Offshore Wind's Economic Doldrums
Today's key economic doldrums plaguing offshore wind projects are higher interest rates, cost inflation, and supply chain issues. Developers make multiyear cost assumptions when bidding for projects, given the often decade-long lead times associated with planning and development, obtaining approvals, and completing construction, before an offshore wind project becomes operational and starts generating cash returns.
The industry's high capital intensity means an increase in interest rates or material costs can result in significant cost increases for a project. On top of that, aggressive government-imposed clean energy targets have led to a spike in demand for the materials and equipment used in constructing offshore wind projects, leading to supply chain shortages.
While future costs are susceptible to fluctuation between the time of the project auction and the time any costs may be incurred or locked in with suppliers, future cash returns in the form of power purchase agreements and tax credits are fixed during the auction. Governments that support these projects could intervene later on to keep these projects economically viable and help achieve government-imposed clean energy targets; this can be accomplished by increasing power prices in these offshore wind contracts or providing additional tax incentives. However, the resulting increase in customer electricity bills may be politically untenable, because of the already high power prices associated with offshore wind.
The large cost increases have forced offshore wind developers to re-evaluate their projects and determine whether the expected financial returns still outweigh the expected costs. In some instances, projects have been determined to be economically unviable as is. If governments decide not to restructure these contracts, developers have little choice but to write-down these projects.
DBRS Morningstar view these problems as near-term credit concerns for project developers and challenges to the industry that may result in some government offshore wind-related clean energy targets not being met within the desired timelines. Over the longer term, we think these industry challenges could be overcome through a potential combination of (1) lower macroeconomic inflation and a return to stable prices; (2) cost reductions from supply chain build-out in the U.S. and technological improvements; and (3) possibly some form of contract restructuring that enables large unforeseen market shocks to trigger a renegotiation of power prices or subsidies.
DBRS Morningstar continue to believe it is likely that the industry will receive some form of support from the governments promoting these projects because of the importance of offshore wind power in enabling policymakers to achieve their decarbonization plans. We expect offshore wind power to remain a vital source of renewable energy going forward and for capacity to continue to increase in coming years once these near-term challenges have been resolved.
Recent Project Write-Downs
European energy companies Orsted (not rated by DBRS Morningstar), Equinor (not rated by DBRS Morningstar), and BP p.l.c. (BP; rated "A" with a Stable trend by DBRS Morningstar) have taken an aggregate $5 billion of write-downs on U.S. offshore wind projects because of significant cost increases resulting in uneconomic projects.
Orsted wrote-down three of its largest projects, the 1,100-megawatt (MW) Ocean Wind 1 and 1,148-MW Ocean Wind 2 projects, both located off the coast of New Jersey, and the 924-MW Sunrise Wind project located east of Long Island, New York. Orsted cited macroeconomic factors, including higher interest rates, cost inflation, and supply chain issues. Orsted's stock price halved after these write-downs were announced, and the company announced the departure of its chief financial officer and chief operations officer.
In addition to the termination of Sunrise Wind's power contract, New York also received power contract cancellations from projects owned by the joint venture between Equinor and BP, namely their 816-MW Empire Wind 1; 1,260-MW Empire Wind 2; and 1,230-MW Beacon Wind projects. In response, New York agreed to a new offshore wind solicitation process on November 30, 2023, with final proposals due by January 25, 2024, and award announcements in February 2024. Orsted, Equinor, BP and others are eligible to participate in the new solicitation process.
Other U.S. offshore wind projects that terminated their power contracts because of macroeconomic factors include AVANGRID, Inc.'s (not rated by DBRS Morningstar) 1,200-MW Commonwealth Wind project and 804-MW Park City Wind project, both located in offshore New England.
The offshore wind industry in Europe has faced similar challenges.
