The effort to decarbonize the US electricity grid involves a range of technologies and power sources. Solar is part of the solution, nuclear may also be a component. Battery storage is key. And so is wind — both onshore and offshore. While there are challenges throughout the process, the offshore wind industry in particular has seen a number of setbacks lately, with the Danish company Orsted having recently made headlines for pulling out of a project slated to be built off the coast of New Jersey. Challenges range from surging commodity costs to a scarcity of vessels, the bidding process for deals, and of course, the surge in interest rates over the last two years. On this episode, we speak with Chelsea Jean-Michel, an offshore wind industry analyst at BloombergNEF to get a clear breakdown of the problems, the degree to which these challenges threaten the larger trajectory of the industry, and the efforts to decarbonize the grid. This transcript has been lightly edited for clarity.
Key insights from the pod:
How bad has it been for the wind industry? — 3:54
What factors go into building a wind farm? — 6:27
How much have costs increased for wind? — 11:09
Renegotiating offtake contracts — 14:38
Reducing the cost of building turbines — 18:03
The Jones Act and offshore wind — 2-:23
The impact of the IRA and federal spending — 24:19
The 30 gigawatt “pipe dream” — 26:38
Physics versus finance in wind — 30:08
The importance of wind in the US’s carbon strategy — 33:23
Wind turbines getting bigger — 34:23
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Joe Weisenthal (00:10):
Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy Alloway (00:15):
And I'm Tracy Alloway.
Joe (00:17):
Tracy, I have to say there are a lot of exciting things happening in energy decarbonization, electrification of the grid, things we've talked about recently with people like Jigar Shah and so forth. But I have to say, I keep seeing negative headlines about wind.
Tracy (00:33):
Oh my gosh, just before we came into the studio to record this, I was taking a look at the S&P Global Clean Energy Index, it's down 30% this year — more than 30% this year. A lot of that is thanks to what's been going on in wind and in fact, if you look at Orsted, which I think is the world's biggest provider of offshore wind farms, it's down 50% year to date.
Joe (00:57):
Yes. So we are recording this November 15th, I think just earlier in the week, two top Orsted executives departed the company. I think there was a project off the shore of, I think New Jersey, that recently the plug was pulled on. And it just seems that every story, everywhere, around the world, with the exception maybe of China, it seems to be … something that seems to be wrong. Whether it's the math doesn't pencil out on the actual projects themselves, there are companies, I think Siemens Wind has had all kinds of manufacturing issues with respect to turbines, etc. So I'm just trying to understand what is going on with this industry and how bad it is in terms of, if it's not going as planned, reaching our decarbonization goals as a country?
Tracy (01:45):
So my understanding is there are two things kind of happening at once. You could say two headwinds for the wind power industry creating a perfect storm, Joe.
Joe (01:55):
I thought a perfect storm would be good for wind?
Tracy (01:57):
I'm just going to get as many weather puns as I can into this conversation. But there's higher borrowing costs because of surging interest rates and then there are also higher component costs. And I guess my question is how much of all of this is sort of growing pains for an industry that, at least in the US, is still relatively new — although it is true that it's also facing problems in places like the UK, or is this a kind of permanent change in the industry's trajectory? Basically is wind power a low interest rate phenomenon like, I don't know, WeWork or cheaper Ubers.
Joe (02:37):
Is wind power a lot of hot air? You know, you mentioned renewable energy stocks and that is sort of another, I don't know if funny is the right word, but we're having this great year in the stock market so far and how many people would've bet it's like the Inflation Reduction Act passed, all this money pouring into renewable energy, all these incentives, you can't lose betting on these companies and wind and, I think solar, I mean it's been pretty dismal.
Tracy (03:03):
Absolutely, and wind especially was a much-hyped component of the renewable energy revolution. And you're right with the Inflation Reduction Act, there is this question about how much of this is a temporary holdup given permitting issues that we've discussed with people like Jigar, versus how much of this is the math just doesn't pencil out; there is something fundamentally challenging in wind.
Joe (03:30):
Lots of questions and we have the perfect guest to get the answers. We are going to be speaking with Chelsea Jean-Michel. She is an offshore wind analyst here at BloombergNEF, one of our colleagues on a different floor. So excited to chat. Chelsea, thank you so much for coming on Odd Lots.
