Risk assessment and reduction: best practices for driving down construction and operational costs
The offshore wind sector has been steadily expanding in recent years, but this has not been without painful lessons learned.
Author(s): Christos Kolliatsas
This article provides an overview of the main challenges faced, categorised into construction, supply chain and contracting issues. It draws on the author’s experience as Lender’s Technical Advisor in the successful non-recourse financing of a number of offshore wind farms in Europe, supplemented by similar experience with other projects currently seeking financing around the world as well as experience from Owner’s Engineer assignments.
Driven by the experiences and technology available from onshore as well as the favourable wind regime offshore, offshore wind has been steadily expanding in Northern Europe for a number of years now, with around 35% growth in installed capacity between 2012 and 2013. As of the end of 2013, the average installed rated power of each wind turbine generator (WTG) connected to the grid in 2013 was 4 MW, owing to the large market domination by Siemens and its 3.6 MW WTG. However, there are a lot of 5 or 6 MW units currently installed on the open sea and 10 MW units not that far off in the near future.
This article aims to draw from the author’s experience as Lenders’ Engineer in the non-recourse financing of offshore wind farms in Europe as well as other roles in dealing with a number of offshore wind projects in the UK, Germany, France and other areas around the world.
The expansion and ongoing maturing of this sector has not been without painful lessons as the harsh offshore environment has introduced challenges not faced by the relatively low risk construction and operation of onshore wind farms. Dealing with offshore projects poses some challenges during the development, construction and operational phases.
Offshore wind risks
Development of an offshore project is associated with multiple risks, which include government policy and uncertainty over long-term support regimes, planning delays, contractual structure and interface risk.
When it comes to offshore wind projects, it goes without saying that government policy will play an important role in the process. Offshore wind is relatively expensive when compared to some other generation technologies. However, politicians have shown strong support for offshore wind as there are a fair number of advantages associated to the technology. The impact in terms of employment can be significant given the number of actors involved in such large projects, with potential to export skills to other countries. So far, a number of support mechanisms have been drawn up to make offshore projects viable. Such mechanisms have ranged from advantageous tariffs to green certificates and tax benefits. Issues have arisen when such support mechanisms have come to an end as well as criticism for the amount of subsidy available. The industry should move to cheaper solutions so that the impact of such mechanisms is not as critical to projects.
Depending on the country, planning and consent can be cumbersome resulting in delays and expenses. Some governments and local authorities have tried to streamline the process; however, developers should be aware of the potential issues associated with the process. Issues have also arisen in the past with permits being too descriptive about the project, so again developers should consider the stage and certainty of design before committing to a permit.
When it comes to contractual structure, multi-contracting has been widely adopted by the industry. Early projects were constructed under single turnkey Engineer Procure and Construct (EPC) contracts. Owing to the nature of the projects, the reward for taking all the construction risk did not materialise. Lessons were learned and a shift has occurred, leading to the current situation of multi-contract strategies. This multi-contract approach brings a number of new risks (compared to a fully wrapped EPC approach); for example, interface risk. Typically, substantial project management structures put in place by the project owner are good mitigants which ensure that the project is being managed in a more proactive and involved manner. Requiring more participants in projects increases the risk of engaging with a company that is lacking the required skills. Key to mitigating this risk is a good track record, robust H&S and quality procedures, and an open and learning culture clearly showing that lessons are learned from previous projects.
Contingencies are further mitigants. It is not unreasonable to expect the financiers to require a contingency fund of close to the EPC wrap up price for projects with a large number of contract packages. Contingency in the budget for a fully wrapped EPC contract has been traditionally set at around 5% for power projects. However, for multi-contract arrangement, especially for offshore wind, such contingency has been set higher. The upshot to the developer is that if the project is managed well, such a contingency fund will not be utilised and instead it will be released back to the investors.
Once development has been finalised and finance provided, construction can start. It is clear that the construction phase of an offshore project is associated to multiple risks; the main ones being supply chain constraints, technology risk, weather risk and accessibility.
Supply chain constraints have proved and continue to be a major challenge in Europe. Vessels required for the installation of foundations and WTGs offshore require specific characteristics. It goes without saying that big vessels are required with significant carrying capacity, and depending on the WTG model, weights could be in the region of 500 tonnes plus for the nacelle. More crucially, the on-board crane should have the capability of moving long. It should be noted that recently new purpose built vessels have become available to the market making this constraint less critical.
Finding a suitable harbour is now regarded as the biggest technical barrier. Requirements for significant storage space, high bearing capacity, length of docking berths and requirements for large draft (when loading heavy machinery) make many harbours unsuitable.