Swedish energy company Vattenfall AB (not rated by DBRS Morningstar) stopped development of its British 1,400-MW Norfolk Boreas offshore wind power project as a result of rising costs. (See Unfavourable Gusts: Cost Inflation Distressing Offshore Wind Projects, Earnings, and Credit Quality). The Norfolk Boreas project was expected to start producing electricity in the late 2020s and was part of Britain's plan to increase its offshore wind power capacity to 50 gigawatts (GW) by 2030 from approximately 14 GW now. Orsted is expecting to decide before the end of this year whether to go ahead with its 2,852-MW Hornsea 3 project.
Is a Revision of Clean Energy Target Timelines in Order?
Ocean Wind 1 would have been the first offshore wind farm in New Jersey, located 15 miles off the South Jersey coast, and both Ocean Wind 1 and Ocean Wind 2 represented the beginning of Governor Phil Murphy's offshore wind plans to help New Jersey move to 100% clean energy by 2035.
New York has a goal of getting 70% of its electricity from renewable sources by 2030. Storm's a Brewing: Offshore Wind Development Affected by Higher Interest Rates, Cost Inflation, and Supply Chain Shortages | December 12, 2023.
The Biden Administration has been targeting 30 GW of power from offshore wind by 2030. The Inflation Reduction Act, which passed in 2022, was designed to accelerate the country's build out of renewable energy, but it may not be enough to compensate for the industry's current cost challenges and the high interest rate environment.
The current state of the industry, with offshore wind developers determining some of their projects to be economically unviable because of significant cost increases and supply chain shortages, makes these U.S. Federal and state clean energy target timelines seem overly ambitious.
Notable U.S. Offshore Wind Projects That Are Still on Track
South Fork Wind
Orsted and Eversource Energy (not rated by DBRS Morningstar) are nearing completion of their jointly-owned 132-MW South Fork Wind project, which is expected to be operational before year-end 2023. The project will consist of 12 13-MW turbines located 35 miles east of Montauk Point (Long Island), New York.
Vineyard Wind 1
The 806-MW Vineyard Wind 1 project will be the first large-scale offshore wind power project once completed; it is expected to start generating power before year-end 2023. The project is ultimately jointly owned by Avangrid Renewables, LLC (not rated by DBRS Morningstar; a subsidiary of U.S. utility holding company AVANGRID, Inc.) and Copenhagen Infrastructure Partners K/S (not rated by DBRS Morningstar; a Dutch fund management company). It will consist of 62 13-MW turbines located 35 miles south of mainland Massachusetts and 15 miles south of Martha's Vineyard.
Revolution Wind
Orsted is continuing its development of the Revolution Wind project, which is a 700-MW wind farm located 15 miles south of Rhode Island jointly owned by Orsted and Eversource Energy. Revolution Wind is more than five times the size of South Fork Wind and would provide Connecticut and Rhode Island with enough power for about 350,000 homes. The project is expected to be completed in 2025.
Coastal Virginia Offshore Wind (CVOW)
Dominion Energy's (not rated by DBRS Morningstar) CVOW project is the largest offshore wind project under development in the U.S. and is located off the coast of Virginia Beach. Once completed in 2026, it will consist of up to 180 turbines and generate up to 2,600 MW.
Notable European Offshore Wind Projects that are Still on Track
Dogger Bank
The Dogger Bank Offshore Wind Farm is a joint venture between Equinor (40%), SSE Renewables (not rated by DBRS Morningstar; 40%), and Vargronn AS (not rated by DBRS Morningstar; 20%). The 3,600-MW wind project is being constructed in three 1,200-MW phases 70 miles off the coast of Yorkshire, UK. Phase A started generating electricity in October 2023 from its first turbine, and the project's 277 turbines are expected to fully achieve commercial operation in 2026. When complete, Dogger Bank will be the world's largest offshore wind farm.
East Anglia THREE
The East Anglia THREE project is the second of four East Anglia offshore wind projects to be developed and is wholly owned by ScottishPower Renewables, a subsidiary of Iberdrola S.A. (not rated by DBRS Morningstar). The 1,400-MW project is located 43 miles off the coast of Norfolk, UK. Onshore construction began in 2022, and the project is scheduled to fully achieve commercial operation in 2026.