Chelsea Jean-Michel (03:46):
Thanks so much for having me Joe and Tracy.
Joe (03:48):
Is our premise correct, more or less, that it's been just a dismal year for the industry?
Chelsea (03:54):
I think ‘dismal’ is a bit of a big word to use but it hasn't been great and there have been a lot of negative headlines and you guys highlighted a lot of the key issues already. I think maybe to highlight at a grander scale we have seen a lot of the impacts most saliently in the US, and Tracy you mentioned it's a very new industry in the US. For context there's only seven operational turbines, 42 megawatts installed.
However, there are two offshore wind farms currently under construction right now, almost a gigawatt. So the industry is growing, but we've also seen over 12 gigawatts of offshore wind projects seek to cancel or renegotiate their offtake contracts in the US. Now what I mean when I say an ‘offtake contract’ is that's typically an agreement that these offshore wind developers, their projects will sign with states, state utilities, to essentially guarantee that they're going to buy their power for usually around 20 to 25 years.
And that's really key for an offshore wind project because they need, you know, you have variable generation, so if you can't guarantee your generation, you can guarantee the price at which that generation is sold. And that makes it easier for these projects to reach financial close, make a business case for them.
Now in the US this is interesting because this happens a little bit earlier on in a project's process. So in the UK, before you bid for an offtake contract, you need to have a grid connection agreement. You also need to have your permits in. In the US that's not needed, and so you might have a couple of years between when you lock in your off date contract until you finally reach financial close and then you want to construct and build the project.
So that leads to a certain level of risk that's a little bit higher in the US than you see in other parts of the world and that's also why, you know, we've seen just how much interest rates have shifted over the last few years, how much inflation's changed. And that has meant that now when these projects are looking to reach financial close, they're in a different macroeconomic environment than when they had initially placed their bids and made those assumptions back in 2019, 2020.
Tracy (05:48):
That's really interesting because I was wondering how higher rates are actually feeding into a lot of this, given you would've assumed that the financing was in place, but you're highlighting the discrepancy between the revenue coming in through the offtake agreements and the financing that is still coming up in the higher interest rate environment. So just on this note, could you maybe tell us the factors or the calculations that go into creating a wind farm, whether it's onshore or offshore? Like if Joe and I were at a bar and we were writing on a napkin, here's our rough cost and here's our rough revenue source, what would that napkin actually contain?
Chelsea (06:27):
Yeah, so there's a lot that goes into it and it depends on if you're building in the US versus if you're building, say, in the Netherlands or in Germany?
Joe (06:38):
We're building in the US, maybe we’ll build in the Netherlands one day.
Chelsea (06:43):
Yeah, so if we're building in the US, for context, offshore wind development takes a really long time. As I mentioned, there's very few projects currently operational in the US right now. But around eight to 10 years is what we see globally, but in the US this can take as long as 14 years and we've seen that for some other projects that are currently in the process of getting built right now.
When you take a look at that really long process, one of the first things you think about is, okay, so that's like 10 years where you have development costs going in, right? So you need the people that are going to help formulate the bids. In the US you have a seabed lease auction, so this is usually the first step in the process where you're like, I want to acquire my seabed for X amount of dollars. We recently saw the New York Bight lease auction last year. Millions and millions of dollars of revenue for the US government, over $4 billion to secure these sites and that's just step one.
Tracy (07:33):
Can I ask really quickly, does the US government owns all those seabeds?
Chelsea (07:37):
On the outer continental shelf they do. However, that being said, I think it's three nautical miles that's state waters, but most offshore wind development is going to take place in federal waters.
Tracy (07:46):
Ah yes, I remember this from my offshore gambling days.
Chelsea (07:49):
So that's like a cost you can expect to pay for the seabed. Then you have kind of other development costs when it comes to bidding into an offshore wind procurement or bidding into an offshore wind solicitation. So this is where you go in to say ‘I will bid X price, I'll bid Y price, I'll bid Z price for this offtake contract,’ that we've talked about in state solicitations and that also takes some costs.
