Norway's Equinor and Danish green energy company Orsted are facing profitability challenges in the offshore wind market they helped pioneer, as competition heats up and price pressures mount.
Renewable energy has been a favourite sector among investors over the past few years, but recent market moves suggest that some of that enthusiasm may be waning.
Oil and gas major Equinor has made its wind energy growth ambitions clear, but the company’s share price took a beating after its 15 June Capital Markets Day, when it pared back its expected rate of return for offshore wind. It has since recouped some of the loss.
After an incredible stock value growth of 250% from 2017, offshore wind giant Orsted’s shares have fallen by more than 30% this year.
In its first-quarter report, it identified inflation, interest rates and higher commodity prices leading to price pressure as major risks for the company.
Mads Nipper, who became chief executive of Orsted at the start of the year, told the Financial Times that delays to licensing decisions risk pushing up costs as competition for acreage increases.
He said traditional renewables players face increased competition from oil majors such as BP and Shell. The company also warned that a broad-based rally in metal prices raises the spectre of inflation for the industry.
Orsted declined to elaborate, referring Upstream to comments from its capital markets day.
Two weeks later, Equinor reduced its guided internal rate of return (IRR) for offshore wind from between 6% and 10% to between 4% and 8%. For its oil and gas projects, it projected an IRR of 30%, with a payback time of 1.5 years.
Still, the company plans to devote 50% of its capital expenditure to renewable energy.
Teodor Sveen-Nilsen, an analyst at Norwegian investment bank Sparebank 1 Markets, said the market reaction to Equinor's announcement was not a shock.
“Equinor was priced high earlier, and analysts like me had to reduce our earnings expectations after the presentation,” he said.
Sveen-Nilsen said Orsted's stock price decline is probably related to the long-term payback from its projects in an environment in which the investors are expecting inflation and higher interest rates.
In June, it became clear that Orsted had changed the metric for rate of return guiding. An illustration in the company’s capital markets day presentation suggested that IRR for future projects would be lower, but did not indicate how much it had been reduced from last year's guidance of 7.5% to 8% IRR.
While Orsted did not offer any reasons for the change, Equinor has said the main factors in lower expected returns from offshore wind are related to increased competition and higher cost of materials.
In established markets such as the US and Europe, the company now expects IRR at the lower end of the 4% to 8% range, while emerging markets will be at the higher end.
Orsted and Equinor are looking towards emerging markets to increase profitability for future offshore wind projects.
However, according to a June International Energy Agency report, a massive obstacle for clean energy in emerging and developing economies is the cost of capital, where investments face debt and equity costs up to seven times higher than in the US or Europe.
This can cause challenges for Equinor’s and Orsted’s business models with up to 70% project financing.
Equinor chief executive Anders Opedal has said its offshore wind ambitions are flexible, as the company is more concerned with profit than volume.
However, a spokesman told Upstream that more than half of the company’s gross investment will go to renewables and low-carbon technologies such as hydrogen and carbon capture and storage.
“Investments in oil and gas will remain the backbone of Equinor for a long time, but our goal is to become a broad energy company, as we believe this will create most value for our owners,” he said.
Equinor believes the timing is right for increasing its ambitions within renewables. The spokesman said offshore wind power has a lower risk profile, which means lower returns, and it wants to continue with farmdowns to improve returns.
He said the farmdowns are not incompatible with the company's goal to have 12 to 16 gigawatts of renewables production in its portfolio by 2030, from the current 600 megawatts of installed capacity and 1.8GW installed and under construction.
“Our goal of 12 to 16GW Equinor share production within 2030 is based on our current portfolio, especially in UK, US and Poland. And we now see opportunities in Asia, especially in South Korea,” he said.
Contracts for difference and power purchase agreements have contributed to low price risk for offshore wind in Europe.
For new projects, these mechanisms are expected to disappear.
However, the Equinor spokesman said this will not automatically increase risk for new projects or affect the required rate of return.
In the June presentation, Equinor also raised concerns about winning bids by BP and TotalEnergies, along with Germany's RWE and EnBW, in the UK's Offshore Wind Leasing Round 4 in February, which Upstream has learned were much higher than Equinor's.
(This article has been amended to correct Equinor's current renewable energy production and installed and under construction capacity.)