Scotland’s £30bn offshore bounty

Having dreamed of endless rows of turbines far out at sea, each the height of the Wallace Monument, the offshore wind industry has had a bad credit crunch.

It already looked like a logistical nightmare to build more than 300 of these giant structures around the coastline and connect them to the grid onshore, but last year the banks became so nervous that they wouldn’t lend to respectable home buyers, let alone enormously risky new industries.

This was dreadful timing for the UK government, which had set targets to build 33GW of offshore wind farms by 2020, much of which was expected to require bank loans.

Now that the Centrica deal suggests that things might finally be looking up, industry debate rages about how optimistic to be about the future. Do we face years of grindingly slow progress and target failures, or is this the beginning of a new phase that is about to explode into life?

Unbeknown to most of us, offshore wind has actually been building up a head of steam since the start of the decade.

Mainland wind farms and their battles with local protesters might have seen most of the headlines, but the first few demonstration offshore farms started quietly appearing five or six years ago.

In the Moray Firth in Scotland, two vast turbines were erected next to the Beatrice oil field by Talisman Energy and Scottish and Southern Energy (SSE), while slightly larger installations were put up in Inner Dowsing and Lynn in Humberside and other places such as North Hoyle off North Wales and Scroby Sands off Norfolk.

Territorial waters owner the Crown Estate, meanwhile, started awarding larger concessions around England and Wales in the so-called Round Two programme in 2003. This created a potential off-coast capacity of 8GW through big future farms such as the Thames Estuary’s London Array (1GW), Triton Knoll off Norfolk (1.2GW) and Gwynt Y Mor off North Wales (750MW).

Scotland was ignored at this stage, since its waters were seen as deeper and more treacherous, but then received a whopping 6.4GW of potential capacity through the Scottish Territorial Waters Round late in 2008.

The whole country is now waiting to see how the Crown Estate decides to allocate its Round Three concessions, which concern nine mega-sites in deeper waters comprising a further 25GW of potential capacity, including four more gigawatts in Scotland.

To put that in context, the UK offshore industry is eventually expected to be four times the size of the onshore industry. Or another way, the 10GW offshore planned for Scotland will be larger than UK onshore wind as a whole. When you factor in grid connections, the first £1.15 billion phase of which is currently being tendered by energy watchdog Ofgem, the estimated total cost is £160bn, at least £30bn of which will be spent in Scotland.

Not only will that demand engineers and specialist construction workers to build the sites and grid connections, but there is likely to be a major local manufacturing industry for the turbines and the “jacket” foundations in which they sit. In an early sign of this, Denmark’s Skykon bought the wind turbine plant at Machrihanish on the Kintyre peninsula last year and is actively looking for other UK sites to be close to its future customers. Siemens and others are also looking for sites, while Scotland’s Burntisland Fabrication is one of the European leaders in jacket manufacturing at its sites in Fife and Stornoway.

“This is on par with the investment in North Sea hydrocarbon production, without a doubt,” says Joel Staadecker, chief executive of Aberdeen-based Sea Energy, which is respectively partnering SSE and npower in two of the existing Scottish sites and jointly bidding with Portugal’s EDPR for two more sites in Round Three.

“And unlike a lot of inward investment,” he adds, “there is the added attraction that once this industry comes, it can’t leave.”

But away from this future-gazing, it is easy to forget that things have only barely started happening.

There are a few Round One sites now operating, while the first of the Round Twos are only starting to be built. In Scotland, Staadecker and the other winners from last year’s allocations are doing preliminary work and might start construction in two or three years.

By the middle years of the next decade, money will still be needed in spades to get the industry off the ground. Industry analysts estimate that around two-thirds of the investment will come from the utilities and other developers like Sea Energy, through existing reserves and fundraisings.

External financiers will provide the rest in the form of debt, which the developers will want in the largest proportions possible in order to maximise their returns and minimise their risks.

