Energy Musings - December 11, 2024
The offshore wind industry continues to experience disruptions and problems due to its business model and changed economic environment. This industry remains in a fragile state.
The Fragile Offshore Wind Landscape
The last two weeks have witnessed numerous developments in the offshore wind sector, but none were positive. Working backward, Denmark just held an offshore wind lease sale and no one bid. Throwing a party, and no one came?
The Danish Energy Agency put three North Sea offshore wind farms out to tender as part of a six-gigawatt (GW) capacity plan. The plan involved six offshore sites. The three North Seas wind farms were followed by three wind farms in Danish coastal waters. Those wind farms would be located in Hesselø, Kattegat, and Kriegers Flak II. The bid deadline for those three wind farms is April 1, 2025.
The six wind farm sites could hold 6 GW of capacity, but the winners could install as many wind turbines as possible, enabling capacity to reach 10 GW or more. Currently, Denmark has 2.7 GW of offshore wind capacity.
The lack of bids prompted the Danish minister for climate, energy, and utilities, Lars Aagard, to ask the Danish Energy Agency to talk with the companies in the market to understand why they failed to bid. The surprising outcome of the sale came despite several companies having expressed interest during the initial marketing of the sale. “This is a very disappointing result. The circumstances for offshore wind in Europe have changed significantly in a relatively short time, including large price and interest rate increases,” said Aagard.
When Aagard talks about a “large price” increase, he means that the cost of building wind farms has increased. This means developers would need higher electricity prices or greater subsidies to consider the projects. Maybe the fact that the Danish offshore wind tender offered no subsidies played a role in the lack of bidders. High electricity prices with no subsidies are lethal for project economics. Bidders were supposed to participate by tendering a fixed payment to the government for 30 years for the right to the lease. The government would also own 20% of the leases, making them a minority party in each project.
Given the changing economics of offshore wind, without healthy subsidies, developers know that the cost of their electricity will be high, risking rejection by utility buyers, i.e., a failed project. The only way to secure the necessary subsidy is for bidders to shock the government by not participating in the tender. That is the new reality of offshore wind in Europe.
Fellow Scandinavian nation Sweden is near Denmark, and it, too, is having problems with offshore wind farms. In early November, the Swedish government blocked the construction of 13 offshore wind farms due to its military’s defense concerns. When queried, the Swedish Armed Forces emailed the news agency AFP saying, “It would pose unacceptable risks for the defense of our country and our allies.”
Scandinavia has become a challenging offshore wind market.
Source: World Map.
The proposed wind farms were close to the “highly militarized” Russian enclave of Kaliningrad. It lies between Lithuania and Poland. Swedish Defense Minister Pal Jonson said Kaliningrad’s location was “central” in the government’s assessment because the wind farms could delay the detection of incoming cruise missiles, cutting the warning time in half to 60 seconds. With Sweden joining NATO in February, likely the risk escalated because it could now be a target of Russia.
Following the Swedish decision, Denmark’s Ørsted announced it was abandoning work on its proposed wind farm, one of the 13 rejected offshore projects. It was another blow to Ørsted’s growth plans.
Across the Baltic Sea from Sweden lies Estonia, which also has a checkered record with offshore wind farms. In April, Estonia began reviewing three offshore wind leases west of Saaremaa: Saare 2.1, Saare 2.2, and Saare 3. In June, it approved bids from Norwegian offshore wind developer Deep Wing Offshore for licenses for the first two sites.
The Norwegian company plans to install up to 98 wind turbines with a potential generating capacity of up to 1,560 megawatts (MW) of power in Saare 2.1 and up to 56 turbines with a generating capacity of up to 840 MW in Saare 2.2. Bidding for the Saare 3 lease was conducted in early July, but no bids were submitted by the two qualified developers.
Following Sweden’s rejection of the 13 proposed Baltic Sea wind farms, the Estonia military has warned about similar problems. In an interview for ERR radio, the head of Estonia’s Military Intelligence Agency, Ants Kiviselg, warned that offshore wind turbines disrupt radio intelligence, complicate the reception and positioning of signals from enemy territories, and shorten the early warning times.
The shortening of warning times is crucial for Estonia and NATO’s defense. Failing to detect an aircraft's takeoff or missile pre-launch maneuvers could reduce warning times by minutes. Estonian Nave Commander Ivo Vark noted that signal detection distortions caused by reflections from moving or still turbine blades make it challenging to locate objects at sea, impacting military missions and rescue operations. This problem has been known since offshore wind turbines were first considered in the late 1990s and early 2000s, and no solution to radar interference has been developed. Vark stated that all wind farms planned for Estonian waters disrupt our operations to varying degrees. He described those areas where turbines are positioned for several dozen kilometers as creating a “barrier.”
