![COLUMN | Offshore wind: Who captures the value? TotalEnergies, BP, Shell, Ørsted and the great German offshore wind auction [Offshore Accounts]](http://media.assettype.com/bairdmaritime%2Fimport%2Fwp-content%2Fuploads%2F230807-Offshore-Accounts1.jpg?w=480&auto=format%2Ccompress&fit=max)
Another month, another record auction for offshore wind farm concessions in Europe, this time in Germany. The tender allowed bidders to compete on their willingness to pay the German government for the right to build the wind farms.
The two winning bidders agreed to pay €12.6 billion (just under US$14 billion) for the right to install a total of up to seven gigawatts (GW) on four sites: three sites in the North Sea, northwest of Heligoland island, and one in the Baltic, close to the island of Ruegen. The four sites will almost double the country's offshore wind generation capacity, which stood at just over eight GW at the end of 2022.
The US$14 billion price to be paid is not the cost of building the win farms; it is only the premium to be paid to the German government for the right to develop them. "The only criterion for the area award is the bidders' willingness to pay," German utility EnBW commented to Reuters.
The government in Berlin is laughing all the way to the Bundesbank. The winners have, rather implausibly, reassured analysts that everything will be okay for them financially in 2030 when the wind power reaches the national grid.
Even Shell admitted it could not compete in the tender, with its CFO telling analysts at the end of July that "the offshore wind sector faces a multitude of issues."
Unfortunately, past record auctions for offshore wind farm acreage in Europe have not necessarily ended with record profits for the buyers of the seabed rights to install turbines. The Crown Estate, which owns the rights to the seabed off most of the United Kingdom, has done very nicely, however, boosting the British government's coffers, the Scottish Government's coffers, and now those of King Charles, as we reported here and here.
But high prices for the rights build windfarms and low fixed electricity prices have proved a disastrous combination. Indeed, we were only recently covering how Swedish utility Vattenfall had announced that it was suspending work on its 1.4GW Norfolk Boreas offshore wind farm project in the British sector of the North Sea last month. Vattenfall said that it would take an impairment of US$537 million on costs already incurred and would not proceed to go ahead and purchase and install the 140 turbines required for the project, as the project was no longer profitable.
"We have decided to stop the development of Norfolk Boreas in its current form and not take an investment decision now," the company said, citing a 40 per cent cost increase.
"The UK offshore wind industry is at a tipping point," Jan Matthiesen, head of offshore wind at the Carbon Trust thinktank, told The Guardian newspaper last weekend. "The maximum prices set are now too low. Last month, we saw Vattenfall withdraw from the Norfolk Boreas wind farm. This may be the first of many if bold and swift action is not taken."
"Bold and swift action", of course, means a slug of taxpayer cash to ensure that Vattenfall, Iberdrola, and all the other companies that have committed to building new wind farms offshore are suitably compensated for getting their sums wrong when they made their offers. Shell's CFO observed that many winning bidders would be carefully scrutinising their terms and conditions to see if there were get-out clauses.
Indeed, the new British windfarm operators, faced with higher costs, are now lobbying hard to have their contracts rewritten to obtain higher electricity prices, or to receive subsidies from the taxpayer to offset the cost increases that they had not foreseen.
Somebody has to pay for all the turbines and now that costs are higher, there is a tug of war between governments (who like large upfront fees and are delighted that offshore wind no longer requires a subsidy but even pays signature bonuses like an oilfield), windfarm operators (who must bear the construction risk for the wind farm and all the associated vagaries of operating costs over two decades), and long suffering electricity users (who are already hit by costs of living increases and inflation and are now in revolt over what many perceive as higher expenses for battery-powered electric vehicles, ground source heat pumps to replace gas boilers, and new wind farms to replace existing fossil fuel-powered generation plants).
Something is going to have to give. So far, it has been return on capital for the operators.
In the first instance, this is the obvious place for immediate pain to be absorbed as the question of who gains the value from investments in wind farms refuses to go away.
