Equinor's investment in Dogger Bank — the world's largest offshore wind project under construction — will be unprofitable, according to a Norwegian government-funded study.

The new research raises challenging questions about the Norwegian state-controlled oil and gas giant's energy transition strategy.

The study was submitted this month to Norway’s Petroleum & Energy Ministry, which financed it as part of wider research into potential energy transition opportunities for the country.

Equinor chief executive Anders Opedal set ambitious new goals in June for the company to step up its investments in "renewables and low carbon solutions" to more than 50% of its gross annual investments by 2030.

Equinor sees the Dogger Bank project in the UK North Sea as a world-class asset that benefits from strong wind conditions, innovations and unprecedented scale: It will have 3.6 gigawatts of installed capacity when completed.

One of the study's authors told Upstream that the massive project's rate of return does not exceed Equinor's rate of return requirement, so the researchers deem the project to be unprofitable.

“In our estimate, Dogger Bank is unprofitable,” said University of Stavanger professor Petter Osmundsen. "The project has to compete with alternative investment opportunities."

Equinor has not disputed the study's conclusions, but emphasised that it had benefited from selling stakes in the project.

Osmunden expressed confidence in the study's conclusions, while acknowledging the researchers had relied on a number of assumptions, public information and industry norms in creating it.

Equinor would do better to focus on other types of clean energy projects with higher entry barriers more aligned with the company's competence, he said.

"Committing to a very large capacity in bottom-fixed offshore wind is putting too many eggs in one basket — possibly also not in the right basket," he said. "Low entry barriers and highly competitive bidding would make it hard to earn a resource rent."

Promising business segments

Equinor is entering new business segments that look more promising for the company than bottom-fixed offshore wind, Osmundsen said, such as seabed minerals, carbon capture and storage, clean hydrogen, and perhaps floating offshore wind.

Equinor emphasised to Upstream that it benefited from Italian energy company Eni buying into Dogger Bank as a partner.

“Equinor entered Dogger Bank early, and the farm downs to Eni demonstrate the value of accessing early and maturing assets before farm downs,” a company spokesperson wrote in an e-mail response to Upstream's questions.

Equinor is in charge of operations for the UK North Sea project, while Scotland-based partner SSE leads the project's construction and Eni is an industrial partner for all three phases of the wind farm. Equinor and SSE each hold 40% stakes in the project, while Eni holds 20%.

Offshore wind challenges

The rapidly expanding offshore wind industry anticipates project construction costs will come down as scale increases, offering robust investment returns.

Costs have indeed come down for the bottom-fixed Dogger Bank and other offshore wind projects, but not at the same pace as strike prices have fallen in UK offshore wind auctions, according to the study.

Strike prices are a government-guaranteed price for electricity that will be generated from the project, which is awarded to the lowest bidder. Strike prices protect the developer from prices falling too much and protect consumers from prices rising too much.

Equinor's bigger wind turbines, low prices for raw materials and limited competition helped the company generate solid profit from its larger early offshore wind projects.

That climate has since changed, as the world's largest player in the segment, Orsted of Denmark, has warned about supply-chain blockages and higher raw material prices. Increased competition for new licences also has significantly reduced strike prices in auctions.

Negative net present value

The researchers calculated the Dogger Bank project's expected net present value (NPV) at minus £970 million (minus $1.3 billion). A negative NPV indicates that the value of the investment is below the rate of return which the company should require from its investments.

They calculated the expected internal rate of return (IRR) on total capital in the Dogger Bank project at 3.6%, in real terms, with a payback period of 17 years. IRR is a method used to compare relative profitability of projects.

Oil and gas projects' internal rates of return often are much higher than for offshore wind, which is not exposed to the volatility of oil prices because of power price guarantees.

The researchers applied industry norms and based their estimates on assumptions about capacity factor, operating and decommissioning costs, and the electricity price for the last 10 years of production.

"Public information from the project gives detailed information about capital expenditure, production capacity and prices for the first 15 years of production," Osmundsen said.

In June, Equinor reduced its expected rate of return for offshore wind to between 4% and 8% (excluding farm downs), from 6% to 10%, but the new study finds that Dogger Bank might end up below the revised range.