The offshore wind turbine radar interference issue has suddenly become more prominent because of the recent decision to allow Ukrainian forces to fire U.S.-provided missiles into Russia in the current war. Russian President Vladimir Putin announced that the decision forced his government to redefine its rules of military engagement, making such missile attacks an escalation of war. With Sweden’s joining NATO and the revised rules of warfare, every NATO member nation has become more concerned about being attacked and how they can protect themselves. This elevates the concerns over offshore wind turbine radar interference. What might have been accepted earlier is becoming a critical defense weakness and a risk to NATO member country residents.
Another development unrelated to radar interference reflects offshore wind’s weak economics. The weak economics – high costs and high interest rates – were observed in Denmark’s recent lease sale with no subsidies and no bids. They are also seen in Shell plc’s announcement that it was stepping back from new offshore wind investments and splitting its power division. The decision came from a company-wide review begun in 2023 to find ways to reduce costs as new CEO Wael Sawan reoriented the company’s strategy to focus on businesses with the highest returns.
The strategy shift meant reducing spending on low-carbon and renewable businesses and increasing the focus on oil, gas, and biofuels. Shell’s move is similar to that of its European competitors, BP p.l.c and Equinor ASA. Their moves were driven by shareholder pressure to boost returns and maintain large payouts, something also haunting Shell’s share price.
The media attributes the shift to two significant developments – the energy shock from Russia/Ukraine and the declining profitability of many renewable projects. Russia’s invasion of Ukraine highlighted Europe’s dependency on Russian crude oil and especially natural gas. The latter fuel primarily powers Europe’s electricity generation, which could not easily be replaced by renewable energy due to its intermittency. Furthermore, replacing Russian natural gas required high prices for imported liquefied natural gas (LNG) to lure supplies away from Asian markets to enable Europe to survive the 2022 winter.
Shell’s announcement continues a series of reversals from the company’s previous CEO's environmentally-centric strategy. It weakened a 2030 carbon reduction target and scrapped a 2035 objective because of its expectation for strong natural gas demand and uncertainty about the pace of the energy transition. That move resulted in strong opposition from climate activists.
Sawan previously stated that the company’s strategy would be to grow its LNG division and stabilize its oil production through 2030. It has also scaled back operations in offshore wind, solar, and hydrogen, and sold its retail power business, refineries, and some oil and gas production. In recent months, Shell retreated from offshore wind projects in South Korea and the U.S.
Turbines in an offshore Swedish wind farm.
Photo: Britta Pedersen via AFP.
Finally, a Financial Times article last week, “How the world’s biggest offshore wind company was blown off course,” highlighted the difficulties Danish developer Ørsted has had after converting from an oil and gas producer to building a renewables-only business. The price of this transformation effort has cost long-term shareholders. Ørsted’s share price has fallen 70% since 2021, when renewable energy was a hot investment sector.
Ørsted’s stock price crash has cost investors and management.
Source: Financial Times.
In 2021, Ørsted was aggressively moving to take advantage of its first-mover advantage in offshore wind to expand globally. At the company’s Capital Markets Day that February, management announced that its directors had approved a new strategic growth plan. Mads Nipper, Group President and CEO of Ørsted said, “Our aspiration is to become the world’s leading green energy major by 2030. With the offshore wind industry’s largest concrete development pipeline, our global development organization, and our industry-leading commitment to innovation, it’s our clear aspiration to remain the global market leader in offshore wind. In onshore wind and solar PV, with our proven track record in scaling and delivering attractive value and as a top 5 developer in the US, it’s our aspiration to become one of the world’s top 10 players in onshore renewables.”
With a total of 12 GW of installed renewable capacity, the company set a goal of 50 GW of installed capacity by 2030. This meant offshore wind growing by a factor of seven and onshore renewables by a factor of 2.5-3. Ørsted planned to invest DKK 350 billion ($49.6 billion) in green energy between 2020 and 2027, representing a 50% increase from its prior investment plan to achieve this goal.
