TODAY’S STUDY: COST DETAILS OF THE UK OFFSHORE WIND BOOM

Great Expectations: The cost of offshore wind in UK waters – understanding the past and projecting the future
Philip Greenacre, Robert Gross and Phil Heptonstall, September 2010 (Technology and Policy Assessment Function/UK Energy Research Centre)

In the U.S., the development of offshore wind has taken a dramatic and exciting step forward this year. It is no longer a fight for IF U.S. offshore wind will get built, it is a fight for how and when it will get built and how much it will cost.

With (1) the final approval of Cape Wind off Massachusetts' Cape Cod, (2) the announcement by the Department of the Interior of solid new guidelines for future development along the Atlantic Coast, and (3) commitments from developers of wind and transmission on the Eastern Seaboard and on Lake Erie to build, a whole new energy industry is being born right before the eyes of a fossil fuel-addicted public.

As the report outlined below recounts, the UK already has 1,000 megawatts (a gigawatt!) of offshore wind capacity built and wants to have 15 to 20 gigawatts by 2020. Because the report shows how the UK is managing details, especially about cost and the nuts and bolts of growth, U.S. developers and all those interested in watching history unfold at ground level can learn much from it.

Imagine getting a comprehensive report from John D. Rockefeller sometime between 1905 and 1910 about how he planned to develop and grow and consolidate the oil industry in response to the mass production of the automobile. That's what this report is.

Overview

This report by the UKERC Technology and Policy Assessment function is concerned with recent cost escalations in offshore wind. It documents early expectations and policy goals, explains recent cost escalations and assesses future prospects.

The reasons for cost escalation are well documented. In common with other energy technologies, UK offshore wind has been affected by commodity and currency movements. In addition, offshore wind has been subject to particular supply chain bottlenecks and cost escalations associated with making offshore turbines reliable and installing them in deeper more distant sites. As a result, cost reductions anticipated in the late 1990s and early 2000s gave way to dramatic increases in the period from 2005 – 2009.

This report finds evidence that cost increases may have peaked, but does not foresee any meaningful reductions in the period to 2015. It disaggregates the cost of offshore wind into key components and tests sensitivity to feasible ranges in the cost of key factors. In the period to around 2025 the report finds grounds for cautions optimism. There is potential for innovation to reduce costs, for supply chain pressures to ease and for new market entrants to provide competitive pressure on costs. However, there are still a number of factors placing upward pressure on costs, not least the implications of moving to even more challenging locations.

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The UK is currently leading the world in offshore wind installation, with aspirations to become a world leading centre for the technology. Yet as much as 80% of a typical offshore wind farm built in the UK in the last five years will have been imported from elsewhere in Europe. Bringing more of the supply chain into the UK offers benefits in terms of reduced exposure to currency movements as well as helping build a ‘green’ manufacturing economy. The UK currently lacks capacity in key parts of the supply chain. This requires investment and the development of UK offshore wind is likely to require policy to continue to engage actively in supporting the development of docks and other facilities.

Offshore wind is still in its infancy, the UK is still building the equivalent of the first conventional power station. Cost escalations stand in some contrast to the optimism of early analysts. However it is not particularly surprising that we have arrived at a point in the history of a particular emerging technology when costs have increased. Many technologies go through such a period, and still go on to offer cost effective performance in the long run. The particular challenge faced by offshore wind is that its role in meeting UK and EU targets gives rise to a widespread expectation of rapid deployment.

Overall, there are grounds to be optimistic about offshore wind, tempered with realism about the challenges associated with its development and the need for policy to engage effectively with all the factors that will affect its success. Policy will need to create clear, long term signals that costs must decrease over time. It is also important for policy to continue to support innovation, reduce problems with planning and grid connection and support the development of the UK supply chain.

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Executive Summary

Introduction

In December 2008, the EU Renewables Directive committed the European Union to satisfying 20% of its energy consumption via renewable sources by 2020. The UK’s national target is 15%. This may mean that the UK will have to find 40% of its electricity generation from renewable sources by the end of this decade. Offshore wind is widely expected to play a major role in contributing to this target. The government has not set a specific target for offshore wind, but projections from a range of analysts suggest the UK will need 15 to 20 GW of offshore wind by 2020, with aspirations to go well beyond that in the decades that follow.

