Energy Musings - November 5, 2023
The turmoil in the U.S. offshore wind industry marked by large write-offs and abandonment of several proposed wind farms signals the industry faces even more challenges ahead.
Summary
The offshore wind industry is reckoning with a different world than it imagined. Developers are blaming their huge asset write-offs on inflation, supply chains, installation vessel delays, and high interest rates. We think a substantial portion of the industry’s problems are due to management failing to understand how their business model was about to be devastated by their poor decisions about factors that make the industry work. They should have understood the infrastructure, supply chains, vessel operational challenges, and what high-interest rates do to highly leveraged financial structures. We examine these issues, while fully expecting to be revisiting them again in the future.
The Offshore Wind Landscape In A New World
U.S. offshore wind developers are suffering. Suddenly, state regulators and utilities are not rolling over and accepting high-priced offshore power. Without higher prices, offshore wind developers are forced to re-evaluate the value of their assets. Such a reckoning is never pretty. And this time is proving no different.
So far this year, we can identify $5.4 billion in offshore wind asset write-downs. The bulk of the write-downs was the $4 billion absorbed by industry-leader Danish developer Ørsted. That followed a $540 million charge by international oil company BP plc and $300 million by Norwegian energy company Equinor. Earlier there was a $331 million charge taken by New England utility company Eversource Energy when it decided to exit its offshore wind investments including three joint ventures (South Fork Wind, Sunrise Wind, and Revolution Wind) with Ørsted. In April when Ørsted repurchased the 25% interest in Ocean Wind 1 from partner New Jersey utility company PSEG, it wrote down the asset by $236 million. This is a huge amount of industry capital (shareholder money) flushed down the drain.
The Ørsted, Equinor, and BP announcements were accompanied by statements that the cost problems arose recently. It is like the Four Horsemen of the Offshore Wind Apocalypse attacked the industry. Instead of Death, Famine, War, and Conquest, the warriors used inflation, supply chain issues, installation vessel delays, and high-interest rates to bring their devastation. Were these surprises or were they the fault of management?
Installation vessel delays were the latest cause célèbre. Before, developers only pointed to inflation, supply chains, and high-interest rates as the root of their financial woes. Developers were given a pass on the first two issues by Industrial Economics, Incorporated (IEc), the economic consulting firm that advised the New York State Energy Research and Development Authority (NYSERDA). IEc was asked by NYSERDA to opine on the financial problems of developers of offshore wind and other renewable energy projects contracted to deliver power to New York. Offshore wind developers were asking for an average 48% price hike, while the other developers (onshore wind and solar) sought 71% average rate increases. All were turned down.
In its report, IEc studied the history of inflation and supply chain issues and concluded that their spikes during and immediately after the pandemic were a surprise for renewable energy developers. Developers had not factored the financial impact of these two challenges into their power bids.
Surprisingly, IEc did not give the developers a pass on failing to anticipate high-interest rates. When we wrote our October 13, 2023, Energy Musings article discussing the rate hikes requested by New York offshore wind developers, we commented on the IEc’s opinion that based on history, developers should not have expected a continuation of ultra-low interest rates. Moreover, a speech by an executive board member of the European Central Bank showed how rising interest rates had a significantly greater impact on renewable energy prices compared to fossil fuel plants.
As a long-time Wall Street energy analyst, we have watched management explain strategic mistakes when forced to accept financial write-offs. Cleansing manager misjudgments by flushing shareholder money away is a practice that quickly destroys investor confidence. One sees such sentiment emerging in the investment reports following Ørsted’s surprisingly large write-off.
At the end of August, Ørsted management announced a potential $2.3 billion asset write-down as it was reevaluating its U.S. offshore wind portfolio. Sixty days later it surprised investors with a nearly 75% larger write-off. Moreover, management warned there were likely more write-offs coming next quarter. Since the August announcement, Østed’s stock has fallen 53%. It is down 76% from its 2021 peak price and sits at a 6 ½ year low.