A further issue with the supply chain is the shortage of skills, which is further exaggerated by the rapid growth in the industry. Rapid expansion of all key stakeholders has resulted in large numbers of inexperienced people being given responsibilities beyond their competence. This is a key issue for the industry which is likely to manifest itself for years to come. Engagement of experienced people or consultancies is a key mitigant and due diligence is required when assessing a company’s capabilities even if it is a company with a long track record, as the personnel may have changed substantially.
As discussed earlier, WTG technology has progressed at an incredible pace. By the time a state-of-the-art at the development stage project begins installation, a number of bigger and more advanced WTG models have been developed. This situation is likely to come to an equilibrium; however, at this stage it is not clear which capacity will prove to be ideal for offshore wind. Ultimately, the question that needs to be answered is whether or not devices will work and for how long. Such evolutionary (and sometime revolutionary) design changes make a number of projects, ‘prototypes’, but developers are happy to trade off the risk of a new design for the promise of better returns. Regardless of the model and design, owing to the infant nature of these units, quantifying the technology risk can be difficult. Certification provides extra comfort, however, it is not considered sufficient mitigant in isolation as certified WTGs and other offshore structures have failed in the past. Independent technical due diligence is a further source of comfort.
Once project construction is finally complete, operations start. The owner now has to secure its investment and ensure performance over the lifetime of the project. The main risks involve uncertainty in wind resource and energy yield, weather risk, maintenance and accessibility as well as the management of operation and maintenance (O&M) costs.
The wind resource is a key concern for the project finance as the energy yield; hence, project revenues are proportionally linked to the cube of the wind speed. Accurate and reasonably conservative predictions are therefore important and need to be taken into account into the financial model. Techniques such as mesoscale modelling (using satellite data) can be used if good quality long-term information is not available. It must be kept in mind that although the wind speed is higher in offshore environment, higher uncertainty is introduced as the wind behaviour is not as well understood as onshore.
Offshore wind O&M strategy is split into two areas: the WTGs and the remaining infrastructure including foundations, cables and substation. Non-WTG infrastructure can be handled on a year-to-year basis. WTG maintenance work is usually contracted to the WTG manufacturer for the first five years of operation (or much longer) and subcontracted to third parties or in-house in the longer term. Contractually, the TSA should be supplemented by a strong long term O&M contract with high availability guarantees.
Owners and lenders place great emphasis on the WTG performance and availability. It is imperative that availability is kept as high as possible, as it drives revenues for the project. WTG availability will be affected by a number of parameters, primarily the reliability of the WTGs and accessibility. It should be noted that the biggest operational risk for an offshore wind farm is the availability of the single point of failures, basically any structure and component associated with the export of electricity. Such failure, depending on the design of the project, could result in no electricity being exported from the whole wind farm for a prolonged period of time.
Reliability of the WTGs is something that the owner can affect by choosing the correct WTG for the conditions and supplementing it with condition monitoring systems and so on. Due consideration should therefore be given with regards to the wind regime and how well the WTG model will suit it, operational history of the particular unit and so on. The owner should have an active presence during the manufacturing of the WTGs and testing of the various components.
Regarding accessibility, similarly to the construction phase, the metocean regime should be considered when selecting the number and type of transfer vessels in order to achieve the availability assumptions. The effort should be to achieve as high as availability as possible during favourable weather periods and minimise downtime during onerous weather conditions. Consideration should be given on spare parts and accessibility of the offshore substation. Projects are considering and implementing helicopter transfers to offshore substations as it is beneficial from a cost benefit point of view to have the substation operational as soon as possible. Furthermore, helicopter transfers to such structures tend to be less onerous than to WTGs.
As noted earlier, a number of lessons can be drawn upon the author’s experience. When it comes to offshore wind development, it has become clear that countries with streamlined planning processes and stable support regimes present more potential for offshore projects. Successful project financing can be obtained through careful preparation. Lenders will finance the right project; that is, projects where the risks are well understood and reduced.
Any risk raised during the development phase should be managed through appropriate mitigation measures or through a suitable contingency plan. It should be noted that the first financed project was installed in the deepest waters at the time, with onerous cable burial depth requirements. The second financed project was using a prototype WTG with a new type of foundation and the third project got financed in the middle of recession. A strong sponsor team and early engagement with key stakeholders including utilities, developers, manufacturers and other peripheral organisations will significantly influence the outcome of a project and is a fundamental factor for success. Finally, ensuring compliance with the Equator Principles during the development phase remains fundamental, such as good assessment of the potential environmental impacts of the project through careful preparation of the environmental impact assessment.