The UK’s ambitions for offshore wind reflect the size of the potential resource and difficulties associated with public opposition to onshore wind. They also reflect a widespread expectation in the late 1990s and early 2000s that costs would fall as deployment expands. However, in the last five years costs have escalated dramatically, with capital costs doubling from approximately £1.5m/MW to over £3.0m/MW in 2009.

All the main electricity generation technologies have been subject to cost increases in the last five to eight years. Exogenous factors such as commodity prices that affect offshore wind also affect the construction other generation options. Moreover, fossil fuel price increases have led to additional increases in the levelised costs of conventional power stations. For example, the cost of electricity from gas turbine (CCGT) plant has almost doubled; it now stands at approximately £80/MWh compared to approximately £42/MWh (inflation adjusted) in 2006. Coal, nuclear and onshore wind all experienced large cost increases over the same period.

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However offshore wind has been subject to particular difficulties and the cost escalations in offshore wind have been considerably larger than those for onshore wind. Onshore wind has recently been estimated to be the lowest cost large scale, commercially available low carbon generator applicable in the UK. In contrast, offshore wind is the most expensive (though costs for CCS and new nuclear in the UK remain hypothetical at the time of writing). Whilst some commentators remain optimistic and see the potential for creating significant economic benefit from offshore wind development, others anticipate a relatively high cost future for UK offshore wind, at least in the short to medium term.

It is important to understand why early commentators were wrong about cost trends in offshore wind. Offshore wind is still very much in its infancy, representing less than 2% of global installed wind capacity. Yet in the UK roll-out of offshore wind is more advanced than any other major emerging low carbon generation option, notably new nuclear and carbon capture and storage. Will cost projections made for other emerging options prove equally optimistic? Finally, we need to assess what the future is likely to hold for offshore wind, whether costs are now declining, by how much, how rapidly and what needs to be done to help this happen.

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Cost in the early years

Until the mid-2000s the consensus in the offshore wind arena was that costs in the future would be significantly lower than then contemporary levels. Actual cost data from the early offshore wind farms were supportive of the idea of a downwards experience curve and reducing costs. In Denmark, for example, Vindeby offshore wind farm was constructed in 1991 at a cost of _2.6m/MW (£1.82m) whilst Horns Rev was built for _1.67m/MW (£1.05m) in 2002. In the UK, North Hoyle was completed in 2003 at a reported cost of £1.35m/MW and Scroby Sands was built the following year for a reported £1.26m/MW.

Analysts of offshore wind costs also looked at the experience of the onshore sector for clues as to the likely cost trajectory. The costs of onshore wind energy fell fourfold in the 1980s, and halved again in the 1990s through a combination of innovation and economies of scale. Grounds for optimism were further supported by positive engineering assessments and extrapolation of learning rates into the medium and longer term future. Such cost estimation techniques indicated that the capital and levelised costs of the nascent offshore wind industry would be likely to fall over time.

Big Ambitions

Cost optimism informed government thinking in the early 2000s. Moreover, it coincided with climate change becoming more prominent on the policy agenda. Round 1 of UK offshore wind development commenced in 2001 with aspirations for nearly 2 GW of installed capacity. This was followed in 2002 by the introduction of the Renewables Obligation (RO) and a year later by Round 2 which aimed to develop nearly four times as much offshore wind capacity as the first Round.

In 2007, the case for even greater offshore wind expansion in the UK became more compelling with the advent of the EU Renewables Directive described above. Round 3 was launched in 2008, resulting in nine development zones totalling approximately 32GW of potential capacity. Meanwhile the RO was successively modified such that currently it runs to at least 2037 and all offshore projects accredited up to March 2014 qualify for 2 ROCs/MWh.

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Cost escalations and emerging problems

UK offshore wind development has been slower than originally expected and has proved to be significantly more costly than much of the literature anticipated.

By June 2010, eleven Round 1 wind farms had been completed with a total capacity of just below 1 GW. Around half the proposed capacity for Round 1 is either still in development or has been lost to downsizing or withdrawals. Round 2 is still in the relatively early stages of development with only one project fully completed and another four under construction. Currently, the typical timeline for a large UK offshore project is estimated to be between seven and nine years, in large part due to the complexity of the planning process (recent changes may have improved matters, as we discuss below).

From the mid-2000s onwards, the costs of offshore wind development have been escalating. For projects coming online in 2008, capital costs were more than double the 2003 level. As of June 2010, the industry consensus is that capital and energy costs are approximately £3.0m/MW and £150/MWh respectively.