Ørsted introduced financial targets consistent with its ambitious growth plan. It expected operating income (EBITDA) to grow by 12% per year on average, reaching DKK 35-40 billion ($5-5.7 billion) in 2027. The growth rate assumed that all offshore wind projects not already in joint ventures Ørsted would reduce its ownership to 50%. Other features of this plan would be a fully loaded, unlevered lifecycle spread above the company’s weighted average cost of capital of 150-300 basis points at the time of its bid or final investment decision, whichever came first, for all its onshore and offshore projects. Furthermore, it was expected to generate a return on capital employed of 11-12% on average for 2020-2027. Finally, it anticipated maintaining its current dividend policy until 2025 with high annual single-digit percentage increases.
The company’s ambitious goals ran onto the shoals of the ending of the era of ultra-low-cost borrowing, the ESG environment, social, and governance) investment boom fading, and clean power overwhelming grid capacity for hookups, delaying project startups. The future of renewable energy was upended. The sector proved to be more fragile than investors thought. “Depending on how you measure it, clean energy is five to 10 times more sensitive to changes in interest rates [than fossil fuels],” Nick Stansbury, head of climate solutions at Legal & General Investment Management, told the FT. Some years ago, a board member of the Bank for International Settlements noted this phenomenon as it evaluated lending to renewable projects. However, it seems few people realize that such a heavily front-loaded capital investment business model lives or dies on the cost of capital.
Ørsted may have misunderstood this aspect of its business model because it was a first-mover with numerous competitive advantages. It had Danish government support (previously the nation’s oil and gas company), seasonally high wind speeds in the North Sea, and a short supply chain as turbine manufacturers Siemens Energy and Vestas were nearby.
When these conditions changed, especially in the U.S. market where Ørsted was making big bets, high interest rates, supply chain problems, and project delays resulted in negotiated electricity contract prices proved inadequate to justify moving forward. Almost every East Coast offshore wind project experienced financial pressures, forcing many to cancel their contracts (paying penalties to their counterparty) and hope for opportunities to rebid their projects. The lack of subsidy increases further weighed on project return economics. That condition forced Ørsted to walk away from two massive projects in New Jersey, resulting in a $4 billion impairment charge. The financial damage done to Ørsted by the changed market resulted in its chief financial and chief operating officers stepping down, suspension of its dividend, a downgrade to its renewables target to 35-38 GW from 50 GW, and up to 800 jobs cut. It has also exited offshore wind markets in Norway, Spain, and Portugal. As part of its recovery plan, the company has accelerated the selling down of interests in its wind farm portfolio to raise capital.
Ørsted is not the only offshore wind developer to suffer from the new investment environment. As noted above, almost every developer has paid a price, including Shell, BP, and Equinor. Recently, RWE, a German energy company, said it would invest less in green energy projects in 2025, opting to increase its share repurchases to appease its investors. It cited the re-election of President Donald J. Trump as a risk to offshore wind in the U.S. and Europe’s delays in developing its green hydrogen industry.
Rapidly rising electricity prices, driven by government mandates to increase clean energy supplies, are inflicting financial pain on people and causing them to adjust their lifestyles. People were assured that the path to a net-zero carbon emissions world would result in cleaner and cheaper electricity. Neither promise is coming true. An expert in energy world development is Thunder Said Energy. Following the Trump election, but also based on other market trends, it wrote, “We increasingly fear our road map to net zero is not what will happen.” It now projects more natural gas being used in the future, as well as coal consumption holding up for longer than expected. These trends are coming not because Trump is opposed to offshore wind and questions the consensus climate change science but because the cost of renewable is not declining as expected.
Renewable energy developers such as Ørsted are retrenching. The halcyon days that drove the industry boom are not likely to return soon, if ever. As analysts at investment bank Jefferies told the FT about the energy transition, “Macro conditions have changed markedly, technologies and business models are hitting inflection points, scale is materializing for some, whilst there will be false dawns for others.”
Many companies recognize this reality and are adjusting their business models, strategies, and expectations. The hydrocarbon industry realizes its future is far from bleak, as it was told just a few years ago. Playing to their technical and business strengths gives the hydrocarbon companies many more years of runway to assess how their business models may need to change.
Renewable energy companies now understand that the yellow brick road to riches has many potholes to be navigated. The view of the future of energy was best summed up by Nazmeera Moola, sustainability director at global investment manager Ninety One, when she told the FT, “There was a view a little while ago that [Ørsted’s path] was the path for all oil companies. [But] we’ve increasingly come to the conclusion that’s a naïve expectation – these are fundamentally different businesses.” We second that view.