Now you have costs over the development lifetime. Then let's say you get to the point where you need to reach financial close and actually build that project. So let's talk about the equipment costs. This includes your turbines, this includes your foundations, this includes your transition pieces, which are kind of the pieces that, exactly what they sound like, transition from the foundation into the turbine.
You have your array cables which connect the turbines to each other. You have your offshore substation, which kind of collects all the power within the offshore wind farm to then get it ready to transmit to shore. Then you have your offshore cable, onshore substation, etc., etc.
So part of the reason why I mentioned the Netherlands and Germany is because these are markets where they pay for offshore transmission. In the US that responsibility falls on the developer. And then of course, you know, as you're financing the project, you also have different financing costs involved with that.
So if you're using project finance and you're going to go to the bank, then you have to factor in the payments that you're going to be making to pay off your loan. And if you're talking about lifetime costs, renewable energy is great because you don't have to pay for fuel costs. But that being said, you do have some O&M, some operations and maintenance that you need to take care of as well.
Tracy (09:19):
This seems complicated, Joe.
Joe (09:21):
It's so complicated. Also, you know how every once in a while, Tracy, you try to convince me to write a book?
Tracy (09:28):
Yeah,with me to be clear.
Joe (09:30):
Yes, with you and the reason I can't do a project that's going to take two years, that's just too long. And so when I hear the process is going to be 10 to 14 years, I can't even imagine thinking about starting out a project 10 to 14 years. I can't even do a two-year project so that just blows my mind.
But when you're talking about such long development timelines, it really drives home, you know, how much financing costs can matter. And that's a lot of time where you're spending a lot of money on various things without revenue and the whole math changes with the change in financing conditions.
But why don't you talk to us about, okay, what are the conditions for these developers in 2023 versus 2019, both in terms of the rate environment, but also just the inflation environment, the cost of labor, the cost of construction, the cost of steel for the materials and so forth. Like how much have things changed for them in four or three years?
Chelsea (11:09):
So when we're talking about the impact that inflation, interest rates and also, you mentioned Tracy, the Inflation Reduction Act, have had on the levelized cost of electricity (LCOE)— so what this means is this is essentially the price at which electricity must be sold in order to kind of break even, make sure your returns are met, etc.
So in 2021, we did some analysis estimating that the LCOE for offshore wind projects in the US, assuming a 30% investment tax credit, so this is investment tax credits as allowed in the Inflation Reduction Act was around $77.30, so this is assuming a 30% ITC. If you take into account CapEx and OpEx rise, so OpEx being operational expenditure, this added around $17 per megawatt hour. Then take into account interest rate hikes, that's around $27 per megawatt hour. But then we also had, when the IRA came out, bonus tax credits, so developers could also get +10% for meeting certain requirements. That took down, so it reduced the levelized cost of electricity by around $7 per megawatt hour.
So when we're sitting here in 2023, this means that now the LCOE, assuming a 40% investment tax credit, stands around $114.20 cents per megawatt hour. So you can see comparing that $114 to that $77 per megawatt hour number, just how much that environment has changed.
And I think to highlight a couple of movement pieces in terms of what has been happening on a macroeconomic scale. So US CPI, so this is the consumer price index average at around 1.9% before Covid-19 in 2019. And then if you take a look at how it peaked in 2022, it was at around 9%, so you can really see how that environment has shifted. Also, for several projects, the secured overnight financing rate, the base rate for interest rates in the US, stood at around 0%, almost nothing at the end of 2020 into 2021 and then when you take a look at where it is in 2023, it's around 5.5%. So you can see just how much the base rate for borrowing money has increased.
Tracy (13:20):
It's like an almost 50% increase in the cost, which is almost perfectly tallied with the drop in Orsted’s share price. It's an efficient market right there! So you just laid out wonderfully all the different cost pressures that have landed on the wind industry and I guess my question now is what levers can they pull to offset some of these?
You have fixed rates on the revenue side because of those offtake agreements, can they renegotiate to try to get additional money? And then on the cost side, I imagine putting together these massive wind turbines is a pretty expensive and complicated endeavor. But we have seen, for instance, in the oil industry that you can do things like have standardization on components and things like that, that can bring down costs. So which of these is the industry looking at, and which in your opinion might be most effective here?
