Part II: The Project Finance Checklist ✔️

I already wrote about why renewable energy companies are using project finance for their energy infrastructure projects here, be sure to check it out before reading this.

Given the fact that project finance is often an expensive and complicated undertaking, it becomes fundamental to figure whether project finance is a realistic opportunity for a renewable energy project. Keep in mind the following considerations:

  1. Size:  Is the project large enough to make PF worthwhile? Banks won’t go through the hassle of PF for small projects, bear in mind that although project finance size varies from country to country, we’re looking at $50m to $100m as being in the ballpark. If the project is too small, both lenders and sponsors will be put off project finance;
  2. Establish Realistic Revenue Streams: Since there are two primary sources of revenue for investors, public funds and the other is revenue streams in the form of charges, paid by end users, sponsors and lenders must figure out what that revenue stream will look like. Will the revenue stream be big enough to support the high debt financing taken by the sponsors?
  3. Length of Project: PF is a long term investment spanning 10-15-20 years so there will be a long payback period;
  4. Physical Assets: Will there be physical assets (solar panels, wind turbine) sufficient to ensure lender repayment in case of default? Banks are going to want more “guarantees”, what is the above-mentioned revenue streams doesn’t come through will they will be able to foreclose on the project’s assets sufficient in value to “make themselves whole,” either by selling the project outright or operating it until the debt is repaid;
  5. Tech Risk: Renewable energy is a very innovative and competitive sector, so tech is evolving quickly. While in many project financings, the tech may be relatively new, generally speaking, project finance lenders do not want to be the first to finance an unproven technology. This is not venture capital. A history of successful use in some context will often be necessary to secure project financing;
  6. Quality of the Contract Network: At the end of the day, project finance is a web of contracts between different parties. It is important to know if the project company has contractual relationships with reputable companies for services key to the success of the project or the technology it employs? Banks will be less keen on lending to a project the success of which depends solely on a few star individuals who may depart, leaving the project unable to meet its potential, so credible contracts are very important;
  7. Receipt of Revenue: In that regard, will the receipt of revenue be enforceable under contractual rights from a creditworthy party? If there is no contract or if the creditworthiness of the purchaser is not credible, this will trigger concern for banks  and set off thorough(er) due diligence procedures regarding revenue projections;
  8. Exit Options: What are the ultimate objectives of the sponsors? Are they looking for a quick exit option, do they want to jump ship? Know that once the project is “project financed” and the contracts are in place, divestiture opportunities are complicated by the requirement of the bank consent, and potential purchasers will be thoroughly examined by banks for development and operational expertise as well as creditworthiness;
  9. Risking the Project: In other words, once project financing is completed, the Sponsor will lose the ability to determine how the vast majority of the project’s revenue is spent. In the event a project becomes uneconomic and unable to service its debt, the only option besides refinancing the debt may be to turn over the project to the lenders (voluntarily or involuntarily), with the loss of the Sponsor’s investment in the project.

You may be interested in Part I: Project Finance 

For more check out: https://www.wsgr.com/PDFSearch/ctp_guide.pdf

Part I: A Quick Note on Project Finance

Project finance is a benchmark financing technique for long-term investment that is emerging as the financing method of choice for renewable energy projects.

The basic premise behind project finance is that lenders loan out money for the financing of one single project, based only on that project’s risks and future cash flows.

Project finance is:

  • mostly used by private companies
  • used for complex infrastructure projects like energy projects
  • tackles one specific project at a time (NOT a portfolio of projects)

However, an easier way to wrap your head around PF, is to think of it as a web of contracts between the project company (we’ll get there) and its stakeholders.

But before we get there, let’s have a quick look at what the macro picture looks like for PF.

In terms of sectors, Scope Ratings analysts estimate that power, particularly renewables, and transportation will continue to dominate new project financing issuance in the short term, with oil and gas representing the primary uses of funds.

Figure 1: EMEA Project Financing H1 2016 (tot: €76bn)

Renewable Energy Project Finance
From Scope Ratings, 2017

The “Power” pie wedge represents 30% largely because of renewables. Indeed, 2016 was marked by strong PF activity, especially in the UK (EUR 11.7bn), with two mega offshore wind projects, Dudgeon (EUR 1.6bn) and Beatrice (EUR 2.8bn), in particular.

How does project finance take place? 

STEP 1: A company wants to build a wind farm. The wind farm is complex, expensive and will require a long-term plan. Since it is unlikely that a single company will be able to swing such a project on its own, the company then seeks out other investors who are interested is such a project, to share the risk (and return) of the project with. This group of initial investors becomes known as the project sponsors.

STEP 2: The project sponsors then create a Special Purpose Vehicle (SPV), which is a company in its own right, with its own balance sheets and cash flows separated from its sponsors. The SPV is created with the sole purpose of managing and handling that one specific project. The SPV is also called the project company.

STEP 3: The SPV and it’s sponsors then must raise money to fund its project, so it approaches banks and bond holders for financing.

Why do companies choose project finance for their investments?

To understand why many (renewable) energy projects are financed via project finance, you have to look at what project finance offers to both the project sponsors (money borrowers) as well as the lender‘s side.

