European offshore wind 2013

European offshore wind 2013 Realising the opportunity

The European energy source of the future

Page 6

What challenges lie ahead?

Page 8

Financing offshore wind

6

How to unlock deeper pools of capital?

Page 19

Market focus

Page 30

What is the optimal grid connection mechanism?

Page 44

B Freshfields Bruckhaus Deringer llp European offshore wind 2013 – realising the opportunityJune 2013

1European offshore wind 2013 – realising the opportunityJune 2013

Freshfields Bruckhaus Deringer llp

About the research

This report provides insight into the European offshore wind sector. The findings are based on a survey of 200 senior executives in the offshore wind industry. The report was written in collaboration with Clean Energy Pipeline, a specialist renewable energy research, data and financial news provider. Transaction data and statistics included in this report have been extracted direct from Clean Energy Pipeline’s databases. Clean Energy Pipeline is a division of VB/Research.

This report was completed between April and May 2013 and covers views from across the offshore wind industry, including utilities, financial investors and the supply chain. Survey respondents were spread across Europe. To supplement the results, interviews were conducted with the following executives:

• David Jones, Managing Director – Head of Renewable Energy, Allianz Capital Partners

• Olivia Breese, Senior Transaction Manager, DONG Energy

• Michael Lewis, Chief Operating Officer Wind Power, E.ON Climate & Renewables

• Tobias Kempermann, Head of Berlin Office, EWE

• Stefanie Pfahl, Head of Wind Energy and Hydropower, German Federal Ministry for the Environment, Nature Conservation and Nuclear Safety

• Burkhard Schuldt, Head of the Division of Ecosystems, GICON Group

• John Price, Sales Director – Subsea Power Cable, JDR Cable Systems

• Fintan Whelan, Co-founder and Corporate Finance Director, Mainstream Renewable Power

• Marc Schmitz, Senior Vice President, Rabobank

• Hans Bünting, CEO, RWE Innogy

• Keith MacLean, Policy and Research Director, SSE

• Jan Rabe, Head of Strategy, Siemens Wind Power

• Chris Veal, Managing Partner, Transmission Investment

• Ian Nolan, Chief Investment Officer, UK Green Investment Bank

• Claus Wattendrup, Director of Offshore Wind Projects, Vattenfall

• Heiko Ross, Managing Director, Windreich

For more information on the issues raised in this report, please get in touch with any of the contacts below.

Paul Bowden Partner, Dispute Resolution, London E [email protected] T +44 20 7832 7273

Wolf Spieth Partner, Dispute Resolution, Berlin E [email protected] T +49 30 20 28 37 91

Marc Lordonnois Counsel, Finance, Paris E [email protected] T +33 1 44 56 44 88

Winfred Knibbeler Partner, Antitrust, Competition and Trade, Amsterdam E [email protected] T +31 20 485 7643

2 Freshfields Bruckhaus Deringer llp European offshore wind 2013 – realising the opportunityJune 2013

Foreword

It is an exciting time to be involved in offshore wind in Europe. Offshore wind will probably make the alternative energy sector’s largest contribution to meeting Europe’s ambitious target of reducing CO

2 emissions by up to

90 per cent by 2050. It also has the potential to create many more jobs than other renewable energy sources in the long term.

The industry continued to take major strides forward in early 2013. Completion of the 630MW London Array offshore wind farm in April 2013 is a major milestone. It is currently the world’s largest operational offshore wind farm. The €850m debt financing of the 288MW Butendiek project in Germany is also a major achievement as it is one of the largest ever debt financing packages put together for an offshore wind farm.

The sector has matured to the extent that it is now a viable investment opportunity for institutional investors such as pension funds and life insurance companies, and industrial corporations.

But despite these positive developments, EU member states are already well behind their forecasts for installed capacity. Is this just another ambition blown off course by the economic storms of the past five years; something that has to be weathered but

which, in time, will automatically shift back on course?

We weren’t so sure. With or without the macroeconomic uncertainties and the preoccupations of the banking sector, we wondered if the sector faces other headwinds that are holding back development.

Working with Clean Energy Pipeline, we thought it was worth taking a closer look at the weather gauge. From Clean Energy Pipeline’s statistics and a recent survey of over 200 senior executives in the offshore industry, with further in-depth interviews with leading figures in the sector, we are pleased to present this report, European offshore wind 2013 – realising the opportunity.

The report tells us that there are many headwinds. Very few survey respondents believe the offshore capacity targets for 2020 will be met, at least not from where we are now.

But there is certainly confidence of significant future growth given the underlying fundamentals of the sector. Five out of 10 survey respondents are either planning offshore wind investments, or believe there will be significant investment activity during the next 18 months in the Netherlands and Denmark. More are targeting investments in France and eight out of 10 are targeting Germany and the UK.



Contents

Executive summary .......................................................... 4

The European energy source of the future ..................... 6

What challenges lie ahead? ............................................. 8• An uncertain subsidy environment• The eurozone crisis still looms large• Pressure on the supply chain will grow

Financing offshore wind ................................................ 16• Why are new financing structures needed?• New equity investors are emerging but more are needed

How to unlock deeper pools of capital? ........................ 19• Export credit agencies and multilateral financial organisations

are vital• Developers must create f lexible packages for institutional investors• Pension funds are also interested in debt• Bonds and securitisation structures must be used to attract

significant capital• Developers must look beyond Europe

Market focus ................................................................... 30• The UK – current appeal masks major future regulatory uncertainty• Germany – a clearer support mechanism although fears remain over

grid connection delays• France – starting to ramp up installation• The Netherlands – new renewable energy target may spur

offshore wind

What is the optimal grid connection mechanism? ...... 44• The UK and German approaches both have their disadvantages


Executive summary

Offshore wind enters uncharted waters

European governments like offshore wind. In theory it should make the greatest impact on achieving European 2020 renewable energy targets and create more new jobs than any other renewable energy source. However, the sector is still in its infancy. Just under 5GW of offshore wind capacity is operational in Europe. This pales in comparison with the 70GW of solar or 110GW of onshore wind capacity operational in Europe at the start of 2013.

According to the National Renewable Energy Action Plans (NREAPs), some 43GW of offshore wind capacity will be installed in European waters by 2020. The bulk of this new capacity will be in the UK (18GW), Germany (10GW) and France (6GW). On an annual basis, that means over 4.5GW must be installed every year between 2013 and 2020. These are ambitious targets – last year a record 1.7GW of offshore wind was installed in Europe.

What could hold back progress?

An uncertain subsidy environment, in the form of new mechanisms or cuts, ranks high among the concerns voiced by survey participants – 83 per cent believe the introduction of new subsidy mechanisms represents a risk to successful future offshore wind project development.

Our survey data also shows there are genuine fears that the ongoing recession in the eurozone will reduce liquidity in the debt and equity capital markets. In 2012, project debt financing decreased 28 per cent to $2.1bn. This is an issue, particularly since we estimate that about $9bn of project debt finance will be needed each year from 2013 if 43GW of capacity is to be installed by 2020.

Financing issues aside, this ramp-up in capacity is likely to put pressure on the supply chain to innovate and reduce costs.

The new financing paradigm

Around two-thirds of survey respondents believe there is insufficient equity financing for European countries to meet their offshore wind targets.

Due to the increasing size of new offshore wind farms, utilities can no longer finance the equity component off balance sheet. Instead, they are relying on long-term investors including European pension funds and Japanese trading houses. Survey respondents expect this trend to continue – over 60 per cent expect international corporate or institutional investors to invest actively in European offshore wind farms during the next 18 months.

Due to the perceived risks with the offshore wind sector, export credit agencies (ECAs) and multilateral financial organisations (MFOs) are now also essential to convince commercial bank debt to invest in projects. All five European offshore wind farms that secured project debt financing in 2012 relied partly on debt from non-commercial banks. Only one (Walney) was financed without support from an ECA. The majority of survey respondents (54 per cent) agree; they expect ECAs and MFOs to continue to be active in the next 18 months.

Given the volumes of debt financing that will probably be required in the sector, capital will also need to be sourced from non-traditional debt providers. An obvious option is pension funds. PensionDanmark became the first pension fund to invest debt in an offshore



wind farm when it allocated €35m ($44m) to the Walney wind farm in June 2012.

If the offshore wind industry is to tap into other sources of debt, it must also create innovative structures that can access institutional investors’ non-alternatives allocation. The most logical option is for developers to use structures such as bonds and securitisation. Survey respondents agree – 80 per cent think that bonds and securitisation structures will become increasingly common.

From a geographical perspective, funding needs be sourced increasingly outside Europe. Survey respondents expect new investors in offshore wind generation assets to come mainly from China (58 per cent), Japan (45 per cent), the Middle East (41 per cent), Korea (33 per cent) and the US (33 per cent).

The UK – appeal masks regulatory uncertainty

The UK is the joint most attractive market for offshore wind investment alongside Germany, according to survey respondents. However, this masks major concerns about the new contract-for-difference feed-in tariff (CfD FiT) regime, which will apply to all offshore wind farms that come online after March 2017.

Most developers of UK offshore wind farms interviewed for this report are accelerating projects that can come online before March 2017, the last date at which projects qualify for the ROC regime. In parallel, they are halting investment in projects that look likely to miss this deadline until further clarity is given on the new CfD FiT mechanism.