The factors that drove the costs escalations from the mid 2000s are well understood and reviewed in Chapter 4. A wide range of factors had an impact and detailed quantification of the contribution of each cannot be substantiated by the available data. However, it is possible to form a view of the relative contribution from these past major drivers; they were (in descending order of impact):

1. Materials, commodities and labour costs
2. Currency movements
3. Increasing prices for turbines over and above the cost of materials, due to supply chain constraints, market conditions and engineering issues
4. The increasing depth and distance of more ambitious projects, affecting installation, foundation and operation and maintenance (O&M) costs
5. Supply chain constraints, notably in vessels and ports
6. Planning and consenting delays

In 2009, key industry actors considered that the likely medium term trajectory of offshore wind costs would be for only a modest fall from 2009 levels out to 2015. Recent evidence suggests that costs in 2010 are no higher than 2009, suggesting costs may have ‘peaked’. There is some evidence that a turning point may have been reached; the agreed price of the latest Round 2 project was reported as £2.9m/MW.

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Future Costs

UKERC has considered the prospects to 2025 using a disaggregated approach, examining each of the drivers or factors that impact on the cost components of offshore wind power:

Turbines represent the largest single cost item in an offshore wind farm, up to around half of overall capital expenditure. Turbine prices have gone up in part because of increasing commodity prices, particularly steel. However the total impact of materials, commodity and labour cost increases explains only around half the rise in turbine costs. The remainder may be explained in part by improving reliability in response to problems with early farms. There is also evidence that turbine prices in the early 2000s did not properly represent production costs, since many turbine makers were not making economic returns. However many analysts and industry experts believe that low levels of competition had an important impact. Moreover, offshore wind is a small element of wider turbine manufacture, and although long term benefits may emerge for ‘first movers’ as this grows, it is to be expected that, at first, serving such a ‘niche’ will require a premium.

Looking ahead, new market entrants, scale effects, innovation, recent movements in exchange rates and lower commodity prices bode well for the future price of turbines. Technology experts expect a range of design improvements, continued upscaling and other innovations to emerge in the coming decade. Given the uncertainties, a downside risk remains and if a range of problems are not addressed the price of turbines could even rise. It does not appear likely that turbine prices will fall rapidly; indeed they are likely to remain at or around their current level until around 2015 or so. However, provided a range of drivers move in the right direction together and assuming no further adverse currency effects (ideally because production moves to the UK) cost reductions could be significant in the period 2010 to 2025. We suggest that turbine cost reductions of up to perhaps 40% could be achieved in that timeframe, with an implication for overall levelised costs of a reduction of up to around 15%.

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Foundations are subject to a similar set of drivers to turbines. With the exception of the Beatrice development, there has been no UK manufacture of foundations. Most have been sourced from Holland and have therefore been subject to Sterling-Euro currency fluctuations. Steel prices have also had a significant impact, and moving to deeper waters creates a significant challenge that is likely to increase costs in the short run. Whilst we did not find evidence of insufficient competition in foundation supply, several commentators highlight supply chain constraints. There is considerable potential for innovation, which many believe to offer substantial potential for cost reduction. Overall, we believe that there is a considerable spread of possible outcomes for foundations hence the range is from a 20% cost increase to a 30% reduction. The impact on levelised costs is moderated by the fact that foundations account for a relatively small share of total costs, and lies in a range of less than 5% either way.

Depth and distance are of particular relevance to future UK offshore wind development given the more challenging ambitions of UK Round 3. We provide crude estimates of the cost levels for the nine Round 3 zones relative to the capital and levelised costs of a typical mid-depth/mid-distance site more typical of Round 2. Levelised costs increase in all cases but one by between 5% and 24%. Whilst innovation and learning in installation, foundations, maintenance and a range of other factors ought to mitigate the impacts of going to more inherently costly locations, on the whole we believe that depth and distance are likely to place upward pressure on costs. It appears unlikely that better wind speeds will be sufficient to compensate for additional costs associated with going further offshore. Assuming no mitigating factors, a range of up to around 15 to 20% increase in the cost of energy is possible.

Load factor is another key intrinsic factor. This has been given particular attention by developers and manufacturers, and improved turbine reliability and better O&M should improve turbine availability. A downside risk remains, since it is possible that the greater distances associated with some Round 3 sites will negatively affect availability, due to greater access restrictions. If Round 3 sites are only able to achieve availability and load factors that are at the lowest end of the plausible range then levelised costs may rise by around 9%. If availability problems are resolved then better wind conditions and optimisation of turbines has the potential to reduce levelised costs. If UK Round 3 developments are able to secure load factors similar to those achieved in several Danish developments, other factors being equal, levelised costs could be reduced by up to around 15%.

