We believe offshore wind has the highest growth potential of all power generation assets over 2025-2030, and will likely shape the credit profiles of rated European electricity producers.

Why it matters:   Massive investments are required, implying increased credit risk. Some electricity producers carry 50%-100% of the cost of wind power development and spending could rise to €10 billion or higher for individual projects. Also, bidding on capacity auctions has often resulted in low strike prices per megawatt hour of electricity in contracts for difference (CfDs; see "European Electricity Producers' Credit Quality And Revenue-Support Contracts: It's Complicated," published July 10, 2024).

What we think and why:  As the size of wind power projects grows, rising development and generation costs will depress electricity producers' profitability. We expect lower power prices over 2025-2027; therefore average credit quality might weaken. Massive cost overruns or delays could also lead to rating pressure for some companies, unless CfDs support strong free cash flows.

The Size Of Offshore Projects Has Increased Markedly In Recent Years

The majority of the current project pipeline relates to windfarms with generation capacity of 1 gigawatt (GW) or more (see charts 1 and 2). No project of that size existed five years ago. In total, the pipeline has nearly quadrupled in size since 2019. At the same time, intensely competitive and sometimes costly bidding on capacity auctions has resulted in low strike prices per megawatt hour of electricity in contracts for difference (see "European Electricity Producers' Credit Quality And Revenue-Support Contracts: It's Complicated," published July 10, 2024).

Chart 1

Chart 2

Offshore wind is a material contributor to the energy transition, accounting for an increasing share of the energy mix in the EU and U.K.  In the EU, 19.4 GW of offshore wind power capacity had been installed as of year-end 2023 and 14.8 GW in the U.K. Offshore wind power now represents 4.0% of Europe's electricity mix (10%-24% for the leading countries: Denmark, the U.K., Netherlands and Belgium).

We expect these shares will keep increasing on the back of ambitious policy targets.   The EU and U.K. target more than 110 GW of wind power capacity by 2030. The U.K., already Europe's leading offshore wind market (see chart 3) and the world's largest after China), has the most ambitious target after the new government, installed in July 2024, increased it to 55 GW to 60 GW from an already challenging 50 GW.

Chart 3

Europe's targets for offshore wind power are also impressive, at about 4x today's capacity, which implies a sharp acceleration in capacity additions over 2025-2030 (see chart 4). Most of the expansion relates to contracts awarded in 2023 or 2024 and will typically be commissioned in 2030 or 2031, assuming timely grid connections. There is a timing gap compared with existing construction plans and ambitions (see chart 4).

Chart 4

In 2023, about 4.2 GW of new offshore wind power capacity was installed in the EU and U.K. combined (2.9 GW in the EU and 0.8 GW in the U.K., according to Windpower Europe). Although an increase from previous years, this is well below the approximately 10 GW-11 GW of offshore wind power capacity additions needed per year for the EU to achieve its target of at least 42.5% renewable energy by 2030.

We are doubtful that certain policy targets will be met, since European power producers face rising construction and financing costs, as well as long permit processes.   Offshore wind will undoubtably continue to expand rapidly over 2025-2030. However, the large number of planned projects and substantial aggregate size (see charts 5 and 6) suggest sustained pressure on Europe's supply chain to deliver on a timely basis. Softer power prices and less robust support schemes increase the risk attached to such investments.

Chart 5

Chart 6

Europe's Offshore Wind Power Buildup Benefits From Tailwinds

Expansion of offshore wind power capacity is a critical component of the EU's goal of achieving net zero emissions by 2050. The development of renewable energy therefore forms part of the European Commission's "Fit For 55" package of measures to reduce carbon dioxide emissions in the EU by 55% from the 1990 levels by 2030, and become carbon neutral by 2050.

These ambitions are supported by several factors:

Industry knowledge.   European industries and companies were early to invest in offshore wind, hence it now has the required development and technology know-how, as well as infrastructure. Production costs have also decreased rapidly over the past few years, making offshore wind more competitive.

Europe's favorable weather and conditions link to the depth and floor of oceans.   In line with this, we see average capacity factors reaching the 40%-50% range for many wind farms. Unexplored seafronts, such as the Polish and Scandinavian areas of the Baltic sea, and pockets of the Mediterranean Sea and Iberia's Atlantic Coast, are further areas for expansion. However, some of these areas could have lower load factors (which measure the efficiency of energy usage) and generally weaker wind resources than the North Sea.

• Offshore wind is one of the best alternatives for expanding or replacing generation capacity besides onshore wind and solar. Albeit increasing, the levelized cost of electricity (LCOE; average net present cost of generation) is lower than for nuclear-powered electricity, and available options to expand hydropower capacity are limited. The buildout of wind farms is quicker than for nuclear plants.
• Offshore wind can typically be built close to large cities and industries, since they tend to be near the coastline. But the advantage of this is limited, since the fixed cost of offshore connections, regardless of the distance to the shore, is high: a 1 GW-2 GW converter station alone can cost €0.5 billion-€1.0 billion.