Chelsea (14:38):
So I think what comes to mind are three things. So one, the first you mentioned being renegotiation. So that's what a lot of these developers have been trying to do. So far, not really any of the renegotiation attempts have been successful. We did see some green lights in New Jersey when Orsted requested basically being able to keep some of the upside of their federal tax credits.
So traditionally in their contracts, they're meant to pass down those benefits to ratepayers if they're going to get any extra access. But New Jersey kind of passed a bill saying that, no, this is okay, Orsted can keep the upside to make sure that that project goes forward. Now, even though that bill passed and Orsted was able to receive the upside, that project still did not go through.
If we take a look at renegotiation attempts in Massachusetts, the regulators had also said ‘No, we're not willing to renegotiate,’ and so then we saw fines of around $50 million, $60 million that these developers were paying to kind of exit those agreements so that they could then rebid into future solicitations.
In New York we also saw regulators decline requests to increase offtake prices and so for New York, we're still waiting to see what exactly might happen, but basically renegotiating kind of opens up a whole can of worms because this is a competitive process that these developers are competing against each other for. And then the second you reopen that up to say ‘Oh, I want a higher offtake price,’ then that kind of calls into question the competitive nature of the award.
Joe (16:03):
Wait, sorry, explain that further. When you say it calls into question, can you clarify that?
Chelsea (16:08):
So essentially when we see something like an offshore wind solicitation, I've been using a lot of different words but solicitation procurement, they're also known as request for proposals, RFP, some people might call them an auction. So these are essentially developers coming in. The state says ‘I want to procure, let's say, four gigawatts of electricity of offshore wind power.’
And so then you'll have multiple developers kind of develop a proposal with different projects. They'll say ‘I'm developing a one gigawatt project, I'm developing a 500 megawatt project’ etc. They'll then say ‘I'm willing to provide this project at let's say a hundred dollars per megawatt hour’ and as this project is going to be commissioned in 2030. And so then you'll have all of these different elements.
Now, usually in the US they'll take into account the bid price. So the lower your price, the more that you can save rate payers money and so then the better that looks. So that's usually around maybe 70% of the evaluation. And then you'll have 30% be attributed to things like environmental attributes, economic development opportunities, how much are you investing in the state. Also, things like project viability, developer experience, different pieces like that.
But the big portion is how cheap can you sell electricity to me? And so when you have these different developers essentially saying ‘I can sell it at this price and this is the lowest one that, or this is the most attractive one that the state selected, you award it and then a couple years later you say ‘Oh, I need an increase.’ Then that calls into question, okay, what about the previous developers that lost out in the auction? Were they bidding at a price because perhaps they had less optimistic assumptions about what the future would be like?
So when you think about contingency planning, things like that, it's good to have an optimistic view of the future, but when the optimistic view doesn't actually end up happening, then that kind of makes it a little bit more difficult.
Tracy (17:55):
And what about on the supply side, like the component idea? How much can be squeezed out of costs there?
Chelsea (18:03):
That is a great question. So a lot of the cost declines we've seen in offshore wind has been due to increasing sizes in turbines. And so what that means is that as a turbine gets bigger, that means that oftentimes you need less turbines for the same amount of output. So for a one gigawatt wind farm, you need less turbines if you have bigger turbines at a higher rate of capacities. You also need less array cables to interconnect them, less foundations, oftentimes less vessel trips needed to go in and install the turbines because there's fewer of them.
So, with that being said, sometimes when you have this longer runway for offshore wind development, that means, oh, well I have a little bit longer time to kind of pick the biggest, newest technology that is going to allow for cost savings on a per megawatt basis. Now that being said, a lot of these projects that have been raising red flags are a little bit more in the later stages. And so kind of reconfiguring and getting the newest and biggest turbine or signing new supplier agreements and trying to figure out where to squeeze can be a little bit more challenging because oftentimes a lot of these supplier agreements are already being put in place or have already been put in place.
