Do Offshore Wind Economics Meet Lower Cost Claims?
“As the U.S. stands on the cusp of an explosion in offshore wind power, a new study supports the claim that the cost of new wind farms is dropping rapidly. A through study rebuts that conclusion and shows that the belief in the view of cheaper offshore power may be due to speculators counting on higher electricity prices that will allow them to abandon their low-price winning bids. U.K. consumers should be concerned about their bills. ”
In the United States, efforts to exploit the nation’s offshore wind resources are moving ahead rapidly. The first offshore wind farm, a five-turbine, 30-megawatt (MW) project constructed four miles off the coast of Block Island, commenced operation in December 2016. That wind farm was located in Rhode Island state waters under policies that facilitated its construction. Recently, two 6-MW wind turbines were installed in federal waters off the coast of Virginia. These turbines will provide information to help their owner, Dominion Energy, manage its planned huge offshore wind farm to be constructed over the next five years in two phases. Each phase will total 880 MWs and require over 70 turbines. These wind farms are expected to begin construction in 2024, following the approval of their plan of development to be presented to regulators in late 2022. The first phase anticipates beginning operation in 2025 followed by the second in 2026.
Off the coast of Massachusetts, Vineyard Wind is planning an 800-MW, 84-turbine wind farm 35 miles south of Martha’s Vineyard. This project originally envisioned commencing operations in 2022, but given an extended environmental review, the Bureau of Ocean Energy Management (BOEM) is now scheduled to render a verdict on the application in December. Regardless of the decision about the Final Environmental Impact Statement (FEIS), we fully anticipate lawsuits over the approval process, which could push the start-up off for another 1-3 years.
As the 45-day comment period for BOEM’s updated environmental review was drawing to a close, we received an email from the Union of Concerned Scientists (UCS) imploring us to: “Write today and tell federal regulators you support the future of offshore energy.” The final battle over the government’s study was its position on the layout of the wind turbines. The plan originally envisioned turbines being arranged in a one-nautical-mile grid, an option that still remains. This layout is designed to permit fisherman to operate within the confines of the wind farm and for ships to transit.
The Responsible Offshore Development Alliance, a coalition of commercial fishing groups, has pushed for another layout option involving several 4-mile-wide transit fairways. If this option is adopted, the size of the wind farm would shrink, potentially rendering the wind farm uneconomic, grounds for the owners to sue. The U.S. Coast Guard okayed the grid layout, but its study has been criticized as inadequate. It relied on Automatic Identification System (AIS) data, a system that allows other vessels in the immediate area to be seen by all vessels to avoid collisions. The problem is that very few fishing vessels have or use AIS. This raises questions about whether the Coast Guard is underestimating the number and operational patterns of the vessels that actually work the fishing banks where the wind farm is to be installed. You can see the legal split generating lawsuits regardless of the layout option BOEM picks.
One paragraph in the email from the UCS caught our attention. It stated:
“Offshore wind is well positioned to be a major source of clean energy for the United States. The wind resources off our coasts are some of the most powerful in the world, and close to where the power is needed. Many states have laid out ambitious goals for harnessing offshore wind power. And its cost has fallen dramatically in recent years.”
There is no question that the potential offshore wind resource is huge. That is well documented by scientific studies. Clearly, the Atlantic Ocean wind resource is close to the major population centers located along the East Coast, so getting them power is an admirable objective. Whether that power would be cheaper than customers are already paying is uncertain, although it is assumed to be by its promoters, besides being cleaner. Those assumptions are key in driving the construction of offshore wind farms to help meet the net-zero carbon emissions mandates of the coastal states. The Block Island wind farm has a much higher electricity cost (27-cents per kilowatt-hour versus the 19-cents/kWh) than charged on the mainland. In addition, the offshore electricity price escalates by 3.5% every year of the 20-year contract life, but not the onshore price. The higher offshore price was rationalized by it competing with electricity from diesel-fired generators on the island whose output cost at the time was in excess of 50-cents/kWh. The wind farm project also included installation of a power cable to shore that would take any surplus power, but also enables the island to always have electricity from shore if the wind farm fails to generate enough.
A quote from an article on e360.yale.edu highlighted the potential growth of offshore wind on the East Coast. It stated:
“According to the U.S. Department of Energy, more than 25 offshore wind projects with a generating capacity of 24 gigawatts are now being planned, mainly off the U.S. Northeast and mid-Atlantic coasts. And although some of these projects may not be built, and only one commercial offshore wind farm has actually been constructed —the tiny, five-turbine “Block Island Wind” project off Rhode Island — analysts say that U.S. offshore wind is expected to enjoy significant growth in the coming decade.”