Offshore Industry Challenges
We still find it interesting how energy writers covering the offshore wind and renewable energy industries appear not to have bothered reading the NYSERDA’s analysis, including the IEc report. Had they read it, and better yet, read energy and wind industry histories, they might have stopped using the words “nascent” and “immature” to describe the offshore wind industry’s problems.
Yes, offshore wind is a relatively new business enterprise in the U.S., but developers knew or should have known, the status of infrastructure and supply chains. It seems they believed any hurdles would be easily overcome as they raced to buy as much offshore wind acreage as the federal government would offer. Moreover, there is a 70-year history of the offshore oil and gas industry providing a template for operating in U.S. waters.
The U.S. maritime industry operates under the 1920 Jones Act. It requires vessels transporting goods between U.S. ports to have been U.S.-built and staffed by U.S. maritime workers and officers. Foreign governments consider the act protectionist, and it makes U.S. maritime transportation more expensive than if foreign vessels were allowed to participate.
Offshore wind developers need Jones Act-compliant vessels for bringing equipment and people from shore to wind farms. They could use a foreign-flagged installation vessel that was supplied entirely by U.S. vessels. One U.S. installation vessel is under construction, but its cost is already 30% higher than initially estimated and that cost overrun may grow.
Another challenge is the push by offshore wind developers to install larger wind turbines to gain increased capacities and lower per-megawatt cost. Larger offshore wind turbines necessitated larger vessels. The first offshore wind farm, Vindeby in Danish waters, was constructed in 1991 with wind turbines with a 0.5 megawatt (MW) capacity. They stood 115 feet tall with blades 115 feet in length. The 2016 30-MW Block Island Wind farm has five 6-MW turbines standing 330 feet tall with blades 240 feet long. The current generation of wind turbines, such as the General Electric Haliade-X with 12 MW of capacity, will stand 853 feet tall with 722 foot-long blades.
Barges were readily available to haul early wind turbine components to the installation site. But a barge to haul Haliade-X or similar turbine components must be nearly six times longer. Not only are there few such barges, but they require more horsepower to be moved offshore, and much larger docks for loading components.
Likewise, larger, and more powerful cranes are necessary on the installation vessels to lift the heavier and larger tower components and blades. Most installation vessels are four-legged platforms with a crane mounted on them, occasionally there may be a three-legged crane platform, but they are physically limited as to how large a structure they can handle.
The primary challenge for cranes is connecting them with the components to be lifted, especially the blades. With the supply barge alongside the installation platform, the lifting danger is the barge heaving up and down with wave action. Wind turbine blade edges are made from composite material that cannot be dented. Therefore, connecting the crane to the blade is a delicate operation. A dented blade is worthless, and the installer would be at financial risk for the cost of a new blade unless indemnified, and a turbine installation project would be delayed as it would require a replacement blade that may not be available. Who can afford to take these risks? The result is that installation times depend on offshore weather and sea conditions. Estimates are that conventional installation units will, on average, only be able to work 50% of the time.
All of these issues were well-known when the offshore wind industry came to the U.S. If executives did not anticipate these conditions, they did a poor job of managing their businesses. Maybe they were mesmerized by the history of declining estimated levelized cost of electricity (LCOE) from offshore wind, but the reasons for that trend were artificial. We question whether the executives fully understood why the LCOE was in a downward trend for all those years. Such an understanding is critical as we have transitioned into a different economic world. This transition will impact the three key variables developers point to the collapse in offshore wind economics. Therefore, instead of making installation vessel delivery delays the fourth cause of the offshore industry’s apocalypse, we would substitute poor management.
Where Is The Offshore Industry Today?
As wind developers were announcing their huge write-offs, the Financial Times was holding a conference on the energy transition. At the meeting, Anjz-Isabel Dotzenrath, BP’s head of gas and low-carbon energy, said that the U.S. offshore wind industry is “fundamentally broken” and requires “a fundamental reset.” She attributed the problems to cost pressures and permitting delays but pressed that the crisis needs to be fixed because offshore wind is vital to slowing global warming.
Claudio Descalzi, CEO of Italian energy company Eni told the FT conference that costs to develop new offshore wind projects have doubled recently. This follows Swedish company Vattenfall abandoning a North Sea wind farm because costs increased by up to 40% this year. That made the project unfeasible. It certainly supported Descalzi’s comment, "To do new offshore wind projects is very hard."
