Big Oil’s big money push into UK offshore wind raises eyebrows

With the UK preparing to host COP26 in Glasgow, the most important UN climate-change conference since Paris in 2015, last week’s auction of 8 gigawatts of offshore-wind capacity in England and Wales under new bidding arrangements raises two pressing questions.

First, are we now set for a slowdown or even a reversal of the strong deflationary dynamic experienced by the offshore-wind industry over the past decade, and hence a potential increase in the cost of the energy transition to consumers going forward?

Second, will the returns available to investors suffer as the oil majors start flexing their balance-sheet muscles while playing catch-up on offshore wind with the established utility players?

The UK currently has the largest and most dynamic offshore-wind market in the world, with the highly successful contract-for-difference auctioning model used to incentivise new projects. The country is well on track to achieve its 2030 target of 40GW of operational capacity with 10GW already in operation and a further 29GW either under construction or planned.

However, under the new arrangements used for the auction this month, there is an extra preliminary stage whereby bidders first bid for the lease of the seabed for a period of 60 years, with an annual option fee to be paid until they make a final investment decision.

And the price of this option paid by the winning bidders, which would add an extra 35 per cent to the overall construction bill, is set to raise both developers’ costs and investors’ eyebrows.

Of course, the extra revenue is great news for the UK Crown Estate and taxpayers but it is bad news for electricity consumers, project developers, and the offshore-wind industry’s equipment suppliers — after all, someone will have to pick up the tab for these extra expenses.

The aggregate annual amount to be paid by the winning bidders — including a consortium led by BP — for this option is £880m, so assuming that it takes an average of six years to reach the FID stage this is an extra £5.3bn (£660m/GW) to add to the money required to build the wind farms themselves. Assuming a construction cost of £1.8bn per GW, or £14.4bn for the 8GW, this implies total capex of £20bn.

So how does all this translate into power prices and returns before and after the seabed leases? By adding in the option cost, we calculate that on average these new projects would need a 25 per cent increase in the power price.

Without the option on the seabed leases, and assuming a 25-year operating life and a 55 per cent load factor, we estimate that a developer could make an 8 per cent internal rate of return on a new offshore-wind project at a power price of £58 per megawatt-hour. But with the average £660m per GW of extra capex for the option, the power price needs to be £73 per MWh in order to maintain the 8 per cent IRR.

In signalling its willingness to pay to play, Big Oil seems to be risking returns for itself and the market leaders.

There was a big gap between the highest and the lowest winning bids, which were made by a consortium in which BP holds a 50 per cent stake and the German utility RWE. The BP consortium will pay £154m per year per GW while RWE will pay £82m per year per GW. The global leader in offshore wind, Ørsted, was squeezed out altogether.

The incentive for the developers will be to bid higher prices into the CfD auctions later in the decade to try to maintain their returns. That risks driving up the cost of shifting from fossil-fired electricity to renewables in the wholesale power market, and from gas boilers to electric heat pumps in the retail energy market, both of which are fundamental pillars of the UK’s 2050 Zero Carbon strategy.

In short, if the costs to consumers are set to rise or the returns to investors are set to fall, then the risk is that the pace of the energy transition in the UK may slow just at a time when an acceleration of momentum globally is urgently required.

With the Scottish Crown Estate now reviewing the bidding arrangements for the next UK auction of seabed leases — the seabed rights for up to 10GW of capacity in Scottish waters will be offered later this year — investors will therefore be watching with a very close eye.

Read the latest issue of the OGV Energy magazine HERE.