Upstream and sister publication Dagens Naeringsliv requested an interview about the study with Equinor’s head of renewables, Paal Eitrheim, but he was not available.

Equinor emailed written comments about the study to Upstream.

“We do not communicate net present value on project basis. However, at our capital markets day we gave an interval for expected returns," an Equinor spokesperson wrote.

"We expect project base-returns between 4% and 8% real with mature markets such as the UK at the lower end of the range and emerging markets at the higher end.”

Equinor has long stressed that offshore wind has a very different risk profile than oil and gas, with more stable revenues.

However, with a fixed price for the power produced, there is also little potential upside, and costs recently appeared to be rising for some other wind power businesses — not falling.

For example, Danish wind installation giant Orsted warned in a third-quarter earnings statement about difficult conditions due not only to weaker-than-usual winds, but also supply-chain difficulties and delays in manufacturing.

Supply-chain instability and rising energy prices — as well as accelerated cost inflation for raw materials, transport and turbine components — also impacted the profitability of leading turbine manufacturer Vestas.

Equinor’s spokesperson acknowledged that the company's projects can be affected by global trends for the cost and availability of inputs, but added that there are contractual mechanisms in place to balance the risk between supplier and developer.

Farming down in offshore wind

Equinor has previously had success in farming down within offshore wind. The sale of a 50% share of Empire Wind in the US was seen as a particularly successful sale.

However, there is still little sign of Dogger Bank boosting profitability significantly for Equinor and SSE, which made two sales to Eni of different parts of the UK project.

After the first sale to Eni, Equinor and SSE increased their internal rate of return to 4.2%, according to the University of Stavanger research.

At Upstream's request, the researchers also calculated the effect of the recent sale.

“After the second sale, where the payment per megawatt is down some 30%, the rate of return increased to 4.4%,” Osmundsen said, adding that the researchers have assumed the three phases are equal.

Equinor's spokesperson acknowledged that the company received less for the third phase of the project, but said there are site-specific conditions for this phase, including a different layout leading to lower production factors than phases A and B, distance from shore and water depth meaning capex per kilowatt is higher.

"Increased corporation tax rate is another element," he said.

Norwegian researchers behind the study

Professor Petter Osmundsen and associate professor Sindre Lorentzen, both from University of Stavanger, and Magne Emhjellen-Stendal, senior advisor in Petoro with a research collaboration with University of Stavanger, have analysed profitability for developers of bottom-fixed offshore development projects, using Dogger Bank as a case study. The report is part of a research program funded by the Norwegian government to explore energy transition opportunities.

Why do the Norwegian researchers deem Equinor's Dogger Bank wind farm to be unprofitable?

Whether the project is profitable, depends on the rate of return requirement. Compared to an International Energy Agency rate of return requirement from 2018 of 6.55%, the Dogger Bank project is not profitable. The same applies with the suggested 6% requirement from 2020 by the UK Department for Business, Energy & Industrial Strategy (BEIS).

While it is normal to use one discount rate, the researchers argue for two rates for this kind of project. One rate for the first 15 years of fixed electricity prices given by the UK contracts for difference (CfD) calculated at 3.9%, and one rate for the period of market price (6.5%). The researchers conclude that with their assumptions, the project is unprofitable, with an expected net present value of minus £970 million.

The UK strike price has fallen drastically, from £114.39 per megawatt hour in the 2015 CfD auction to the 2019 Dogger Bank award of £39.650/MWh for phase A and £41.611/MWh for phases B and C (all in 2012 prices).

Other researchers, who have observed the dramatic reduction in the strike price awarded after aggressive bidding, conclude that very significant cost reductions are needed to safeguard project economics. One way of achieving this, these researchers argue, is for investors to reduce the rate of return requirement. The internal rate of return for offshore wind farm developers is now only half of what it was six years ago.

(Ole Ketil Helgesen is Upstream's Norway energy reporter. Morten Aanestad and Mikael Holter are reporters for Upstream's sister publication, Dagens Naeringsliv.)

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