We have already seen criticism of the low margins Norway's Equinor is expected to achieve in its investment in the 3.6GW Dogger Bank wind farm, also in the UK. Norwegian researchers calculated in 2021 that the Dogger Bank project's expected net present value (NPV) for Equinor was around negative US$1.3 billion, indicating that the investment was destroying value for the state-owned Norwegian energy company. Upstream reported that the Norwegian academics had estimated the expected internal rate of return (IRR) on total capital in its Dogger Bank project at 3.6 per cent, in real terms, with a payback period of 17 years – very low for an investment outside dry bulk shipping.
Equinor didn't argue with the findings of the report, but said it had been able to sell down its share in the Dogger Bank project to other investors for a profit, boosting its expected returns to between four per cent and six per cent.
So long as a greater fool emerges to buy windfarm assets for more than the original bidder, Equinor appeared to be saying its low returns didn't matter. This approach has also boosted Ørsted's profitability in recent years as it is has sold stakes in wind farms it built to oil and gas companies desperate for exposure for renewables.
In the German auction last month, windfarm industry leader Denmark's Ørsted actually chose to exit the process and did not submit a final bid. Ørsted's CEO Mads Nipper said in a post on LinkedIn that his company "very deliberately chose not to pay record high concession prices for new offshore projects in Germany."
The fact that this pioneer of offshore wind walked away from the German auction process because the prices were too high is very revealing. In September last year, Ørsted also decided not to submit a bid in the first auction of the Round 3 Zonal Development Phase in Taiwan. The company said that local content regulation, high cost inflation, and rising interest rates simply made it unviable to offer to compete in the auction, even though Ørsted is the largest shareholder in Taiwan's first commercial-scale offshore wind project, Formosa 1, which has a capacity of 128 MW.
If the industry leader can't make the German (and next Taiwanese) wind investments worthwhile, who would be reckless enough to offer billions to Berlin? To take the oft abused line from Alexander Pope's An Essay on Criticism, which fools chose to rush in where angels fear to tread?
Readers of this column will recall TotalEnergies' CEO Patrick Pouyanne playing hardball on Mozambique's stalled liquefied natural gas (LNG) project saying he wouldn't tolerate any price increases from vendors compared to 2020. We thought he was delusional, as high LNG prices mean the project economics have improved since the contracts with Saipem and others were first signed.
But that same penny pincher in Paris has now committed to spending around US$6.4 billion for its three GW of offshore German wind acreage, based on estimates of German power prices in 2030 and beyond. This is a huge sum and it again raises the question of where the return on those funds is going to come from, and what the return on investment will be.
Reuters reported that TotalEnergies will pay an initial €582 million (US$641 million) upfront to the government, which has promised to use the money to reduce electricity bills and to protect the marine environment (obviously not the bits of the marine environment that are going to have the wind farm built on them, but others), rather ironically. After the 10 per cent of the bid is paid upfront, the remainder will be paid over 20 years when the wind farms are commissioned and online.
Speaking to analysts at the announcement of TotalEnergies' second quarter profits of US$4 billion in mostly fossil fuel on July 27, Mr Pouyanne made some reassuring statements:
"We also won some maritime leases in Germany, three GW offshore. Some people think it's too expensive. It's not, because I think it's exactly what we are looking for in Integrated Power. It's fitting. It's a perfect illustration of our business model.
"Why? Because first it's the German market, which will offer the best price for electricity in the future. Germany has decided not to go to nuclear. So, you know, in the end, [the] price of electricity in Germany will be supported.
"Secondly, it's like an oil and gas concession. Amounts are important, but in fact, it's an upfront payment, like when we pay a bonus for an oil and gas concession plus a royalty. We fixed exactly what we pay upfront, 10 per cent, for all these three gigawatts, it's something around €500 million (US$551 million). And then we will pay a royalty for around 20 years. And the royalty by the way avoids us to pay any connection fee to the grid.
