Empire Wind (New York) - Sweetheart deal or outrageous costs?

This post provides details of the financial analysis of a wind farm in New York which I prepared in writing a piece for the National Center for Energy Analytics where I am a Senior Fellow. I am grateful to my NCEA colleague, Jonathan Lesser, who helped me with information on the tax treatment of offshore wind in the US.

Empire Wind is an offshore wind farm located 15 miles south of Long Island (NY) with a planned capacity of about 810 MW.[1] It has recently signed a contract to deliver power to the New York grid at an offtake price of $155 per MWh. This price is more than four times the average market price of $36 per MWh from July 2023 to June 2024.[2] Since the project is expected to receive an investment tax credit from the Federal Government worth at least 40% of its capital cost, this offtake price seems extremely generous. Can it be justified? I have carried out a standard financial analysis to test this.

The sole owner and operator of Empire Wind is Equinor, formerly Statoil, Norway’s state oil company. For some time Equinor, like most large European oil companies, has been investing a portion of its large cash flow into offshore wind farms. It controls or has large shares in major offshore wind farms in the UK sector of the North Sea. Its projects include the world’s largest offshore wind farm at Dogger Bank with a capacity of 3,600 MW.

In principle, Equinor has the expertise and financial resources to negotiate the best deals for capital equipment and installation of wind turbines, offshore transmission and other elements of an offshore wind farm. The capital costs and base operating costs for Empire Wind should not exceed those for European projects by a significant margin.

Technically, the Empire Wind project is not particularly challenging.  The average water depth is about 33 meters and the hub height of the turbines will be 160 meters. There will be two export cables, each of which should be less than 25 km in length. The Dogger Bank project uses similar turbines, is in deeper water and is much further from land. Thus, on any reasonable basis the Empire Wind project should cost less than the Dogger Bank project to build.

Announcements of project financing imply that the first two phases of Dogger Bank will cost about $9.8 billion for 2,400 MW of generating capacity, equivalent to $4.1 million per MW of capacity. There is a history of offshore operators underestimating the cost of their projects, typically by at least 30%. On a generous assessment the capital cost of Empire Wind should not exceed $5.5 million per MW including the offshore transmission cables and landing facilities.

The economics of any wind farm depends critically on how much electricity it produces, which is usually reported as a capacity factor. This is calculated as the annual output in MWh divided by 8760 hours in the year times the capacity of the wind farm in MW. Because wind speeds are higher and more stable at sea, offshore wind farms can achieve a capacity factor of more than 50%, though their capacity factors tend to fall as they age.

No large offshore wind farm has ever averaged a capacity factor of 50% or better over 10 years, let alone over a lifetime. The capacity factor for Empire Wind should be greater than for existing European projects because its hub height is greater. Based on historical data, the average wind speed at hub height for the site is 8.3 meters per second, which is not outstanding.   A reasonable assessment is that Empire Wind should achieve an average capacity factor of 52% over its first 5 years under “normal” wind conditions, but the annual capacity factor will decline by about 1 percentage point per year after that.[3]

My financial analysis assumes that the project has a debt-equity ratio of 75:25 with an average cost of debt of 5%, debt repayable over 10 years, and a post-tax cost of equity of 8%. These are relatively conservative assumptions by comparison with the financial structure of European offshore projects. Fixed operating costs are assumed to be $125,000 per MW. Operating expenses increase in real terms by 2% per year, which reflects experience in the UK. And last, but certainly not least, the analysis allows for an investment tax credit (ITC) of 40% under the Inflation Reduction Act with the money credited over 4 years. The conditions necessary to qualify for this level of ITC are built into the agreement between Equinor and New York State.

On these assumptions the Empire Wind project is extremely profitable with a net present value after tax of just over $1.4 billion. If Equinor is able to deliver what it and its partners regularly claim to be feasible in Europe, then the Empire Wind offtake agreement with a price of $155 per MWh is indeed a sweetheart deal. For those who prefer to focus on rates of return, the post-tax return on equity for the project is about 30%. Wonderful if you can get it!