On the Project Sponsor’s side: Project Sponsor’s love to project finance because the liabilities and obligations associated with the project are removed from the Sponsors. This has many benefits, including:

  1. Limited Recourse: Usually, when a company defaults on a loan, the bank has “recourse” to the assets of the company. In project finance, the bank’s only recourse is to the assets of the project company. Given that the magnitude of the average project is in the order of 100m and above, this is an important consideration. This enables the Sponsors to effectively protect their assets, investments in other projects, intellectual property, and key personnel;
  2. Avoiding Risk Contamination: closely tied to the above point, project finance makes sure that risk incurred by the Project Company does not spread to the project sponsors because the Project Company is it’s own entity with its own balance sheet, so risk does not spread to the balance sheet of its sponsor. Sponsors avoid mixing cash flows with other projects they are financing;
  3. High Leverage: Project finance is typically involved highly leveraged transactions, usually not financed with less than 60/40 debt/equity. The key advantages that such a capital structure for has for the project sponsors are:
    • more debt means that lower initial equity injections are needed, making the project less risky (leading to a lower cost of borrowing);
    • enhanced shareholder equity returns;
    • debt finance interest may be tax deductible from profit before tax, further lowering the cost of borrowing;
  4. Balance Sheet: Normally, in “non project” finance situations, when a company needs to raise debt financing, they approach a bank, which will judge the company’s creditworthiness based on its balance sheet. Project finance allows debt to be booked off the balance sheet, depending on projects;
  5. Hedging Risks: Project finance is also a way for companies to hedge risks of their core business.

The advantages above all come down to this→ the reduction of risk corresponds to a lower cost of borrowing for the Project Sponsor’s balance sheet. Having a high Weighted Cost of Capital has negative effects on balance sheets, so avoiding this is an imperative. Shareholders will look very favorably at this.

Moving on to the lender’s side: The lenders, which are banks or bond holds tend to view project finance favorably as well.

The main disadvantage of project finance for banks (and a corresponding advantage for the Project Sponsors) is that the structure is nonrecourse that we discussed above. The revenue generated by the SPV is the primary, if not sole, the source of payback of the project debt. Thus, banks in project finance transactions, view the increased risk of not being repaid if the project is unsuccessful very negatively. So, if the risk cannot be allocated or credit-enhanced, by default the risk falls to the banks.

In spite of this, lenders are keen on project finance because:

  1. Higher Fees for Banks: The higher degree of risk for lenders also translates into higher fees and costs than for other types of financings. The risk inherent in project finance and the complexity of the projects result in an extensive and expensive due diligence process (the cost of which is borne by the project sponsors) conducted by the lenders’ lawyers, technical adviser, insurance consultant and other consultants, and big fees can be earned here;
  2. More Fees for Banks: owing to the higher risk involved, lenders scrutinize project sponsors more. Banks require more supervision over the construction, management, and operation of the project relative to other forms of financing.  The increased supervision during construction, startup or commissioning, and operations often adds up to higher transaction costs;
  3. Avoid Sharing Cash Flows: Once a bank identifies a project as being worthy of investment, they will not want to mix the eventual cash flows that the SPV will generate with other, pre-existing creditors;
  4. Focus on One Project: Lenders like PF also because they can focus on one specific project. This means that the lender evaluation will be on analyzing if that project will be able to generate sufficient cash to pay back principal and interest.

A quick note of explanation is necessary: You’re probably wondering why on earth would a bank forgo recourse to a project’s sponsor, therefore putting itself in a risky position?

Renewable energy has a projected and predictable revenue stream that can be secured to ensure repayment of bank loans. When it comes to wind and solar power projects, this revenue is typically generated from a power purchase agreement (“PPA“) with a utility, under which the can piggyback on the creditworthiness of the utility to reduce its borrowing costs. While the wind power market has matured, resulting in the successful project financing of “merchant” projects in the absence of long-term PPAs, solar projects are generally not there yet.

As legal advisors, Wilson, Sonsini, Goodrich and Rosato explain in this detailed note,
in merchant power projects, lenders get a guarantee of the project’s ability to repay its debt by focusing on commodity hedging, collateral, and the income that will be generated based on historical and forward-looking power price curves.

While project finance lenders prefer a long-term power contracts that ensure a consistent and guaranteed revenue stream (including assured margins over the cost of inputs), in the context of some industries, banks know that sufficient revenues to support the project’s debt are of a high enough probability that they will provide debt financing without a long-term off-take agreement.

However, solar projects are different. Due to their peak period production, high marginal costs, and lack of demonstrated merchant capabilities are not yet viewed as “project financeable” without PPAs that most of their output. Moreover, solar’s lack of merchant viability is worsened by the fact that the southwest United States (the region most appropriate for utility-scale solar power development in the USA) does not have a mature merchant power market that functions in the absence of long-term bilateral sales agreements. This is not likely to change in the short or medium term.

Stay Tuned for Part II: Renewable Energy Project Finance: The Checklist

🇺🇸Mr. Trump, Make The Grid Great Again!

One of President Trump’s most resounding battle cries during the election was the bold promise to invest in infrastructure. I am going to argue that Mr. Trump should focus on upgrading the US electric grid, most of which is +25 years old and some parts are even +40 years old.

100 years ago, when the original electric grid was built, it was not conceivable to imagine consumers choosing their distributed generation because an energy generator would burn a fossil fuel and create electricity, which would be transmitted to consumer’s homes and that was that.

But the advent of renewable energy and small, private wind and solar producers means that today’s grid is nearing the end of its useful life both physically and functionally. Today the world is much more mobile, fluid, and flexible, but the grid has not kept up. A smart grid is set to provide real benefits to all stakeholders, including consumers, utilities, and regulators.

