Wind farms: the next dotcom bubble? 

The wind energy industry is growing rapidly on the back of technological advancements, political will and government subsidies.

Utility companies, independent power providers, institutional investors and oil companies are all seeking to capitalise on lucrative support mechanisms to unlock greater commercial and competitive advantages, meet their renewables targets and boost their green credentials.

Strong growth therefore continues on the back of record sustainable energy investments, yet record wind farm development costs and valuations are now driving ‘dotcom’ comparisons as the economics of wind farming projects come under increasing pressure. However, a new series of reports* by market analyst Datamonitor says that wind farm projects can still be profitable and competitive under very specific financial, technical, regulatory and legislative conditions.

Concerns about the security of energy supply and climate change, rising demand for power as well as record energy commodity prices are all driving the development of renewable energy generation. While the total power output of these energies remains very small compared with traditional power generation, the growth of global wind energy generation has outpaced that of total global energy generation 10-fold over the past fifteen years. With the majority of new capacity now outside Europe, wind power has become one of the broadest-based renewables technologies with installations in more than 70 countries.

Wind is often considered an unreliable generation technology, yet Datamonitor research shows that while wind turbine load factors might vary from site to site and country to country, they need not be unpredictable.

Turbine load factors are typically very consistent, albeit low, says Datamonitor energy and utilities senior analyst Alex Desbarres. “Over the past eight years, European wind turbines have returned consistent load factors of 18-20 per cent. This consistency and predictability have played a large role in underpinning recent record investment levels in wind assets.”

The global wind energy industry is facing several challenges – rising costs, supply chain difficulties and skills shortages – due mainly to booming demand. Yet increasing regional and state-based climate policies and support mechanisms are instigating long-term wind strategies split between domestically-focused wind generators complying with regulatory requirements, and companies applying global strategies to tap major growth opportunities. Strong growth therefore continues on the back of record sustainable energy investments, yet with wind development costs and valuations at an all time high, the economics of some projects can be marginal at best.

In the UK the Government has failed to enact regional climate policies that encourage and optimize the proliferation of wind projects, particularly offshore. Indeed, the promotion of wind investment structures has been undermined by the generous yet overly complex quota and certificate subsidy mechanism, and severe planning permission limitations. Reactions have been mixed: Shell, the oil giant, has abandoned the largest offshore project in the UK on the grounds of sub-optimal returns and planning permission difficulties. In contrast, Scottish & Southern Energy (SSE) is reportedly going ahead with the construction of a record size offshore wind farm on the basis that it would meet the company’s “rigorous investment criteria”.

New UK offshore projects will be dependant on new UK draft legislation, optimal financing structures, and leveraging lucrative power purchase agreements to boost the economics of such projects.

Failing that, companies are likely to rapidly deploy exit strategies that would see them sell part or entire project equity just as wind farm valuations reach all time highs, Mr Desbarres says. “For now, the UK government will have to act decisively to make wind farm projects more attractive in the short term or risk losing key wind farm developments to countries such as the US, which offer more attractive wind development project investment conditions.”

In Germany, a stable feed-in tariff, well-organised legislation, and frameworks for allowances and grid connection have facilitated the record development of capacity for electricity from renewable sources. Recently proposed amendments to the Renewable Energy Sources Act (EEG) – which provides for increased feed-in tariffs – will drive further innovation and investment. In the long term, Datamonitor believes recent draft amendments will facilitate the government’s target of expanding offshore wind generation capacity through new build development projects. In the shorter term, however, these amendments are more likely to generate increased levels of offshore M&A activity against a backdrop of limited offshore new build prospects. Indeed, the world’s offshore industry has now reached a critical phase which requires major investments to increase new build capacity and free up current supply and installation bottlenecks.

Despite recent escalating wind power capital costs, wind is still very competitive against coal and gas. When the cost of carbon is ignored, gas and coal are cheaper than wind. However, in markets where fossil fuels do carry a carbon penalty, wind power beats thermal power generation. Therefore, as primary energy costs soar the attraction of wind power as a generation technology with no fuel price risk has never been greater, Mr Desbarres says. “In the current context of soaring generation costs and until true demand-pull can be created, it is however worth remembering that the wind industry is increasingly driven by public policy trends and is at the mercy of government programs that drive artificially stimulated demand.”

With demand for wind power generation at an all time high and record dependence on a burgeoning array of tariff and fiscal support initiatives, escalating valuation multiples in the wind sector are now driving dotcom comparisons. This raises the question as to whether current onshore and offshore wind market entry strategies are still profitable, as talk of a renewables bubble spreads across the industry, he says.

“Whilst the speculative IT bubble was driven by investors focusing on multiples of forecast profits, wind farms differ in that they generate actual profits and more predictable long-term returns.”

However, the recent decline in the share price of Iberdrola Renovables and EDF Energies Nouvelles – the renewables divisions of major European utility companies – might suggest enthusiasm for renewables is on the decline. This could echo market doubts as to whether these companies will be able to deliver on their ambitions to strategically grow renewable generating capacity, or growing concerns over recent record acquisition and development prices.

Applying conservative financing standards and typical turbine load factor characteristics and subsidy prices, Datamonitor’s cost and profitability model shows that onshore wind farm projects can be profitable and competitive, provided capital costs are kept below the US$1.75million per megawatt threshold, whereas offshore has become a high risk, high margin business. The model also shows that acquiring onshore wind can deliver more value for money than new build development, provided the cost is kept below US$2.35m per megawatt. However, the high premium paid for the acquisition of offshore wind farms often makes the overall investment less attractive than new build, Mr Desbarres says.

“Historically wind generation technology has been seen as a chair with solid feet, yet it is now on the tipping point of having to undergo some share price correction, particularly if national and state-based support policies disappear or fail to keep up with price increases, both of which are admittedly unlikely scenarios.”

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