TODAY’S STUDY: HOW THERE COULD BE U.S. OFFSHORE WIND

Fulfilling the Promise of U.S. Offshore Wind: Targeted State Investment Policies to Put an Abundant Renewable Resource within Reach

Douglass D. Sims, February 2013 (Natural Resources Defense Council)

The Promise and Failure of U.S. Offshore Wind

Offshore wind holds great promise. An inexhaustible resource lies just off our shores. The U.S. Department of Energy’s (DOE) landmark study, 20% Wind Energy by 2030: Increasing Wind Energy’s Contribution to U.S. Electricity Supply, found that the United States could obtain 20 percent of its electricity from wind by 2030, and more than 15 percent of that wind power could come from offshore projects, totaling 54,000 megawatts (MW) of generating capacity’

The benefits are manifold, especially on the East Coast where, from Virginia to Maine, the offshore wind potential is more than 1 million MW, political and popular support for renewable energy is strong (as evidenced by the enactment of renewable portfolio standard (RPS) laws from Maryland to Maine), and electricity prices are highest in the continental United States. The benefits include:

-Electric supply delivered directly to the coastal cities, where prices are highest (thereby lowering the cost of any necessary subsidy), demand is greatest, and generation and transmission siting are the most challenging

-Diminished need for onshore long-distance transmission lines

-Lower electricity prices due to displacement of the highest-cost fossil fuel generators

-Improved energy security through diversification of transmission and supply

-Creation of a brand-new industry and substantial supply chain, which can assist in revitalizing manufacturing, growing the economy, and creating jobs

-Satisfaction of state renewable electricity standards

-Health benefits from decreased fossil fuel generation

-Aggressive combat of climate change

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Despite these benefits, today, exactly zero MW of offshore wind capacity are installed or even under construction in the United States, with only three projects in advanced stages of development: Cape Wind in Nantucket Sound (468 MW), Deepwater Wind off Block Island, Rhode Island (30 MW), and Fishermen’s Energy near Atlantic City, New Jersey (25 MW). The first has long-term supply contracts, called Power Purchase Agreements (PPAs), for approximately 75 percent of its energy, the second has a PPA for all of its output, and the third is awaiting a decision from the New Jersey Board of Public Utilities on whether the project should be awarded Offshore Wind Renewable Energy Certificates (ORECs) under New Jersey’s centralized procurement program.

Compare this with the rest of the world, particularly in Europe, where offshore wind has been spinning for more than 20 years. According to the European Wind Energy Association, by the end of 2012, Europe had an installed capacity of 4,995 MW distributed among 55 offshore wind farms in 10 countries, including 1,165 MW of capacity installed in 2012 alone. In Asia, China was forecast to have commissioned approximately 295 MW of offshore wind by year end 2012, and Japan has deployed demonstration turbines. In sum, offshore wind is becoming increasingly mainstream and mature in other countries.

So, what is going wrong? Why is investment flowing in other places but not here? Enormous improvements have been made on siting and permitting, such that they are not the main bottlenecks. As discussed in detail in the National Wildlife Federation’s recent report on offshore wind, these impediments are being overcome as overlapping governmental entities have begun working together. But there remain fundamental challenges ahead. The underlying limiting factor for offshore wind, a factor not found in places where the sector has advanced, is that the basic economic and financial conditions for offshore wind success are not in place. Without them, investors are not comfortable providing capital for these projects, and the sector inevitably will struggle to get off the ground.

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Federal incentives in the form of tax credits and accelerated depreciation are a vital part of creating these conditions, and the recent extension of these benefits by Congress is welcome news.7 But federal support, while necessary, has so far not been sufficient. For investment to flow to the offshore wind sector, states also must implement policies that ensure that projects have: (1) certainty that they will receive sufficient revenues for the energy, capacity, and other attributes they generate, and (2) sufficient access to affordable debt capital at a time when the capacity of private sector banks to fund large projects is limited.

The good news is that the emerging, state-led U.S. offshore wind policy model contains the building blocks to satisfy these conditions. The United States has a successful track record of deploying massive amounts of capital into onshore wind, cultivated by supportive policies like state renewable portfolio standards and federal tax credits. But we can learn from Germany, which, up until recently, had difficulty attracting offshore wind investment relative to neighbors like Denmark, Belgium, and the United Kingdom.