For starters, it will bring environmental benefits: through efficient use of energy and existing capacity by using digital communications technology to detect and react to local changes in usage and it will give customers options and choices to change their behavior when it comes to the price and type of power they use, and when to use that energy resource efficiently.

Efficiency is optimized thanks to a smart grid because of a two-way power flow and the integration of energy storage capacity, which would allow consumers to take energy when they need it, and the feed it back (in the case of solar/ wind producers) into the grid when prices are higher or store it. However, today, the grid is not really equipped to handle neither reverse power flows nor storage.

The Grid: An Economy Enhancing Investment

Although Americans bemoan the disrepair of their dilapidated roads, transit, and airports in countless NYT editorial pieces, the Trump Administration must consider the unseen but increasingly crucial issue of reinventing the power grid.

While the electric utility sector may not be the most riveting, the U.S. smart grid expenditures forecasts at more than $3 billion in 2017 (PDF) and the global smart grid market expected to surpass $400 billion worldwide by 2020. Navigant Research, a clean tech consultancy, reports on worldwide revenues for smart grid IT (information technology) software and services, are expected to grow from $12.8 billion in 2017 to more than $21.4 billion in 2026.

The private sector is stepping up. Not only tech companies such as Oracle, IBM, SAS, Teradata, EMC, and SAP but also utility giants such as General Electric, Siemens, ABB, Schneider Electric, and Toshiba are getting involved in smart grid IT.

Moreover, with historically low-interest rates (for now) and the potential for infrastructure projects to deliver long-run economic returns, many believe infrastructure investment could kick-start the country’s slowish GDP growth. Yet in spite of a body of economic evidence which points to clear benefits derived from infrastructure investment, simply building more roads will not guarantee economic growth on its own, as the textbook examples: Japan and China indicate. This lesson is particularly important considering the falling returns from public investment in U.S. highways.

U.S GDP Growth % 1965-2015

USAGDP
World Bank Data, 2017

And this brings us to the grid: aiming investment at the grid would improve conditions for millions of people as well as address the needs of the private sector.

The average American endures 6+ hours of blackouts a year, which amounts to at least $150 billion for the public and private sector each year — about $500 for every man, woman, and child, – that is remarkably bad for a developed country. Power outages in the USA are mostly caused by the effect harsh weather on the aging grid. Heavy industry tends to be most affected by tiny outages, and this example from Saviva Research is painfully illustrative:

A robotic manufacturing facility owned by Toshiba experienced a 0.4-second outage, causing each robot to become asynchronous with the grid; thus short circuiting chips and circuits. Toshiba spent the next 3 months reprogramming each robot, leading to an estimated economic loss of $500m.


International Grid Reliability

Capture
Source: Saviva Research 2013

In the U.S, investments in the power grid lag behind Europe. Across the pond, since 2000, the U.K., Italy, Spain, France and Germany have spent a combined $150.3 billion on energy-efficiency programs, compared with $96.7 billion for the U.S, according to data by Bloomberg New Energy Finance. Moreover, according to a 2015 report by energy consultancy, the Rocky Mountain Institute the, the U.S.  needs about $2 trillion in grid upgrades by 2030.

The Smart Grid: A Strategic Economy-Enhancing Objective

Yet there is much that the government and the private sector should seek to unpack about consumer behavior, strategic implications, governance, and decision-making regarding the grid, before committing to such a massive investment. The incoming investments in the next decades offer a historically important opportunity to rethink how the whole system of power generation, transmission, and usage operates.

Here’s just one consideration: ownership. Future smart grids are likely to have multiple ownerships, which will most likely span across:

  1. The government: through publicly owned power and transmission lines;
  2. The private sector: independent wind farms developers and operators or utility-owned generators;
  3. Private citizens: owners of household-level battery backup systems or rooftop solar panels.

All it really means is that combining forces for a specific project makes it possible to focus each parties’ inherent assets in the way that best reduces their shared risks, and reduced risk means a lower cost of borrowing, and therefore: cheaper projects.

As J. Michael Barrett explains: If the federal or state government can reduce the investment risk of the project by providing seed capital, issuing tax-exempt bonds, and/or signing a power purchase agreement to buy energy for a guaranteed period of time, the private sector can then provide investment capital at more favorable rates because total project risk is reduced. When all the parties share the up-front construction costs (and risk), promote open access to usable land, and lock-in the commitment of long-term users.

Finally, the most plausible way forward is to invest in new technologies opposed to retrofitting them later, an educated, unideological clear-eyed strategic effort to make the most of these investments would ensure both improved operations improvements in resilience and adaptability across the board.

tl;dr: A functioning integrated electricity system is a basic public good, imperative to the wealth, safety, and wellbeing of any modern society. In the context of a rapidly evolving energy infrastructure landscape, taking a strategic stance during the development of the smart grid in the USA will determine how much value is captured and who will capture it.

Read more: here The Energy Infrastructure that the US Really Needs

What’s (not) happening with Algae Biofuels

Next generation algae biofuel is a fuel derived from growing synthetic (genetically modified) algae and decomposing it to extract oils that can be used to substitute conventional petroleum. It is (was?) envisioned principally as a fuel for vehicles and aircraft and therefore as a possible replacement for gasoline/kerosene.

