Part 1 of this article highlighted the need for developers to reduce long-term operating costs to support their offshore wind farm viability. Part 2 now looks at how developers can improve their (future) OPEX. Part 3 (to follow) will then look at how the main developers are set up for O&M and how the turbine suppliers might adapt.
Can’t we just keep doing what we have always done?
The most straight forward O&M strategy for a developer is to build its O&M around a fixed-price, 15-20-year service and maintenance agreement (“SMA”) procured from or offered by their turbine supplier at the same time as the turbines.
With an SMA, the turbine supplier provides the people, resources and parts to perform both planned and corrective maintenance on the wind turbines. The SMA dovetails nicely with any equipment and component warranties provided under the turbine supply agreement since the same turbine supplier company is both servicing and carrying out any warranty works. The SMA will normally include an availability warranty which is a performance mechanism whereby incentive or compensation sums are paid depending on the turbines’ outturn availability to generate.
An SMA is particularly attractive to developers and investors who (i) want a degree of certainty in the majority of their operating costs, or (ii) whose core competence may not be in power operations or (iii) who do not seek to retain long-term ownership once operational. Lending (debt) investors also like the fixed price and warranties backed by the turbine supplier’s credit support such as a Parent Company Guarantee.
A fixed price with warranties. That sounds brilliant, what’s not to like?
Primarily, the problem is cost but the second problem is loss of operational flexibility. As we saw in part 1, If your investment case is under pressure, the SMA costs may just eat too much into revenues.
What price Owner comfort? What price Supplier risk?
SMAs are attractive precisely because the turbine supplier takes on so much of the operating risks. This includes both the day-to-day execution but also responding to larger cost unplanned events such as main component exchanges which might cost on average +/- EUR 500,000 for a 3-4 MW offshore turbine, maybe EUR 600,000 – 1,500,000 for the 6-9 MW turbines depending on the circumstances and just for an indication of scale.
Therefore, the SMA price necessarily reflects not just the reasonable forecast day-to-day costs but also the risk exposure to all the underlying potential costs. Furthermore, the turbine supplier also needs to make a commercial margin both on the services and also on the warranties. To make matters worse, as with any warranty or risk protection of duration, the SMA risk premium must rise over time to reflect how risk uncertainty escalates over time. A developer commits to pay these rising margins in exchange for the convenience and comfort of an SMA.
Figure 1: SMA pricing theory
Figure 1 illustrates SMA pricing theory using the example of a bath-tub profile for technical performance over time to illustrate theoretical pricing of an SMA. Assuming high confidence in the technical event forecast, the turbine supplier can price accordingly to achieve its margin goals. The problem is the uncertainty. Wind turbines are beautiful but complex machines with a lot of moving parts operating in this case in a marine environment. The lower the confidence in the technical event forecast, the greater the headroom the turbine supplier needs above its technical forecast.
If we add to this the natural temptation for conservatism in scope and specification for logistics, workforce and facilities then clearly, in the end, the Owner pays for the comfort of the SMA.
In other bad news
The second problem with an SMA is that the developer must sacrifice control and operational optionality to its turbine supplier. While this wind farm gains the SMA protections, the developer loses some valuable strategic chips since this wind farm is now locked into its O&M delivery model for up to two decades. It has therefore conceded its biggest opportunity to reduce future OPEX which is through synergies from co-operating with neighbouring wind farms (now or future). This is achieved by sharing costs of facilities, working teams, logistics and more. More on this below.
Table of Pros/ Cons of an SMA for the Owner
Give me options then. What does a developer do if the SMA cost is too high?
Tactic 1: My pain is your pain
The bluntest method to lower OPEX is to contrive lower prices from suppliers. Historically, competitive tension created via robust procurement practice has achieved some results. GE, for example, must have made competitive offers to Avangrid’s Vineyard (860MW in the US) and the huge 3,600 MW Dogger Bank complex in the UK (owned by SSE, Equinor and Vårgrønn) to secure those orders.
Yet, negotiating lower prices is easier said than done. Turbine suppliers have been on a bruising journey. Senvion went bust in 2019 and no sooner did GE win these contracts then it closed doors to focus on their delivery.[1] Procuring ever lower prices is tough in a market with very few suppliers.
Moreover, since 2023, turbine suppliers have been reluctant to offer the same level of SMA protections as before. Siemens Gamesa Renewable Energy booked charges of EUR 472m for higher warranty and service cost in January 2023.[2] Around the same time, Vestas announced impairments and warranty provisions of EUR 210m for increased repair and upgrade costs.[3] Since then, turbine suppliers have “re-priced the risk” and have required higher risk margins and scaled back warranties in their service contract offers.