Confidence in the UK offshore wind sector has also been dented by a perceived lack of

political support. Only 20 per cent of survey respondents anticipate that 18GW of offshore wind capacity, the volume needed for the UK to meet its 2020 renewable energy targets, will be operational in UK waters by 2020.

Germany – clearer support mechanism but fears remain over grid connection delays

In total contrast to the UK, the subsidy mechanism for offshore wind is clearly defined in Germany. This is why 80 per cent of survey respondents are targeting investments in offshore wind power generation assets in Germany during the next 18 months.

Despite recent legislation, grid connection remains a concern – 85 per cent of survey respondents do not believe the new measures taken by the government to address grid connection problems and liability for delays are enough to prevent further delays.

Surveyed respondents are more positive about meeting targets in Germany than in the UK. Yet they remain undecided as to whether the country’s 2020 target of 10GW installed offshore wind capacity will be achieved.

Looking beyond the major markets

There is also significant growth potential in other European countries. France awarded tenders for 2GW of offshore wind capacity in April 2012 and is tendering for an extra 1GW. It will probably launch a tender for a further 3GW towards the end of the year. The Netherlands has fallen behind other European countries in recent years after announcing major subsidy cuts in 2011. However, there is a renewed focus on offshore wind in the Netherlands after the new government established a 16 per cent renewable energy target.


The European energy source of the future

Many European countries have singled out offshore wind as their preferred alternative energy source. The sector has the potential to generate enough power to fulfil a meaningful proportion of Europe’s energy requirements. The industry offers the greatest chance for European countries to meet their 2020 renewable energy targets. Lastly, but perhaps most importantly, the offshore wind industry is expected to help create new jobs. According to the Carbon Trust, the offshore wind industry could create up to 70,000 jobs in the UK alone by 2020.

Global cumulative and annual offshore wind installations

CumulativeAnnual

0

1GW

2GW

3GW

4GW

5GW

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Source: EWEA



For these reasons, many countries have set themselves ambitious installation targets. Germany is targeting 10GW of installed capacity by 2020. France and the Netherlands have both set a 2020 target of 6GW. The UK needs to install about 18GW of offshore wind capacity to meet its 2020 renewable energy target.

According to the NREAPs, some 43GW of offshore wind capacity will be installed in European waters by 2020. In early 2013, just under 5GW had been installed. This means that over 4.5GW must be brought online every year until 2020. Last year a record 1.7GW of offshore wind capacity was installed in Europe. This puts the scale of the challenge into perspective.

It should be noted that capacity expectations outlined in EU countries’ NREAPs somewhat overestimate the volume that

Breakdown of installed capacity by country (December 2012)

United Kingdom

Denmark

Belgium

Germany

Netherlands

Sweden

Other

59%18%

8%

6%5%3%

1%

will probably be installed by 2020. These forecasts were submitted in 2009. It has since become apparent that some countries, including the UK and France, will fall short of these forecasts due to delays or revised targets. Indeed, EU member states were already 14 per cent behind their NREAP expectations of installed capacity at the end of 2012, according to the European Wind Energy Association.

The UK is the largest offshore wind market, with 2.9GW installed at the beginning of 2013. Denmark follows with 921MW, then Belgium (380MW), Germany (280MW), the Netherlands (247MW) and, further behind, Sweden (164MW).

Total capacity 4,995MW

Source: EWEA



This section analyses the obstacles that survey respondents believe are most likely to affect offshore wind development in Europe.

Which of the following changes in the offshore wind industry present the most risk to successful future project deployment?

Somewhat a riskSignificant risk

New tendering procedures

Installation and integration of new system designs (eg new foundation models)

Increasing development of offshore wind farms in deeper waters

Stricter environmental law (eg regarding foundations)

Stricter permitting regulations

Emergence of capacity deficiencies in the supply chain

New subsidy mechanisms (eg switch to CfD FiTs in the UK)

The continuing eurozone crisis

Cuts to offshore wind subsidies

65%

39% 52%

35% 51%

35% 49%

31% 49%

23% 56%

21% 54%

8% 51%

10% 46%

31%











65%

39% 52%

35% 51%

35% 49%

31% 49%

23% 56%

21% 54%

8% 51%

10% 46%

31%











65%

39% 52%

35% 51%

35% 49%

31% 49%

23% 56%

21% 54%

8% 51%

10% 46%

31%

86%of European survey respondents believe the introduction of new subsidy mechanisms represents a risk to successful future offshore wind project development.



An uncertain subsidy environment

Our survey data highlights the negative impact that new subsidy mechanisms can have – 86 per cent of survey respondents across Europe believe the introduction of new subsidy mechanisms represents a risk to successful future offshore wind project development. This is one of the greatest perceived threats to the industry.

In the UK, Europe’s largest offshore market, there is significant uncertainty surrounding the subsidy framework. For projects that come online from 1 April 2017, an entirely new approach to subsidising utility-scale energy generation assets based on a CfD FiT will be introduced. The new subsidy mechanism will be implemented as part of the UK government’s Electricity Market Reform (EMR) process. As a result, developers are accelerating projects that can be brought online before CfD FiT. Minimal investment is being allocated to projects that risk missing the 31 March 2017 deadline.

‘EMR is already affecting offshore wind development in the UK as we don’t yet know what the strike price will be, we don’t know what the rules are for selling power into the market, we don’t know who will buy the power and how they will be motivated to do so,’ explained Fintan Whelan, Co-founder and Corporate Finance Director at Mainstream Renewable Power. ‘We also don’t know how the Levy Control Framework will interact with allocation of contracts. There couldn’t be more questions around the revenue line.’

A detailed analysis of the impact of CfD FiT on the UK market is covered in ‘Market focus’ later in this report.

Survey respondents remain jittery about future subsidy cuts – two-thirds of European survey respondents state that cuts to offshore wind subsidies are a significant risk to future project development. Referring to a recent proposal in Germany to impose a one-year 1.5 per cent retroactive cut to feed-in tariffs and its impact on confidence Heiko Ross, Managing Director,

“EMR is already affecting offshore wind development in the UK as we don’t yet know what the strike price will be, we don’t know what the rules are for selling power into the market, we don’t know who will buy the power and how they will be motivated to do so.

Fintan Whelan Co-founder and Corporate Finance Director, Mainstream Renewable Power

$2.1bnEuropean project debt financing in 2012.


Windreich, commented: ‘If we have another electricity price break discussion and another government official pops up with some, let’s say, interesting comments, then hitting this target will be tough. Discussions about the electricity break in Germany cost a lot of confidence.’

Certain countries have already cut offshore wind subsidies. The Netherlands cut its €4.5bn ($8bn) annual offshore wind subsidy in late 2011. Development in the Netherlands has since decelerated. Similarly, the UK offshore wind industry is already preparing for subsidy cuts agreed in July 2012. A 5 per cent reduction to 1.9 ROCs per MWh comes into force in 2015–16, with an increased reduction to 1.8 ROCs in 2016–17.

The eurozone crisis still looms large

Survey respondents rank the eurozone crisis as the second greatest threat to the successful future development of offshore wind projects. Only cuts to offshore wind subsidies represent a greater challenge.

The eurozone recorded its sixth consecutive quarter of negative economic growth between January and March 2013, making it the longest eurozone recession since the euro was launched in 1999. This is directly affecting the offshore wind industry by reducing risk appetite among banks and overall liquidity.

Last year $2.1bn project debt financing was invested in four European offshore wind farms, a 28 per cent decrease on the $2.9bn invested in 2011. This is a concern, particularly since we estimate that about $9bn of project debt finance will be needed each year from 2013 if 43GW of capacity is to be installed by 2020. This estimation assumes a modest cost of $5m per MW and a leverage ratio of 60 per cent, which is in line with recent project finance transactions tracked by Clean Energy Pipeline. It also assumes that only projects accounting for two-thirds of this capacity will be partly financed by debt. Some projects sponsored by major utilities will continue to be financed off balance sheet.




The most important elements of transactions executed in 2012 and early 2013 are covered in the table below.

Project Owners Debt financing secured

Debt providers Financing date

Financing type

Debt–equity ratio

Tenor

Butendiek – 288MW (Germany)

Marguerite Fund (22.5%), Industriens Pension (22.5%), PKA (22.5%), Siemens Financial Services (22.5%), WPD (10%)

€850m ($1,150m)

KfW IPEX-Bank, UniCredit, Bremer Landesbank, EIB, EKF, KfW, BayernLB, HeLaBa, HSH Nordbank, ING, Rabobank, SEB

Feb-13 Non-recourse project financing (pre-construction stage)

65:35 N/A

Note: the European Investment Bank provided €450m ($602m) in two tranches. The first tranche of €300m ($401m) is covered by Danish export credit agency EKF, while the second €150m ($201m) tranche is an uncovered senior loan. KfW contributed €200m ($268m) while the remaining €300m ($401m) was provided by the commercial banks, with each providing an average of €30m ($40m).

Walney – 367MW (UK)

DONG Energy (50.1%), SSE (25.1%), PGGM (12.4%), Ampere Equity Fund (12.4%)

£224m ($362m)

Lloyds Bank, Royal Bank of Scotland, Santander, Siemens Bank, UK Green Investment Bank (GIB)

Dec-12 Refinancing of minority stake (operational)

N/A N/A

Note: the financing involves PGGM and Ampere Equity Fund refinancing on a non-recourse basis their 24.8% stake purchase of the Walney offshore wind farm completed in December 2010 – 70% of the purchase price was refinanced. This is the first minority refinancing without an ECA guarantee and the first time the GIB has invested in offshore wind.

Lincs – 270MW (UK)

Centrica (50%), DONG Energy (25%), Siemens Project Ventures (25%)

£425m ($656m)

Abbey National Treasury Services (trading as Santander Global Banking & Markets), BNP Paribas, Nordea Bank, Skandinaviska Enskilda Banken, Unicredit Bank, DNB Bank, HSBC Bank, KfW IPEX-Bank, Lloyds TSB, Bank of Tokyo-Mitsubishi UFJ

Jun-12 Non-recourse project financing (construction stage)

43:57 Construction plus 15 years

Note: Lincs is the first UK offshore wind farm to secure non-recourse project debt financing during construction.

Northwind – 216MW (Belgium)

Northwind €595m ($783m)

Senior lenders: ASN Bank, Belfius, BNP Paribas Fortis, European Investment Bank (EIB), ING, KfW IPEX-Bank, MTI, PensionDanmark, Rabobank. Subordinated lenders: DG-Infra, PMV, Korys, Autofinancing

Jun-12 Non-recourse project financing (pre-construction stage)

70:30 Construction plus 15 years

Note: debt guarantors include EKF, GIEK and the Office National Du Ducroire (ONDD) Delcredere. This is the first time that a pension fund has invested debt in an offshore wind farm.

Gunfleet Sands – 172.8MW (UK)

DONG Energy (50%), Marubeni Corp (50%)

£158m ($250m)

Mizuho Corporate Bank, Sumitomo Mitsui Banking Corporation

Mar-12 Refinancing of minority stake(operational)

N/A 13 years and 8 months

Note: the project financing utilised Overseas United Loan Insurance provided by Nippon Export and Investment Insurance (NEXI). The insured volume was £158m ($250m). This deal is the second ever UK offshore wind project finance deal and the first time that Japanese banks have financed a UK offshore wind farm.


The eurozone crisis has also resulted in shorter tenors. Banks with a track record of investing in more mature renewable energy technologies, such as solar PV and onshore wind, are currently only offering miniperm structures. This type of structure is unsuitable for offshore wind projects. ‘A number of banks who like the offshore sector are not able to lend the construction plus 15 year operating phase debt that is needed,’ confirmed Fintan Whelan. ‘You want to avoid refinance risk that would come about by taking a 7–10 year mini-perm structure. Interest rates are low at the moment so it is far more likely that interest rates will be higher when you come to refinance the debt in 7–10 years. Offshore developers and indeed any investor want to avoid this risk. So that begs the question as to where the long dated debt will come from.’

Given the decline in longer-term funding it is unsurprising that two-thirds of survey respondents do not believe there will be sufficient project debt finance for European countries to meet their collective 2020 offshore wind targets.

Marc Schmitz, Senior Vice President at Rabobank, agrees. ‘It really depends on the number that will come online,’ he explained. ‘Building 1–2GW per year will require $5–10bn of total investment, and there is capacity for this. But building 4–5GW per year, which is what will be needed for Europe to reach its targets, will require $20–25bn capital investment per year and this is too much to be financed.’

To what extent do you agree that there will be sufficient project debt finance for European countries to meet their 2020 offshore wind targets?

Strongly agree

Agree

Disagree

Strongly disagree

2%34%

55%

9%


12.9GWThe maximum capacity of the Dogger Bank development zone.



Pressure on the supply chain will grow

New European offshore wind farms will be developed further out at sea and in deeper waters during the next five years. This is particularly true in the UK, where a number of Round Three projects are located more than 70km from the shore. The Round Three development zone Dogger Bank is a prime example, being located 195km from the coast at its outermost point. These distances create logistical challenges for the supply chain, which is more used to operating closer to shore. Survey respondents are very aware of this – 71 per cent anticipate that developing projects in deeper waters will present a ‘significant risk’ or ‘somewhat a risk’ to successful project development

across Europe. If the case of Germany is anything to go by then survey respondents are right to be concerned. German projects are currently being developed much further out at sea than Round One and Two UK projects. This has required the use of more complex direct current connection technology, which has contributed to substantial delays.

In the next decade European offshore wind farms will also be larger than their predecessors. Most operational projects are in the 50–300MW range. However, many projects in the pipeline are over 500MW. Some of these projects are outlined in the table below.

UK Round 1 and 2 projects

over 500MW

Developer Planned capacity

(MW)

Triton Knoll RWE 1,200

Race Bank Centrica 620

Gwynt y Môr RWE, Siemens, Stadtwerke Munchen 576

Dudgeon Statoil, Statkraft 560

Docking Shoal Centrica 540


Even these projects pale in comparison to the size of some of the UK Round Three development zones. The East Anglia development zone has a maximum capacity of 7,200MW while the Dogger Bank has a maximum capacity of 12,900MW.

This increase in scale will put huge pressure on the supply chain, including manufacturers of turbines, foundations and high-voltage cables, not to mention the entire installation industry. Over 80 per cent of survey respondents anticipate that the emergence of deficiencies in the supply chain presents a ‘significant risk’ or ‘somewhat a risk’ to successful project development.

‘We fear that bottlenecks could arise if everything happens at once,’ explained John Price, Sales Director – Subsea Power Cable, JDR Cable Systems. ‘In cables there is most potential for a shortage of HVAC and HVDC cables. There should be sufficient medium-voltage array cables. A lot of UK Round Three projects will use HVDC cables, as will lots of German projects. But there are currently only three suppliers globally. There are already

long lead times of over two years for HVDC cables. These will increase as the market accelerates. There may also be bottlenecks on the installation side as the current f leet of vessels are more akin to shallow water. Requirements change as you go to deeper water.’

There is also pressure on the supply chain to reduce costs. For example, the UK government has set the industry a target of reducing offshore wind costs to £100 per MWh by 2020, a 29 per cent decrease on the £140 per MWh cost of projects at the final investment decision stage in December 2011. There is potential across the entire supply chain for costs to be brought down. Factors that will drive down costs in the next decade include the introduction of larger turbines, greater competition in the supply chain, economies of scale and optimising installation procedures.

‘The supply chain needs to become more industrialised if costs are to be brought down,’ explained Jan Rabe, Head of Strategy at Siemens Wind Power. ‘We need to move




towards an automobile-type supply chain. We are moving in that direction with turbine manufacturing already, but foundations and cables are still a long way from being manufactured at scale. Today, foundations are custom made for a specific site. We would rather see platforms manufactured in high quantities and then customised for specific sites. This would significantly bring down costs.’

Supply chain deficiencies will not be plugged by simply ramping up production of existing equipment designs. It is also vital that new technology is brought to the market. Direct drive turbines and f loating foundations are just two examples of new technology that looks set to play a major part in the offshore wind supply chain in the next decade. ‘There

is discussion about capacity deficiencies in the offshore wind supply chain,’ confirmed Burkhard Schuldt, Head of the Division of Ecosystems, GICON Group. ‘These deficiencies certainly exist but it is not just a case of ramping up capacity of established technology. There is also a need for new technology to exploit as yet underutilised wind resources. A prime example is f loating offshore wind turbines, which also make better use of onshore supply-chain resources than fixed foundations.’

“The supply chain needs to become more industrialised if costs are to be brought down. We need to move towards an automobile-type supply chain. We are moving in that direction with turbine manufacturing already, but foundations and cables are still a long way from being manufactured at scale.

Jan Rabe Head of Strategy, Siemens Wind Power


Why are new financing structures needed?

Until early 2010, most offshore wind farms were small enough to be financed with equity and in some cases debt from multilateral financial organisations like the European Investment Bank (EIB). Today the average size of an operational offshore wind farm in the UK is 130MW, which requires an average capital investment of $5–6m per MW, depending on multiple factors including distance from the shore.

The scale on which offshore wind farms are being built is now changing and with it comes a need for much higher levels of investment. The 270MW Lincs offshore wind farm, where construction was completed in April 2013, cost £725m ($1.1bn). The 630MW London Array offshore wind farm, which came online in April 2013, cost £1.8bn ($2.7bn).

Utilities will not be able to fund these assets alone. Many European utilities are arguably

in a worse financial state today than they were six years ago, when annual installed offshore wind capacity surpassed 300MW for the first time. In response, many utilities are divesting stakes in offshore wind projects to recycle capital into new projects, in addition to tapping the project debt finance markets.

‘Like other major European utilities RWE suffers from declining wholesale power prices,’ confirmed Hans Bünting, CEO, RWE Innogy. ‘Lots of utilities have in the last years invested heavily in conventional generation assets, which are now faced with significantly lower wholesale power prices than a few years ago when the investment decisions were taken.’ This partly explains why the majority of survey respondents (61 per cent) do not believe that utilities are sufficiently capitalised to self-finance the equity component of future offshore wind projects.

To what extent do you agree that utilities are sufficiently capitalised to finance construction-stage equity investment in future offshore wind projects?

Strongly agree

Agree

Disagree

Strongly disagree

51%

11%

1%

37%




New equity investors are emerging but more are needed

Project debt finance is out of the question for projects that are majority owned by utilities due to the negative impact this structure has on ratings. Securing project equity investment from financial investors or other utilities is therefore the only option for major utilities.

