BP’s first venture into the offshore wind market provides a floor for the company’s promise of reasonably robust returns on renewables investments, a modelling exercise by equity research firm Redburn has suggested.

The UK giant on Thursday agreed to pay $1.1 billion for a 50% stake in Equinor’s Empire Wind and Beacon Wind projects, located off the states of New York and Massachusetts, respectively.

Empire Wind will provide 2 gigawatts of power-generation capacity, about 800 megawatts of which is due onstream in 2024 and a second phase preparing for solicitations, while permitting reviews are beginning for Beacon Wind, which will have potential for more than 2.4 gigawatts.

Energy transition drive

BP reset its course towards the energy transition this year and is pursuing a strategic objective of net-zero carbon emissions by 2050.

The supermajor recently announced plans to invest $5 billion annually in renewable energy, aiming to reach 50GW of capacity by 2030, up from just 2.5GW in 2019.

These objectives are underpinned by expected returns of 8% to 10% from its low-carbon electricity investments, while legacy investments in oil and gas are supposed to sustain overall returns at 12% to 14% through to 2030.

IRRs under scrutiny

Redburn’s modelling suggested that the first phase of Empire Wind should supply an overall rate of return (IRR) of 6.8%, rising to 9% if project financing were to cover 70% of capital expenditure.

The model — which assumes $3 billion of gross capital expenditure and a disclosed 25-year power purchasing agreement offering a strike price ranging from $99 per megawatt-hour to $159 per MWh — produces different results following Equinor’s sell-down.

In BP’s case, Redburn assumed that two-thirds of the $1.1 billion consideration relates to Empire Wind Phase 1, and factored in development capex to come up with an IRR of 3.4%, rising to an equity return of 6% if the project is 70% project-financed.

For Equinor — which acquired the Empire Wind lease in 2016 for $42.5 million — Redburn calculated an equity return of 14%.

“This is a good return and actually matches or betters most oil and gas projects” Redburn’s Stuart Joyner told Upstream.

“For BP, the IRR is not much more than the cost of capital but this is just the first move into a partnership. We can see this deal as providing a floor for IRR, leaving scope for using debt or subsequent M&A transactions to improve the overall return.”

With BP’s consideration due in in the first quarter of 2021 and Beacon Wind’s original acquisition price of $135 million, Equinor is set to make a $1 billion gain on disposal for the whole transition.

In BP’s case, Redburn said options for a second-phase development of Empire Wind (600 MW net to BP) and future development of Beacon Wind (1.2 BW net to BP), together with de-risking and selling-down of stakes, could allow the UK giant to book a future gain of more than $1.1 billion, boosting the overall return on equity to more than 8%.

These numbers — which Redburn acknowledged to be “back of the envelope” calculations — address concerns about the capacity of BP’s strategic shift toward renewables to wipe billions of dollars off its market value.

New, long road ahead

BP chief executive Bernard Looney has chosen energy transition as the strategic aim and has promised to “reinvent” BP, and claims to be responding to demands from a civil society that sees fossil fuels as the main driver of climate change.

BP is one of several European oil and gas companies moving forward with clean energy strategies despite the economic fallout from the coronavirus pandemic.

Recipe for success? BP boss Bernard Looney is cooking up something new at the UK supermajor Photo: RYTIS DAUKANTAS/UPSTREAM

The company has cut dividends to shareholders while telling investors to expect a gradual reduction in hydrocarbons output and more spending on low-carbon energy.

“The onus will ... be on BP at its strategy update next week to provide more detail on how the company plans to create value from such transactions,” Redburn stated.

Biraj Borkhataria, an analyst at Royal Bank of Canada, estimates that BP will have to spend about $60 billion to achieve its renewables target, assuming an even split between offshore wind and solar power production.

On the assumption that 70% of that amount can be raised through project financing, BP would need to make net capital spending of $18 billion over the next decade, he says.

Equinor and BP’s deal — closure of which is expected in early 2021 — was also framed as a strategic partnership to pursue other opportunities in US offshore wind.

In an interview with Upstream’s sister publication, Recharge, Equinor’s executive vice president for New Energy Solutions, Paal Eitrheim, said the wind deal with BP will free up financial capacity to help accelerate the company’s growth in renewables.

Low carbon: BP's vice-president for gas and low carbon energy Dev Sanyal Photo: BP

BPs executive vice president for gas and low carbon energy, Dev Sanyal, said the partnership will "leverage BP’s trading expertise and onshore wind experience with Equinor’s sector-leading track record in offshore wind to deliver value for our shareholders".

He added: "We look forward to working with Equinor and together exploring further opportunities in the fast-growing US wind market.”

Equinor aims to raise its own renewables capacity to 16 GW by 2035, with a strong focus on offshore wind in the North Sea, the US and the Baltic Sea.

Man on emission: Bernard Looney is making sure BP gets its energy transition skates on Photo: RYTIS DAUKANTAS/UPSTREAM