Here's What's Going Wrong in the US Offshore Wind Industry

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1:14Hello and welcome to another episode of the Odd Lots podcast. I'm Jill Weisenthal. And I'm Tracy Alloway. Tracy, I have to say there are a lot of exciting things happening in energy, decarbonization, electrification of the grid, things we've talked about recently with people like Jigar Shah and so forth. But I have to say, I keep seeing negative headlines about wind. Oh, my gosh. You know, just before we came in studio to record this, I was taking a look at the S &P Global Clean Energy Index. Yeah. It's down 30 percent this year, more than 30 percent this year. And a lot of that is thanks to what's been going on in wind.

1:53And in fact, if you look at Orsted, which I think is the world's biggest provider of offshore wind farms. It's down 50 % year to date. Yes. So we are recording this November 15th. I think just earlier in the week, two top Orsted executives departed the company. I think there was a project off the shore of, I think, New Jersey that recently the plug was pulled on. And it just seems that every story everywhere around the world, with the exception maybe of China, it seems to be something seems to be wrong, whether it's the math doesn't pencil out on the actual projects themselves. There are companies, I think Siemens Wind has had all kinds of manufacturing issues with respect to turbines, et cetera.

2:39And so just trying to understand what is going on with this industry and how bad is it in terms of if it's not going as planned, reaching our decarbonization goals as a country. Yeah. So my understanding is there are two things kind of happening at once. You could say two headwinds for the wind power industry, creating a perfect storm, Joe. I'm just going to get a perfect storm would be good for wind. I'm just going to get as many weather puns as I can into this conversation. But there's higher borrowing costs because of surging interest rates. And then there are also higher component costs. Yes.

3:13And I guess my question is, how much of all of this is sort of growing pains for an industry that at least in the U.S. is still relatively new, although it is true that it's also facing problems in places like the U.K.? Or is this a kind of permanent change in the industry's trajection? Basically, is wind power a low interest rate phenomenon like, I don't know, WeWork or cheaper Ubers? Is wind power a lot of hot air? You know, you mentioned the renewable energy stocks. And that is sort of another, I don't know if funny is the right word, but we're having this great year in the stock market so far.

3:54And how many people would have bet? It's like, oh, the Inflation Reduction Act passed, all this money pouring into renewable energy, all these incentives, can't lose betting on these companies and wind and I think solar. I mean, it's been pretty dismal. Yeah, absolutely. And wind especially was like a much hyped component of the renewable energy revolution. And you're right. With the Inflation Reduction Act, there is this question about how much of this is a temporary holdup given permitting issues that we've discussed with people like Jigar versus how much of this is the math just doesn't pencil out.

4:29There is something fundamentally challenging in wind. Lots of questions. And we have the perfect guest to get the answers. We're going to be speaking with Chelsea Jean-Michel. She is an offshore wind analyst here at Bloomberg NEF, one of our colleagues on a different floor. So excited to chat. Chelsea, thank you so much for coming on OddLot. Thanks so much for having me, Joe and Tracy. Is our premise correct, more or less, that it's been a just dismal year for the industry? I think dismal is a bit of a big word to use, but, you know, it hasn't been great. And there have been a lot of negative headlines, and you guys highlighted a lot of the key issues already.

5:08I think maybe to highlight at a grander scale, we have seen a lot of the impacts most saliently in the U.S. And Tracy, you mentioned, you know, it's a very new industry in the U.S. For context, there's only seven operational turbines, 42 megawatts installed. However, there are two offshore wind farms currently under construction right now, almost a gigawatt. So the industry is growing, but we've also seen over 12 gigawatts of offshore wind projects seek to cancel or renegotiate their offtake contracts in the U.S. Now, what I mean when I say an offtake contract is that's typically an agreement that these offshore wind developers, their projects will sign with states, state utilities to essentially guarantee that they're going to buy their power for usually around 20 to 25 years.

5:53And that's really key for an offshore wind project because they need, you know, you have variable generation. So if you can't guarantee your generation, you can guarantee the price at which that generation is sold. And that makes it easier for these projects to reach financial close, make a business case for them. Now in the U.S., this is interesting because this happens a little bit earlier on in a project's process. So in the U.K., before you bid for an off-take contract, you need to have a grid connection agreement. You also need to have your permits in. In the U.S., that's not needed. And so you might have a couple of years when between when you lock in your off-date contract until you finally reach financial close and then you want to construct and build the project.

6:30So that leads to a certain level of risk that's a little bit higher in the U.S. than you see in other parts of the world. And that's also why, you know, we've seen just how much interest rates have shifted over the last few years, how much inflation has changed. And that has meant that now when these projects are looking to reach financial close, they're in a different macroeconomic environment than when they had initially placed their bids and made those assumptions back in 2019, 2020. Oh, that's really interesting because I was wondering how higher rates are actually feeding into a lot of this.