Permitting is a favorite area of attack for offshore wind developers. We sense that they would like to be able to just buy a lease and start building a wind farm and negotiate a power purchase agreement. Such speed of development is seen as a way to overcome inflation and supply chain problems. However, every offshore development under U.S. law must receive an environmental assessment. Contrary to offshore wind developers, the U.S. government is moving forward with permitting faster than ever.
Permitting has been so fast that it has angered a coordinating agency involved in the process. NOAA is the primary coordinating agency to the Bureau of Ocean Energy Management (BOEM), and it has complained in writing about the speed with which the offshore wind projects are being reviewed. An August 14, 2023, letter to BOEM from Michael Pentony, the Regional Administrator of the Greater Atlantic Regional Fisheries Office of the National Marine Fisheries Service (NMFS) highlights the frustration. NWFS is part of NOAA and is specifically charged with overseeing the review of offshore wind farm plans and their potential impact on marine mammals and fisheries. Pentony wrote:
“The high number of projects moving through the NEPA [National Environmental Policy Act] process between now and 2024 makes it very difficult for us to provide the detailed level of review and interagency cooperation we have provided in the past. The extensive interagency cooperation we have invested with you to improve the NEPA documents for previous wind energy projects is no longer feasible, and we will be required to take a more limited Cooperating Agency role in the process.”
NMFS is worried about becoming a second-class citizen in these reviews. Their fear is based on BOEM’s treatment of the agency in previous draft environmental reports. NMFS was not only irritated by the treatment but worried that their input was carrying little weight. Therefore, NMFS threatened to cause greater problems in the future if their relationship with BOEM did not improve. This tension continues to escalate. A bureaucratic feud could seriously disrupt the offshore wind farm approval process making things worse for offshore wind developers.
The major problem for offshore wind developers is that they are not receiving sufficient subsidies. Developers have enlisted New England and Middle Atlantic governors to lobby the Biden administration to get the Inflation Reduction Act (IRA) tax credit rules written more leniently for offshore wind. That would enable developers to harvest an additional 10%-20% tax credit on top of the normal 30% credit. Since these tax credits are salable, developers can turn them into cash immediately as we just saw with Vineyard Wind. The owners acknowledged that this was critical to their ability to finance the wind project.
Ørsted even twisted the arms of the governors of Maryland and New Jersey to give the company the IRA tax credits destined for state residents to help reduce their high electricity bills. Even with nearly $1 billion in IRA credits, Ørsted deep-sixed the Ocean Wind 1 and 2 projects off New Jersey. That move did not sit well with New Jersey Governor Phil Murphy who said, “Today’s decision by Orsted to abandon its commitments to New Jersey is outrageous and calls into question the company’s credibility and competence.” Reports are that Murphy knew of Ørsted’s decision a week before it was announced. Now there will be a battle over the $300 million that Ørsted recently posted to ensure it would be going ahead with the project.
Since the fall of 2022, offshore wind developers have acknowledged that their projects were not financeable at their current contracted electricity prices. They began and have completed terminating six contracts even after having to pay penalties. The terminations only came once state governments assured the developers that they could terminate contracts and that would not prevent them from being able to bid in new offshore wind power solicitations. Following New York State’s rejecting offshore wind developer rate hike requests, we expect several more contract terminations since the governor assured the developers that they could compete in a new offshore wind power solicitation that is racing ahead.
The NYSERDA report recommending to the state Public Service Commission that it approve slightly reduced rate hikes for renewable energy projects including the offshore wind ones carried the following commentary about future economic conditions. The agency thought that paying more for power now might prove cheaper than waiting for new projects.
“F[f]orecasts indicate that inflation will moderate, but remain positive, over the next ten years. Inflation projections show that the GDP Deflator and the Consumer Price Index will stabilize slightly above the Federal Reserve’s 2% inflation target between 2024 and 2033. Economic analysts are not projecting that price deflation (a sustained drop in the general price level) will occur in the next ten years. Forecasts indicate that the price level in the U.S. will nearly double by 2033 relative to the end of 2020. Labor costs are also expected to increase, but at slower rates. Historical relationships between general measures of inflation and commodity prices indicate that the latter, despite peaks and troughs, will follow an upward trend over the next ten years.”
