BORSSELE TENDER REVEALED

The announcement of the Borssele auction results was greeted by the offshore wind industry with a mixture of astonishment, delight and (from competitors) a little concern. DONG had beaten not just the 37 other bidders but also smashed the €100/MWh levelized cost of energy (LCOE) barrier well ahead of schedule!

The offshore wind community was astonished that this significant milestone was broken by so much for a project that is due to start producing electricity as early as the mid-2020s. The Dutch Government were delighted that this was part of a trend that meant they could save at least €2 billion on offshore wind energy subsidies. That, of course, will ultimately please consumers as it should translate to lower energy cost for them. Industry Advocates, a group that includes BVG Associates, were also delighted that it brings closer the day when offshore wind achieves cost parity with the cheapest alternatives for new power generation. As that parity gets ever nearer, we can expect an acceleration of offshore wind deployments across the globe, leading to even further costs reduction as the significant economies of scale are compounded.

Of course, the achievement of this new cost may well have sent a little shiver down the backs of competitors, knowing that the industry now has a new benchmark against which every subsequent project will be judged. DONG’s bid secured 15 years of SDE+ funding (the Dutch equivalent of a contract for difference or CFD) for the project followed by the ability to sell energy at market price for the rest of the project’s life. DONG submitted the lowest bid at €72.7/MWh. Not only was this 51 Euros less than the Dutch Government’s upper limit of €124/MWh it is significantly below the previous ‘best’ price of €103/MWh for a wind farm off the coast of Denmark.

Obviously, LCOE and CFD bid prices are two distinct measures that cannot be directly compared. LCOE takes into account all the project’s expected lifetime costs (including construction, financing, fuel, maintenance, taxes, insurance and incentives) adjusted for inflation and discounted to allow for the time-value of money.

DONG’s bid of €72.7/MWh implies an LCOE of about €68/MWh excluding transmission. The Dutch Government has already paid for key elements of project development activity and is taking the risk on the transmission connection for which it will add a (fairly modest) €14/MWh to the costs, giving a total project LCOE of about €82/MWh That is a dramatic decrease from current levels.

So what is behind this headline figure and how have DONG managed to leap ahead in the race to ‘subsidy-free’? There are six main levers of LCOE -energy production, annual operating cost, total capital cost, project lifespan, cost of finance and timing of capital expenditure. Assuming a ‘normal’ expected life of the project of 25 years and a timing of capital expenditure in line with standard practices, our analysis suggests that DONG’s bid is likely to have pulled hard at the other four levers.

The chart below shows how DONG is may have been able to make this leap ahead.

We start with BVGA’s estimated range of LCOE for 500MW self-developed sites across different locations in European waters with FID in 2020. This range, shown as the top bar in the figure, reflects ‘typical’ conditions and costs.

The natural advantages of the Borssele sites put them close to the lower end of this range for LCOE. The sites are relatively closer to shore (23 kilometres off the shore of Zeeland province), have a water depth that is suitable for the lower-cost (versus jackets) monopiles and have good wind conditions. Transmission costs will be paid separately paid by the Dutch Government. These would add around €14-16/MWh to the LCOE normally for a self-developer (though the Dutch Government is only charging €14/MWh for this). The Dutch Government is also paying for some development activities. The government regulates all conditions for the construction of the wind farms: the exact location, consents, and the connection to the electricity grid. This makes the construction of the wind farms more certain, cheaper and simpler for the developer.

Project size is a factor. Many significant costs for developing an offshore wind farm are fixed or at least not directly proportional to project size. For bigger projects, such costs can be allocated across a larger generating capacity, reducing the average LCOE. By bidding and being successful for both sites (and bidding for the absolute maximum allowed), totalling 760MW, DONG should be able to achieve economies of scale, further reducing LCOE.

So, our estimate for LCOE at Borssele using only the advantages of site conditions and the Dutch government’s approach to transmission and development costs is €84/MWh. At 8.5 per cent WACC, this would have implied SDE+ / CFD bids at €92/MWh. Of course, this is very much the starting point for all bidders, with an expectation that competition (from the reported 36 bidders) would drive bids lower.

Combining the additional 760MW with existing supplier orders can give DONG an advantage in enabling it & its supply chain to industrialise to lower LCOE. Through its deep knowledge of the sector, DONG probably has greater buying power (even in a pipeline situation) than other bidders. When combined with DONG’s ability to learn lessons and reduce cost faster than the industry average, this will deliver further benefit to their costs.

DONG and its turbine supplier may have come up with ways to increase AEP, especially rotor size, but also reliability, availability, overrating in some conditions and reduced losses. DONG’s finance providers may view that any investments are relatively low risk due to the financial attractiveness of the DONG organisation, as demonstrated by the recently successful IPO. If so, a lower WACC (weighted average costs of capital) would be available on the project (even after allowing for pipeline WACC reduction). WACC has a major impact on LCOE. For example, reducing WACC from ten per cent to five per cent would drop LCOE by over 30 per cent and the LCOE share of finance cost to below a third.

As shown, by pulling hard on most of the available levers, DONG has been able to offer the Dutch government a stunningly low price at the Borssele sites. It also puts them in a strong position for the auction for the second half of the Borssele auction (sites III and IV) that will be closed in the last week of September 2016. If they are successful in that auction as well, the costs reductions from economies of scale, lower risk and faster learning are likely to be even more significant. That should be welcomed by electricity consumers, governments and ultimately the industry as a whole.

Now that DONG has set this new benchmark, they and other developers will have to examine their supply chain, procurement strategy, finance structures, site characteristics and technology to ensure they match (or beat) this price level for future projects. Governments will also need to examine policies that encourage equal levels of competitiveness, offer project clarity and enable the benefits of industrialisation and the other approaches used to be delivered by multiple players.

As with all significant breakthroughs, it’s important to recognise, appreciate and understand DONG’s breaking of the €100/MWh barrier. Its importance is not just in achieving a significant numerical mark but also in what it means for the industry, economy and the environment in the longer term. And we’ll discover parts of the answer to that in each of the future auctions for offshore wind farms in national waters across the world.

Written by Giles Hundleby
BVG Associates