‘We will not do project debt finance,’ confirmed Michael Lewis, Chief Operating Officer Wind Power, E.ON Climate & Renewables. ‘It is more efficient to take debt from our balance sheet than it is to do project finance so that is ruled out. It is also a ratings issue for us. If we project finance an offshore wind farm and initially remain the majority shareholder, which we do intend to, the ratings agencies will treat the project finance debt as if it is E.ON’s debt.’

New equity investors in offshore wind power generation assets are emerging. Three investments have already been announced in 2013, which compares favourably with the trend of two per year since 2010. Investments include acquisitions of majority and minority stakes of operational and pre-operational assets. Pension funds are the most prominent acquirers. Of the nine acquisitions shown in the table below, five involved pension funds and two involved Japanese trading houses.

Despite the increased participation of financial investors, 65 per cent of survey respondents do not believe there will be sufficient project equity finance for European countries to collectively meet their targets.

To what extent do you agree that there will be sufficient project equity finance for European countries to meet their 2020 offshore wind targets?

Strongly agree

Agree

Disagree

Strongly disagree

57%

8%

2%33%


Project Equity investors Vendor Deal value Stake acquired

Date announced

Butendiek – 288MW (Germany)

Marguerite Fund (22.5%), Industriens Pension (22.5%), PKA (22.5%), Siemens Financial Services (22.5%)

WPD Undisclosed 90% Feb-13

Note: construction of the project is scheduled for spring 2014. It is expected to be operational in late 2015.

London Array – 630MW (UK)

Caisse de dépôt et placement du Québec DONG Energy £500m ($768m) 25% Feb-13

Note: it has been widely reported that this acquisition is close to being officially announced, but it has not yet been confirmed by either party. The final turbine was installed in December 2012.

Luchterduinen – 129MW (The Netherlands)

Mitsubishi Corp Eneco Undisclosed 50% Jan-13

Note: the investment is Mitsubishi’s first in a European offshore wind farm. Construction will begin in July 2014. The project is scheduled to be operational in mid-2015.

Deutsche Bucht – 210MW (Germany)

Highland Group Holdings Windreich Undisclosed 100% Oct-12

Note: Windreich will retain responsibility for the construction and operation of the project. It has an unconditional grid connection confirmation from the Federal Network Agency.

Borkum Riffgrund 1 – 277MW (Germany)

KIRKBI (32%), Oticon Foundation (18%) DONG Energy DKK4.7bn ($836m)

50% Feb-12

Note: the deal is the first time a privately owned company has acquired a stake in an offshore wind farm. DONG will retain liability for constructing the project – it has agreed to construct the project for a fixed price and by a fixed date. The payments will be made in instalments.

Gunfleet Sands – 172MW (UK)

Marubeni DONG Energy £200m ($324m) 49.9% Sep-11

Note: this deal is the first time a Japanese company has invested in an offshore wind project.

Anholt – 400MW (Denmark) PensionDanmark (30%), PKA (20%) DONG Energy DKK6bn ($1.1bn) 50% Mar-11

Note: the deal is the second time pension funds have invested in an offshore wind farm but the first time pension funds have invested in a pre-operational asset. DONG will retain liability for constructing the project – it has agreed to construct the project for a fixed price and by a fixed date. The payments will be made in instalments.

Walney – 367MW (UK) PGGM, Ampère Equity Fund DONG Energy £320m ($518m) 24.8% Dec-10

Note: the purchase price includes the acquirers’ pro-rata share of the construction costs. The cost to acquire DONG’s stake in the project was £16m ($25m). DONG has given certain assurances to the acquirers on the final construction cost and timescales. SSE also owns a 25.1% stake in the project, which it acquired from DONG in December 2009.

Nysted – 166MW (Denmark) PensionDanmark DONG Energy DKK400m ($68m) 50% Sep-10

Note: the transaction is the first time a pension fund has invested in an offshore wind farm. The asset was operational at the time of acquisition.

Note: this table does not include investments made by utilities in offshore wind farms.





To prove survey respondents wrong, new financial structures need to be adopted that can unlock unconventional sources of debt and equity financing from the likes of pension funds and life insurance companies. Almost 90 per cent of survey respondents believe that developers and utilities will need to create increasingly innovative project structures to ensure offshore wind projects are financed.

This section looks at institutions that could be attracted to finance the offshore wind sector through debt or equity and the structures that might be used to entice them. We also look at certain projects to understand how they have secured finance.

Export credit agencies and multilateral financial organisations are vital

Due to the risks of developing, constructing and operating offshore wind farms, support from government-backed organisations such as export credit agencies (ECAs) and multilateral financial organisations (MFOs) is essential to bring down the cost of capital. ‘These types of organisations can be very important from a turbine supply and payment risk mitigation perspective,’ confirms Heiko Ross. ‘This reduces the risk profile of the projects and helps to reduce the cost of capital.’

All five of the offshore wind farms financed since 2012 relied on some form of non-commercial debt. Only one

(Walney) was financed without the support of an ECA. The most active non-commercial debt providers have been German export credit agency KfW IMPX, which financed the Lincs, Northwind and Butendiek projects, and the EIB, which financed the Northwind and Butendiek offshore wind farms. The export credit agencies of Denmark (EKF) and Japan (NEXI) have also supported the financing of one project each since the beginning of 2012.

Hans Bünting highlights the importance of this type of investor to offshore wind projects. ‘What we need is strong public funding on the debt side,’ he said. ‘The main contributors at the moment are the European Investment Bank and KfW, which has launched

To what extent do you agree that developers and utilities will need to create increasingly innovative project structures to ensure offshore wind projects are financed?

Strongly agree

Agree

Disagree

Strongly disagree

68%

12%

1%19%

54%of survey respondents expect MFOs and ECAs to be active investors in offshore wind farms in the next 18 months.


a €5bn offshore investment programme. We also need the export credit insurers to help. And don’t forget the UK Green Investment Bank, which made its first direct equity investment in our Rhyl Flats offshore wind farm in the Irish Sea in March 2013. All of these public organisations will be very important in financing offshore wind.’

The majority (54 per cent) of survey respondents expect MFOs and ECAs to be active investors in offshore wind farms in the next 18 months. In their support, the EIB announced in January 2013 that its budget will be increased by €10bn ($13.4bn) so it can invest €60bn ($80bn) over a three-year period. The additional capital will be allocated to four priority sectors, one of which is clean energy. KfW has gone one step further and set aside €5bn (£6.7bn) for investment in a maximum of 10 offshore wind farms in German waters.

Fintan Whelan agrees that the EIB will continue to support offshore wind. ‘We are also seeing the country of origin for turbines being a driver for pulling in senior debt capacity, facilitated by the relevant export credit

agencies,’ he said. ‘This is already a European feature but we can expect to see it as a feature of Asian initiatives in North Sea offshore projects. The EIB is a major anchoring supporter of offshore wind. It is reinforcing its commitment to European infrastructure including renewable energy. It has spoken only recently about raising more capital to commit to this space. As I look at how our projects will be financed,

What types of investors do you expect to see acquiring or investing actively in offshore wind farms in the next 18 months?

Other

Hedge funds

Insurance companies

Sovereign wealth funds

Governments

MFOs/ECAs

Private equity/infrastructure funds

Pension funds

International industrial companies

Energy companies 80%

66%

58%

58%

54%

37%

36%

32%

22%

6%




I would have confidence in its continued support for North Sea projects if the opportunities can be properly shaped.’

Developers must create flexible packages for institutional investors

Pension funds have been the most active financial investors in European offshore wind generation assets during the past three years. They are targeting alternative investments including offshore wind assets due to the low yields currently offered by traditional pension fund instruments such as bonds.

Given their low risk profile, institutional investors are not naturally predisposed to assume any construction-stage risk. This can be significant given the long project lead times and the harsh conditions associated with offshore wind project locations.

Despite this, a small number of developers have managed to create structures that have convinced institutional investors to invest in projects at the construction stage. DONG Energy has been the most successful at this. Since 2010 it has divested stakes in

five offshore wind projects, three of which (Walney, Anholt and Borkum Riffgrund 1) were at the construction or pre-construction stage when the deal was announced.

DONG has been able to attract these investors because, in each instance, it has retained the construction risk and agreed to complete the project for a fixed price on an agreed timescale. For added comfort, the equity investment has been staggered over the course of construction based on fixed milestones. DONG’s deals are market-leading examples of how institutional investors can be attracted to invest in pre-operational offshore wind farms.

‘If we go in at the earlier stage we would want something that is very well wrapped, effectively as a turnkey EPC contract, whether that’s by the EPC contractor or the utility that is selling the minority stake,’ explained David Jones, Managing Director, Head of Renewable Energy at Allianz Capital Partners – the company is exploring offshore wind investment opportunities. ‘We have seen a couple of structures like this. DONG has

“We are also seeing the country of origin for turbines being a driver for pulling in senior debt capacity, facilitated by the relevant export credit agencies. This is already a European feature but we can expect to see it as a feature of Asian initiatives in North Sea offshore projects.

Fintan Whelan Co-founder and Corporate Finance Director, Mainstream Renewable Power


used this structure successfully and others are starting to copy it. In this structure the investor’s cash is used for construction but it is in an all-embracing turnkey EPC package so it is not exposed to construction risk. Utilities are increasingly doing this to reduce their cost of capital.’