So this was the case for Ocean Wind 1 and 2, where if you take a look at Orsted’s impairment, the vast majority of it was due to supply chain complications, mostly in Ocean Wind 1. And this is because they experienced kind of knock-on effects from delays and kind of scheduling issues that they were having with suppliers predominantly with vessels. And so there is some wiggle room that you can do with reconfiguration and redesigning the project. Orsted mentioned for their skipjack projects in Maryland that they are revisiting some reconfiguration to see if they can make the project as valuable as possible.
But that being said, for some projects it's not always possible. Sometimes you reconfigure as much as you can until you kind of have to make a final investment decision. And for some projects you have less runway. So if you're early on in the development process, then you have more leeway to shift your designs and change your suppliers. But if you're later on, it's a little bit more challenging.
Joe (20:06):
So you mentioned supply chains and the big stress point has actually been the vessels?
Chelsea (20:11):
For Orsted’s Ocean Wind 1 and 2 that's what they mentioned.
Joe (20:14):
Was that the one off of that was going to be off of New Jersey? And wait, what's the vessel constraint? Is it actually the number of ships? What’s going on there?
Chelsea (20:23):
So the US has essentially this law called the Jones Act. I'm not sure, are you guys familiar?
Joe (20:30):
Oh yes. We love it. It always comes back...
Tracy (20:32):
It always comes back to the Jones Act. We've done a couple episodes.
Joe (20:36):
I had no idea this was going to turn into a Jones Act episode and now I'm really excited.
Chelsea (20:40):
So I have my own personal feelings about it, but that aside.
Joe (20:44):
I've noticed by the way, like on social media, that's one of the most hot button topics that you could talk about. So I never say anything about the Jones Act online ever, people have really strong opinions. Sorry, go on...
Chelsea (20:54):
No worries, I mean it's a hot button topic. So essentially, basically if you are traveling between two points in the US then that ship has to be US built, US crewed, US flagged. And what that means for offshore wind is that that offshore wind farm counts as a point. And so the US has, I mentioned, seven turbines currently installed, two projects currently under construction. But what happens is because of the Jones Act, you either have to have a Jones Act compliant vessel that can do that transportation. That doesn't exist in the US right now, currently there's only one wind turbine installation vessel that Dominion is building right now.
Tracy (21:38):
I'm getting dredging flashbacks.
Joe (21:40):
Oh my god, this is so amazing. It all comes full circle
Chelsea (21:43):
So, yeah. There's only one vessel currently under construction right now and that's not going to be ready until a few years from now. And Dominion's planning on using that on their 2.6 gigawatt coastal Virginia offshore wind project, set to be the largest in the US when it commissions one of the largest in the world, which is great for them. But for other projects, Orsted was actually hoping to use this for their Sunrise Wind and Revolution Wind projects. But now that the vessel has been delayed, they are no longer able to use that Jones Act compliant wind turbine installation vessel.
So another thing that you can consider doing is using a European wind turbine installation vessel and then using a kind of feeder barge method. And so this is what a lot of US offshore wind projects are hoping to do. Essentially the feeder barges are Jones Act compliant and you feed in the components to the European vessel that stays at the offshore wind site.
This is traditionally not how projects are installed in Europe, as you might imagine. Usually the European WTIV will go to the port, pick up the components, load it up, go to site, and then install the components. And so you kind of have this mishmosh way of doing things.
And then the last one that we don't really expect to see because it's super expensive, but you might stage your components in say Canada and then use a European WTIV and then go get the components and then install them. So the Jones Act has essentially created a situation where so many vessels involved in the offshore wind installation process need to be built here. And right now there's only one. So that's a huge constraint.
Tracy (23:08):
Joe, I dare you to tweet that the Jones Act causes pollution and adds to the US’s carbon load by denying wind energy.
Joe (23:16):
I'll tweet it from my locked alt account that nobody knows about.
Tracy (23:20):
Okay. But this actually leads nicely into another question. Just going back to the IRA, a lot of this sounds like difficulty with how the US system is set up for wind power. So you have the ship constraints via the Jones Act that you just described, and then you have the permitting process, which can also be difficult. You have the sort of time discrepancy between when the offtake agreements are agreed and when the financing is actually secured, which is different to other countries, different types of subsidies and things like that.
