Offshore wind is the new darling of the European oil industry. The biggest names in petroleum have amassed gigawatt-scale development pipelines and frequently battle it out for seabed acreage in premium markets in western Europe and North America.

Equinor is leading the pack. The Norwegian oil major expects offshore wind to account for two-thirds of its 12–16GW renewables capacity by 2030, and is “determined to be a global offshore wind energy major”.

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That determination is driving European international oil companies (IOCs) into a tight corner. Once-cautious companies that weighed high-risk, high-return global investments on cold-blooded financial metrics appear to be making exuberant ‘green’ bets that could land them in hot water.

UK offshore wind farm
Offshore wind farm on the northeast coast of England. (Photo by pauljrobinson via Shutterstock)

Competition for prime acreage is rife, resulting in some questionable bids. BP faced accusations it overpaid in the UK’s latest leasing round. There is a similar scramble to secure 15-year fixed returns enshrined in UK contracts for difference (CfD) for offshore wind. More generally, CfD auctions frequently clear at the minimum price, as occurred at a recent 1GW Danish tender that saw companies draw lots in a tiebreak.

With clearing prices falling more rapidly than costs, major turbine supplier Siemens Gamesa recently warned that margins have been squeezed “too far”, hobbling reinvestment in factories and technology improvements. These cannot be deferred forever, which means turbine costs cannot keep falling forever either.

Lowering the bar

European IOCs now tacitly admit they cannot emulate oil-sized profits from renewables investments. Shell says future upstream oil projects must be profitable at $30/barrel, deliver an internal rate of return (IRR) of 20–25% and pay back capital within seven years. As global oil demand returns to pre-pandemic levels, investments made on this basis have a big safety margin.

The bar is set much lower for renewables, in which Shell is investing $2bn–3bn each year. The company is targeting an “unlevered” IRR (i.e. pure equity, no debt) of “more than 10%”, which it says is made possible by its integrated business model.

A higher margin requirement for oil investments reflects exploration risk and demand uncertainty for crude stemming from decarbonisation policies. Wind might not carry these risks, but much lower margins mean investments carry less ‘fat’ to absorb contingencies. 

This might not matter while wind accounts for a tiny proportion of IOC capital expenditure, but that is set to change. Equinor expects renewables to account for 50% of its capital expenditure by 2030. 

Razor-thin margins

Researchers from the University of Stavanger in Norway did the maths for Equinor’s investment in the 3.6GW Dogger Bank wind farm in the UK’s southern North Sea. The megaproject is being financed in three separate 1.2GW chunks co-owned by Equinor (40%), SSE Renewables (40%) and Italy’s Eni (20%). Each phase will cost a cool £3bn.

The Stavanger researchers found Equinor can expect an IRR of 5.6% after tax in their “best estimate” central case for Dogger Bank. On a net present value basis, the wind farm comes in at a negative £907m – meaning the investment is not worth making for Equinor.

“Our estimation, based on the project economics of the Dogger Bank project, is that this activity will be cash negative for a very long time,” say researchers Petter Osmundsen, Magne Emhjellen-Stendal and Sindre Lorentzen.

This compares unfavourably with Equinor’s claim that the project will achieve a “nominal equity return” of 12–16%. This figure includes profits from the sale of 10% project equity to Eni.

Equinor said at its capital markets day in June that unlevered wind IRRs of 4–8% could be boosted to 12–16% by leveraging up projects with cheap debt and selling down big chunks at a premium. Osmundsen challenges this notion.

“By gearing up a project you may have higher expected return, but at the same time higher risk and thereby higher rate of return requirement, so the value of your project does not change. This is confirmed by sensitivity calculations we have done for the [Dogger Bank] project. By increasing the debt to 70% [from zero], you get a high variability in equity return.”

Flawed assumptions?

Osmundsen’s study concluded that Equinor’s Dogger Bank investment will not be paid off until a year or two after the CfD’s 15-year fixed revenue support ends. The study suggests this could deter lenders, but not everyone agrees.

There is uncertainty around the overall economic life of an offshore wind farm, and the price risk it will face after the 15-year CfD expires. Osmundsen et al assume lots of price cannibalisation and low or negative wholesale prices after a rapid ramp-up of UK wind power in the 2030s. They also assume the turbines will be dismantled after 25 years.

Wind industry sources say Dogger Bank is being developed as a 30-year asset, and that 35 years is starting to be viewed as the norm as technologies improve. The extra operation and maintenance costs of keeping ageing offshore turbines spinning for another five years will be vastly outweighed by the additional revenue from a fully amortised asset, they add. Some claim that holds true regardless of price volatility in a wind-dominated power market.

The bottom line

Aggressively selling down project equity pre and post-construction might keep Equinor’s renewables investments above water, but those buying in face dismal returns. Eni’s two Dogger Bank deals will achieve IRRs of just 2.7% and 2.9%, according to the Stavanger researchers. Equinor and SSE will enjoy higher overall margins at Eni’s expense, which Osmundsen’s paper describes as a “zero-sum game”.

There is only so much economic value to go round from investments in ‘cheap’ offshore wind. Spectacular reductions in auction prices have spawned a misleading narrative that this sector is becoming an attractive investment proposition for oil companies scrambling for a means to reduce emissions, remain relevant and keep ESG investors onside.

Moving early pays off. Sadly, the macro conditions that led to DONG Energy’s successful reincarnation as Ørsted no longer exist. Equinor is a laggard by comparison but arrived just in time to cream off value from initial investments in UK offshore wind via project equity sales to Eni.

If Dogger Bank is representative of Eni’s plans to squeeze value from wind, the Italian oil company faces big problems. The same might hold true for Shell, BP and TotalEnergies; time will tell. For now, their collective push into offshore wind is still gathering steam. Do not be surprised if a few big projects are quietly dropped along the way.

This is an abridged version of an original deep dive first published by the Energy Flux newsletter. Read the full-length original here: