about some of the recent negatively presented developments in the renewable energy industry.
Q. What do you make of all the negative news surrounding offshore wind at the moment?
I think it is actually a big positive for the medium-to-long term.
Take offshore wind which historically has had a high project success rate. Most projects with consent and a grid connection end up securing government contracts and get built. Why? Because governments have been rocks when it comes to the availability of subsidies for offshore wind developers. (It also helps that the supply of offshore wind leases is tightly controlled by the Crown Estate with a thorough identification process). It was at risk of creating complacent developers.
For example, recent bashing of the U.K. government is unwarranted. The U.K. is currently the biggest offshore wind market outside of China (70% greater than the next nearest, Germany) and by most analyst forecasts are set to remain so to at least 2035. I’d rather developers don’t bid in an auction than win and relinquish contracts later like in the U.S. The latter is good for initial company and government public relations but even more harmful to the supply chain. Avoiding the ‘winner’s curse’ is good for everyone (with time).
From the news, it is easy to forget that the value chain doesn’t stop with developers and manufactures. Insurers, brokers, lenders, lawyers, consultants and advisors, to name a few, are also hit by project developers postponing projects. These are nearly all local jobs and form a thriving service sector replete with experience that are critical to a project’s success. Securing future revenue will always be a business risk but it’s not just developers and manufactures that are affected.
But, for those companies budgeting for U.K. offshore wind construction, fear not. The CfD rounds are now annual. I’d wager that the government will react positively and gigawatts of projects will receive contracts in the next round. Results of the next round (6) are due by 11 September 2024 at the latest, but as early as 28 June 2024.1 (For perspective, there was circa four gigawatts of eligible offshore wind capacity in round 5, with at least another gigawatt likely to pre-qualify for round 6). I also suspect we will see at least 50MW of floating wind secure a contract.
Q. With all this talk about impairments and loss-making manufacturers, who is making money in offshore wind?
Vessel owners! Year-on-year the financials of vessel companies (specialising in offshore wind) are up on most positive metrics, with revenues up by over 50%. Why? Utilization rates are at record levels, day rates are up, and contractually the vessel owners are over-performing and reaping the associated performance bonuses. Order books are fat, too.
There is also an impending supply-demand imbalance for foundations.2 So, I’d guess that experienced foundation manufacturers are probably faring well or are about to. Foundation makers have historically passed through raw material costs to customers, like a cost-plus contract. In theory it means that raw materials inflation is passed through to customers instead of eroding the maker’s profitability. Turbine makers did the opposite but in recent years have also moved to a quasi-cost-plus model in a bid to transfer risk and turn their finances around.
Q. Are other sectors facing headwinds?
Yes, sort of, but it’s — again — manageable. Take the battery energy storage system (BESS) market in the U.K. It’s a buoyant market, with over 3GW/3.4GWh installed but some future additions face a big challenge. 3 Major EPC and independent connection providers (ICP) are entering insolvency processes. For partly constructed projects it puts the client – the developer or investor(s) – in an awkward position. It adds extra costs as clients pay a premium to replace the EPC and/or ICP and can cloud the insurance cover. For example, it was normal (in the U.K.) for the EPC/ICP contractor to control the insurance via a contractor-controlled insurance program (CCIP). The validity of a CCIP is unclear once the contractor is in an insolvency process: did it pay the premium? Is the policy still valid given the material change in risk?
In the short-term we have found solutions for our clients to bridge the gap at the end of construction and for the start of operations. Going forward, we encourage our clients to control the insurance with an owner-controlled insurance policy (OCIP). Controlling insurance is important since borrowing is predicated on insurance and insurance is on the critical path for project delivery. It also brings the added benefit of establishing direct relationships with insurers and a curated program. For example, for high growth clients we structure insurance programs that bring consistent and replicable insurance pricing and terms to a portfolio of projects set for construction and, or operations. It leaves the client spending its time focussing on growth rather than insurance.
- Document Template V2.1 (cfdallocationround.uk)
- PowerPoint Presentation (sif-group.com)
- UK battery storage news from Centrica, Pulse, Habitat, Gore Street (energy-storage.news)