A very large share of the return in excess of the 8% post-tax cost of equity is linked to the ITC. If no Federal subsidy was on offer, the breakeven price would have to be about $160 per MWh for the project to just cover its 8% post-tax cost of equity. The breakeven price with the ITC is less than $113 per MWh.[4] Hence, the ITC is worth about $47 per MWh to the project. Taking the ITC over 2 years rather than 4 years increases the net present value by about $120 million. This illustrates just how important financial engineering linked to tax credits can be.

The offtake price in the original agreement between Empire Wind and New York state signed in 2022 was $107.50, less than the apparent breakeven price for the project. It is not surprising that Equinor refused to go ahead with the project on that basis. Even so, the project seems to have veered from unprofitable to highly profitable in two years. Does New York State have any understanding of the economics of offshore wind? Or, was it just desperate to get something off the ground? If they got things wrong in 2022, why should anyone believe that they have got it right now?

There are two ways in which the parties might seek to justify their current agreement. The first is that both capex and opex costs will be higher than in Europe. All costs would have to be 20-25% higher than comparable European levels for the agreed offtake price to yield a post-tax return on equity of 8%. That is a substantial premium given what Equinor and other operators claim is possible in Europe.

The second adjustment is that the average capacity factor may be much lower than would be expected for a new offshore wind farm. Rather than starting at 52% and declining gradually over time, the project would cover its cost of equity if the capacity factor were a constant 34% over its lifetime. However, we should be clear, this is just terrible performance. No offshore wind farm would be countenanced anywhere else in the world with this expected level of the average capacity factor.

So, what is the truth behind the agreement between Equinor and New York State? Is this a sweetheart deal that is likely to prove extremely profitable for Equinor at the expense of electricity ratepayers in New York? Or, alternatively, are the costs of developing and operating offshore wind farms off Long Island outrageously high by comparison with levels that are regarded as reasonable in Europe?

There is a third possibility that cannot be discounted. The project may not be super-profitable nor are its costs out of line with those in Europe. Rather, the claims made in Europe about how low the costs of developing and operating offshore wind farms are may simply not reflect financial reality. Privately, even semi-publicly, almost every company in the offshore wind industry complains about how unprofitable the business is and how much prices or subsidies must rise to put the industry on a sustainable financial basis.

The real lesson of the Empire Wind project may be that offshore wind is just very expensive and needs very heavy subsidies, whether via high prices or investment tax credits, to deliver the green vision of low carbon generation.

Translated to UK prices the breakeven capex cost of Empire Wind is £5.3 million per MW of capacity including offshore transmission. That is far from the headline figure of £3.3 million per MW quoted for the Dogger Bank project. Who is being taken for a ride here? Note that the new Labour government’s favourite energy consultant, Ember, has recently claimed that higher guaranteed prices are required to achieve its Net Zero decarbonisation targets.

What is certainly true is that a great deal more transparency is required to assess the true economics of offshore wind in the US - and Europe.

[1] Originally, the developers proposed to develop the Empire Wind project in two phases. The second phase, Empire Wind 2 with a planned capacity of 1,280 MW, was cancelled early in 2024 because of high costs and technical difficulties. For simplicity the first phase, Empire Wind 1, which has continued is referred to as Empire Wind in this article. It is expected that the wind farm will begin to deliver power in 2026 with full commercial operation commencing in 2027.

[2] This is the average locational marginal price for New York reported by NY ISO for July 2023 to June 2024. The data is published on the Energy Information Administration’s wholesale market portal.

[3] Using data on wind speeds for the years from 2000 to 2021 at the Empire Wind site plus the power curve for the Vestas V236-15 turbine, the potential capacity factor would be 52.8% averaged over 22 years. Downtime for maintenance and outages will reduce the actual capacity factor by a small amount, so an average capacity factor of 52% in the early years should be achievable if the wind farm is operated efficiently.

[4] The exact breakeven price with the ITC depends on how the project deals with tax losses over the life of the project. Another concession for offshore wind farms is that they are allowed to write off their assets over an accelerated depreciation life of 5 years. This, plus a low offtake price, creates large tax losses which cannot be offset over the life of project. If these tax losses can be transferred to an associated entity, the breakeven price is less than $110 per MWh. Offshore wind projects tend to have complicated cash flow profiles which encourage various kinds of financial engineering.