Tactic 2: Economies of volume or scale
Historically, developers confident in their pipeline have secured comparatively better terms from turbine suppliers with volume commitment. Committing to a framework order with firm, minimum commitment across several wind farms helps the turbine supplier to manage its risks and costs some of which should pass through as a discount for volume. Such commercially sensitive agreements are not publicised, but it is reasonable to speculate that RWE, CIP or Orsted might have adopted elements of this approach with turbine suppliers in the past.
Alternatively, the previously mentioned Dogger Bank, Vattenfall’s Hollandse Kuist West and Orsted’s Hornsea complex have all been able to leverage their scale with their respective suppliers to reduce comparable service cost.
That said, this tactic has become vulnerable to the very scale of projects required to succeed. The sheer size of today’s wind farm developments can make them too risky for one developer’s balance sheet. Developers therefore now partner for most large-scale wind farms. Unless your partner is the same across all the various wind farms, unifying procurement across multiple joint-ventures, construction schedules and potentially competing interests becomes prohibitively challenging.
Tactic 3: We’re in this together
A third tactic has seen some developers enter some form of strategic partnership with their turbine supplier. For example, Vestas bought a 25% stake in Copenhagen Infrastructure Partners[4] (CIP). Between 2016-2020 Iberdrola held an 8% minority stake in Siemens Gamesa Renewable Energy.[5]
A variation on this theme has seen turbine suppliers (or their financial arms) co-investing between 10-20% in a handful of wind farms. For example, Siemens Financial Services invested in Galloper and Gwynt y Mor with RWE, in Gemini with Northland Power and in Veja Mate its owners).
This is quite a neat tactic, still in play with developments such as Awel y Mor and Five Estuaries. Once operational, the Turbine Supplier affiliate can divest its stake to the secondary market ideally netting a developer premium in the process. This is an interesting topic for Chinese turbine suppliers seeking to enter the European offshore wind market which we will explore in the coming article.
Nonetheless, turbine supplier partnering is hardly common practice. RWE has been involved in most of them. Besides, while such an arrangement may help reduce a developer’s capital expenditure and cash flows, affiliation with a turbine supplier will not eliminate the risk and profit margins within the turbine supplier’s service fee and therefore do not necessarily offer a short-cut to lower operating costs.
Tactic 4: Self-operate
The fourth and most potent tactic is to target that risk and profit premium and value from retaining operational flexibility by self-operating. To illustrate, we need to break down the potential risk premium value to a third-party and the value of synergistic operations.
(i) Service contract margins
O&M service contract margins are generally 15 – 35%. Where within that range normally depends on the risk allocation in the contract. The greater the protections (warranties, fixed pricing and other provisions) and the greater the Owner optionality, the greater the risk to the supplier and the greater the supplier’s target margin.
Not only is every developer, investor and lender under pressure to procure every protection possible, the investment process often compounds this by requiring layers of optionality within the contract such as termination options, scope reductions, substitution rights and extension options. It should come as no surprise when their SMAs are at the top of the margin range.
To put this in context. If you are outsourcing all of your O&M to third-party suppliers, then your 1000MW wind farm operating for 50-60m EUR a year is paying out to third-parties between EUR 10-20m per year in risk protections and margin expectations.
(ii) Synergy value
By locking in the SMA services and protections, the developer also relinquishes control of how O&M is delivered during that contract term. This sacrifices the option to share operations either with the developer’s own or other proximate wind farms.
The value of such synergy can quite easily be up to 20-25%[6] of the direct O&M costs (facilities, execution and support personnel, logistics, administration, management, systems) depending on which services and resources can be provided on a shared basis and when compared to a standalone operation. This sharing approach is common in the oil and gas industry but not yet in the offshore wind industry because of the dominance of the long-term fixed service contracts described above. There is a huge opportunity to reduce O&M costs for Developers and owners that have the foresight and desire to look beyond the SMA protections.
In conclusion, to really change the dial on O&M costs, if the developer can take on some of the high price O&M risk and back the wind farm to optimise and synergise over time, it may, in the right circumstances be able to reduce its direct O&M costs by a staggering 40-50% all told. This comes via saving on the SMA risk premium and profit margin and gaining its future operational optionality.
However, before we all start training for our Chester test, there is always a counter-cost and self-operating is not for the faint hearted. Part 3 of this article (coming soon) will examine how developers self-operate as well as the “price of self-operating,” Both for Owners within a joint-venture and what it means for debt financing or the “bankability” of a wind farm.
[4] Vestas invests in Copenhagen Infrastructure Partners to further expand its presence across a wider range of the renewable value chain
[5] Iberdrola Leaves Siemens Gamesa After More Than Three Years Of Difficult Relationship | The Corner
[6] See McKinsey commentary on this opportunity in articles such as here Winds of change? Why offshore wind might be the next big thing | McKinsey and here Offshore wind operations and maintenance: A turning point
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