During the construction phase, it has become clear that one of the key focal point should be a good understanding of the met ocean conditions to allow appropriate planning and optimal use of vessels. A conservative approach should be considered in order to allow sufficient time for completion, along with sufficient contingency in terms of both schedule and budget to account for worse than expected weather conditions. The recipe for successful construction can be obtained through a combination of different factors, including but not limited to an experienced and competent project team with strong ability when it comes to managing contractors. Although it is a good starting point to have a reputable contractor, it is also important to ensure that the contractor’s team will show willingness to learn and adapt to the requirements of the project, as these will unfold during construction. Well-defined contracts along with a clear overview of interfaces will allow the project team to promote a culture of cooperation during the project which has so far shown the best results. But it cannot be underestimated that the most successful projects have been because of good management, as people build these projects; a fact that can be forgotten looking at the size of the projects.
A number of offshore projects have been operating for a few years and experience has shown that being reasonably conservative with the energy yield assumptions provides some comfort in case of low wind years, especially at the beginning of the project. As discussed earlier, the biggest operational risk for an offshore wind farm is the availability of the single points of failures. Condition monitoring is primordial to allow for early detection of issues in the WTGs. Strong support from WTGs manufacturers over the long-term life of the project is key, as availability affects the financial performance of the project since the current dispatch regime enables wind project to export electricity when it is produced. Synergies with other offshore projects during the operational phase should promote cost reduction, which is a key focus in the offshore industry.
Bringing costs down
The next step in the development of the offshore wind industry is cost reduction. Cost of energy is (at a very basic level) a function of the capital expenditure (Capex), operating expense (Opex) and energy produced. Cost reduction is therefore mainly focused on reducing the Capex and Opex while increasing the energy production. As discussed earlier, offshore wind has progressed at an incredible pace, with the majority of projects remaining as prototypes.
The first area of focus for Capex reduction is the WTG design. Since the first semi-offshore wind farm built on a harbour pier in Ebeltoft, Denmark in 1986 comprised 16 WTGs of 55 kW, projects have evolved to multi-megawatt, truly being offshore wind farms. Currently in Europe, most projects are continued to be developed with 3–5 MW units in mind; however, more recent projects such as Thornton Bank Phases II and III use 6 MW models. The increase in capacity from 5 to 6 MW is significant (20%) and provides further evidence that the industry has not reached the point of optimum wind WTG capacity. Indeed, capacities of up to 10 MW are currently being considered as feasible in the next few years. Nevertheless, for offshore wind, an ever-increasing capacity should not be the only priority for WTG manufacturers. As a matter of fact, some manufacturers are focusing on extracting more energy from the same capacity. A key consideration, nevertheless, for offshore wind should be the reduction in weight both in real terms and kg/MW basis as well as reducing the complexity of wind WTGs both for construction and operations. The aforementioned approach could result in cost reductions for an industry that has seen construction costs steadily increasing in the last 5 years. A further benefit could be the use of smaller vessels and harbours. Similarly, foundation design has not yet reached maturity; conventional foundation design is sometimes replaced by bespoke designs for each WTG location in an attempt for developers to reduce costs up to 15%, which is more challenging in terms of quality control and project management. Again, maturity should help bringing costs down. Electrical design needs to be optimised, considering potential synergies with export cables. Another strong area of focus for Capex reduction is vessel design. Specialised vessels are in great demand; the use of vessel purpose-built for the offshore industry is likely to reduce the costs. Finally, it is foreseeable that the price competition will increase over the next years with the emergence of new markets such as South-East Asia.
Regarding Opex reduction, it is clear that great emphasis is put on field experience drawn upon actual operating wind farms. Synergies between wind farms rationalising vessel usage, harbour usage and the use of a common O&M base, for example, should enable significant savings during the operational phase of offshore projects. As previously explained, WTG O&M works are usually contracted to the original equipment manufacturer that does not give much room for price competitiveness during the first five years of operation at least. Introduction of third party contractors for the remaining years of operation allows the owner to negotiate the contract price and bring the cost down. Lessons learned, drawn upon further commissioning of offshore wind farms, will result in better understanding of issues, and other costs such as financing and insurance could come down as more success in the industry will bring more confidence, given that there is no catastrophic experience which would indeed have the contrary effect.
Offshore wind is and will continue to play an important role in the energy mix of many countries that have the resource and will to harness it. It is important to note that there are not many new lessons to be learned in offshore wind, but old ones to be revisited. A number of risks, some of which are unique to this industry, should be fully understood before embarking on such projects, as these risks affect the design, manufacture, installation and operation of the offshore wind farm. Mitigation measures and management of these risks are fundamental to the success of these projects. Developers should consider these risks and come up with a strategy that would minimise them. Equally, potential investors or financiers should aim to understand and quantify these risks before deciding to proceed with the deal. A technical advisor having a very good understanding of these risks and a track record of leading projects to financial close will provide substantial value to the decision-making and assessment of the risk profile of offshore wind projects and could facilitate selecting the front runners from the dead horses.