Hurdles To Expanding Offshore Capacity Have Increased

Over the past year, we've seen developments that we believe could hinder expansion of offshore wind power in line with policy targets:

Supply chain issues increased in Europe in 2022-2023, and costs have risen rapidly.   These include finance, raw material, and construction costs. As a consequence, Vattenfall stopped its project in Norfolk in 2023 (combined capacity of 4.3 GW), which it later sold to RWE. In May 2024, SSE reported that its 1.2 GW Dogger bank project phase A had been delayed by one year due to poor North Sea weather, installation vessel availability, and supply chain delays.

Rapid wind power capacity expansion will require similarly rapid expansion of grid capacity.   We already see bottlenecks related to this. For example, three of the planned new offshore grid connection systems in the German North Sea are delayed by up to two years, according to Renewables Now in January 2024. Offshore connections represent a considerable proportion of power transmission system operators' spending in the Netherlands and Germany. In another example, TenneT expects to spend about €16 billion per year on its Dutch and German networks, primarily offshore, in efforts to reduce curtailments (see "European Electricity Producers' Credit Quality And Revenue-Support Contracts: It's Complicated," July 10, 2024).

Permitting and licenses for renewable projects are still complex throughout Europe.  For example, in the U.K.'s fifth licensing round in 2023, no company put in a bid, likely as a reaction to huge cost inflation. This implies that even the maximum auction price was considered too low. In the following round, the U.K. government increased the maximum guaranteed price (or strike price) to £73 per megawatt hour (/MWh; expressed in 2012 money value), a hefty 66% increase from £44/MWh. In the end, the outcome released on Sept. 3, 2024, highlighted a strike price of £78/MWh in 2024 money on 3.4GW of capacity and an additional £74/MWh on 1.6GW of capacity. We consider these outcomes as supporting the economics of newbuilds, since they significantly exceed current U.K. futures power prices. We expect strike prices can be sustained after being on a downward path during the previous decade (see chart 7).

Chart 7

Technical risks are still material, and the complexity of projects is increasing.   The size of wind turbines and sweep areas, which determine how much wind the rotor can capture, continue to expand. Projects are also becoming larger, implying more capital will be required. This means exposure to single projects is becoming significant, even for the largest operators. Under such a scenario, material cost overruns or delays are therefore more likely to have a negative rating impact. An example is Orsted, which was downgraded to 'BBB' in February 2024 following impairments and cancellation costs of Danish krone (DKK) 36 billion (about €4.8 billion) predominantly related to Ocean Wind 1 in the U.S.

A Massive Rampup Of Projects Is On The Way

Despite the hurdles, we expect investment in the European offshore wind industry will rise rapidly to about $270 billion on aggregate over 2024-2030, more than double that in 2020-2023 (see chart 8). Combined, the projects of Europe's eight largest offshore wind power players represent about 42 GW of capacity. This is nearly as high as the EU's and U.K.'s current combined 49 GW of installed capacity.

There could however be material changes to project pipelines, since not all projects result in commissioned wind parks. At any rate, Europe, along will China, will likely show the highest absolute project growth in the next five years. What's more, we believe offshore wind will be a key component of Europe's ambitious green hydrogen strategy, which targets production of 10 million tons a year by 2030.

Chart 8

Of the renewable energy technologies, offshore wind is set to post one of the highest growth rates in Europe during 2025-2035.   Large European offshore wind operators like Orsted, Iberdrola, RWE, and EnBW, are in our view well placed to retain a chunk of investment opportunities in the coming decade. Smaller utilities and various financial investors may increasingly participate but are unlikely to be drive any large project, given the risks inherent to financing single projects costing several billion euros. S&P Global Commodity Insights forecasts more than 16,000 MW of new clean energy sources across Europe by 2030 (see chart 9).

Chart 9

As the size and power of turbines and wind farms increase (see chart 10) to achieve economies of scale and stronger load factors, we observe many developers recycling capital. They do this by selling stakes in assets to investors at various stages of development. Although this may spread risks in a credit-supportive manner, it also tends to increase complexity because companies' asset composition and capital at risk are continuously evolving.

Chart 10

Europe and China will continue to lead the offshore wind power industry in 2025–2030.   According to S&P Global Commodity Insights, mainland China and Europe accounted for 51% and 46%, respectively, of the total installed offshore wind power capacity in 2023. Although China has not disclosed a target, it is expected to remain the largest offshore wind market in the world, closely followed by Europe. We note, however, that strong operators in the Middle East, like Masdar in the United Arab Emirates, are increasingly active in the industry. Europe's strong position depends much on its early start, combined with its drive to achieve net zero emissions. Despite this, in 2022 there was almost no investment in Europe, and less than 5 GW was financed annually on average over 2021-2023 (see chart 11), highlighting the mismatch between investment and political ambitions.