As Olivia Breese, Senior Transaction Manager at DONG Energy, explains, the key to attracting institutional investors to pre-operational assets is to be f lexible. ‘DONG Energy recognises that direct investment into an offshore wind farm is a material investment,’ she said. ‘We are very f lexible. We expect and are happy to spend a long time talking institutional investors through the offshore wind industry and the construction and operation phases so that they get comfortable with the risk profile. We also expect to retain a substantive shareholding in divested projects throughout the project life. We then go into more detail to address the elements individual investors seek more comfort on. In some cases we offer investors a construction contract, whereby we commit to construct the

asset and therefore take the construction risk. However, some investors prefer to take the construction risk themselves and to be more involved in the construction process – it is really a question of tailoring the structure to address investor requirements.

‘In general we offer a full construction contract for pension funds to limit their exposure to construction risk. We also offer 15-year O&M contracts so investors can always be certain that there will always be a reputable operations contractor in place. All of our more recent offshore wind projects have service and warranty agreements with Siemens. We also offer a PPA in the UK to give investors a guaranteed route to market for their share of the power offtake and ROCs. All of this is very important to investors.’




Pension funds are also interested in debt

To date, the majority of debt project finance invested in offshore wind farms has been provided by commercial banks, ECAs and MFOs. There has been next to no activity from pension funds or insurance companies.

In June 2012, Danish pension fund PensionDanmark broke new ground when it invested €35m ($44m) alongside a consortium of commercial banks in the 216MW Northwind offshore wind farm. This was the first time a pension fund had ever invested debt in an offshore wind project and, more importantly, a project that had not begun construction. PensionDanmark was prepared to assume this risk because the loan was guaranteed by the Danish export credit agency EKF.

This structure has the potential to be replicated in other countries to unlock more debt finance from pension funds. KfW IMPX Bank has already guaranteed loans to European offshore wind farms, as have the export credit agencies of Norway (GIEK), Denmark (EKF) and Belgium (Office National Du

Ducroire). These organisations will be essential in creating the low-risk investment opportunities that pension funds crave.

This structure could also be applied to unlock debt capital from institutional investors who want to invest in UK offshore wind farms. UK-based developers could potentially tap into the Green Investment Bank or the Treasury’s recently introduced Infrastructure UK Guarantee Scheme, which assists financing of large-scale infrastructure projects in the UK that are struggling to secure capital through guaranteeing debt repayments. This scheme, launched in July 2012, completed its first transaction in April 2013 when it guaranteed a £75m ($115m) amortising debt facility provided by UK pension and insurance company Friends Life to power utility Drax. The programme has the capacity to guarantee finance for £40bn ($61bn) worth of infrastructure projects in the UK, meaning it certainly has the potential to unlock financing for offshore wind.


‘The UK’s infrastructure loan guarantee programme, which is for infrastructure projects in general, could in some way create a similar risk profile to what DONG has done but for UK assets, helped by the UK Treasury,’ explained Fintan Whelan. ‘This would replicate the monoline insurers who used to enhance the credit ratings of project bonds but have left the market since 2008. I think it is a very clever idea on the part of the treasury to create a programme that removes a blockage for institutional investors in infrastructure. We have seen this structure already being used in energy.’

Marc Schmitz anticipates that pension funds will become more active on the debt side. ‘Pension funds will certainly become more active as lenders in the next three years,’ he said. ‘I have spoken to many of them and their attitude

has certainly changed since 2009. Pension funds need to be compensated for inflation, and renewable energy assets with inflation-linked tariffs can do this. Renewable assets are especially attractive when the yields on bonds are so low. They want a yearly 5 per cent return and this is not available for many traditional investments. Sustainability is also becoming a higher priority for pension funds.’

Whether it is debt or equity, pension funds will be meaningful investors in offshore wind for the next 18 months – almost 60 per cent of survey respondents expect pension funds to be active investors in offshore wind projects during the next 18 months, more than the 54 per cent that expect ECAs and MFOs to be active.

£75mThe guarantee provided by Infrastructure UK Guarantee Scheme to power utility Drax.




Bonds and securitisation structures must be used to attract significant capital

The examples mentioned above all involve institutional investors investing directly into offshore wind farms, either through debt or equity structures. However, most institutional investors only allocate a tiny percentage of their available capital to alternative investments. The allocation within this category dedicated to energy infrastructure is even smaller. For the offshore wind industry to truly access institutional capital it will need to create structures that are attractive not just to the likes of Danish pension funds and Japanese trading houses, but also the mainstream institutional investors.

‘There are some active direct investors that are really in the alternatives bucket and are a small proportion of the total volume of institutional capital,’ explained Ian Nolan, Chief Investment Officer at the UK Green Investment Bank. ‘They are willing to do a lot of work to understand projects and act as the principal investor. They are also more prepared to

own a concentrated portfolio with limited diversification. This is an active part of the market but it is not where the real weight of the money is. Most pension funds only allocate a few per cent to alternatives, which includes all forms of private equity, commodities and various other things. PensionDanmark is a very interesting example of an investor that is deeply engaged in the sector, but there are not too many pension funds like this.’

To what extent do you agree with the following statements?

AgreeStrongly agree Disagree Strongly disagree

Securitisation structures will increasingly be used to finance portfolios of wind farms

Bonds will increasingly be used to finance or refinance offshore wind farms

10% 70% 18% 2%

7% 76% 10% 7%

80%+believe that securitisation structures or bonds will be used increasingly to finance portfolios of offshore wind farms.


Survey respondents point to bonds and securitisation structures as ways to package offshore wind assets into a digestible investment opportunity for mainstream institutional investors – over 80 per cent believe that securitisation structures or bonds will be used increasingly to finance portfolios of offshore wind farms.

Another way to attract institutional investors is to create listed vehicles with the sole purpose of acquiring and owning stakes in offshore wind assets. This structure clearly works. In March 2013, Greencoat Capital secured £260m ($387m) through the f lotation of a UK wind fund on the London Stock Exchange. The fund, called Greencoat UK Wind, will use the proceeds to acquire stakes in a series of onshore and offshore wind assets including a 24.95 per cent stake in the 90MW Rhyl Flats operational offshore wind farm owned by RWE.

‘Greencoat was fascinating as the prospect of a 6 per cent yield in cash – increasing in line with inflation and with the prospect for the value of the underlying asset to go up

proved to be pretty compelling for a number of institutional and private investors,’ confirmed Ian Nolan.

Whether it is bonds, listed vehicles, securitisation structures or another asset type, institutional investors’ non-alternative capital allocation to the offshore wind industry will depend on not needing specialist knowledge of the sector.

‘These funds are not very likely to invest directly in an offshore wind farm, so the project has to be structured, packaged and taken to the investors,’ explained Ian Nolan. ‘It could be through a quoted vehicle like Greencoat for example. But the asset would certainly have to be managed on their behalf and meet their risk return profile. It would have to be very investible and quite liquid for them. It could be bonds or some form of other structure, but it would have to be no harder to buy than anything else they are used to purchasing. It will be a simple risk versus return judgement for them.’

“These funds are not very likely to invest directly in an offshore wind farm, so the project has to be structured, packaged and taken to the investors.

Ian Nolan Chief Investment Officer, UK Green Investment Bank




The greatest challenge to deploying these structures is that the offshore wind industry is still relatively young. More than half of all installed offshore wind capacity across Europe began operations in the past three years and only a fraction has operated for more than half of its expected lifespan. Offshore wind simply does not yet have the track record to attract low-risk mainstream pools of institutional capital. The current small volume of installed capacity also means there is a limited pool of assets that can be packaged into attractive structures. However, this certainly won’t be a problem in five years if European countries proceed on course to meet their offshore wind installation targets.

‘Institutional investors and banks need this track record to increase their investments,’ explained Claus Wattendrup, Director of Offshore Wind Projects, Vattenfall. ‘But there is so much construction going on at the moment. So

in 2014 and 2015, when all of these have been built and are operating and you have some success stories, that may be the time to try to attract these investors.’

Developers must look beyond Europe

Given the state of the European financial markets, developers of offshore wind farms must look beyond Europe to secure more capital. Of those surveyed, seven out of 10 believe that investment from non-European companies and funds is essential if countries are to meet their offshore wind targets.

According to survey data, the most likely source of capital outside Europe is the Asia-Pacific region. Survey respondents expect new investors in offshore wind generation assets to come principally from China (58 per cent), Japan (45 per cent), the Middle East (41 per cent), Korea (33 per cent) and the US (33 per cent).


Notable investments by investors based in the Asia-Pacific region during the past 18 months are outlined in the table below.

Project Investors Deal value Deal type Date announced

Luchterduinen – 129MW (The Netherlands)

Mitsubishi Corp Undisclosed Acquisition Jan-13

Note: the investment is Mitsubishi's first in a European offshore wind farm. Construction will begin in July 2014. The project is scheduled to be operational in mid-2015.

London Array phase one transmission project (UK)

Mitsubishi Corp £428m ($693m) Acquisition Sep-12

Note: Mitsubishi acquired the transmission asset as part of a consortium that includes Macquarie Capital, Barclays Infrastructure Funds and Frontier Power. The disposal is in line with regulation requiring offshore wind farm generators to divest their transmission assets to new offshore transmission owners via a competitive tender run by Ofgem. The consortium won a competitive tender to acquire the project in September 2012. It is the largest transmission asset to be tendered.