How much can the government do to alleviate some of these pressures? And then on the IRA specifically, setting the griping aside about the permitting process, what does it actually do to help wind power here? Does the existence of a very large underwriter in the form of the US government provide some certainty to the industry at a time when it seems like there are a lot of challenges?
Chelsea (24:19):
I think that you mentioned what governments can do? So A) I think going back to one of your initial questions that I think that I'd ended up missing at some point, starting at the state level, what states have begun to do is starting to introduce inflation adjustment mechanisms in their offtake contracts.
And so the US, I mentioned having that timeline between being so long between when you agree with that offtake to the offtake price and then when you actually finance the project being really long, that makes it really risky. But also another piece is that the US offtake contracts are not indexed to inflation. And so what that means is that in the UK and Poland, partially in Ireland over the 20, 15, 20, 25 year offtake contract lifetime, the price might go up by a certain percentage that is usually up by inflation.
In the US, these projects bid at like a flat price or at a set escalator say two or 3%. And so again, given the shifts that we've seen in the environment over the last few years, this means that these projects are not nearly as protected as they are elsewhere. And so states have been starting to say, we're not necessarily going to index this price over the lifetime of the contract, but we will say we'll give you a one time adjustment mechanism.
And so in New York what this means is from the time that you bid until the time you receive your final federal permits, your price will be indexed to metrics like steel, labor, fuel, copper, different pieces like this to help kind of protect the developers a little bit more and stave off a little bit more of that risk. So that's one beneficial thing that we've seen kind of help in this way at the state level.
Now at the federal level for the Inflation Reduction Act, a lot of the big drivers for offshore wind have been at the state level. And so the Biden administration came out with a 30 gigawatts of offshore wind by 2030 goal a few years ago. And that's a good sign for the industry, but in reality, these off-take agreements that are really what these developers need, a guarantee of like route to market and a future for like how much build is going to be, is there going to be in the future, that kind of long-term certainty, that's what the states have really been giving. And so the Biden administration's goal, while a good sign also just for context at BloombergNEF...
Tracy (26:36):
Didn't one of your colleagues call it a “pipe dream?”
Chelsea (26:38):
One of my colleagues did call it a pipe dream. And, you know, part of the reason for that is because we've never once forecasted that the US was going to meet this goal even before it came out. But it is a good sign for the industry, just to kind of hammer that home. The ambition is good, but it doesn't look like it's realistic.
And in our latest forecast it looks more likely that it's going to be half of that. And for the Inflation Reduction Act, I think that the tax credits that are included in it are a very good sign. They help kind of decrease the price of offshore wind, onshore wind, onshore renewables in general, right? And so it becomes a more attractive space to certain investors, let's say.
But offshore wind is one of the most expensive renewable energy technologies out there. And so when we take a look at why developers and countries are building it, it's not necessarily because it's the cheapest form of electricity. Offshore wind has super high capacity factors. And so what that means is that essentially if you take the entire year and assume a wind farm is generating at 100%, the wind speeds are like ideal generation is at a hundred percent, but then you actually take the actual generation.
So sometimes wind is variable and wind speeds are lower and the turbines aren't spinning at high speed all the time. There's some curtailment perhaps. That percentage of the year, in] which it's like fully operational, is the capacity factor. And so for solar, where you might have a capacity factor of like 20%, and that makes sense given that it's only really generating when the sun is out. Onshore wind, you might have something like 30% or so, 35%. Offshore wind and the US you can get 40, 45% and so it's a lot higher.
And so when you're looking at renewable generation, as it gets more and more integrated into the grid, having higher capacity factors, having technology which is able to generate a lot more, is more beneficial for the system. And then also scale, so you have gigawatt scale projects that are offshore wind projects. For context you might see a hundred, 200 megawatt onshore wind project in the US but that turns to a thousand sometimes 2000 megawatts when you go offshore.