The IEc report included in the NYSERDA report offered a view of offshore wind’s future costs:
“Renewable energy project costs will remain above pre-2022 levels until sometime during the 2025-2030 period, with the exact year dependent on the technology type…Though technology and efficiency gains are lowering costs for offshore wind development over the long term, recent press reports and industry analyses provide strong evidence that supply of key components will not keep pace with global demand for offshore wind generation, which will increase costs in the sector through 2030.”
Those outlooks are not favorable for residents who have been told that offshore wind power would be cheaper. Higher inflation and sustainably higher interest rates undercut offshore wind economics. As former BP CEO Bernard Looney said in August, "We will not develop projects that don't meet our returns thresholds" of 6% to 8%.
His company’s $540 million write-off reflected the $1.1 billion it paid to Equinor to become a joint venture owner of the offshore projects that had their rate hike requests rejected by New York. Equinor booked a nearly $900 million capital gain on the sale. The $240 million difference in write-off amounts between BP and Equinor is explained by the purchase price and respective company costs.
We were interested in the assessment of adding an inflation protection clause in New Jersey’s offshore wind solicitation offered by rate counsel Brian Lipman to the New Jersey Board of Public Utilities. “If the inflation provision had been in place for the past two offshore wind projects, it could have significantly increased the cost to ratepayers,” Lipman said. “For Ørsted’s Ocean Wind 2, the inflation adjustment would have cost ratepayers an additional $1.4 billion and an additional $1.9 billion to Atlantic Shores Offshore Wind LLC.” Those are not inconsequential costs for New Jersey electricity customers.
Earlier this year, New Jersey utility, PSEG, exited its 25% joint venture with Ørsted. The reasoning was explained by PSEG’s Senior Vice President and Chief Commercial Officer Lathrop Craig. "As Ocean Wind 1 has evaluated the optimal way to move forward, it has become clear that it is best for the project for PSEG to step aside and allow for a better positioned tax investor to join the project so that it can proceed with an optimized tax structure. While this was a difficult decision, it was driven by the best interests of the project and New Jersey's offshore wind goals. PSEG will continue to actively support offshore wind in New Jersey and the region." President and CEO Ralph LaRossa elaborated on the rationale, saying the decision was “consistent with our goal to increase the predictability of our business.”
Our last observation about the offshore wind industry’s write-offs was that Ørsted’s $4 billion write-off included a $56 million charge for its Block Island Wind farm. When Ørsted purchased Deepwater Wind, the developer of Block Island Wind, from hedge fund DE Shaw in 2019, it received not only the first operating U.S. wind farm but also interests in leases accumulated by the developer. Some of those leases were involved in Ocean Wind 1 and 2 and have been abandoned, along with Sunrise Wind and Revolution Wind which were written down in value. This Block Island Wind write-off amounted to about 11% of the $510 million Ørsted paid to DE Shaw. We suspect this charge was a pro-rata share of the other wind farm write-offs.
This will likely not be the last time we learn of financial problems in the offshore wind industry. The primary culprit is high-interest rates that destroy the low returns earned by renewable energy projects. The 6% to 8% returns mentioned by BP’s Looney are less than half the return targets for oil and gas projects. Those projects have a higher risk because they do not convey monopoly selling power for their output, in contrast to offshore wind that is sold to local utilities forced to purchase the power under state clean energy mandates.
Structuring offshore wind projects with 80% or more debt is a recipe for financial disaster. If our future is a high-interest-rate world, these offshore wind projects need to be financed with lower amounts of debt. The equity component of the financing structure will not benefit as much as it did when leverage was high and interest rates low. This financing structure guarantees higher offshore wind power prices. That reality is what is driving the push for greater government subsidies. The future of ever-cheaper renewable energy is over. Offshore wind developers have yet to recognize this new world and what it means for their projects. We are just beginning to see the fracturing of the offshore wind’s business model.