Lincs – 270MW (UK) The Bank of Tokyo-Mitsubishi UFJ £425m ($656m) Project debt finance Jun-12

Note: a consortium of 10 banks provided £425m debt financing to the project. The size of BTMU’s investment was not disclosed.

Gunfleet Sands – 172.8MW (UK)

Mizuho Corporate Bank, Sumitomo Mitsui Banking Corporation

£158m ($250m) Refinancing of minority stake

Mar-12

Note: the project financing used Overseas United Loan Insurance provided by Nippon Export and Investment Insurance (NEXI). The insured volume was £158m ($250m). This deal is the second ever UK offshore wind project finance deal and the first time that Japanese banks have financed a UK offshore wind farm.

HelWin 2 and DolWin 2 transmission projects (Germany)

Mitsubishi Corp €336m ($449m) Acquisition Mar-12

Note: the transaction completed in January 2013. The transaction was completed following a 47% increase in Germany’s renewable energy levy enacted by the government to pay for offshore grid construction.

Borwin 1 and 2 transmission projects (Germany)

Mitsubishi Corp €240m ($318m) Acquisition Feb-12

Note: the transaction completed in January 2013. The transaction was completed following a 47% increase in Germany’s renewable energy levy enacted by the government to pay for offshore grid construction.




Which countries or regions will acquirers or investors in European offshore wind assets most likely come from?

Offshore wind transmission assetsOffshore wind power projects

Africa

Italy

Australia

Other

Canada

Spain

US

Korea

Middle East

Japan

Netherlands

France

China

UK

Germany

0 10 20 30 40 50 60 70 80%


Africa

Italy

Australia

Other

Canada

Spain

US

Korea

Middle East

Japan

Netherlands

France

China

UK

Germany

0 10 20 30 40 50 60 70 80%


Africa

Italy

Australia

Other

Canada

Spain

US

Korea

Middle East

Japan

Netherlands

France

China

UK

Germany

0 10 20 30 40 50 60 70 80%

Non-European investors are interested in European offshore wind for two reasons. First, these are low-risk investments offering stable long-term returns that are often inflation indexed. This is exactly the type of investment that Japanese trading houses and industrial

conglomerates are targeting. Second, many international investors are investing in Europe to gain first-hand sector experience before their domestic offshore wind market kicks off.

‘From the perspective of the banks participating in non-recourse project finance and the supply chain, offshore wind is mostly a European business,’ explained Heiko Ross. ‘We are now seeing interest from banks coming from other regions such as the US, the Middle East and the Far East. I don’t think it will be too long until we see the first Chinese offshore wind turbine installed in Europe. China has a huge interest in European offshore wind as it realises that this technology has lots of potential domestically. The same applies to investors, who will see investing in European offshore wind as a way to learn from construction and operation, and how to manage the risk. These lessons can then be applied to their own countries. But it is not just China. We are also seeing interest from Korea and Japan. So offshore wind is becoming a global market, like onshore wind already is.’


Market focus

The UK and Germany are by far the most attractive markets for investment – eight out of 10 survey respondents are either targeting investments in offshore wind power generation assets in these countries during the next 18 months, or believe that there will be significant investment activity in these countries. France is third with 60 per cent, followed by Denmark (50 per cent), the Netherlands (49 per cent), Sweden (26 per cent) and lastly Norway (22 per cent). The following sections explore what is driving, and in some cases preventing, investment in Europe’s major offshore wind markets.

The UK – current appeal masks major future regulatory uncertainty

The UK is currently the joint most attractive market for offshore wind investment alongside Germany, according to survey respondents. However, this masks major concerns about the new CfD FiT regime, which will apply to all offshore wind farms that come online after March 2017.

Most developers of UK offshore wind farms interviewed for this

report are accelerating projects capable of coming online before March 2017, the last date at which projects can qualify for the ROC regime. In parallel they are halting investment in projects that look likely to miss this deadline until further clarity is given on the new CfD FiT mechanism.

In which of the following countries are you planning to acquire or invest in offshore wind assets in the next 18 months? In which of the following countries do you expect developers, corporates and investors to invest in offshore wind assets in the next 18 months?

0 10 20 30 40 50 60 70 80 90%

Companies in the offshorewind supply chain

Offshore windtransmission assets

Offshore windpower projects

Other

Norway

Sweden

Netherlands

Denmark

France

UK

Germany



To what extent do you agree with the following statements about the UK offshore wind market?


The proposed CfD FiT system will increase political risk as contracts will only be negotiated when significant capital has already been committed to a project

The proposed CfD FiT system will increase price certainty

More than 18GW of offshore wind capacity will be operational by 2020 (18GW is the volume of offshore capacity required for the UK to meet its 2020 renewable energy targets)

22%

9%

3% 17% 37% 43%

53% 35% 3%

55% 19% 4%

However, clarity means different things to different investors. E.ON is prepared to continue to invest in UK offshore wind projects due to come online after March 2017 on the proviso that an adequate CfD strike price is announced. The UK government is planning to unveil the strike price this year.

‘If the strike price is adequate then we will continue to invest in large Round Three offshore wind farms,’ confirmed Michael Lewis. ‘If the new mechanism is delayed then one would assume they would continue with the ROC mechanism until it is approved. In the end you either believe the government is serious about delivering the target or you don’t. If you don’t you should quit now. We believe that the government is very serious on delivering its renewable and offshore wind targets and therefore are confident that the system will be adjusted in a sensible way that gives investors enough time to adjust to the new mechanism.’

However, setting an adequate strike price will not be enough for some generators to commit capital to offshore wind projects that will come online after

March 2017. This is because the new system will have to be approved for state aid by the European Commission before it can be implemented. This could lead to delays.


“Even if there is some modest reduction in the cost of capital from taking away market price risk, the CfD is now structured in a way that there are so many additional risks that generators have to manage.

Keith MacLean Policy and Research Director, SSE

‘They [the UK government] can only apply for state aid clearance when there is sufficient information for the Commission to make a decision, so they will certainly need to have the strike price and will also need to have finalised lots of the detail around EMR,’ explained Keith MacLean, Policy and Research Director, SSE. ‘We can’t see the government putting a state aid notification in until well into next year. State aid guidelines are currently being revised and the new guidelines don’t come out until July. The Commission will not want to set a precedent that anything will be let through. They also don’t like CfDs in Brussels as it goes the wrong way in terms of market liberalisation and compliance with the single market.

‘So if the Commission is notified in the middle of 2014, it could easily take 18–24 months to make a decision. So you are already into 2015 or 2016 even if there are no problems. Investors will not invest in big Round Three projects under the hope that Brussels will come up with the correct answer.’

The core purpose of the CfD FiT is to reduce market price risk for long-term investors by offering an inflation indexed strike price for the sale of electricity generated. If the price available on the open market is less than the fixed strike price, the price will be grossed up to cover the difference. However, generators will have to pay the CfD authority if the market price exceeds the strike price. The survey data suggests this mechanism will have the desired effect – 63 per cent of survey respondents believe the CfD FiT will increase price certainty.

63%of survey respondents believe that the CfD FiT will increase price certainty.

Market focus



The other major new risks the CfD FiT introduces are outlined below

However, the new CfD FiT system also creates a number of new risks that generators will have to bear. One of the major concerns is that there is no guarantee that a project will be allocated a contract. As the bill is currently drafted, the government is allowed to instruct the contract allocation authority to take certain targets into account when making allocation decisions. For example, the government could introduce targets that favour a certain renewables technology or a certain region. If offshore wind falls out of favour, projects that have already had significant initial investment may not secure a contract. This is a major added risk – 78 per cent of survey respondents believe that the proposed CfD FiT system will increase political risk as contracts will only be negotiated when significant capital has already been committed.

• Change in legal provisions – there is currently no provision for generators to be compensated with a higher strike price if a general change in the law fundamentally alters the cost structure that generators face. Generators will only be compensated if there is a change in law that specifically affects generators, projects or offshore wind technology.

• Claw back provisions – the government is considering introducing a clause in CfD contracts that would allow the CfD counterparty to claim some of the profits from refinancing offshore wind farms.

• Payment indexing – the government is in favour of indexing CfD payments to the CPI, a lower measure of inflation than the RPI. Payments under the ROC regime were indexed to the RPI.

• Basis risk – the government plans to use the hourly day ahead auction price as the reference price. However many generators, particularly smaller ones, may not be able to achieve this reference price when selling power into the open market.

• CfD counterparty risk – the authority that will be established to allocate and manage CfD contracts is only obliged to pay generators with money at its disposal. Generators may therefore not be paid as much as they expect if the authority is unable to raise sufficient funds from suppliers and consumers.

• Termination risk – the CfD counterparty is entitled to terminate a CfD contract if certain conditions are not satisfied. These include failing to achieve 95 per cent of targeted capacity or not meeting timescales.


‘Even if there is some modest reduction in the cost of capital from taking away market price risk, the CfD is now structured in a way that there are so many additional risks that generators have to manage,’ explained Keith MacLean. ‘This means that the strike price would have to be higher to compensate for these additional risks. But this won’t be politically acceptable here or in Brussels. If the government doesn’t reduce any of these risks then the hurdles will be too high for investors to proceed. So we now have a real impasse due to the current plans and the additional risks they entail.’