Before we go any further, any discussion on the viability of algae biofuels needs to be framed along these points:

  • Can biofuels from algae compete on price with fossil-derived petroleum?
  • Is it carbon neutral, emitting only CO2that it absorbs first during growth?
  • Can it scale?
  • Does algae biofuel yield substantial energy relative to the energy inputs involved in its production? (Energy Return on Energy Invested)

Basically, you’re asking yourself: is it better than what’s already out there?
The answer is: Nope, at least for now.

The Value Proposition of Algae Biofuels

Potentially the most promising of biofuel technologies, algae set themselves apart from all other biofuel feedstocks, for the following reasons:

  • Algae do not compete with farmland & water: Algae have been shown to thrive in polluted or salt water, deserts and other inhospitable places, bypassing the age old (and legitimate) problem which has plagued the development of conventional biofuels.
                                     Optimum land for growing biofuel sustainably

    ATAG
    Source: ATAG

    Circle sizes are estimates of potential locations for new generation biofuel feedstock production.

  • They do not have an impact on food prices: Since conventional biofuels like corn and sugar are also used as food for us, and farmers can get better prices for their corn and sugar if they sell them to biofuel refiners, leading to volatile food prices. Hartmut Michel, Nobel Prize winner, explains, that when you have “energy plants” competing with food plants, we are all worse off.
  • They feed off CO2: According to Jansson, Wullschleger, Kalluri, & Tuskan, human activities are responsible for an annual emission of 9 gigatons of carbon (33 gigatons of CO2). Whilst terrestrial and oceanic systems manage to absorb 3 and 2 gigatons respectively, leaving the remaining 4 gigatons in the atmosphere making algae ideal for carbon capture from sources like power plants.
  • Fast Oil Production Rate: One of the biggest advantages of algae for oil production is the speed at which they can grow. Some studies estimated that algae produce up to 15 times more oil per square kilometer than others pointed to algae strains that produced biomass very rapidly, with some species doubling in as few as 6 h, and many exhibiting two doublings per day.

So the promise of algae oil is tantalizing: it’s like the silver bullet.

In a nutshell: scientists were meant to identify a strain of algae to be genetically modified to produce lipids (oils) very quickly while feeding on carbon dioxide from the atmosphere. The lipids would be harvested and converted into usable oil while they ducked carbon from the atmosphere. And all this was meant to be economical and scalable.

  🔥 From 2003-2012: The Hype Was On🔥

Turning pond scum into a petroleum-like fuel is both laborious and expensive, yet the end goal was very alluring. As Eric Wesoff ironically puts it, “dozens of companies managed to extract hundreds of millions in cash from VCs in hopes of ultimately extracting fuel oil from algae”.

Researchers and algae oil companies were making huge claims about the promise of algae-based biofuels; the U.S. Department of Energy caught on early and was also making big bets through its bioenergy technologies office; industry advocates claimed that commercial algae fuels were scalable in the near-term and investors jumped the gun.

In 2006, there were a meager handful of specialized companies devoted to commercializing algae biofuel. By 2008 there are over 200, most of which had been active for less than a year. While most of these were angel investor or venture capital backed, there were also some bigwigs that took a stab at developing algae biofuels, such as Shell, Johnson Mathey, General Atomic, Boeing, Honeywell, DuPont, BP, and others.

However, in spite of optimistic investors and bold promises, a few hard truths began to transpire.  It became clear that whilst the technology was indeed “promising”, scaling it in a time frame relevant to our needs at an economic price was not within reach, anytime soon.

Cracks began to show in investment patterns as Exxon Mobil decided to invest $600 million into a joint venture with Craig Venter’s Synthetic Genomics for research into algal fuels, which they quickly scaled back to $300m and then to $100m. Another star player, Sapphire Energy, an algae biofuel start-up, which raised over $100 million in venture capital, including from Bill Gates’ investment firm Cascade Investment, has pivoted away from algae fuel and is now producing omega-3 oils and animal feedstock, while the famous startup GreenFuel, which grew out of Harvard and MIT research, went bust blowing through $70 million.

In the meantime, the surviving algae oil companies have shifted their core business and “branched out” to produce more economically sustainable co-products, like supplements, algae cosmetic oil, pigments and animal feedstocks and products for the pharmaceutical and chemical industry. Here is a list of algae oil companies that have been forced to move away from algae oil.

 So what went wrong?

I think that many stakeholders were blindsided by the great potential of the technology. To date, no company has been able to grow algae at the large enough scale required to produce meaningful quantities of a fuel, affordably. While there are many hurdles, I identified these two main reasons:

  • The basic science behind its cultivation:
    • The first part of the life cycle of the algae turned out to be burdened by obstacles.  As companies developing these algae have attempted to scale up, problems emerged which they could not have anticipated, including the emergence of competitor algae, predators such as microscopic animals that ate the algae, the occurrence of algae diseases in the form of bacteria and fungi and temperature fluctuations, which could kill the algae.
    • Whilst algae can grow quickly, the can do so only in the presence of sufficient nutrients. Algae can obtain carbon, their primary nutrient from atmospheric carbon dioxide, but the amounts present are insufficient to promote the rapid growth that was observed under lab conditions. That requires something more than 10% CO2 concentration in the atmosphere and in fact some of the earliest attempts to grow algae as a fuel source were predicated upon the development of pervasive industrial carbon dioxide capture.

