What does the pressure on offshore wind farms mean for the energy trust sector?

The wide discounts and high yields on many trusts give significant margin for error

Renewable, turbine
Photo by Jason Blackeye on Unsplash

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It has been a tough week for the offshore wind industry. Ørsted, the world’s largest offshore wind developer announced that it would abandon two US projects, taking a loss of $4bn. Avangrid, a subsidiary of the Spanish utility Iberdrola, said it would stop work on its offshore Park City Wind project in Connecticut because the project was “unfinanceable”. Swedish energy giant Vattenfall has halted development of its multi-billion pound Norfolk Boreas windfarm due to spiralling costs.

This appears to be part of a broader trend. In September, the UK government said that it had received no bids for new offshore wind contracts. At the time, the industry said the framework did not recognise the higher inflation environment and adjustments needed to be made. Both Ørsted and Avangrid blamed higher costs, supply chain disruption and higher interest rates for the failure of US projects. Vattenfall said rising global gas prices has delivered a 40% hike in costs.

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These failures are a problem. The UK has a target of tripling its offshore wind capacity by the end of the decade, and offshore wind is a key part of achieving the country’s net zero goals. The US is also relying heavily on offshore wind to meet climate targets. It is also important for investors. Ørsted remains a major holding in many clean energy funds, along with other wind farm groups such as Vestas Wind Systems. Concern around the future of renewables is also weighing on the sentiment of renewable energy infrastructure trusts.

Barry Norris, CEO and founder of Argonaut Capital, gave a damning verdict to Ørsted’s problems: “It is somewhat ironic that an industry that receives so much economic support in the form of government subsidies and coercion (with carbon-taxes making gas generation less competitive) still cannot generate adequate profits for its investors and ends up also having to be rescued by government, funded by higher electricity bills and taxes. Wind is an unsustainable economic rent seeking parasitical industry, a fact that is masked by its virtue seeking.” 

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In a recent report, Morningstar was more circumspect, but agreed that offshore wind prices would have to rise: “Offshore wind costs have soared 50% because of higher construction and capital costs and resulted in project impairments, renegotiations, and failed auctions. Prices will have to increase substantially to ensure renewable targets are met because these costs are unlikely to revert to prior levels…. Costs for offshore wind have soared largely due to higher turbine prices, which spiked in 2022 after years of declines. We do not expect a return to prior levels, which will keep pressure on offshore wind costs and risk renewable energy targets.”

In spite of these harsh conclusions, it is not a universally bleak picture for offshore wind. The problem appears to be far more acute in the US than elsewhere. When cancelling its New Jersey projects Mads Nipper, chief executive of Ørsted, said in the Financial Times that the pressure “is the same everywhere but it is nowhere near as profound as it is in the US market”. There continue to be success stories: in the UK, the Dogger Bank offshore wind farm, slated to be the largest in the world, connected its first turbine to the grid in October. When complete, it will be capable of powering up to six million UK households.

Morningstar says that offshore wind providers have already been significantly punished by the market. It says groups such as Ørsted, SSE and RWE have already seen major share price drops. Interest rates and inflation appear to be peaking, which may ease pressures on some companies – or at least ensure that the problem doesn’t get any worse.

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Equally, there should be little read-through from offshore wind to other parts of the renewables market. For example, the onshore wind market remains relatively buoyant. Octopus Renewables found willing buyers for its Krzecin and Kuslin onshore wind farms in Poland at an uplift to their holding value in the trust. The problems largely affect the development of new wind farms rather than the operation of existing wind farms. Solar also remains largely unaffected by the weakness.

This makes the ongoing discounts on renewable energy trusts look anomalous. Trusts have been hit by a confluence of factors: the cost disclosure rules have driven many wealth managers and multi-managers out of the sector, while higher bond yields have removed a compelling reason to hold some of these trusts. Sentiment around renewables has been a final nail in the coffin.

However, selling associated with those factors appears to have ebbed and there is no longer a clear reason for the discounts. James Carthew, head of investment company research at QuotedData, says that is no justification for the low ratings of renewable energy funds, adding: “Six of the 22 renewable energy funds offer yields greater than 10%.”

He says that areas such as battery storage look attractive, as changes to the grid start to emerge, adding: “Confidence in battery storage stocks took a knock when Gresham House Energy Storage said that its UK revenues were depressed partly because the National Grid Electricity system operator did not have an IT system that could cope with using batteries in its grid balancing mechanism. That is supposed to be sorted out fairly soon, but this issue is far less of a problem for Gore Street Energy Storage as it is much further down the road in developing its business overseas where margins are much higher. It has shown a strong commitment to increasing its dividend in line with inflation.”

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Among the renewable energy funds, he highlights NextEnergy Solar fund – on a 25% discount and a yield of over 10% and SDCL Energy Efficiency – also on a 10% yield, with a 39% discount. He adds: “The upside from the environmental funds is more dependent on a change in sentiment towards ‘growth’ stocks. This is linked to the direction of interest rates and here the news seems to be much better. All of the major central banks kept rates on hold recently. This is helpful for the renewable energy funds too.”

The wide discounts and high yields on many trusts give significant margin for error, and offshore wind development is a negligible part of the portfolio mix for most trusts. Wind farm developers feature in the top ten holdings for many clean energy funds, but the recent weakness appears to be largely in the price. The concerns around offshore wind should not be a significant deterrent to investment in the renewable energy sector.

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