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O&M costs. The relationship between improving O&M and optimising availability is important. Whilst a range of learning effects are likely to improve effectiveness and decrease relative costs, absolute increases in O&M costs are not unlikely, given both more challenging conditions and the importance of improved availability. However, a 25% increase or decrease in O&M spend will respectively increase or decrease levelised costs by less than 3%.

Currency movements are obviously outside the control of project developers (currency hedging aside) or direct policy support for offshore wind. Whilst we do not speculate on the future of sterling, it is important to note how large an impact currency movement has had on offshore wind prices. Appreciation/depreciation of 20% has the potential to increase/decrease costs by around 12%, assuming that around 80% by value of an offshore wind farm is imported. Increasing the UK built, sterling denominated, proportion of offshore wind farm costs therefore has considerable merits in terms of reducing uncertainty as well as bringing wider economic benefits to UK companies and regions. Bringing more of the supply chain to Britain will also maintain downward pressure on costs if the pound remains relatively cheap by historic norms, in line with recent UK government expectations.

Commodity price movements had a big impact on the price of some of the key components of offshore wind farms, notably turbines and foundations. However, the impact of any single material input on the overall costs of offshore wind should not be overstated. Steel for example accounts for only around 12% of the capital cost of an offshore wind farm. We do not speculate on commodity prices out to 2025, though it is worth noting that the price of steel returned to its historic mean in 2008 and there are few reasons to expect dramatic increases in commodity prices in the short term. We illustrate the impact of steel over the longer run by testing sensitivity to a 50% increase/decrease in costs. Fluctuations of this magnitude only change levelised costs by around 5% in either direction.

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Docks and ports are already inadequate to the task and considerable investment is needed. Better facilities exist in mainland Europe, in part because of public investment in docks. Sustained commitment, and perhaps further public spending, is likely to be needed to support an emerging UK supply chain.

Vessels and the wider installation supply chain are also tightly constrained at present and the wind industry must often compete with offshore oil and gas. Longer term, increasing confidence in the stability of the offshore market especially from Round 3 would be expected to lead to increasing supply. Investment in vessels and associated capabilities is expanding.

Planning delays have had a substantive impact on Rounds 1 and 2. We have not attempted to quantify this, but in terms of both absolute costs and revenue foregone it has a substantial and material impact on project finance and economics. It also places further strain on the supply chain, since lengthy delays undermine confidence. The IPC promised to improve matters, and it is essential that the Coalition government’s revised arrangements do not compromise these improvements.

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Conclusions about future costs

Whilst there a few reasons to expect meaningful costs reductions by 2015, many of the factors that drove costs up have either moderated or have the potential to be remedied. Looking ahead to the mid 2020s there are grounds for optimism.

To illustrate the range of possibilities, UKERC used sensitivity analysis to develop a range of plausible developments in key cost factors in the period to 2025. Because of the uncertainties that currently surround offshore wind costs we do not attempt to apply a learning curve based approach, instead we recommend expert market and engineering based assessment. This approach informs UKERC’s analysis of costs, reported in Chapter 5. In our worse case, the costs rise from a current level of around £145/MWh to around £185/MWh. If favourable developments take place in all of the main factors, then costs could fall to under £95/MWh.

Cost projections have to be tentative at this current stage in the history of the offshore wind industry. However, we believe a gradual fall in the cost of offshore wind is a reasonable possibility over the period between now and 2025, particularly if policy can place downward pressure on costs and support the emerging UK supply chain.

Our ‘best guess’ figure for the mid 2020s is a fall of around 20% from current levels to just over £115/MWh, with continued falls thereafter.

Greater reductions are possible, but would require most, if not all, of the major cost drivers to move decisively in the right direction at once. A significant downside risk remains and it is possible that the costs of offshore wind could continue to go up, particularly if supply chain problems are not addressed.

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Implications for future policy

Our analysis suggests that achieving overall costs which are consistent with reducing support from the Renewables Obligation Certificate (ROC) multiple back down to 1.5 ROCs/MWh will require capital cost reduction of the order of 17-18%, assuming no major change in other factors.