  • Energy Return on Energy Invested:
    Researchers who looked at life-cycle analysis and the EROI/EROEI found algae biofuels would not have a positive energy balance, in other words, you’d have to put more energy in cultivating, harvesting, refining and transporting the algae biofuel than you would get out of it once it’s burned.

    c458bd8454b21bcc39f8255059793d11aabdc4f7
    EROI is a straightforward and simple concept to get your head around, and it is defined as the energy contained in one unit of fuel divided by the total nonrenewable energy required to produce one unit of fuel. It’s a way of getting a handle on how energy-efficient your energy production is.

    The breakeven point is 1. When the EROI is 1 there is no return on the energy invested, and the entire investment has been wasted. When the EROI ratio is higher, it also signals that the energy from that source is easy to get and cheap. Conversely, when the number is small, the energy from that source is difficult to get and expensive.

    Now, I will be the first to admit that there is no consensus on the methodology used to calculate either Life Cycle Analysis or EROI, making calculations on it is somewhat abstract. In part, it depends on what one counts as an “input”, and neither energy companies nor biofuel producers report detailed information on their energy consumption, resulting in researchers generating assumptions in order to calculate them.  To calculate the energy input, researchers have to make an estimate based on the dollars spent on various processes and goods, which means that two reports calculating EROI will likely yield different results, because of the different variables used.

    In spite of this ambiguity, The National Academy of Sciences (Chapter 8 NAS 2012) concludes: “An energy return on investment (EROI) of less than 1 is definitely unsustainable. An algal biofuel production system would have to have or at least show progress toward EROI within the range of EROI required for the sustainable production of any fuel (Pimentel and Patzek, 2005). Algal biofuels would have to return more energy in use than was required in their production to be a sustainable source of transportation. Microalgal fuels use high-value energy inputs such as electricity and natural gas. If these high-quality energy sources are downgraded in the production of algal fuels, it is certainly a sustainability concern that can only be truly understood through careful life-cycle analysis. EROI of 1, the breakeven point, is insufficient to be considered sustainable. However, the exact threshold for sustainability is not well defined. Hall (2011) proposed that EROI greater than 3 is needed for any fuels to be considered a sustainable source. EROI can be estimated with an LCA that tracks energy and material flow”.

    Here is a look at the available literature on Algae EROI:

    EROIbio.PNG
    Source: Quantitative Uncertainty Analysis of Life Cycle Assessment for Algal
    Biofuel Production, 2012

The studies that gave algae biofuel a positive EROI depended on co-products (something produced along with a main product which carries equal importance as main product, for the pharmaceutical, animal feed, and chemical industry) to tip the balance from a negative energy return to a positive.  But the Department of Energy pointed out “if biofuel production is considered to be the primary goal, the generation of other co-products must be correspondingly low since their generation will inevitably compete for carbon, reductant, and energy from photosynthesis…and coal-fired power plant carbon dioxide”.

So far, nobody has been able to make fuel from algae for a cost anywhere close to cheap, let alone competitive. Companies are trying to overcome these problems, but we will not be seeing companies selling large amounts of algae biofuels anytime soon.

tl:dr -> Cool idea, but due to unreliable cultivation methods, large nutrient requirements (of carbon, nitrogen, and phosphorus), low EROI, high capital costs, and competition from below $50 petroleum, the technology isn’t close to being ready.


 

Reading up on the EROI was very interesting so you might be keen on it too. Check out the following sources:

Peakoil.com,. (2014). EROEI as a Measure of Biofuel Effectiveness

Epa.gov. (2010). Renewable Fuel Standards Program Regulatory Impact Analysis Office of Transportation and Air Quality: The United States Environmental Protection Agency.

Inman, M. (2014). Behind the Numbers on Energy Return on Investment.

 

 

 

 

Energy Transition: From Oil 🔜 Wind

It is often touted as a truism, that in the effort to migrate our energy production from fossil fuels to renewables, we will have to use natural gas (controversially argued to be the *least* polluting fossil fuel, out of coal and oil) as a bridge transition energy source as we develop the green infrastructure necessary to satisfy our consumption.

Be that as it may, I see a trend run in parallel to this. While cheap and abundant gas is readily available, oil companies are starting to challenge the biggest wind developers in the race to build off-shore wind turbines in the North Sea.

North Sea: Wind is Eating into the Energy Market Share

Shell, Statoil, and Eni are three giants who are moving into multi-billion-dollar offshore wind farms in the North Sea. They’re starting to score victories against leading power suppliers including Dong Energy (I wrote about them branching out of conventional oil exploration into offshore wind here) and Vattenfall in competitive auctions for power purchase agreements (PPA).

The idea seems to be to leverage the know how they used from off-shore oil, into offshore wind. Irene Rummelhoff, EVP for New Energy Solutions at Statoil (see here) said she was convinced global warming was a very serious problem and her company wanted to help find a solution. “We strongly believe oil and gas will still be needed in future but we also know we have to do things differently and are working to reduce the carbon footprint of these operations,” she said.

“It makes sense to utilize our project-management skills from oil and gas to offshore wind which is why we are operating Sheringham Shoals and Dudgeon Sands off the UK. We are also looking at more carbon capture schemes and at solar worldwide.”

Even Exxon Mobil, in spite of having a conservative reputation, has recently unveiled plans to investigate CCS more fully in a new partnership with a fuel cell company. They also have pledged million of dollars to developing photosynthetic algae for transportation fuels.