Putting aside the minutiae of the CfD FiT support mechanism, confidence in the UK offshore wind sector has also been dented by a perceived lack of political support. ‘Not only do we have government departments with differing views but you even have different views being publicly aired by ministers within the same department,’ explained Keith MacLean. ‘We just don’t have a clear vision or a clear narrative on the journey we are embarking on.’

All this uncertainty creates an extremely unattractive investment environment for offshore wind after March 2017. A telling statistic is that only 20 per cent of survey respondents anticipate that 18GW of offshore wind capacity, the volume required for the UK to meet its 2020 renewable energy targets, will be operational in UK waters by 2020.

The UK government could do many things to demonstrate its long-term commitment to offshore wind. For a start, it could bring forward plans to establish 2030 power decarbonisation targets to 2014. Under the government’s current schedule, this will not be set until after the next general election in 2016. It could also set out a clear offshore wind capacity target for 2020 and 2030. More importantly, the UK government has the opportunity to demonstrate its commitment to offshore wind by announcing a CfD strike price that is attractive for investors this year.

20%of survey respondents anticipate that 18GW of offshore wind capacity will be operational in UK waters by 2020.

“Not only do we have government departments with differing views but you even have different views being publicly aired by ministers within the same department.

Keith MacLean Policy and Research Director, SSE

Market focus



‘It always helps to give a longer-term perspective,’ confirmed Michael Lewis. ‘But in the end the proof of the pudding is in the short-term decision-making. An adequate strike price announced in the short term is much more important than a long-term aspirational goal.’

Germany – a clearer support mechanism although fears remain over grid connection delays

In total contrast with the UK, the subsidy mechanism for offshore wind is clearly defined in Germany. This is why 80 per cent of survey respondents are either targeting investments in offshore wind power generation assets in Germany during the next 18 months, or believe that there will be significant investment activity in Germany.

As part of the Renewable Energies Act (EEG), offshore wind generators are entitled to choose between the ‘initial’ remuneration package of 15 euro cents per KWh over 12 years or the ‘initial accelerated’ package, which offers 19 euro cents per KWh for eight years. Once the initial period expires, projects are paid the basic

remuneration price of 3.5 euro cents per KWh. Projects that come online after 2018 will not be able to apply for the accelerated model. In parallel, the initial remuneration rate will be reduced by 7 per cent annually. For example, projects commencing operations in 2018 will receive an initial remuneration rate of 13.95 euro cents per KWh.

The accelerated model is particularly attractive for projects financed by banks. ‘Around two-thirds of offshore wind developers opt for the accelerated model,’ explained Stefanie Pfahl, Head of Wind Energy and Hydropower, German Federal Ministry for the Environment, Nature Conservation and Nuclear Safety. ‘It was implemented because of the financial crisis and the banking crisis, which took hold just as a lot of offshore wind farms were being permitted. So it was very difficult to get banks to finance these long-term, very expensive, projects. Banks needed a fast return on their investment, which the acceleration model addresses. Big institutional investors, which have lots of experience in infrastructure

80%of survey respondents are either targeting investments in offshore wind power generation assets in Germany during the next 18 months, or believe there will be significant investment activity in Germany.


investment, don’t really need the acceleration model. But it is really useful when projects are getting financed by a club of banks.’

Although there has been tariff clarity for many years, there has been significant uncertainty concerning the way offshore grid connections are structured. This contributed to a series of connection delays in 2011 and 2012. In response to this, the German government enacted a series of new laws that came into force in December 2012 that clarify the obligation of the offshore grid operators to connect offshore wind farms to the grid and the liability of the offshore grid operator in the case of delayed or uninterrupted grid connection.

The government has also dictated that future grid connection will be developed in accordance with the country’s offshore grid development plan. In February 2013 Bundesamt für Seeschifffahrt und Hydrographie (BSH), Germany’s maritime and hydrographics federal agency, released a plan for a transmission network in the German North Sea that will serve the country’s offshore

To what extent do you agree with the following statements about the German offshore wind market?


Delays to securing grid connection for German offshore wind projects hasseverely dented investors’ appetite to invest in the offshore wind sector

TenneT will need to divest stakes in further offshore wind connections to free up capital for further development

Germany’s 2020 target of 10GW installed offshore wind capacity will be achieved

New measures taken by the government to address grid connection problems and liability for delays are sufficient to prevent further delays

32%

9%

3%

15% 63% 22%

40% 47% 10%

73% 18%

62%

3%

3%

wind farms through to 2030. The plan summarises 21GW of approved and planned wind farms along Germany’s 120km coast and details the planned

Market focus



location of grid connections, and converter and transformer platforms. BSH’s plan, drawn up to facilitate the construction of 25GW of offshore wind in Germany by 2030, includes 25 converter platforms and an estimated 3,880km of submarine cable.

‘The industry has certainly had some ups and downs in recent years,’ explained Hans Bünting. ‘One of the major obstacles was that it was unclear how wind farm owners would be compensated if the grid connection was delayed or if there are grid outages. This has been solved now with new legislation in the Energy Law. Investors and grid operators now have certainty on what happens when there is a delay or an outage. This is an important milestone but it took quite a long time to get there and this time has essentially been lost.’

Despite the new laws, grid connection remains a concern – 85 per cent of survey respondents do not believe that the new measures taken by the government to address grid connection problems or liability for delays are sufficient to prevent further delays. This

is not surprising given that the initial delays were caused by multiple factors. In fact, survey respondents cited a lack of capital on behalf of the offshore transmission systems operators (TSOs) as the principal reason for the delays – 90 per cent of survey respondents believe this was a significant factor.

‘There are many reasons for the grid connection delays,’ explained Hans Bünting. ‘There is a very complex permitting process, which takes lots of time. The authorities that deal with permitting are partly understaffed so cannot keep pace with applications. In addition, German wind farms are a lot further out than UK offshore wind farms, maybe up to 100km off the coast, meaning that we need to use direct current grid connections with huge converter stations. This technology has never before been deployed at such a scale offshore worldwide. In addition, there are some issues and delays in the supply chain.’

“There are many reasons for the grid connection delays. There is a very complex permitting process, which takes lots of time. The authorities that deal with permitting are partly understaffed so cannot keep pace with applications.

Hans Bünting CEO, RWE Innogy


‘The jury is still out on whether the new legislation will solve all issues. The first grid connection dates for our projects are announced now but sometimes they are not firm, so we are working against moving targets. But at least the legal situation is clarified, so we know what compensation we are entitled to receive.’

The extent to which survey respondents believe a number of grid connection issues contributed to delays is summarised in the diagram opposite.

To address its capital shortfall, TenneT, the TSO for Germany’s North Sea, has started to contact financial partners to invest in its grid connection projects. In January 2013, it completed the divestment of 49 per cent stakes in its Borwin 1 and 2, HelWin 2

and DolWin 2 transmission assets to Mitsubishi Corp for a total consideration of €576m ($767m). More deals like this are needed if it is to avoid further connection delays.

Given grid connection delays, our surveyed respondents are undecided as to whether the country’s 2020 target of 10GW installed offshore wind capacity will be achieved.

Hans Bünting does not expect the targets to be met. ‘The targets are very ambitious. The grid access delays mean that lots of projects are delayed. We will likely reach between 6 and 8GW by 2020 and then get to

“The jury is still out on whether the new legislation will solve all issues. The first grid connection dates for our projects are announced now but sometimes they are not firm, so we are working against moving targets.


Market focus



What were the most important reasons for delays in the development of German offshore wind?

Somewhat significant factorVery significant factor Not a significant factor

28% 62% 10%

Grid connections: the transmission system operators (TSO) lacked capital

General: lack of resources (eg ships and other machinery, trained personnel, harbour capacities)

Grid connections: lack of communication between TSOs and project developers on project schedules

Grid connections: lack of experience of companies building the grid connections

General: government targets were too ambitious and unrealistic from the beginning

Grid connections: strict legal requirements for the building of grid connections (eg nature protection law, planning law)

Wind farms: insufficient subsidies to support construction and operation of wind farms and feed-in tariffs for electricity produced

General: difficult external conditions (large water depth and distance to coast, lack of knowledge about sea ground and environmental issues)

Grid connections: insufficient subsidies to support construction of offshore grid connections

Wind farms: strict legal requirements for building wind farms under environmental and nature protection law (eg noise thresholds for porpoises, protection of birds, EIA-requirements)

30%

28%

32%

22%

13%

6%

36%

13%

15% 30% 55%

33% 54%

18% 46%

52% 42%

47% 40%

40% 38%

32% 36%

48% 24%

49% 21%

Somewhat significant factorVery significant factor Not a significant factor

28% 62% 10%

Grid connections: the transmission system operators (TSO) lacked capital

General: lack of resources (eg ships and other machinery, trained personnel, harbour capacities)

Grid connections: lack of communication between TSOs and project developers on project schedules

Grid connections: lack of experience of companies building the grid connections

General: government targets were too ambitious and unrealistic from the beginning

Grid connections: strict legal requirements for the building of grid connections (eg nature protection law, planning law)

Wind farms: insufficient subsidies to support construction and operation of wind farms and feed-in tariffs for electricity produced

General: difficult external conditions (large water depth and distance to coast, lack of knowledge about sea ground and environmental issues)

Grid connections: insufficient subsidies to support construction of offshore grid connections

Wind farms: strict legal requirements for building wind farms under environmental and nature protection law (eg noise thresholds for porpoises, protection of birds, EIA-requirements)

30%

28%

32%

22%

13%

6%

36%

13%

15% 30% 55%

33% 54%

18% 46%

52% 42%

47% 40%

40% 38%

32% 36%

48% 24%

49% 21%


the original target of 10GW a few years later. But this is not a big issue. The most important thing is that the industry moves forward.’