6:58You would have assumed that the financing was in place, but you're highlighting the discrepancy between the revenue coming in through the offtake agreements and the financing that is still coming up in the higher interest rate environment. So just on this note, could you maybe tell us like the factors or the calculations that go into creating a wind farm, whether it's onshore or offshore? Like if Joe and I were at a bar and we were riding on a napkin, here's our rough cost and here's like our rough revenue source. What would that napkin actually contain? Yeah, so there's a lot that goes into it.

7:35And it depends on, you know, if you're building in the U.S. versus if you're building, say, in the Netherlands or in Germany. We're building in the U.S. We're building in the U.S. Yeah, so if we're building in the U.S., right, for context, offshore wind development takes a really long time. As I mentioned, there's very few projects currently operational in the U.S. right now. But around eight to 10 years is what we see globally. But in the U.S., you know, this can take as long as 14 years. We've seen that for some other projects that are currently in the process of getting built right now. But when you take a look at that really long process, one of the first things you think about is, okay, so that's like 10 years where you have like development costs going in, right?

8:16So you need the people that are going to help formulate the bids. In the U.S., you have a seabed lease auction. So this is usually the first step in the process where you're like, I want to acquire my seabed for X amount of dollars. We recently saw the New York Bight Lease auction last year. Millions and millions of dollars of revenue for the U.S. government, over$4 billion to secure these sites. And that's just step one. And then you also have... Can I ask really quickly, does the U.S. government own all the seabeds? On the Outer Continental Shelf, they do. However, that being said, I think it's three nautical miles.

8:47That's state waters, but most offshore wind development is going to take place in federal waters. Ah, yes. I remember this from my offshore gambling days. But yeah, so that's like a cost you can expect to pay for the seabed. Then you have kind of other development costs when it comes to, you know, bidding into an offshore wind procurement or bidding into an offshore wind solicitation. So this is where you go in to say, I will bid X price, I will bid Y price, I'll bid Z price for, you know, this offtake contract that we've talked about in state solicitations. And so that takes also some costs. Now, you have costs over the development lifetime.

9:22Then let's say you get to the point where you need to reach financial close and actually build that project. So let's talk about the equipment costs. This includes your turbines. This includes your foundations. This includes your transition pieces, which are kind of, you know, the pieces that exactly what they sound like transition from the foundation into the turbine. You have your array cables, which connect the turbines to each other. You have your offshore substation, which kind of collects all the power within the offshore wind farm to then get it ready to transmit to shore. Then you have your offshore cable, onshore substation, et cetera, et cetera.

9:53So part of the reason why I mentioned, you know, the Netherlands and Germany is because these are markets where they pay for offshore transmission. In the U.S., that responsibility falls on the developer. And then, of course, you know, as you're financing the project, you also have different financing costs involved with that. So if you're using project finance and you're going to go to the bank, then you have to factor in the payments that you're going to be making to pay off your loan. And if you're talking about lifetime costs, renewable energy is great because you don't have to pay for fuel costs.

10:19But that being said, you do have some O &M, so some operations and maintenance that you need to take care of as well. This seems complicated, Joe. It's so complicated. Also, you know how every once in a while, Tracy, you try to convince me to write a book? Yeah, with me, to be clear. With you. And the reason I can't do a project that's going to take two years, that's just too long. And so when I hear, oh, the process is going to be 10 to 14 years, I can't even imagine thinking about starting out a project 10 to 14 years. I can't even do a two-year project. So just that blows my mind. But when you're talking about such long development timelines, it really drives home how much financing costs can matter.

11:02And that's a lot of time where you're spending a lot of money on various things without revenue. And the whole math changes with the change in financing conditions. But why don't you talk to us about, okay, what are the conditions for these developers in 2023 versus 2019, both in terms of the rate environment, but also just the inflation environment, the cost of labor, the cost of construction, the cost of steel for the materials and so forth? How much have things changed for them in four years or three years? significantly. I actually I have those numbers when we're talking about the impact that inflation interest rates and also you mentioned, Tracy, the Inflation Reduction Act have had on the levelized cost of electricity.

11:45So what this means is this is essentially the price at which electricity must be sold in order to kind of break even, make sure your returns are met, etc. So in 2021, we did some analysis estimating that the LCOE for offshore wind projects in the U.S., assuming a 30 % investment tax credit. So this is investment tax credits as allowed in the Inflation Reduction Act, was around$77.30. So this is assuming a 30 % ITC. If you take into account CapEx and OpEx rise, so OpEx being operational expenditure, this added around$17 per megawatt hour. Then take into account interest rate hikes, that's around$27 per megawatt hour.