Italian oil and gas major, Eni has signed an agreement with General Electric (GE) to develop renewable energy projects and hybrid solutions with a focus on energy efficiency. Their objective is to jointly identify and develop large-scale power generation projects from renewable energy sources, covering innovative technologies such as, onshore and offshore wind generation, solar power, hybrid gas-renewable projects, electrification of new and existing assets, waste-to-energy projects, the ‘green’ conversion of mature or decommissioned industrial assets and the deployment of technologies developed by Eni’s R&D department.

Luca Cosentino, VP of energy solutions, had this to say, “It is certainly an area of interest for us because there are obvious synergies with the traditional oil and gas business…As the oil and gas industry we know, we cannot get stuck where we are and wait for someone else to take this leap.”

This shift in business can be attributed to many factors. Firstly, large oil companies have spent millions in R&D for building oil projects offshore, and now that that business is on its way in some areas where older fields have drained, it makes sense to shift from off-shore oil to off-shore wind. Returns from wind farms are predictable because producers enter into long-term PPA which reduce risk by pinning down government-regulated electricity prices, unlike volatile oil prices, as the dramatic fall in the oil price from 2014 powerfully showed, the value of oil and gas assets is variable and uncertain.

Secondly, even as oil production is declining in the North Sea over the last 15 years, economic activity has been buoyed by offshore windmills. The notorious North Sea winds which threatened oil platforms have become a godsend for the new workers to install and maintain turbines popped into the Northern seabed.  According to Bloomberg New Energy Finance, about $99 billion will be invested in North Sea wind projects from 2000 to 2017. A decade ago, the industry had projects only a fraction of that size.

Circling the drain: The terminal decline of North Sea Oil

There is an evident trend going on in the North Sea, in spite of a slight resurgence we’ve seen in the last year.

north_sea_oil
Data from EIA, taken from Investopedia

Energy consultancy Wood Mackenzie said oil companies were likely to stop output at 140 offshore UK fields during the next five years, even if crude rebounded from $35 to $85 a barrel. According to the Financial Times, this compares with just 38 new fields that are expected to be brought on stream during the same period. Industry execs believe that this will be good news for the decommissioning industry, still in its nascent phase. Shell is preparing to take apart the first of four platforms in its Brent field, while Riverstone-owned Fairfield is to abandon Dunlin. As the sector oil declines, service providers anticipate that decommissioning may help them plug the revenue gap left by diminishing exploration.

Oil Decommissioning Frenzy?

Thirty years ago, North Sea production helped shape the UK’s energy landscape in a way similar to what the shale boom has done for the United States. In the 1980s, offshore production propelled the UK  to become a net crude exporter of oil and then of gas. But today, it’s a net importer of both oil and gas as the North Sea matured and their productivity declined.

As assets reach the end of their useful lives, company resources will become increasingly drawn into the expensive and at times technically complex activities required to cease production, safely remove subsea and surface infrastructure, and ensure that wells are permanently and safely abandoned.

According to a 2017 KPMG report,

The decommissioning era has now dawned in mature oil and gas provinces such as the North Sea – worsening economics, deteriorating infrastructure, technical limits on further recovery and regulatory pressure will make change inevitable. Industry forecasts suggest an unprecedented scale and pace of decommissioning activity in the years ahead.

The North Sea strategy seemed to be to delay the decommissioning of many offshore platforms, preferring to continue squeezing out increasingly small amounts of oil and gas rather than incurring the massive costs of decommissioning and bringing that equipment back onshore.

But those decommissioning delays mean only that oil companies have been kicking the can down the road and set up a more dramatic decline in North Sea production which will still be true even if prices increase.

This makes the shift into offshore wind all the more interesting.

The Energy Infrastructure That the U.S. Really Needs

A power grid is what transmits electricity from where it is made to our homes because electricity cannot be stored (efficiently…yet).

There are thousands of power plants that generate electricity using solar, wind, gas or coal. These generating stations produce electricity at a certain electrical voltage. Conventionally, this voltage is then “stepped-up” (increased) to very high voltages, to increase the efficiency of power transmission over long distance and minimize the dispersion of energy. Once this electricity gets near your town, the electrical voltage is “stepped-down” (decreased) in a utility substation to a lower voltage for distribution around town. As this electrical power gets closer to your home, it is stepped-down by another transformer to the voltage you use in your home. This power then enters your home through your electrical meter. All of this is very good, but given the evolution of energy production, it needs to modernize to meet consumer preferences and environmental requirements.

Enter the smart grid.  The core premise of a smart grid is to add monitoring, analysis, control, and communication capabilities to the grid to maximize the throughput (the maximum rate of production) of the system while reducing the energy consumption. A smart grid entails technology applications that will allow an easier integration and higher penetration of renewable energy, facilitating homeowners and businesses that wish to put their privately-produced energy on the grid. It will be essential for accelerating the development and widespread usage of plug-in hybrid electric vehicles (PHEVs) and their potential use as storage for the grid. Smart grids will allow utilities to move electricity around the system as efficiency and economically as possible.

Essential to efficient use smart grids are smart meters:  Smart meters help utilities balance demand, reduce expensive peak power use and provide better prices for consumers by allowing them to see and respond to real-time pricing information through in-home displays and smart thermostats. For example, you may want to run your dryer for 5 cents per kilowatt-hour at 22:00 pm instead of 17 cents per kilowatt-hour at 18:00 pm in the evening, when demand (and price) is highest. Consumers will have the choice and flexibility to manage your electrical use while minimizing costs.