And so you have things like scale, higher capacity factors, also there are huge economic development opportunities, really kind of being the driver for offshore wind more so than it is the price of that electricity. And so I think the IRA is great for taking the impact off the price of that electricity and the amount that states are going to have to be paying and kind of putting that on the federal budget side of things. But in terms of actually spurring on that build and making it essentially being a driver for more offshore wind growth I think that that's really lying more so with the states than it is with the federal government and the IRA.
Tracy (29:37):
Just to hammer this point home, how much of the challenge here is the physics of wind power versus financial conditions, the increase in borrowing costs and the higher cost of physical components like labor, like ships, things like that. In other words, could there be an argument that unless those costs come down really significantly, that wind power just isn't, I guess, energy dense enough to make financial sense?
Chelsea (30:08):
That's a really interesting question. I think that one thing that's important to contextualize is that these things that we've been talking about in terms of inflation and interest rates, it's not just relegated to wind, right? Like we have been seeing this hit other renewable technologies, we've been seeing it hit other sectors.
I know I go to the grocery store now and say ‘Oh my goodness, what? Like, this has gone up by X amount. This is a ridiculous amount of money.’ Or now when you try to go for a loan, I think my parents were saying the other day that interest rates are crazy nowadays. And so this is something that's hit a lot of industries and it's not necessarily just wind power.
If we take a look at offshore wind in particular, I think that one of the reasons why we've been seeing so much news around it is because these are large infrastructure projects, they're billions of dollars. The second a project says ‘I can no longer develop,’ it's huge news because that's like a gigawatt of clean electricity, versus if one solar project doesn't move forward maybe that's 50 megawatts and it's gone so it's a smaller fraction.
These are also huge government initiatives so you might have government-backed contracts now being called into question versus if you have a corporate bilateral PPA at a smaller scale, you know, that's a little bit easier to renegotiate, perhaps have a little more wiggle room.
And so I think that a big portion of it is on the financing side of it and the macroeconomic situation that's impacting everything. But also if we take a look at wind and offshore wind in particular, there are some unique pieces to it that I think make it a little bit more susceptible to say, I'm trying to figure out the right words, but let's say ‘grandioseness’ or like bigger news, because they are larger projects, they are billions of dollars, they are huge when it comes to the amount of clean energy that you see it can contribute to countries’ portfolios, but also from a company level as well, right? We’ve seen a lot of oil and gas majors get into offshore wind and it's because they've been starting to integrate renewable energy goals into their strategies.
And offshore wind, you win a huge seabed lease auction, you get gigawatts immediately added to your clean energy portfolio. And so I think the bigness of the projects — bigness is not a word, but we'll go with it — how expensive they are. But also these longer timelines I think, I mean, I don't know about you guys, but I'm a lot more upset when I've been working on something for a really, really long time and it doesn't work out when you've been working on it for a couple days.
Tracy (32:46):
Joe just admitted that he doesn't work on any long-term projects.
Joe (32:48):
I don't do long-term projects, so I completely agree. I have one last question, which is that there are all these challenges from interest rates to statewide legal issues to the Jones Act to whatever, if things don't get figured out, how important is the wind component to overall clean energy goals? Especially, I know in the Northeast we don't get a ton of sunlight, there aren't a ton of other alternatives for decarbonization. Just talk a little bit about the significance of somehow getting this right in terms of the US's bigger strategy.
Chelsea (33:23):
Yeah, I mean I think it's huge. For context, our view at BNEF is that this is more of a bump in the road than anything. So for years we've seen cost declines, cost declines, cost declines, especially in solar. And now's one of the first times in years where we've seen a little bit of a bump in costs.
And so a lot of it in part is due to the inflationary pressures and higher costs of capital that we've been seeing. Now we do think we're going to see a return to normal, whatever that means to you in the next few years. And so then we should come back to seeing some cost declines. And yes, there are bigger components and I think that there are some structural issues that the industry needs to work out. I mentioned bigger turbines being like a huge push, a huge reason why we've seen cost declines in offshore wind. But then there's also the question of how big can those turbines get?
Tracy (34:16):
Yeah, I saw like one of them, or some of them, are now 350 feet or like a hundred meters, something like that, the blades?