12:25But then we also had, when the IRA came out, bonus tax credits, so developers could also get plus 10 % for meeting certain requirements. That took down, so it reduced the levelized cost of electricity by around$7 per megawatt hour. So when we're sitting here in 2023, this means that now the LCOE, assuming a 40 % investment tax credit, stands around$114.20 per megawatt hour. So you can see comparing that$114 to that$77 per megawatt hour number, just how much that environment has changed. And I think to highlight a couple of, you know, movement pieces in terms of, you know, what has been happening on a macroeconomic scale.

13:06So U.S. CPI, so this is, you know, consumer price indexed, averaged at around 1.9 % before COVID-19 in 2019. And then if you take a look at how it peaked in 2022, it was at around 9%. And so you can really see how that environment has shifted. Also, for several projects, the secured overnight financing rate, so this is the base rate for interest rates in the US, stood at around 0%, almost nothing in, you know, kind of end 2020 into 2021. And then when you take a look at where it is in 2023, it's, you know, around 5.5%. And so you can see just how much the base rate for, you know, borrowing money has increased.

13:44Wow. It's like a almost 50 percent increase in the cost, which is almost perfectly tallied with the drop in Orsted's share price. Oh, perfect. Yeah. Efficient markets right there.

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15:52Okay, so you just laid out wonderfully all the different cost pressures that have landed on the wind industry. And I guess my question now is, what levers can they pull to offset some of these? So, you know, you have fixed rates on the revenue side because of those offtake agreements. can they renegotiate to try to get additional money? And then on the cost side, I imagine putting together these massive wind turbines is a pretty expensive and complicated endeavor. But we have seen, for instance, in the oil industry that you can do things like have standardization on components and things like that that can bring down costs.

16:37So which of these is the industry looking at? Which, in your opinion, might be most effective here? So I think what comes to mind are three things. So one, the first you mentioned being renegotiation. So that's what a lot of these developers have been trying to do. So far, not really any of the renegotiation attempts have been successful. We did see some green lights in New Jersey when Orsted requested basically being able to keep some of the upside of their federal tax credits. So traditionally in their contracts, they're meant to pass down those benefits to ratepayers if they're going to get any extra access.

17:13But New Jersey kind of passed a bill saying that, no, this is OK. Orsted can keep the upside to make sure that that project goes forward. Now, even though that bill passed and Orsted was able to receive the upside, that project still did not go through. If we take a look at renegotiation attempts in Massachusetts, the regulators had also said, no, we're not willing to renegotiate. And so then we saw fines of around$50 million,$60 million that these developers were paying to kind of exit those agreements so that they could then rebid into future solicitations. In New York, we also saw regulators decline requests to increase offtake prices.

17:50And so for New York, we're still waiting to see what exactly might happen. But basically renegotiating kind of opens up a whole can of worms because this is a competitive process that these developers are competing against each other for. And then the second you reopen that up to say, oh, I want a higher offtake price, then that kind of calls into question the competitive nature of the award. Wait, sorry. Explain that further when you say it calls into question. Can you clarify that? Yeah. So essentially when we see something like an offshore wind solicitation, I've been using a lot of different words, solicitation, procurement.

18:19They're also known as request for proposals, RFP. Some people might call them an auction. So these are essentially developers coming in. The state says, I want to procure, let's say, four gigawatts of electricity of offshore wind power. And so then you'll have multiple developers kind of develop a proposal with different projects. They'll say, I'm developing a one gigawatt project. I'm developing a 500 megawatt project, et cetera. They'll then say, I'm willing to provide this project at, let's say,$100 per megawatt hour. And this project is going to commission in 2030. And so then you'll have all of these different elements.

18:52Now, usually in the U.S., they'll take into account the bid price. So the lower your price, you know, the more that you can save a rate payer's money. And so then the better that looks. So that's usually around maybe 70 percent of the evaluation. And then you'll have 30 percent be attributed to things like environmental attributes, economic development opportunities. How much are you investing in the state? Also things like project viability, developer experience, different pieces like that. But the big portion is how cheap can you, you know, sell electricity to me? And so when you have these different developers essentially saying, I can sell it at this price and this is the lowest one or this is the most attractive one that the state selected, you award it and then a couple years later you say, oh, I need an increase.