Several key developments could help place downward pressure on costs:

Long term signals and cost monitoring capabilities

Concern has been expressed by some commentators about the relationship between the emergence of the 2 ROC multiple and the market power of some in the offshore wind supply chain, with limited competition in some areas and strong demand from a booming onshore market. A range of factors conspired to drive up costs and the government made the decision to provide ‘emergency’ 2 ROC support in response. Without additional support it is likely that offshore wind development would have faltered. Industry representatives will obviously wish to alert policymakers to cost escalations when development depends in part on policy subsidies. However, industry ‘capture’ of regulatory change is clearly a danger if support levels are in some part the product of a negotiation between policymakers and industry, particularly where industry structure is relatively concentrated.

Detailed development of a process for setting ROC multiples or Feed in Tariff (FiT) rates is beyond the scope of this report. Nevertheless we believe that it is essential for such arrangements to create clear, long term and binding signals that costs need to be reduced. Periodic ‘reviews’ cannot set long term signals and may be amenable to lobbying by special interests, particularly where key cost data is allowed to reside solely within the private sector. One means by which this might be achieved would be for the government to establish clearly specified regression in support levels over time. This is common in FiT regimes overseas, a feature of the micro-generation FiT, and whilst simplest in FiT systems could apply to either FiT or ROC based support for UK offshore wind in future. In order to better inform this it may also be desirable for the government to support the development of an independent, non-commercial cost monitoring capability, perhaps in collaboration with other countries, international bodies and academia. Such a capability could shape expectations ahead of time.

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Planning and transmission

It is essential that the government’s proposed changes to planning rules do not undermine progress made towards accelerating planning. ‘Join-up’ is essential, since the benefits of a streamlined system for offshore assets would be undermined by a slower process for substations and other onshore assets. Similar concerns relate to Offshore Transmission Owners (OFTOs) and connections to the national grid – though we have excluded these aspects from this review.

Support for innovation

Given the importance of continued innovation to cost reduction we also recommend that support for innovation in offshore wind continues to be given a priority in research, development and redeployment (RD&D) programmes. Important research on innovative, cost-reducing solutions is already a focus of the Carbon Trust’s offshore wind ‘accelerator’, the Energy Technologies Institute (ETI) offshore wind work and the European Wind Energy Technology Platform.

Support for the UK supply chain

Our analysis also suggests that building a UK industry offers benefits in terms of transport costs and currency stability. Since UK consumers foot the bill for offshore wind a case can also be made that policy should seek to maximise benefits to UK companies, helping build a ‘green’ manufacturing economy. This will require investment, particularly in dock facilities, since there is little point in making turbines and other large components in the UK if we lack the wherewithal to install from UK bases. Direct and targeted support lower in the supply chain, in addition to the overarching incentive provided by the RO (or a FiT), is likely to be a cost effective way to secure UK based offshore wind. Failing to do this effectively risks both a higher cost trajectory for offshore wind and that UK developments are built out of ports in other parts of Europe. It is beyond the scope of this report to speculate further about the role of policy in securing UK manufacture, but doing so is likely to be key, both to cost reduction and perhaps to maintaining support from consumers.

Further work could investigate the potential to explicitly target a fraction of the support coming through the RO to the UK supply chain and perhaps UK RD&D.

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Conclusions

Offshore wind offers lessons for policymakers and technology analysts alike. This report charts the progress with offshore wind – and the aspirations for it – from its beginnings in Denmark in the 1990s to present developments in Britain, now the world leader in offshore installation. Our review suggests that early, small scale, developments did not give a good guide to future costs and indicates that rapid upscaling of an emerging technology can create supply chain constraints, amplify design flaws and cause costs to rise whilst progress is slower than expected. External economic factors can also, at least for a while, overwhelm intrinsic learning or other effects.

It is important not to lose sight of the fact that offshore wind is still in its infancy – in terms of energy output we are still building the equivalent of the UK’s first conventional power station. So-called ‘first of a kind’ costs still apply in large part to offshore wind. It is also important to avoid ‘dogged optimism’; extending the timeframe in order to reconcile emerging evidence of cost escalation with a desire to demonstrate that costs can be attractive, eventually. However, we should not be particularly surprised that we have arrived at a point in the history of a particular emerging technology when costs have increased and problems mounted. Many technologies go through such a period, and still go on to offer cost effective performance in the long run. Overall, there are grounds to be optimistic about offshore wind, tempered with realism about the challenges associated with its development and the need for policy to engage effectively with all the factors that will affect its success.