Equinor’s investment in Dogger Bank – the world’s largest offshore wind project under construction – will not pay off, according to a study funded by the Norwegian government.
The new research raises tough questions about the energy transition strategy of the state-controlled Norwegian oil and gas giant.
The study was submitted this month to the Norwegian Ministry of Petroleum and Energy, which funded it as part of a larger research on potential energy transition opportunities for the country.
Equinor CEO Anders Opedal set ambitious new goals for the company in June to intensify its investments in “renewables and low carbon solutions” to more than 50% of its gross annual investments by 2030.
Equinor views the Dogger Bank project in the British North Sea as a world-class asset that benefits from high wind conditions, innovations and unprecedented scale: it will have an installed capacity of 3.6 gigawatts when completed .
One of the study authors told Upstream that the rate of return for the massive project does not exceed the rate of return required by Equinor, so the researchers find the project uneconomic.
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“In our estimation, Dogger Bank is not profitable,” said Petter Osmundsen, professor at the University of Stavanger. “The project must compete with alternative investment opportunities.”
Equinor did not dispute the findings of the study, but pointed out that it had benefited from the sale of stakes in the project.
Osmunden expressed confidence in the study’s findings, while acknowledging that the researchers relied on a number of assumptions, public information and industry standards to create it.
Equinor would do better to focus on other types of clean energy projects with higher barriers to entry and more aligned with the skills of the company, he said.
“To commit to a very large capacity in the offshore wind farm attached to the bottom is to put too many eggs in one basket – maybe also not in the right basket,” he said. “Low barriers to entry and very competitive tenders would make it difficult to obtain a resource rent. “
Promising business sectors
Equinor is entering new business segments that look more promising for the company than offshore wind anchored at the bottom, Osmundsen said, such as seabed minerals, carbon capture and storage, clean hydrogen and can -be the floating offshore wind turbine.
Equinor told Upstream that it has benefited from the purchase of Italian energy company Eni in Dogger Bank as a partner.
“Equinor entered Dogger Bank early, and Eni’s operating farms demonstrate the value of accessing early and maturing assets before operating shutdowns,” wrote a company spokesperson. in an email response to Upstream questions.
Equinor is in charge of operations for the UK North Sea project, while Scotland-based partner SSE is leading the construction of the project and Eni is an industrial partner for all three phases of the wind farm. Equinor and SSE each own 40% of the project, while Eni owns 20%.
The challenges of offshore wind
The rapidly expanding offshore wind industry predicts that project construction costs will decrease as scale increases, providing robust returns on investment.
According to the study, costs have indeed fallen for the fixed-bottom Dogger Bank and other offshore wind projects, but not at the same rate as strike prices have fallen in offshore wind auctions in the UK.
Strike prices are a government guaranteed price for the electricity to be produced from the project, which is awarded to the lowest bidder. Strike prices protect the developer from falling too much in price and protect consumers from rising too much in price.
Equinor’s larger wind turbines, low raw material prices and limited competition have helped the company generate solid profits on its first larger offshore wind projects.
That climate has since changed, as the world’s largest segment player, Orsted of Denmark, warned of supply chain bottlenecks and rising commodity prices. Increased competition for new licenses has also significantly reduced strike prices in auctions.
Negative net present value
The researchers calculated the expected net present value (NPV) of the Dogger Bank project to be minus £ 970million (minus $ 1.3 billion). A negative NPV indicates that the value of the investment is less than the rate of return the company should charge on its investments.
They calculated the expected internal rate of return (IRR) on the total capital of the Dogger Bank project at 3.6%, in real terms, with a payback period of 17 years. IRR is a method used to compare the relative profitability of projects.
Internal rates of return for oil and gas projects are often much higher than for offshore wind, which is not exposed to oil price volatility due to electricity price guarantees.
The researchers applied industry standards and based their estimates on assumptions about the capacity factor, operation and decommissioning costs, and the price of electricity for the last 10 years of production.
“Public project information gives detailed information on capital expenditure, production capacity and prices for the first 15 years of production,” Osmundsen said.
