By Bryony Collins, Bloomberg New Energy Finance editor. This article first appeared in BNEF’s ‘New Energy Deals’ publication, available to clients on the web and on the Bloomberg Terminal.

Dong Energy said it is confident that financial investors will be prepared to buy equity stakes in the 480MW of German offshore wind farms, which the company won the rights to build thanks to record-breaking zero-subsidy bids in an auction in April.

Martin Neubert, chief strategy officer at the wind power division of the Danish company, told BNEF that the three offshore wind projects in the German North Sea would be suitable for Dong’s ‘farm-down’ approach, in which it sells equity stakes pre-construction to outside investors in order to free up its own capital for further projects.

Investors have previously shown they are willing to take on a certain degree of merchant price risk when committing capital to German

renewable energy projects, “which typically only had a very short feed-in tariff period compared with the full lifetime of the asset,” he said in a telephone interview. And Dong Energy has also shown that asset rotation works with U.K. projects built using Renewables Obligation Certificates that “have a very significant merchant price element”, he added.

The farm-down model, otherwise known as asset rotation or build-sell-operate, involves utilities selling stakes in green power assets to institutional investors seeking long-term, stable yield. In the case of renewable energy, revenues for such projects have, until now, been underpinned by guaranteed subsidies.

By bidding to build two 240MW offshore wind projects with no subsidy on top of the wholesale power price, Dong Energy has demonstrated the vastly improved economics of the technology, but has also increased the electricity price exposure for future investors. According to Neubert, the change is not representative of a “complete paradigm shift.” Investors have shown they are comfortable with merchant price risk in certain situations, he said. Neubert also said that it would signify a “fundamental market failure” were power prices to differ substantially from what the company has forecast, when the time comes to make a final investment decision on the recently-contracted German projects in 2021. Markedly low power prices would present a problem for the energy industry as a whole, not just offshore wind, Neubert said.

By 2024, when the three projects are scheduled to begin operation, Dong expects turbines of 13-15MW in size to be available – enabling it to increase power production and reduce installation time – while the option to add additional volume to the contracted wind farms in next year’s auction will also help to achieve cost reduction through scale. Neubert spoke about optimal project size and offshore wind development in the U.S. and Taiwan in the following interview with BNEF.

Q: How will the absence of a stable revenue stream from the zero- subsidy bids won by Dong Energy in Germany’s offshore wind auction

impact the company’s farm-down model?

A: Firstly: We have a bit of time until we will build these projects in Germany, which is not before 2024. Secondly: Obviously with a higher merchant risk, that element needs to be priced, but this is exactly what we have reflected in the economics underlying our bid. Infrastructure investors think in the same way as us – looking at the risk/return picture and this needs to make sense for them. Thirdly: It’s not that as we for those German projects move into a subsidy-free world and suddenly people are comparing this to having before had 20 to 25 years of a secured FiT [feed-in tariff]. Looking at our current portfolio and where we have actually done farm downs… The revenue of U.K. projects built using ROC certificates have a significant merchant price element already. And where we have farm-down projects in Germany – under the current compression regime – there is a FiT model for around 8 to 9 years. However, investors have been coming in for the lifetime of the project, for typically 25 years.

Q: So investors are willing to take on board a certain amount of merchant power price risk?

A: That is what you can see with U.K. ROC projects and with German projects, which typically only had a short feed-in tariff period compared with the full lifetime of the asset. It’s not like we have a complete paradigm shift here.

Q: What would happen if the power price trajectory you have forecast by 2024 isn’t reached and prices are actually lower than anticipated?

A: First of all, we made it very clear after the auction that we have not been betting on high power prices. We have moderate power price assumptions, and we are not betting on a revival of the ETS (Emissions Trading System). However, if the prevalent market price when we need to take a final investment decision is very different from what we assumed, then we have the option not to build. The penalty we would have to pay is 59 million euros ($66 million) for the 3 projects, or 100,000 euros per megawatt. If we could not economically build in 2024 due to power market conditions, it would not [only impact] Dong Energy’s offshore wind projects, it would basically mean that you cannot economically build new power generation projects, whether conventional or renewable anymore in Germany. It would be a fundamental market failure.