Chelsea (34:23):
Yeah, I think in meters. So the Vestas 15 megawatt turbine has a 236 meter rotor dynamic. So they're really big. But yeah as they get bigger, you need vessels that are going to be able to install them, ports that can house them, factories that can manufacture them. The entire supply chain has to grow with it. And so there's some structural issues there that also need to be worked out.
And turbine makers have differing strategies on whether or not it's better to keep going big or to kind of maintain one turbine size. Now that aside in terms of how important it is, to your question, Joe, yeah, we can't necessarily just have an energy system that's made completely of solar panels, right? The sun's going to rise, you're going to have lots and lots and lots of solar energy and then it's going to set and then everyone's in a blackout. That doesn't really make sense. Then you add storage, how many batteries can you add?
You have wind, you want to have different sorts of electricity sources with differing profiles so that your system can be a little bit more flexible, you can be a little bit more nimble with moving your resources around so that you can actually go where demand is needed. So that includes investments in the grid, right? And making sure that that is upgraded to a point where electrons can flow a little bit more easily.
And in the Northeast, as you mentioned, there's not a lot of sun and it doesn't always make a whole bunch of sense to build solar, even if it might be cheaper on a levelized cost of electricity basis than onshore offshore wind. And so the big push in the northeast for offshore wind has to do with the fact that we see these really high electricity price spikes in the winter due to gas constraints and high prices for gas.
And so offshore wind kind of helps offset that a little bit more. So those kind of tie into some of the other benefits that I mentioned, not necessarily environmental attributes and economic benefits, but when you look at the electricity system as a whole and kind of trying to reduce those price spikes and price drops, offshore wind can kind of help add to it in that way. So there are benefits there that I think are good for the industry and I think wind is a really big necessary part of the energy transition.
Joe (36:23):
Chelsea Jean-Michel, that was amazing. That answered so many questions. Really appreciate you coming on the podcast.
Chelsea (36:29):
For sure. Happy to be here. Thank you guys.
Tracy (36:31):
That was great.
Joe (36:45):
Tracy, I thought that was great. That answered so many questions and the fact that it ended up coming back around to being a Jones Act episode too, it was like a classic interview from my perspective.
Tracy (36:55):
We should have seen it coming.
Joe (36:56):
I had no idea. I had no idea that was a big part of the story.
Tracy (36:59):
There was so much packed into that. Chelsea got so much in and I'm struggling to think about where to start. So one thing I'm thinking is like, on the one hand, a lot of this sounds really complicated to solve. So these are huge infrastructure projects as she laid out, working on very long timelines. And so you would imagine that the macroenvironment might change as the project actually matures and comes to fruition.
But on the other hand, it does seem like there are some little things that could be kind of fixed almost immediately. So the idea of off-take contracts actually being indexed to inflation. I'm sure that would be an extremely politically unpopular move, but I guess if other countries are doing it, maybe you could make the argument, and if wind power is a necessary source of energy to get us to our carbon goals, maybe there is some political appetite for making the projects more financially sound.
But, yeah, it seems like it's complicated. It seems like there are multiple things happening here and multiple levers you could pull. And the question is again, like which [levers] are the most efficient? And at the end of the day, if you do all of them, is wind power still efficient and financially viable?
Joe (38:18):
And you could see though too, why even with all of these challenges from engineering to financing, the prize is great, right? I think I saw some that all it takes is one spin of the blade, literally just one and that powers multiple houses for a few days or something like that. And there's just so much potential energy out there, a couple miles off the shore, that you could see why there's this pursuit.
But then also, there are so many different follow-up conversations that we can now have related to questions about, well, what is the optimal size of the blade or the optimal size of the turbine and all these different things that you could see. Or the optimal bidding process as you described.
Tracy (39:00):
Oh yeah, that was really interesting. The renegotiation of the off-take agreements and the idea that, obviously the environment has changed, so if you're an energy provider you might want to get additional revenue to cover your costs, but given the way those auctions are structured, you can't really do that in a fair way.
Joe (39:20):
Electricity markets future episodes for sure.
Tracy (39:23):
Yeah, and probably a Jones Act debate in our future.
Joe (39:27):
Yes, for sure.
Tracy (39:28):
Alright, shall we leave it there for now?
Joe (39:29):
Let's leave it there
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