Schadenfreude reigns!

There has been a certain amount of online gloating prompted by a report from the Danish Energy Agency (ENS) that no offshore wind operator had responded to their request for proposals for the development of up to 10 GW of offshore wind capacity in 6 blocks. One of the conditions for the tender were that no subsidies were offered, though that is an elastic term as actual subsidies are often disguised in transmission charges and offtake arrangements. Hence, commentators have made dubious claims about what the non-bids imply about the future costs of offshore wind in Europe.

Government agencies such as ENS can be remarkably foolish, but its senior officials may not have been surprised to receive few or no bids, though its PR staff may have wished for a different outcome. Rather than treating renewable generation as something special we should consider what advice an outsider might give to potential investors in offshore wind in Danish coastal waters. The big companies with potential interest in the market are Equinor, Orsted, and Vattenfall. They have interests in many other offshore markets, so that any projects in Denmark would have to compete for both capital and staff with projects in the rest of the world.

Denmark is far from being a particularly attractive location for large offshore investment. It is divided into two power bidding zones: (a) DK1 which covers the western two-thirds of the country with the main links to Germany, and (b) DK2 which is physically smaller but covers Zealand including Copenhagen and is linked to Sweden. A third bidding zone (DK3) is being introduced which covers the island of Bornholm in the Baltic Sea and, more important, new subsea transmission links to Germany. Wind farms in the Danish sector of the North Sea are connected to DK1, while those in the Danish sector of the Baltic Sea are connected to DK2, DK3 (in future) or Germany.

Longer distance interconnectors between Denmark and other countries include the Viking Link (1.4 GW) to Great Britain which was completed in 2023 and the Cobracable link (0.7 GW) to the Netherlands completed in 2019. There are multiple shorter distance interconnectors to Germany, Norway, and Sweden. In practical terms, Denmark is a huge transit node for power travelling between Germany, Great Britain and Norway. The driving factors are very large storage hydro capacity in Norway, regular import demand into Great Britain, and large swings from surplus to deficit in Germany.

Market prices in Denmark tend to be lower than those in Germany and Great Britain. The average Nordpool market prices in the year from December 2023 to November 2024 were €68.8 per MWh for DK1 and €69.0 for DK2 compared to €76.3 for Germany and €83.5 for Great Britain (converted at the average exchange rate for 2024). Power prices in Norway and Sweden are much lower - €44.3 for bidding zone NO1 which covers Oslo and €50.6 for bidding zone SE4 in the south of Sweden.

In addition, the variability of market prices in Denmark is much higher than in Great Britain. The standard deviations over the same period were €43.0 and €46.0 for DK1 and DK2 as compared with €32.2 for Great Britain. This high variability was a direct consequence of the extreme variability of prices in Germany with a standard deviation of €59.6. This is caused by repeated swings from surplus generation and thus exports via Denmark to deficit generation with a reversal of electricity flows.

This combination of average prices that are lower than those in large countries like Great Britain and Germany plus high price variability mean that Denmark is not a particularly attractive location for investing in merchant generation – i.e. plants which rely upon selling power at prevailing market prices.

Currently, Denmark’s offshore wind capacity is 2.6 GW with another 1 GW due for completion in 2027, while its onshore wind capacity is 4.8 GW. Its peak load in 2023 was 6.1 GW and the median load was 3.9 GW. Since wind generation is unsuitable for meeting peak demand, the country’s current and planned wind capacity is probably sufficient to meet typical demand. Adding an additional 10 GW of offshore capacity would certainly drive down market prices and might lead to periods in which excess wind generation led to curtailment of output.

The inference is that the probable revenues from 10 GW of offshore capacity will be very uncertain. This will exacerbate another problem, which is where the capital required to build the wind farms will come from. The cost of building new plants in the late 2020s is likely to be at least €4 million per MW of capacity excluding offshore transmission. That is a total of €40 billion for Denmark alone. While Equinor, as an oil company, has a large cash flow and strong asset base, the same is not as true for pure power companies like Orsted and Vattenfall.

A large part – up to 80% - of capital cost could be financed out of debt, but lenders will be much more cautious if they are potentially exposed to market price risk. That is the crucial point about subsidies. It is not just the higher average price that can be earned but the existence of some form of price guarantee or underwriting. An alternative route, adopted by wind farm developers in the UK, is to sell power via a power purchase agreement (PPA) which transfers some or all risk from the operator to a trader, which may be an associated company. Still, any transfer of risk involves a cost of insurance. There is a trade-off between a higher cost of capital with no insurance or a lower cost of capital with a higher insurance cost.

Governments which offer price insurance via subsidy arrangements can reduce the cost of capital for new offshore wind farms by a significant margin. The fact that the Danish government did not do that in this case, suggests that either it had misjudged the market, or it was not too concerned about whether the offshore sites were developed.

Under the right conditions, the amount of debt finance available to fund new offshore projects may be quite large. However, the amount of equity finance is much more limited. In its 2024 Q3 accounts Orsted, the largest offshore wind operator, reported total capital employed in its offshore business of $15.7 billion in September 2024 and negative cash flow from that business of $2.8 billion over the first three quarters of 2024. The total shareholder equity of Orsted A/S was only $9.3 billion. Overall, Orsted is a heavily leveraged company that, in turn, invests in projects with high debt to equity ratios. The overall financial structure is a house of cards which can only be sustained because 50% of the company is state-owned and approximately one-quarter of its external revenues come from regulated activities in Denmark. Still, even these fallbacks do not allow Orsted to increase its investments in new projects at the rate that it has in the past.

Equinor and Vattenfall are both state-controlled entities. Equinor is predominantly an oil and gas company that is using a portion of its free cash flow to invest in offshore wind farms. Vattenfall has nuclear generation, electricity distribution and related businesses in Sweden. It is not as quite as leveraged as Orsted. Even so, in 2024 it has cut back its investments in wind and solar quite sharply, partly because of the need to finance investments in its networks and partly because of limits on public borrowing.

Some people, including the current UK government, appear to believe that there is a vast pool of equity finance available to fund offshore wind farms. That is far from correct. Oil companies, especially those controlled by governments, may be willing to divert some of their cash flow to offshore wind, but this has proved an uncertain source of finance because shareholders have been less than impressed by the potential returns. The other main group of potential investors consists of power generation and network companies – RWE, E-On, EDF, SSE, Iberdrola, Enel, etc. However, many of these companies have competing claims on their cash flow, especially to upgrade electricity networks or to fund nuclear power projects.

While the supply of equity finance for offshore wind projects is heavily constrained, the demand for such finance is growing rapidly as the number of potential projects being proposed in Europe, the US, and other countries has expanded. Hence, large operators with both the finance and the technical skills can choose their projects on the grounds of expected profitability and prospects for future growth. This is most obvious in the US East Coast where some companies – e.g. Shell and BP - have withdrawn from major projects, while Equinor and Orsted have pushed states to renegotiate financial terms and offer high offtake prices.

The failure of the Danish bidding process does not tell us that offshore wind is not viable at unsubsidised market prices. That may be true, but it is not the real story. The lesson is that the necessary resources of finance, skills, and equipment required to sustain the expansion of offshore wind generation in Europe and the US projected by politicians and lobbyists simply do not exist. Countries are competing in a very limited market. Their plans will either not be realised or will drive costs far above current levels.

Naturally, few policymakers will listen to news that they do not want to hear. And so, the creeping disaster that is the energy transition will get worse while proceeding ever more slowly.