The need for a smart grid is increasingly recognized by US policymakers at all levels of government, as ways to improve the energy efficiency of producing and using electricity in our homes, businesses, and public institutions become an entrenched imperative. Many believe that a smart grid is a critical foundation for reducing greenhouse gas emissions and transitioning to a low-carbon economy. Certainly, PHEVs and renewable energy have been of great interest to Congress.

In light of this brief introduction, I came across Ethan Zindler’s prepared testimony before the senate Committee on Energy and Natural Resources, here is the meat of what he had to say:

Before I get to my main points, a quick note about “infrastructure”. In the current climate, this term has become a Rorschach test of sorts representing different things to different constituent groups. In the case of energy, infrastructure can encompass a broad scope, including, among other things, building power-generating facilities, expanding oil and gas distribution pipelines, or hardening local power grids.

Those topics are worthy of discussion and I know my fellow panelists will shed light on them. However, my testimony today will focus on the next generation of energy technologies and the infrastructure that will be critical to accommodate them.

The U.S. is transforming how it generates, delivers, and consumes energy. These changes are fundamentally empowering business and home owners, presenting them with expanded choices and control. Consumers today can, for instance, analyze and adjust their heating, air-conditioning, and electricity use over their smart phones thanks to smart meters and smart thermostats. And they can make efficiency improvements through advanced heating and cooling systems and innovative building materials and techniques.

Consumers in much of the country can choose their electricity supplier and may opt for “green choice” plans. They can produce power themselves with rooftop solar photovoltaic systems. They can even store it locally with new batteries.

Consumers can choose to drive vehicles propelled by internal combustion engines, electric motors, or some combination of both (hybrids). That car can be powered by gasoline, diesel, electricity, ethanol, or perhaps even methanol, natural gas, or hydrogen. And electric vehicle drivers who own homes can turn their garages into fueling stations simply by using the outlet on the wall.

Now, realistically speaking, few Americans today have the inclination or income to become high-tech energy geeks. But that is changing as prices associated with these technologies plummet. In the case of electric vehicles (EVs), such cars can be appealing simply because they perform better.

We at BNEF believe that further growth and eventual mass adoption of these technologies is not possible, not probable, but inevitable given rapidly declining costs.

For instance, the price of a photovoltaic module has fallen by 90 percent since 2008, to approximately $0.40 per watt today. For millions of U.S. businesses and homeowners, “going solar” is already an economic decision. Last year the U.S. installed far more solar generating capacity than it did any other technology.

By the end of the next decade, cost competitiveness for distributed solar will arrive most places in the US – without the benefit of subsidies. We expect the current installed base of US solar to grow from approximately 3.6 percent capacity to 13 percent by 2030 then to 27 percent by 2040.

Similarly, the value of contracts signed to procure U.S. wind power have dropped by approximately half as the industry has deployed larger, more productive turbines. We expect current wind capacity to at least double by 2030.

Many of these new energy technologies are, of course, variable (no wind, no wind power; no sun, no solar power). Thus the growth in these and other new energy technologies will be accompanied by unprecedented sales of new batteries of various shapes and sizes.

Utilities such as Southern California Edison Co and others have already begun piloting large-scale batteries in certain markets while providers such Stem Inc and Tesla Inc offer “behind-the-meter” storage for businesses and homeowners.

In the past five years, lithium-battery prices have fallen by at least 57 percent and we expect a further 60 percent drop by 2025. That will contribute to 9.5GWh/5.7GW of battery capacity in the U.S. by 2024, up from 1.7GWh/0.9GW today.

Continuing battery price declines will also make electric vehicles (EVs) for the first time a viable option for middle-class US consumers without the benefit of subsidies. Last year, EVs represented 0.8 percent of global vehicle sales. By 2030, we anticipate that growing to one in four vehicles sold.

The most popular place to fuel such cars could be augmented gasoline stations… or the local grocery store, or simply your garage.

The changes we’ve seen to date are giving U.S. energy consumers unprecedented opportunities to manage, store, distribute, and even generate energy. However, the new, empowered consumer poses inherent challenges to the traditional command-and-control / hub-and-spoke models of conventional power generation and power markets. Already, we have seen examples around the globe where incumbent utilities were caught flat-footed by rapid clean energy build-outs.

In some cases, it has been heavy subsidies for renewables that have catalyzed the change. But more recently, simple low costs are allowing wind and solar to elbow their way onto the grid.

So, where does “infrastructure” fit into this changing energy landscape?

First, conceptually, we must accept that the empowered consumer is here to stay. To some degree, this acceptance is already underway in the private sector where companies that once focused mainly on large-scale power generation are merging with consumer-facing utilities, or buying smaller solar installers and battery system providers.

Second, policy-makers should seek to promote infrastructure that accommodates a new, more varied, more distributed world of energy generation and consumption. Most immediately, this can mean supporting greater deployment of so-called smart meters. To date, the U.S. has installed almost 71 million of these devices, which enable better communication between energy consumers and utilities. Compare that to Italy where all consumers have such meters and are now receiving a second generation with more advanced functionality, or China which has installed 447 million units, across almost its entire urban population.

Policy-makers may also seek to facilitate the development of high-voltage transmission across state lines. It has long been an adage that the Great Plains states represent the “Saudi Arabia of wind”, given the exceptional resources there. To some degree, those states might as well be in Saudi Arabia, given the major challenges of building transmission that would move electrons generated there to more densely populated states in the east or west. The US has added approximately 1.5GW of high-voltage direct current transmission since 2010. By comparison, China has added 80GW over that time.

