London, 08 Apr 2016
Times are challenging for many forms of renewable electricity generation across Europe - except perhaps for offshore wind.
Despite the landmark climate accord struck in Paris in December
, 2015 to limit greenhouse gas emissions, there has so far been little evidence the trend in Europe of cutting subsidies for solar power and onshore wind will be reversed.
Political uncertainty makes investors and developers nervous, especially with an asset class like renewables that has historically been dependent upon government support to make it viable.
However, one renewable energy technology that still seems to have broad political support is offshore wind power.
Europe is leading the way in the construction of wind farms in water. Of the 11.7GW of global offshore wind capacity installed as at 2015, 11GW was installed in Europe and the remaining 700MW in Asia-Pacific, mostly in China.
The vast majority of offshore wind capacity in Europe is found in the UK and Germany, with just over 5GW and 3GW installed respectively at 2015.
Investment in any form of energy generation, including offshore wind, is currently very difficult due to extremely low wholesale power prices.
According to Macquarie Research, baseload power prices in the UK fell by 26 per cent in 2015 and by 5 per cent since the start of October 2015. Macquarie has also reduced its power price forecast from £45.6 MWh to £38.6 MWh.
This price level is insufficient to attract the large initial capital outlay required for most energy infrastructure projects.
Therefore, some price support is necessary for European countries such as the UK to build the infrastructure needed to replace power plants that are shutting down - either due to age or, in the case of coal, environmental legislation.
Mark Dooley, Macquarie Capital Head of Infrastructure, Utilities and Renewables in Europe, says that at the moment, investments cannot occur without government intervention.
“Market price risk is so difficult for investors at the moment, that you need some sort of price underpinning, like the Contract For Difference (CFD) in the UK, and the Feed-in Tariff (FIT) in Germany,” says Dooley.
Under the CFD scheme, the government pays the difference between the strike price and the wholesale cost of electricity. If the cost of electricity exceeds the strike price, the generator must then pay back the extra revenue to the government.
This long-term, inflation-indexed revenue stream is precisely the kind of stable cash flow favoured by the fastest growing source of equity and debt for European infrastructure: institutional investors.
Pension funds, sovereign wealth funds and insurers that invest in infrastructure have typically been attracted to assets such as regulated utilities and availability-based Public Private Partnerships (PPPs) that have fixed payments over a long-term period – up to 30 years in the case of some PPPs.
However, as more institutional investors enter the infrastructure space – either on the equity or debt side – less conventional assets such as offshore wind become more attractive, explains Dooley.
“The traditional centre of what infrastructure investors like to look at, for example utilities and transmission in strong European markets, are seeing fewer assets and more money chasing them,” says Dooley.
As returns on core infrastructure are pushed lower and lower, there is an incentive to chase offshore wind.
Kit Hamilton, Managing Director at Macquarie Infrastructure Debt Investment Solutions says offshore wind has the potential to offer stronger returns than more conventional infrastructure assets.
“There are certainly areas of infrastructure debt that have felt crowded out, such as conventional availability-based PPPs,” says Hamilton.
“In recent years PPP sponsors have been able to command financing packages with returns in the low 100s of basis points,” explains Hamilton.
“Then when you add the competitive nature of the PPP bidding processes, you still risk not achieving any asset at the end of it. With returns approaching twice those, it's fair to say offshore wind has a lot of attractive features for us.”
Not least among these attractive features is the large amount of capital that each offshore wind farm requires to be built.
With project build costs typically well into the billions of pounds, offshore wind offers the kind of scale of investment opportunity that technologies such as onshore wind and solar simply cannot.
Dooley says the size of offshore wind financings are such that even Macquarie’s clients who traditionally have focused solely on big-ticket M&A are interested.
“There’s so much investment opportunity here that they have to look at it,” he adds.
Another attraction of offshore wind is the sheer size of project pipelines in key markets like Germany and the UK.
According to UK Trade and Investment, there is currently 1.7GW of offshore wind capacity under construction, 5.1GW that is yet to be built but has secured financial support, and a further 7.4GW of capacity that has gained planning consent but has not yet secured subsidy support. Add projects currently in the planning process, and the UK has an offshore wind project pipeline totaling 19GW of capacity.
Overall, the UK government continues to seek a balance between meaningful support for selected renewable generation, on one hand, and insistence on driving costs down, on the other hand.
The 2016 Budget announced that the UK government will auction CFDs of up to £730 million corresponding with around 4GW of generation capacity in “less established technologies,” a category that includes and is likely to be dominated by offshore wind. The auctions will take place between 2016 and 2020 and will be for projects that begin generating power between 2021 and 2026.
The first round of these CFDs will be auctioned with bids capped at £105 MWh, a price point on the glide path to UK’s Secretary of State for Energy and Climate Change Amber Rudd’s desired outcome of even lower prices by the end of the decade. While some may think this an ambitiously low target, Macquarie is optimistic that the offshore wind market can meet the challenge.
For more information on the report "Renewable Energy Funds: Potential double whammy ahead" (4 December 2015) contact Macquarie Research.