19:36Then that calls into question, okay, what about the previous developers that lost out in the auction? Were they bidding at a price because perhaps they had less optimistic assumptions about what the future would be like? Yeah, their math was better. Exactly. Right. So when you think about contingency planning, things like that, it's good to have an optimistic view of the future. But when the optimistic view doesn't actually end up happening, then that kind of, you know, makes it a little bit more difficult. And what about on the supply side, like the component idea? How much can be squeezed out of costs there?

20:08That is a great question. So a lot of the cost declines we've seen in offshore wind has been due to increasing sizes in turbines. And so what that means is that as a turbine gets bigger, that means that oftentimes you need less turbines for the same amount of output. So for, you know, a one gigawatt wind farm, you need less turbines if you have bigger turbines at higher rated capacities. You also need less array cables to interconnect them, less foundations, oftentimes less vessel trips needed to, you know, go in and install the turbines because there's fewer of them. So with that being said, you know, sometimes when you have this longer runway for offshore wind development, that means, oh, OK, well, I have a little bit longer time to kind of pick the biggest, newest technology that is going to allow for cost savings on a per megawatt basis.

20:55Now, that being said, a lot of these projects that have been raising red flags are a little bit more in the later stages. And so kind of, you know, reconfiguring and getting the newest and biggest turbine or signing new supplier agreements and, you know, trying to figure out where to squeeze can be a little bit more challenging. Because oftentimes a lot of these supplier agreements are already being put in place or have already been put in place. So this was the case for Ocean Wind 1 and 2, where if you take a look at Orsted's impairment, the vast majority of it was due to supply chain complications, mostly in Ocean Wind 1.

21:26And this is because they experienced kind of knock-on effects from delays and kind of scheduling issues that they were having with suppliers, predominantly with vessels. And so there is some wiggle room that you can do with reconfiguration and redesigning, you know, the project. We have seen, you know, I mean, Orsted mentioned for their Skipjack projects in Maryland that they are revisiting some reconfiguration to see if they can, you know, make the project as valuable as possible. But that being said, for some projects, it's not always possible. Sometimes you reconfigure as much as you can until you kind of have to make a final investment decision.

22:01And for some projects, you have less runway. So if you're early on in the development process, then you have more leeway to shift, you know, your designs and change your suppliers. But if you're later on, it's a little bit more challenging. So you mentioned supply chains. And the big stress point has actually been the vessels. For Orsted's Ocean Wind 1 and 2, that's what they mentioned. Was that the one that was going to be off of New Jersey? Yes. And wait, what's the vessel constraint? Is it actually the number of ships? Yeah, what's going on there? Yeah, so the U.S. has essentially this law called the Jones Act.

22:33I'm not sure. Are you guys familiar? Oh, we love it. It always comes back. It always comes back to the Jones Act. No, we've done a couple episodes. I had no idea this was going to turn into a Jones Act episode. Now I'm really excited. So I have my own personal feelings about it. But that aside. I've noticed, by the way, like on social media, that's one of the most hot button topics that you can talk about. So you never say anything about the Jones Act online. People have really strong opinions. OK, sorry. Go on. No worries. I mean, it's a hot button topic. So essentially, basically, if you are traveling between two points in the U.S., then that ship has to be U.S.

23:12build, U.S. crewed, U.S. flagged. And what that means for offshore wind is that that offshore wind farm counts as a point. And so the U.S. has, you know, I mentioned seven turbines currently installed, two projects currently under construction. But what happens is because of the Jones Act, you either have to have a Jones Act compliant vessel that can do that transportation. That doesn't exist in the U.S. right now. Currently, there's only one wind turbine installation vessel that Dominion is building right now. I'm getting dredging. This is so amazing. It all comes full circle. So, yeah, there's only one vessel currently under construction right now, and that's not going to be ready until a few years from now.

23:55And Dominion's planning on using that on their 2.6 gigawatt coastal Virginia offshore wind project set to be the largest in the U.S. when it commissions, one of the largest in the world, which is great for them. But for other projects, Orsted was actually hoping to use this for their Sunrise Wind and Revolution Wind projects. But now that the vessel has been delayed, they are no longer able to use that Jones Act compliant wind turbine installation vessel. So another thing that you can consider doing is using a European wind turbine installation vessel and then using a kind of like feeder barge method.

24:24And so this is what a lot of U.S. offshore wind projects are hoping to do. Essentially, the feeder barges are Jones Act compliant and you feed in the components to the European vessel that stays at the offshore wind site. This is traditionally not how projects are installed in Europe, as you might imagine. Usually the European WTIV will go to the port, pick up the components, load it up, go to site and then install the components. And so you kind of have this mishmash way of doing things. And then the last one that we don't really expect to see because it's super expensive, but you might stage your components in, say, Canada and then use a European WTIV and then go get the components and then install them.