Investment is needed at lower voltages too. Our passive, one-directional, electricity distribution system is under strain as new distributed generation capacity comes online. In addition, policy-makers might also consider ways to expand support for EV charging stations. As sales of such cars grow, consumers are already putting greater pressure on certain distribution nodes around the country. Ensuring that EV “fuel” demand is managed in an orderly manner will be important.

Finally, the changes afoot and to come will require what might best be described as infrastructure “software”. Most importantly and pressingly, this must include the reform of electricity markets to take into account the new realities of 21st Century power supply and demand.

It may also include expanded programs to educate energy professionals on the new realities of modern energy markets. And, yes, it could include more software to improve energy monitoring and optimize system performance.

In closing, I would reiterate that none of this need be done at the exclusion of investing in traditional energy infrastructure where the needs are also pressing. However, any rational discussion about energy infrastructure investment today must do more than take into account the current situation. It must also consider where we will be tomorrow.

And the Wind Turbine Winner is … Vestas

Bloomberg New Energy Finance reports that Danish wind manufacturer Vestas reclaimed the top spot in the annual ranking of wind turbine manufacturers.

Top Onshore Turbine Manufacturers, 2016

top-turbine-manufacturer
BNEF 2017
  1. 🇩🇰  Vestas has been on the scene since 1945 as an appliance manufacturer and moved into turbine production in 1979 and has plants in Denmark, Germany, India, Italy, Romania, the United Kingdom, Spain, Sweden, Norway, Australia, China, and the United States. They installed a whopping  8.7GW of turbines in 2016, good for 16% of all onshore wind installations last year. 43% of those 8.7GW were in the USA. Vestas has a very international reach and is continuing to pursue a global strategy with projects commissioned in 35 countries, more than any other turbine maker.
  2. 🇺🇸 General Electric placed second with 6.5GW, some 0.6GW more than in 2015. They are the largest producer in the USA and while they narrowly lost its traditional lead in the US market for newly commissioned turbines to Vestas, GE managed to increase its global presence to 21 countries in 2016, from 14 in 2015.
  3. 🇨🇳  Xinjiang Goldwind Science & Technology fell from first to third place with 6.4GW in 2016. Virtually all of the Chinese manufacturer’s capacity was built in its home market, where Goldwind further extended its market share. China’s contracting wind market had a clear impact on Goldwind, as overall installations were 22.8GW, down 21% from the record 29GW in 2015.
  4. 🇪🇸 Gamesa came in fourth and reported that it had beaten its own annual turbine manufacturing record, having already made more than 1,880 units with a total productive capacity of 3,880 MW. The new record was a long time in the making, taking eight years to beat 2008’s 3,787 MW. Their record was set with turbines assembled all over the world — India (36%), Europe (28%), China (26%) and Brazil (10%). Almost one in three Gamesa turbines was installed in India.
  5. 🇩🇪  Enercon sits in 5th place, with a market share of 7.2% worldwide and 59.2% only in Germany. Enercon has production facilities in Germany, Sweden, Brazil, India, Canada, Turkey, and Portugal. They are limited to onshore wind turbines.
  6. 🇩🇪  Nordex, in 6th place has installed wind power capacity of more than 18 GW in over 25 markets. The production network comprises plants in Germany, Spain, Brazil, the United States and soon also India. Nordex closed the first half of 2016 with a new record in German installations, with a total 134 new turbines installed marks an increase of 135% over the same period in the previous year
  7. 🇨🇳  Guodian / United Power is the Chinese runner-up, with its manufacturing spread entirely across China. Originally, a joint venture with Westinghouse and later a joint venture with Siemens from 1998 to 2006 before restructuring to a state-owned enterprise in 2007. Today, they have 23,030 MW of wind power installed, they have grown rapidly and strategically in the last 15 years.
  8. 🇩🇪  Siemens Wind Power in 8th place seems to be coming in short, but this is because this list looks at onshore wind, whilst Siemens supplies about 60% of European offshore wind turbines.
  9. 🇨🇳  Ming Yang 明阳风电 is the largest privately owned wind turbine manufacturer in China.
  10. 🇨🇳  Envision, the “smallest” Chinese entrant, Since its foundation in 2007, Envision Energy has maintained rapid growth in its business operations.

Top Offshore Turbine Manufacturers, 2016

top-offshore-turbine-manufacturer
BNEF, 2017

🇨🇳  Sewind is the undisputed offshore leader, supplying nearly 60% of the 832 MW of new offshore wind turbines commissioned in 2016 globally and since it manufactures Siemens offshore turbines under license in China, the company actually installed 388 MW of Siemens turbines and 101 MW of own design machines.

What to expect next

I wrote about the upcoming merger between Gamsea and Siemens a few months ago here and the merger between the two is set to go through. It appears that they are aiming at speeding up consolidation due to competition and price pressures. As Gamsea and Siemens combine their wind-turbine manufacturing businesses, creating a company that will dominate the industry, Vestas will be dethroned to second place.

A recent report by the Global Wind Energy Council (GWEC) shows that China installed 592 MW of offshore wind in 2016, entering the global top three alongside Germany and the Netherlands. Although the GWEC and BNEF reports focus on different aspects, both point to a steady rise in Asian offshore wind markets. This is also evident in day to day new reports on deals and contracts.