Q: Is combining projects located near to one another a new tactic for reducing cost?

A: Certainly, offshore wind has been a scale-play and will continue to be. The logic of the auction in April in Germany was to combine projects. The three that we won aggregate together close to 600MW, while stand-alone they are sub-scale. That matters a lot to get that scale. And that’s what you’re starting to see happen in other markets – the Dutch regulator tendered individual 350MW projects last year together as combined projects of 700MW in scale.

Q: What are the key factors that enable you to reduce cost with such large projects?

A: The more components you can acquire, the more you get synergies in scale and reductions in cost. The installation and mobilization of logistics is a large fixed cost and if you can allocate that over a larger project of 600-800MW, then the incremental per-unit cost becomes relatively small. It doesn’t make sense to build 2,000, 3,000 or 5,000MW projects – there is a limit of where you will not see additional scale benefits but increased complexity. Between 700 and 1200MW is probably the optimal size of a project in today’s world.

Q: In the U.S., Maryland and Massachusetts have already committed to offshore wind, and New York is expected to commit in 2017. What other states are interested?

A: We focused on Massachusetts as our entry point to the U.S., and now we know there will be a RFP [request for proposals] auction coming up in December. There, the regulator has asked developers to submit bids for 400MW, but bidders can propose as low as 200MW and as high as 800MW. We also have a large-scale project [under development] in New Jersey. We are quite hopeful that the state will recognize the momentum built up around the U.S. East Coast for offshore wind and that they will join the train as Massachusetts, Maryland and New York have done. New Jersey has a regulatory and legal framework for developing and building offshore wind but it has not been activated yet, not least as the current governor [his term will expire in 2017] has not been promoting the technology. We hope this will change. There was also an auction in North Carolina in March where a site was tendered – Iberdrola won the auction for approx. $9 million. It proves the increasing confidence in U.S. offshore wind. Also, the Bureau of Ocean Energy Management (BOEM), which is now under the new administration, has publicly stated that it intends to run more lease auctions in Massachusetts and New York. So it’s not like since President Trump took office, BOEM has refrained from doing anything on the offshore wind side. If you look at it, offshore wind can tick quite a lot of boxes that the Trump administration has made priorities. Whether you’re looking at building domestic energy sources, renewing energy infrastructure, or creating long-term sustainable and qualified jobs in the U.S. – all of these are boxes that offshore wind is perfectly capable of ticking. The reduction of carbon emissions, and offshore wind as a scale solution for that, is not so much an agenda point in Washington, but it’s very much an agenda point in all the states and given that climate policy is very much decided in the states, we do not see a slow-down of the offshore wind agenda in the U.S. – to the contrary.

Q: How will building offshore wind parks in the US be different to Europe?

A: Experience from Europe shows that you need steady build-out volumes to attract supply chain commitments. That is what key policymakers are also realizing. [Massachusetts is on track, launching its first RFP auction in December, and the state aims to install some 1,700MW by 2027]. And in terms of supply chain this still needs to be developed in the U.S., but unlike other countries the U.S. East Coast has a large industrial base and history.

Q: What is the timeframe for project development in Taiwan?

A: There is promising development in Taiwan. Over the past 18 months, there were more than 30 sites earmarked for development – all of which have been taken. A number of new, established players from the rest of the world have entered Taiwan and there is a lot of development going on. The government is very committed to achieving their target of installing at least 3,000MW by 2025. And there’s more than 10,000MW currently under development. They are looking to reach proof-of-concept stage, not only with a view to decarbonizing their energy industry, and doing a transition away from nuclear, but also they are expecting this to trigger local employment and boost their local

industrial economy.

Q: What advantages does offshore wind present over onshore wind and solar?

A: The load profile of offshore wind is much higher and much more stable throughout the year – we produce on 350 days a year with an average capacity factor of more than 50%, which makes offshore wind a renewable energy source with baseload characteristics. In comparison, the load factors for solar PV in northwest Europe is [10-15%] and [20-30%] for onshore wind.