On the f lipside Heiko Ross believes there is a fighting chance these targets will be met. ‘The 10GW target roughly translates to 2,000 turbines that need to be installed by 2020, or 300 turbines per year,’ he said. ‘Moving to this from only installing 10–20 per year in recent years will of course be challenging. But there are around 5,000–6,000MW in the pipeline that have grid connection contracts and, following the delays in the past two years, are now ready to go. Final investment decisions have already been made on all of these projects.’

‘I think that at least all of this will be installed by the end of 2017 when, according to the current regulation, the acceleration model in Germany disappears and feed-in tariffs will be reduced to €13.95 per KWh. The target is for 6,000MW to be installed by 2017, which means that 4,000MW will need to be installed in three years. If the supply chain can be ramped up sufficiently then there is still a chance that the 10GW target can be met. But it is still only a small chance.’

€576mThe total value of TenneT’s 49 per cent divestment of its Borwin 1 and 2, HelWin 2 and DolWin 2 transmission assets.

“The targets are very ambitious. The grid access delays mean that lots of projects are delayed. We will likely reach between 6 and 8GW by 2020 and then get to the original target of 10GW a few years later.


Market focus



France – starting to ramp up installation

France’s offshore wind market is many years behind the rest of Europe. The country’s first offshore wind tender was launched in July 2011 for 3GW of capacity across five designated development zones. The winners were announced in April 2012 with a consortium led by state-owned utility EDF securing three out of the five development zones up for bidding. A fourth tender was won by a consortium headed by Spanish utility Iberdrola in partnership with French power construction group Areva. The fifth development zone was not awarded after a sole bid by GDF Suez was deemed to be overly costly to French energy consumers. In the end only 2GW of tenders were awarded, representing an investment of €7bn ($9bn).

A second tender was launched in March 2013 calling for bids for the construction of 1GW of offshore wind capacity. This will be split across two 500MW sites, one near Le Tréport in northern France and the other near the Noirmoutier and Yeu islands on the Atlantic coast.

To what extent do you agree with the following statements about the French offshore wind market?


France will meet its target of installing 6GW of offshore wind capacity by 2020

France’s offshore wind market is inaccessible for non-French companies and investors

The seemingly similar structure to Germany in which one TSO is responsible for constructing grid connections is making investors nervous about investing in the French offshore sector

Offshore wind grid connections will be completed in time for the first French offshore wind farms that are due to come online from 2018 onwards

72%

8%

5%

5% 19% 29% 47%

29% 52% 14%

38% 31% 23%

17% 11%


Connecting offshore wind farms to the onshore grid will be managed by the TSO RTE. Encouragingly, the majority of French survey respondents (54 per cent) are not worried about France’s similar grid connection structure to Germany’s, in which one TSO is responsible for facilitating grid connections. This also explains why 72 per cent are confident that offshore wind grid connections will be completed in time for the first French offshore wind farms that are due to come online from 2018 onwards.

Market focus

6GWFrance’s target for installed offshore wind capacity by 2020.

On a less positive note, only a quarter of survey participants expect France to reach its target of 6GW of installed offshore wind capacity by 2020. This is due to the unallocated first tender, delays to the announcement of the first two tenders and the fact that the third tender, which will seek bidders for the remaining capacity to meet 6GW, will only be held after the country’s energy transition debate. The third tender is unlikely to be announced until the second half of 2013.



The Netherlands – new renewable energy target may spur offshore wind

Offshore wind development has stalled in the Netherlands. The country has set an ambitious target of 6GW of installed capacity by 2020. By 2008, 247MW had been installed. However, no projects have been brought online since then. This is because in November 2011 the government decided to cut offshore wind subsidies by a third and to pass the cost of subsidies from the government to energy consumers. The annual cost to the taxpayer rose to $6bn in 2010.

Today there is some cause for optimism. The new government, elected in September 2012, has set a target for renewable energy to account for 16 per cent of total energy consumption by 2020. This is an increase on the previous government’s target of 14 per cent. The new government is prioritising offshore wind to ensure these targets are met and is currently evaluating how to manage grid connection.

To what extent do you agree that the Netherlands will meet its target of 6GW installed offshore wind capacity by 2020?

Strongly agree

Agree

Disagree

Strongly disagree

61%

23%2%

14%

‘The Netherlands does not have much renewables in its energy mix compared to Germany,’ explained Tobias Kempermann, Head of Berlin Representation, EWE. ‘As the Dutch government has decided to raise the share of renewable energy to 16 per cent by 2020, the new government is looking at a whole set of procedures and subsidies including new areas for offshore wind farms closer to the shore that can raise this percentage. Offshore wind is certainly part of their plans.’

But despite the government’s renewed interest in offshore wind, the hiatus caused by previous subsidy cuts means that the country’s 6GW 2020 target will probably not be met – over 80 per cent of survey respondents do not believe the Netherlands will reach these targets.


What is the optimal grid connection mechanism?

The UK and German approaches both have their disadvantages

Germany and the UK have adopted radically different approaches to connecting offshore wind farms to the grid. In Germany, a TSO is responsible for providing generators with a grid connection. In the UK, the responsibility lies with the developer itself.

Both systems have their advantages and disadvantages. ‘The main advantage of the German system is that developers are not responsible for the grid connection, which is obviously beneficial from a financial perspective,’ explained Claus Wattendrup. ‘But at the same time the German system has some risks, as developers are not in control of when the grid connection will be ready. Developers are essentially dependent on a third party with no contractual relationship.’

To what extent do you agree with the following statements about offshore wind grid connection policy?


Making one TSO responsible for connecting all offshore wind farms in a particular country is very risky as it makes every project dependent on the performance of one single company

The OFTO model involving competitive tenders for individual connections is inefficient as it does not encourage investment in transmission infrastructure with wider, longer-term system benefits

The OFTO model involving competitive tenders for individual connectionsis inefficient as it results in offshore projects connecting to shore via radial links

The OFTO model involving competitive tenders for individual connections is preferable to depending on a single transmission system operator for construction of offshore wind grid connections

22%

12%

9%

7% 46% 40% 7%

53% 36%

62% 25%1%

2%

50% 23% 5%



Survey respondents agree that this is a major fault of the German model – three-quarters believe that making one TSO responsible for connecting all offshore wind farms in a particular country is very risky as it makes every project dependent on the performance of a single company.

The UK system has its advantages in that generators do not rely on a counterparty to provide their grid connection. However, it also has its disadvantages in that generators have to finance the grid connection themselves. ‘The disadvantage in the UK is that you have to find ways of pre-financing the grid connection,’ confirms Hans Bünting. ‘If you look at Round Three projects, they might require DC technology, which will at least triple the cost of such a connection. So the investors in generation assets may not be able to pre-finance the grid connection in the future.’

Another disadvantage of the UK system is that it inherently creates inefficiencies as connections are developed on a project-by-project basis. It would be much more efficient for clusters of offshore wind farms to feed into the onshore grid via one transmission line and via one offshore connector. However, this can only be achieved with central planning.

‘We have not been fans of the OFTO regime from the start and all the concerns we raised at the outset have now come to pass,’ explained Keith MacLean. ‘The biggest problem is that we really need a joined-up approach rather than point-to-point links. This is an inefficient system as you just end up with a series of radial links with no interconnected network. Point-to-point links are less resilient and are more expensive for the generator.’ Survey respondents clearly agree – 61 per cent believe that the UK model is inefficient because it results in offshore projects connecting to shore via radial links.

“The disadvantage in the UK is that you have to find ways of pre-financing the grid connection. If you look at Round Three projects, they might require DC technology, which will at least triple the cost of such a connection. So the investors in generation assets may not be able to pre-finance the grid connection in the future.



This inefficiency will become more pronounced for larger Round Three offshore wind farms that are much further offshore. ‘The wind farms we have had in the UK to date have all been up to 40km from shore,’ explained Chris Veal, Managing Partner, Transmission Investment. ‘AC technology is the most efficient for this. The most you can connect on an AC link is 200MW. So it has been more economic to have radial links. But this will change in the future. Wind farms in Dogger Bank, which is a long way offshore, will need to be connected using HVDC technology. But Dogger Bank is up to 13GW so will need multiple radial HVDC links just to that one site. National Grid now has a role to provide some

co-ordination for the offshore grid and has produced a 10-year plan of its view of what the offshore grid should look like through to 2022. There were only one or two links in this plan that were not radial, which, in the scale of the whole British system, is quite small. So there is potential for non-radial links but it is small.’

Opinion is divided on which system is best – 54 per cent prefer the UK mechanism while 46 per cent prefer the German TSO model. Most developers interviewed for this report think the German system just edges the UK approach, now that they are part-compensated for any delays.



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© Freshfields Bruckhaus Deringer llp, June 2013

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