Given all this activity, we wondered if the assumption about falling costs was actually true, especially given the surge in offshore wind in Europe. As we contemplated this question, we were alerted by a headline from The Independent newspaper in the U.K. that offered hope for some data on wind farm costs. The headline read: “Climate crisis: Offshore wind power ‘so cheap it could return money to consumers.’” Was this negative pricing, which we hear about repeatedly with wind energy? How was that benefitting customers? Actually, it was a statement that the subsidies the U.K. government is paying for offshore wind would decline in the future due to lower cost wind power. In other words, the government wouldn’t be providing as large a subsidy for the future wind power, therefore the monthly charge on customer bills would decline. As with all promises of largess due to government prescient investments, we suggest U.K. consumers hold on to their wallets.
The article was based on a paper recently published in Nature Energy by researchers at the Imperial College London’s Centre for Environmental Policy, jointly with institutions in Denmark, Belgium, the Netherlands and Germany, along with comments to the reporter from the paper’s authors. Lead researcher Dr Malte Jansen, from the Centre for Environmental Policy at Imperial College, said:
“Offshore wind power will soon be so cheap to produce that it will undercut fossil-fueled power stations and may be the cheapest form of energy for the UK. Energy subsidies used to push up energy bills, but within a few years, cheap renewable energy will see them brought down for the first time. This is an astonishing development.”
Exhibit 19. How U.S. Power Market Has Changed Recently SOURCE: Ofgem, PPHB
The U.K.’s power market has changed materially in recent years. As Exhibit 19 shows, since 2012, coal has lost most of its market, while natural gas, wind and solar grew. The most recent surge in wind and solar has cut into nuclear energy’s contribution, as well as that of natural gas. The first quarter of 2020 is the initial quantification of the offshore wind and solar contribution. It represented 47% of the total wind and solar power category. Based on the number of offshore wind farms scheduled for completion or planned over the next five years, this share will rise substantially.
That is why the newspaper article’s headline, with its promise of a shrinking renewables subsidy, sparked our interest. The shrinking subsidies are arguably due to new offshore wind farms costing less to construct. Cheaper power needs less in subsidies - assuming the study is right. An analysis by other researchers showed that the assumption of dramatic declines in offshore wind farm construction costs is wrong, meaning government subsidies will continue rising, along with customer bills.
According to the U.K. government’s budget projections for environmental levies – the amount of money paid to renewable fuel providers ‒ will rise steadily for the next five years. The data was in the March 2020 update from the U.K. Office for Budget Responsibility.
Exhibit 20. Forecasts Call For Environment Fees To Rise SOURCE: Office For Budget Responsibility
The critique we referenced above was entitled “OFFSHORE WIND STRIKE PRICES - Behind the headlines,” and published shortly after the Imperial College London paper. The critique was prepared by three highly recognized energy researchers and published by The Global Warming Policy Foundation. The paper’s summary points to other explanations for lower prices in recent offshore wind power contracts than lower capital costs. In fact, bidders may be gaming the market as developers seek to win projects and will deal with profitability later, if at all. The summary stated:
“Because the successful bid prices (£57.50/MWh and £74.75/MWh, in 2012 prices, $75.43/MWh and $98.06/MWh, respectively) for offshore wind in the second round of competition for UK renewable electricity Feedin Tariffs with Contracts for Difference (FiTs CfDs) are very significantly lower than those awarded in 2015 (£114–£150/MWh in 2012 prices, $150/MWh and $197/MWh, respectively) it has been widely assumed that the underlying costs of offshore wind are falling, and that the CfD prices indicate a sudden paradigm shift for the technology. However, statistical analysis of the data available, covering 86 offshore wind farms, suggests that the capital cost of offshore wind (£/MW installed) is not in fact falling, since the extra costs of necessarily moving into deeper water are offsetting a real but modest rate of technological progress. The successful projects in the second round are almost certainly not viable at the low CfD prices offered, and these bids therefore must have other explanations. We infer that developers see the CfD as a low-cost, no-penalty option for future development, and that, because the contract is easily broken once the windfarm has been built, they regard the price as a minimum not a ceiling. Should the market price rise above the contracted price, because of rising fossil fuel costs or a carbon tax, they would cancel the CfD contract and take the higher price that would become available. On the other hand, if there is no significant probability of that elevated market price, these sites are very unlikely to be built. Contrary to media exaggerations, the low CfD prices are commercial speculation, not the dawn of a new age for offshore wind and renewables.”