Frustrated by the lack of completed projects, yet convinced of the potential of offshore wind, Germany tweaked its initially unsuccessful offshore wind investment policies in the recent past and investment started to flow. The United States can do the same. Germany successfully addressed the revenue problem by revising its rules to ensure that any qualifying offshore wind project is entitled to a long-term tariff that is sufficient to attract investment, but it did so in a way that also ensures that the public (ratepayers and taxpayers) get maximum value for their money. Germany also reduced the cost and increased the availability of debt capital by creating an innovative program whereby a public bank will match the debt provided by private banks, ensuring that projects will go forward and lowering the overall financing costs.

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Why should we feel confident that this strategy will work in the United States? States routinely benefit from the experience of other states and countries that have faced similar challenges about what does and does not work in attracting investment to new sectors, such as the offshore wind sector. While it is true that every policy must be adapted to local conditions, it is also true that investors do not substantively change their investment requirements when they invest in a new jurisdiction. On the contrary, investors look for places to make investments that have policy conditions that are as close as possible to those where they have successfully invested in the past. So, whatever the differences in form among different countries or states, successful offshore wind policies must be similar in function to attract similar types and levels of private investment.

The polices that Germany put in place to unlock offshore wind are instructive to U.S. states because they are designed to attract—and are attracting—the same investors that the states want to attract: commercial banks and project developers. It is these investors that finance, build, own and/or operate power plants in coastal states, so policies must be designed to fit requirements of this market while minimizing impacts on ratepayers. The German story is not a fairy tale, however. After perfecting its investment policies to stimulate an unprecedented level of domestic offshore wind financing in 2011, major failures in transmission policy resulted in a lackluster 2012. This paper focuses on the German policy successes and the lessons they present for the United States and also briefly examines the very unsuccessful German approach to transmission as a cautionary tale that should not be replicated in the United States.

In sum, the United States can quickly tap into this unparalleled resource if we take the lead by: (1) ensuring revenue certainty through strategically refining the innovative Offshore Wind Renewable Energy Certificate (OREC) programs, such as those adopted in New Jersey, and under consideration in Maryland, and (2) leveraging the resources of commercial banks to make available sufficient levels of low-cost debt available through co-lending programs. Supportive federal policy such as the investment tax credit and accelerated depreciation also play a vital role. However, a solid state-level framework that supports financing is a necessary condition to truly launch the sector.

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…Revenue Certainty…Access to Affordable Debt Capital…

Conclusion and Take-Aways

More than 20 years after Europe started building offshore wind farms, the United States is on the verge of getting serious about implementing policies that will exploit this vast renewable resource at its doorstep. Germany is an example of a country that has taken those steps with a feed-in tariff achieving revenue certainty and KfW program for improving access to debt financing. In the United States, states should craft functionally similar solutions that unleash the American offshore wind energy potential and deliver transformative environmental and economic benefits.

The way forward for U.S. states seeking to reap the benefits of offshore wind is clear: put in place targeted investment polices that provide the revenue certainty and debt capacity necessary to make projects viable and attractive to the equity and debt investors that comprise the sector.

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First, ensure revenue certainty by building on the demonstrated success of RPS programs with OREC programs that:

-Create secure revenue streams (consisting of environmental attribute payments plus compensation for energy or other products) without market risk during a period long enough to support debt and equity investment (15 to 20 years, optimally, but 12 years minimum).

-Protect consumers by creating a mechanism that refunds money to ratepayers if the market value of the energy produced by the offshore wind farm exceeds the OREC price.

-Adjust each offshore project’s OREC payment to account for varying degrees of complexity as measured by depth and distance from shore, since these factors are the main drivers in project costs. A one-size-fitsall approach risks underpaying some projects and overpaying others.

-Optimize the price paid for energy by offering different OREC disbursement schedules to meet the needs of diverse equity investors and the preferences of lenders, thereby maximizing available financing and minimizing financing costs. For example, some investors may accept smaller total amounts if payments are made over a shorter period.

-Make OREC clearinghouse structures “bankable” by endowing them with sufficient collateral to support their obligations to pay for the ORECs that they purchase from projects and ensuring that collateral and other funds of the clearinghouse are permanently segregated from general funds.

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Second, ensure the sufficiency of affordable debt capital by building on the demonstrated success in Europe in financing offshore wind by creating co-lending programs, possibly through state “green banks” that:

-Offer debt capital to a specified number of offshore wind projects to provide evidence that the state is making a commitment to ensuring projects are completed.

-Create effective partnerships with commercial banks in which the banks are not “crowded out” but take the lead in structuring the financing and share the risks equally with the green bank.

-Use the government’s low cost of borrowing as an anchor of the debt financing which will reduce the financing costs of a project and, ultimately, the delivered cost of electricity…

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