"So, when you look at the math, I can tell you, I'm very happy that we have managed to get access to the three gigawatts of offshore wind because it's exactly the model we want to put in place. Price is not controlled, up to us to decide which part we will sell to PPAs, to German manufacturing industries and which part we'll keep merchant in order to trade around and to asset integration. So, my answer to the ones who have criticised us is that, in fact, we are exactly in the model, not an infrastructure model, but an Integrated Power merchant model, exactly what we do in oil and gas."
You thought M. Macron had an imperial style? It's not at all clear at all to me why Germans will pay the highest prices for electricity in Europe for the next twenty years, as TotalEnergies seems to believe that they will, or where the claim that "the price will be supported" comes from.
The lesson from the UK is that wind power is expensive to develop, but cheap when it is online – so cheap in fact that it has a marginal cost of nearly zero, so that when it is most available (that is, when the wind is sweeping across the North Sea), consumers are offered an abundance of choice from wind suppliers. The windfarm business is most certainly not like oil and gas, where pricing is global and fungible.
If buyers in Japan are willing to pay more for LNG compared to Europeans or Indians, then shipments of LNG will divert to Yokohama from Qatar, Brunei, and Australia. If hedge funds think oil is cheap, they rent tankers, fill them up with crude, and wait for prices to rise to sell the cargo for a profit. That's how the oil and gas markets work: there's a global price, and the products can be shipped around the world to the highest bidder.
Unfortunately, if buyers of electricity in Beijing or Seoul are willing to pay more for electricity than those in Cologne and Munich, TotalEnergies has no way of getting it to them from offshore Heligoland and the Baltic, and it is stuck with the prices German consumers are willing to pay at the time the turbines turn. The boss of TotalEnergies must know this.
The biggest tell-tale factor that TotalEnergies completely overpaid is the amount paid by the second winner.
The second winner was BP. BP won four GW of capacity in the German offshore auction and said it was making initial payments totalling €678 million (US$746 million) to the German government, equivalent to 10 per of the bid amount, which will be paid by July 2024.
So… BP paid €6.78 billion (US$7.48 billion) for 4 GW, and TotalEnergies paid €5.82 billion (US$6.42 billion) for three GW. BP paid €1.695 (US$1.87) per gigawatt, whilst TotalEnergies paid €1.94 (US$2.14) per gigawatt. TotalEnergies paid 14 per cent more than BP. Perhaps the critics of Total's CEO have a point?
Even worse for the credibility of TotalEnergies, BP assured its investors in a press release that the investment "is fully aligned with [the company's] integrated energy strategy and disciplined capital allocation", saying that it expected returns from the project of "between six per cent and eight per cent."
You will recall that TotalEnergies, which paid more than BP, said it expected to receive a "double digit" return on its German wind investment. How is this possible? TotalEnergies paid 14 per cent more than BP for each unit of power and BP expects to receive barely half what TotalEnergies expects as an unlevered return.
Something has to give here. My guess is that it will be TotalEnergies' return on capital. Why should TotalEnergies make massively higher returns on capital than BP for the same acreage? By the time his unfortunate guesses are put to the test in 2030, Mr Pouyannne will be sipping Rose on a yacht in the south of France, or lecturing executives on his genius. He won't be around to see whether his big, bold bet offshore Germany created value.
Shell and Ørsted walked away in Germany. BP paid 14 per cent less than TotalEnergies. TotalEnergies was a big winner in the German auction, but the biggest winner was the German government. Longer term, the biggest losers may yet be the German consumers if TotalEnergies is correct that they will be paying the highest energy prices in Europe for decades to come.
If those assumptions are wrong, then the biggest losers will be TotalEnergies' shareholders.
Game on.
Background Reading
Clean Energy Wire has an excellent account of the German offshore wind industry and all the statistics you need on current capacity and future plans.
You may consult the German government press release on the 2023 offshore wind auction if what I have written is not clear.
