Green Investment Bank’s crucial role

The core of any business model is a predictable return on investment, but uncertainty surrounds the cost of next-generation wind turbines, writes Tim Probert


As the UK prepares to build its 32-gigawatt Round 3 offshore wind programme, uncertainty over construction costs has raised concerns among investors that the £100-billion capital that is required may not be forthcoming.

Round 3 may seem a small step from Round 2 but, in terms of the amount of money needed, it is a giant leap and utilities will not be able to finance many projects at this scale from their balance sheets without credit-rating agencies taking a very dim view.

To realise the North Sea’s full potential, Round-3 projects will be located further out to sea – potentially 200 kilometres from shore at depths of 50 metres or more – which requires larger arrays, bigger turbines, deeper foundations and longer construction times.

As no other nation has attempted to build offshore wind at these depths and distances, nobody can be exactly sure how much these pioneering projects will cost to build.

Potential early-stage investors fear these complex projects pose a significant risk of returns being heavily diluted by construction over-runs. The message from a project finance community, battered by recent economic headwinds, is clear: they will not invest until there is greater certainty.

However, there may be a white knight on the horizon in the form of the Green Investment Bank (GIB). Investors view the GIB as having a crucial role to play in plugging gaps where the private sector is unable to bear the full construction risks of Round 3.

Anthony Marsh, head of transactions at UK Green Investments, set up by the Department of Business, Innovation and Skills last year to oversee the creation of the nascent GIB, says the bank could directly invest in Round-3 projects in partnership with the private sector.

“The plan is to prove it works so that private capital piles in and then we move on to another technology,” he says. “The Holy Grail is to get institutional, long-term funds into the offshore wind sector – they are not investing because they think the risk-reward profile is not appropriate. They need long-term certainty and we will encourage them to have it.”

As the GIB sits on the Government’s delicate balance sheet, the Treasury has capitalised the bank with just £3 billion. But, after 2015 when the GIB assumes full borrowing powers, liabilities are expected to increase substantially.

Andy Cox, head of power and utilities at KPMG, believes the GIB is the key to unlock the £100 billion required for Round 3, but not necessarily as a front-line investor.

“At this stage, the GIB needs to be a pioneer focused on financing first-of-a-kind-type projects by underwriting construction risks via guarantees rather than capital,” says Mr Cox. “The GIB could stand behind primary project contractors, which would assume a certain level of over-run risks, with a second tranche of construction support. By assuming some of the construction risks, more private capital will be forthcoming.”

Calculating some of the more exotic construction risks of Round-3 projects, like weather windows and non-availability of vessels, is proving such a headache that insurers are unable to step into the breach, according to Jerry Biggs, chief executive of UK renewable energy finance and insurance company Narec Capital.

Nobody can be exactly sure how much these pioneering projects will cost to build

“There are gaping gaps in insuring offshore wind farms and some projects have been uninsured,” he says. “This is particularly unpalatable for debt finance.”

Mr Biggs believes GIB should work with insurance companies and research institutions to develop models to underwrite challenging debt structures, and in turn lower the cost of premiums, which on average account for 26 per cent of operational expenditure. “Once they have that knowledge base, insurers will then undercut each other and bring down premiums rapidly,” he says.

HIGH SEAS, HIGH RISK

CASE STUDY The 504-megawatt (MW) Greater Gabbard offshore wind farm, a joint venture between RWE Innogy and Scottish & Southern Energy (SSE), has been beset by a lengthy construction over-run.

The project, which involves the installation of 140 wind turbines located 25 kilometres off the Suffolk coast, was initially scheduled to be commissioned in 2009, but is now due to be completed by the end of 2012.

The delay is allegedly due to apparent welding defects in 52 of the array’s transition pieces, which form a base upon which the wind turbine stands.

The principal contractor for Greater Gabbard is US firm Fluor, which is responsible for installation of the wind turbines as part of a $1.8-billion turnkey contract. Last year, Fluor sued Greater Gabbard Offshore Winds Limited (GGOWL), jointly owned by RWE and SSE, for a £300-million claim, alleging the latter had carried out unnecessary testing and repairs to the transition pieces.

GGOWL is preparing to counter-sue Fluor over the quality of the transition pieces and steel monopoles, which were fabricated by Chinese firm Shanghai Zhenhua Heavy Industries and then shipped to the Netherlands.

The project has also faced construction delays following the bankruptcy of sub-contractor Subocean, the death of a worker and even the controlled explosion of a 680kg Second World War German mine.

There have been other setbacks to befall offshore wind farms. Slower-than-planned repairs at a faulty export cable, linking to the 300MW Thanet wind farm off the Kent coast has cost operator Vattenfall an estimated 60 gigawatt hours (GWh) of lost power generation, while at the Swedish utility’s Kentish Flats array, some turbines are on their fourth gearbox. Meanwhile, Danish utility Dong found that grouting in the foundations of 164 turbines at its Horns Rev 1 and 2, and Burbo Bank offshore wind farms had failed, necessitating costly repairs.

However, most industry analysts view these teething troubles as an inevitable part of the UK’s pioneering offshore wind programme and consider they need not deter investment.