Growing pains

Tom Grimwood

Published 22 January 2024

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Offshore wind developers are grappling with significant cost pressures after years of plummeting prices, not least because of the effects of rapid growth in turbine sizes. Tom Grimwood examines whether the industry is facing a temporary blip or a new normal.

An illustration of just how quickly the cost of developing offshore wind farms has fallen in recent years can be found in the predictions made by government back in 2016.

Setting the levelised cost of energy (LCOE) for the technology at £109 per megawatt-hour (MWh) for that year, the energy department estimated it would only hit £100/MWh by the middle of this decade. However, by the fourth allocation round of the Contracts for Difference (CfD) scheme in 2022, strike prices had already plunged as low as £37.35/MWh.

This reduction was in large part driven by a rapid growth in the size of wind turbines in the intervening years as manufacturers sought to one-up each other and briefly hold the title of world’s largest. But by the time the fourth CfD round set another record low, strike prices appeared to be plateauing. Since then the trend of falling costs has not only come to halt but has shifted into reverse.

Despite warnings the government remained wedded to the narrative of ever-decreasing costs in offshore wind and stuck to its strike price cap of £44/MWh in last summer’s fifth round auction. The result was a well-documented failure to secure any offshore wind bids at all in that auction round.

There has since been a substantial increase in the cap for the sixth auction round later this year and there is consensus in the industry that this should provide enough headroom to get projects over the line. But questions remain over how much of this headroom will be needed, and the whether the industry is facing a temporary blip or a new normal.

One person who witnessed developments first hand is Danielle Lane, who left Vattenfall as its UK country manager in December 2022. She now works as director of offshore development in the UK and Ireland at RWE, which shortly before Christmas announced it was purchasing Vattenfall’s three Norfolk offshore wind developments, including the 1.4GW Boreas project which had been shelved earlier in the year.

Lane said there is no “single factor” that explains why costs have risen over the past year or so. The sector has been hit hard by the macroeconomic environment of cost inflation and high interest rates. These supply-side shocks have come at the same time as growing global demand, in particular from the US following the passage of the Inflation Reduction Act.

That Vattenfall erred on the side of optimism is hardly surprising given the large cost cuts the industry appeared to have achieved previously. Lane admits they were perhaps a little slow to fully acknowledge the situation they were facing, and were bidding into the CfD auctions as if “we were continuing down the cost reduction curve, when actually it turned out we had pretty much bottomed out”.

She says there were already “beginning to be signals” of supply chain difficulties back in 2022 “but there’s a momentum that comes behind these processes and projects”.

“You’re working to really tight deadlines,” she explains. “I think sometimes it’s very difficult for people to suddenly go: ‘Right, stop. We don’t believe this is going to work.’ You’re really focused on getting the best possible business case for your bid and you believe in it.”

Lane says “when you become so focused, maybe you miss the macroeconomic signals that would have told you this wasn’t a great thing to do at this price. But to be honest, hindsight is wonderful and they weren’t benefitting from it at that time”.

Discovering the true cost of turbine turbo-charge

The macroeconomic environment has also exposed cracks in the sector’s mantra of “bigger is better”.

In a report published last year, the specialist insurer GCube noted that the leap in turbine size from 8MW to 18MW (the largest announced turbine at the time) had occurred in “a fraction of the time” it took to go from 3MW to 8MW. Citing claims data, the company urged the sector to “apply the brakes” to address a “rising tide” of mechanical breakdowns, component failures and serial defects.

“In years gone by, no profit was made by the top manufacturers, but that was attributed to development costs: they were investing in the future,” the report explained.

“Now, several years later, when the reward for that investment should be materialising, extensive multi-billion-dollar losses have been reported due to increasing warranty, repair and maintenance costs on larger machines.”

It continued: “At the heart of the issue for manufacturers is the focus on continually increasing megawatt output, which perpetually keeps new technologies within their prototypical phase. Consequently, the sector lacks true industrial standardisation, despite being rooted in serial production and repetitive tasks.”

Growth spurt

According to Tom Smout, senior associate at Aurora Energy Research: “For bigger, newer turbines, there’s less experience in manufacture, there’s less experience in maintenance, they’re more prone to breakage.

“People are discovering the cost of actually building bigger turbines.”

Smout says manufacturers’ profit margins are “razor thin” on the first batch of a new model. These already small margins are now being squeezed by inflation, which has seen the cost of raw materials and components increase significantly.

Moody’s last year highlighted the cost of steel, which makes up to 70% of a wind turbine in terms of material intensity (kg/MWh). The ratings agency said although steel prices did come down in the second half of 2023, they remain elevated when compared to pre-crisis levels.

Because turbine contracts are agreed years in advance, manufacturers have had to swallow these cost increases for their existing order book, but for future orders they are increasing prices. Moody’s said turbine prices had increased by almost 40% over 2021 and 2022.

Smout says the higher interest rates mean shareholders are less willing to absorb short-term losses: “In the past, people were looking for growth opportunities, so they were very interested in offshore wind. Now maybe people are looking for more kind of immediate payback because they could just sink their money into a government bond.”

These issues are exemplified by Siemens Gamesa, which was already slightly in the red in 2019 but has since seen its negative EBIT margin fall to almost -15% in 2022.

“When interest rates were low, it was less important for a company like Siemens to be able to demonstrate profitability today,” says Smout. “They just needed to be able to show that they would be big in the market in the long term.

“Now that interest rates have come up, companies are under more pressure to demonstrate that they can be profitable in the short term.”

Siemens Gamesa, which has put in place a “roadmap” for returning to profitability, said it faced a number of challenges, including “unsustainable competition” between manufacturers, which had led to “pricing below healthy levels”; “fast development cycles,” which had affected the quality levels of new platforms; “inadequate” contracts terms and conditions, which prevented them from passing on cost increases; and difficulties in ramping up production to keep up with the rapid growth of offshore wind.

Siemens said it had already increased its turbine prices by 20% over the last 18 months and going forward would seek to share the risks of cost increases with its customers and suppliers. It said it would also be more selective in the projects it supplies, applying “disciplined bidding” and “strict hurdle rates”.

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