In June, Equinor cut its expected rate of return for offshore wind to 4% to 8% (excluding farm downs), from 6% to 10%, but new study reveals Dogger Bank could end up below the range revised.
Upstream publication and sister Dagens Naeringsliv requested an interview on the study with Equinor’s renewable energy manager Paal Eitrheim, but he was not available.
Equinor sent written comments on the study to Upstream.
“We don’t communicate net present value per project. However, on our day in the capital markets, we gave an interval for expected returns, ”wrote a spokesperson for Equinor.
“We expect project base returns of between 4% and 8% actual with mature markets such as the UK at the lower end of the range and emerging markets at the upper end of the range. “
Equinor has long emphasized that offshore wind has a very different risk profile than oil and gas, with more stable revenues.
However, with a fixed price for the electricity produced, there is also little upside potential, and costs have recently appeared to increase for some other wind energy companies, without decreasing.
For example, Danish wind power plant giant Orsted warned in a third quarter earnings release of difficult conditions due not only to weaker-than-usual winds, but also to string difficulties. supply and manufacturing delays.
Supply chain instability and rising energy prices, along with accelerated inflation in raw material, transportation and turbine component costs, have also impacted the profitability of the leading manufacturer. of Vestas turbines.
The Equinor spokesperson acknowledged that the company’s projects may be affected by global trends in the cost and availability of inputs, but added that there are contractual mechanisms to balance the risk between the supplier and the developer.
Farming down in offshore wind
Equinor has already successfully adapted to offshore wind power. The sale of 50% of Empire Wind shares in the United States was considered a particularly successful sale.
However, there are still few signs that Dogger Bank will significantly increase the profitability of Equinor and SSE, which have made two sales to Eni of different parts of the UK project.
After the first sale to Eni, Equinor and SSE increased their internal rate of return to 4.2%, according to research from the University of Stavanger.
At the request of Upstream, the researchers also calculated the effect of the recent sale.
“After the second sale, where the payout per megawatt dropped by about 30%, the rate of return dropped to 4.4%,” Osmundsen said, adding that the researchers assumed all three phases were equal.
The Equinor spokesperson acknowledged that the company received less for the third phase of the project, but said there are site-specific conditions for this phase, including a different layout leading to lower inputs. to those of phases A and B, the distance from the shore and the depth of water meaning the capex per kilowatt is higher.
“The increase in the corporate tax rate is another element,” he said.
Professor Petter Osmundsen and Associate Professor Sindre Lorentzen, both from the University of Stavanger, and Magne Emhjellen-Stendal, senior advisor at Petoro with a research collaboration with the University of Stavanger, analyzed the profitability for developers of fixed-bottom offshore development projects, using Dogger Bank as a case study. The report is part of a research program funded by the Norwegian government to explore the opportunities for energy transition.
The profitability of the project depends on the required rate of return. Compared to a rate of return requirement from the International Energy Agency from 2018 of 6.55%, the Dogger Bank project is not profitable. The same is true of the 6% requirement from 2020 suggested by the UK Department for Business, Energy and Industrial Strategy (BEIS).
While it is normal to use a single discount rate, researchers argue for two rates for this type of project. A rate for the first 15 years of the fixed electricity prices given by the British contracts for difference (CfD) calculated at 3.9%, and a rate for the period of the market price (6.5%). The researchers conclude that with their assumptions the project is unprofitable, with an expected net present value of minus £ 970million.
The UK strike price has dropped significantly from £ 114.39 per megawatt hour in the 2015 CfD auction to the Dogger Bank award in 2019 of £ 39.650 / MWh for phase A and from £ 41.61 / MWh for phases B and C (all at 2012 prices).
Other researchers, who have observed the dramatic reduction in the strike price awarded after aggressive tendering, conclude that very significant cost reductions are needed to save the economics of the project. One way to do this, these researchers say, is for investors to reduce the required rate of return. The internal rate of return for offshore wind farm developers is only half of what it was six years ago.
(Ole Ketil Helgesen is Upstream’s energy reporter in Norway. Morten Aanestad and Mikael Holter are reporters for Upstream’s sister publication Dagens Naeringsliv.)