As Charlie Hodges, an offshore wind analyst at London-based New Energy Finance, puts it: “If we are going to reach our forecasts, it’s extremely important that the developers can take advantage of commercial debt. Non-recourse loans spread risks and improve returns.”

The challenge is that there are much cheaper ways to get electricity. Hodges estimates that the cost of producing offshore wind power is between £120 and £155 per megawatt hour, which is about 50% higher than the cost of onshore wind and easily triple that of more conventional power.

For years the UK government has been offering subsidies in the form of its renewable obligations certificate scheme, but it was forced to refine its policy in the face of mounting gripes about affordability at the height of the economic crisis that saw Shell withdraw from the London Array consortium in January. In April the government raised the offshore wind subsidy by 50%, before raising it again just two weeks later by introducing a temporary two-year booster.

Fearing that the UK could get left behind by rivals in Europe and North America, panic was clearly starting to set in.

The first sign that the tide was turning did not come from the UK, however, but from Belgium in July, when a wind farm called Belwind succeeded in getting the first half of its 330MW planned capacity funded by a syndicate of banks. Not only was this the first deal since the crash, it saw the EU-owned European Investment Bank (EIB) playing a major role for the first time, in a sign that it will now get involved with the industry and thereby build confidence among private lenders.

The deal was also done on a non-recourse basis, which meant that the lenders and not the developers would assume ultimate responsibility if things went sour. This kind of deal had been done several times pre-2008 in Belgium and the Netherlands, but nobody had been sure whether it would reappear.

The Centrica deal has been done on similar terms, which will be taken as a sign that the government’s double April intervention worked, even if the EIB has not been attracted this time.

Jérôme Guillet, head of energy at Dexia, a Belgian bank which has lent money in both the Centrica and Belwind deals, says that Centrica is a “great step forward”, regardless of the fact that it relates to an existing wind farm that is near shore and is for a relatively modest amount of money compared to what will be needed for the likes of the London Array and ScottishPower’s Argyll Array (1.5GW).

“You have to start somewhere,” he says.

“You need the banks to learn with basic deals to get more comfortable. You don’t learn by doing the hardest thing first. Bankers love their precedents.”

Hodges counters that the industry will be seriously constrained if debt syndication markets remain largely closed and there are only a select number of banks prepared to lend up to around £50m per deal. Even if there are now 15 banks willing to lend to offshore wind, big deals will still entail long, complicated “club” negotiations, and everyone’s overall lending power will be restricted by the need to keep capital ratios high in the wake of the credit crunch.

“It’s hard to believe that we are going to see 25GW built offshore [in the UK] by 2020. We will probably see about 14GW and perhaps only 3GW or 4GW of Round Three projects. By 2030, it will be a different story,” he says. He adds that if the UK is to stand any chance of meeting the 2020 targets, the subsidy booster will need to be maintained indefinitely.

Adam Bruce, chairman of the British Wind Energy Association, sees more reason for optimism, not least because the Crown Estate is going to jointly develop the Round Three sites rather than leaving it purely to developers.

“I think 2020 is a huge target, but we need it as something to aim for,” he says. “I think we’ll come damn close, even if we don’t hit it. By 2025 and certainly by 2030 we’ll have achieved it and we’ll probably have built the first part of a European supergrid as well.”

For a clearer sign of the way in which things are moving, all eyes will be on the shape of deals that emerge in the coming months. Next up could be the £2bn first phase of the London Array, whose developers E.ON and Dong of Denmark are said to be in talks with the EIB and other banks to borrow money. Centrica is expected to be seeking a deal on its 250MW Lincs development, also in Humberside, while other major players like SSE, Vattenfall and npower will all be reviewing their options.

Before any of these deals come to fruition, however, Bruce argues that the Round Three allocations will help to raise industry confidence when they are imminently announced. He says: “The winners will include large international players, some of which will be new to the sector, with experience in areas like offshore oil and gas and construction. Collectively, they will have a transformational effect.”

Life is unlikely to look assured for offshore wind for years to come, but if Bruce is right, together with the Centrica deal, the picture could look very different by the turn of the year.