The authors of the critique point to the sloppiness of the media by not focusing appropriately on the difference in the timing of the prices – 2012 versus 2017, and for some new projects what their costs might be in 2024-2025. They ask why the media hasn’t questioned whether it is possible for such a dramatic decline in pricing in such a short time span. But, as they also point out, there is little data on offshore wind farm capital costs. In their critique, they relied on three databases, one assembled from public reports by companies. Another database from an “EU-funded study by the FOWIND consortium (Facilitating Offshore Wind in India) covering various European sites, and prepared under the auspices of the Global European Wind Energy Council.” In that study, the authors, who examined a smaller database and over a shorter time period, noted, “The broad trend in the development of Capex since the early days of offshore wind technology in the early 1990s is contrary to any expectation of conventional industrial maturation. Learning or experience curve theory would predict reducing costs with time, through the combined impact of innovation, learning effects and economies of scale. The historical reality has been dramatically different . . .with Capex increasing . . . .”
The critique paper utilized a larger database and over a longer time period that they created. They produced a scatter plot of the data for offshore wind farms by water depth and year of construction.
Exhibit 21 Offshore Wind Farms Show Rising Costs SOURCE: GWPF
When the capital cost for a standard wind farm – capacity 600 MW, built in North Sea waters with a depth of 40 meters (132 feet) – was analyzed, the authors found unit costs in 2012 dollars rose at a 6.1% annual rate from 2005 to 2013. Since then, the cost has declined at a 4% annual rate. The authors said this decline “is a real but modest rate of technological improvement, and to be expected.”
Exhibit 22. Rising Wind Farm Costs Are Now In Decline SOURCE: GWPF
The question is what may be going on within the cost data. They found that wind farm capacity and distance from short had little or no effect on unit costs. There also seemed to be no indication that increasing the size of turbines actually reduced the capital cost of new installations. The authors wondered whether the rising cost trend in the early years was due to the extra costs of upgrading 2-3 MW onshore turbines for offshore use, at least in deeper waters.
The authors then looked at what has happening to the cost of standardized wind farms built in 2016 when water depth increased. The data showed a steadily rising cost trend. As a result, the authors concluded that the decline in standardized wind farm costs since 2013 has been somewhat offset by the move to deeper waters and larger wind farms, thus more infrastructure investment. They point out that U.K. offshore wind farms completed between 2000 and 2009 were in an average water depth of 15 meters (45.5 feet), increasing to 21 meters (69.2 feet) for 2009-2014, and is set to double to 42 meters (138.6 feet) for ones coming into service after 2020. This trend has been a counter to the cost decline in recent years.
Exhibit 23. Deeper Water Translates Into Higher Wind Cost SOURCE: GWPF
After assessing the data, the trends suggested to the authors that the recent auction prices are assuming unsupportable trends, or bidders are purely speculating on rising power prices. There are several possible explanations. First, bidders believe equity and debt investors will accept lower rates of return on their investments. As the authors calculated, for these projects to be successful at the pricing terms and projected capital investment criteria, rates of return need to be below 2%. They question whether investors would accept such low returns for the risk of these projects. This return issue is associated with the entire renewable energy space, as BP plc cited in its recent earnings report. BP forecasts a return on average capital employed of 8% to 10% for renewable energy investments compared to 12% to 14% for its hydrocarbon investments, and 15% to 20% for its convenience stores and mobility business. When BP CEO Bernard Looney presented his initial perspective on energy diversification earlier this year, he highlighted that pension investors (those counting on dividends in retirement) would have to accept a lower return from their BP investment if the current renewables return environment continued and the company devoted more capital to the business. This may be a hidden pitfall for investors if they fail to understand the low returns of renewable energy investments.
The authors’ second explanation is that bidders believe the cost of building new offshore wind farms after 2020 will be less than 40% of the projected figures that came from their analysis of cost trends. They see no evidence of that belief, based on public statements made by developers, which tend to be optimistic in any case.
The third possible explanation, and the one favored by the authors, is that bidders bid low and uneconomic prices in order to make sure