Chart 11

We believe Orsted, RWE, Iberdrola, and SSE will likely continue to lead the field in Europe.   These companies together hold the most capacity for wind-powered electricity in Europe on a net pro rata basis, our key indicator, as opposed to gross capacity. They are also correspondingly the biggest spenders (see chart 12).

Chart 12

Despite a strategic downward revision of its long-term ambitions in early 2024, Orsted looks set to remain the strongest wind power producer (see chart 13), along with RWE (not rated) and SSE. At the other extreme, based on project pipelines (planned and permitted), several companies with limited experience and project assets are planning large expansions (see chart 14), which raises doubts about whether all projects will be realized. Iberdrola also has a large pipeline under development and is likely to remain one of the largest operators. Beyond utility companies, oil and gas players--notably Equinor, Total, and BP--are becoming more visible in the wind power industry, based on their project portfolios. That said, in June 2024, BP paused new offshore wind projects and renewed its strategic emphasis on its traditional oil and gas investments. Vattenfall's pipeline declined markedly following the sale of its Norfolk offshore zone in the U.K. to RWE.

Chart 13

Chart 14

Europe's largest power producers have built a pronounced competitive advantage related to project construction, supply chain management, procurement, weather forecasting tools, and asset maintenance optimization.   They also have a competitive advantage in the installed asset base, which allows for secured cash flows from the favorable long-term pricing mechanisms in place. Each strategy differs somewhat however, and none of these companies aims to become a global operator. The most abrupt strategy revision came from Orsted in 2023 following its write down of close to Danish krone (DKK) 40 billion (about €4.8 billion) in the U.S.; we understand Orsted's expansion will focus more on Europe in future.

Increasing Costs Undermine Profitability

In the years preceding 2023, we saw increased competition in Europe's wind power industry, with negative prices and the entrance of oil and gas companies. Projects were without subsidies and prices very competitive. For example, in 2023, oil majors BP and TotalEnergy paid a combined €12.6 billion for the rights to build three wind farms in the North Sea totaling 7 GW of capacity, equivalent to a substantial cost of €1.8 million-2.07 million per MW of capacity. The farms are expected to be completed by 2030.

Competition for auctions might be abating to some extent, since operators, including oil companies, are becoming more aware of increasing costs and balance-sheet impacts.   To illustrate, in the U.K., there was no bidder for the 10th license round, and the 11th has been postponed. In Germany's June 2024 auction of the N-11.2 and N-12.3 sites, EnBW and Offshore Wind One Gmbh won a combined 2.5GW of offshore wind power capacity at €1.0/MW-€1.1 MW, despite a well-participated process with 46 and 55 auction rounds respectively (source: Results of Offshore Tenders from Dynamic Bidding Procedures; bundesnetzagentur.de).

In the U.K., auction winners have material costs for seabed leases.   This likely reflects the government's attempt to speed up the process between awarding the license and the start of construction. Auction winners need to pay a material price for seabed leases, even if they subsequently do not take a final investment decision (FID).

For example, in the U.K.'s fourth seabed lease auction round, we estimate that RWE, BP, and EnBW will each pay £154 million-£164 million annually until their FID on certain projects. We understand financial statements typically capitalize such amounts instead of expensing them, leading to write-offs if no FID is taken. Depending on the project's size and assumptions on load factors, we estimate this adds roughly €10/MWh of costs during an assumed 25-year production lifetime.

Comparisons are difficult across projects, depending notably on seabed lease costs, negative bidding, and who is responsible for building the quite expensive connections to the shore.   Power producers can face capital expenditure for connections to the shore alone of up to €1 million per MW, or even higher, based on our observations on certain U.K. and French projects. By contrast, in Germany and the Netherlands, transmission system operators are responsible for the connection, depending on the distance to shore, nature of the seabed, and other factors. Only gradually are plans emerging for hybrid interconnectors, which get closer to offshore grids than point-to-shore connections; a pioneering project in that field is Belgium's Princess Elizabeth artificial island, which has begun construction. In our view, financing is one of the blind spots in the unification of Europe's power markets via cross-border interconnections (see "Europe's Power Push: Can Project Finance Help Fund Interconnections?," Nov. 16, 2023).

For plants commissioned in 2024, the nominal average cost to produce electricity from a fixed-bottom offshore wind farm is about €74/MWh on average in Europe.   We expect the LCOE to increase further and average about €77/MWh during 2024-2030, a hefty 26% increase from the 2020-2023 average (see chart 15). This, we expect, is a temporary departure from the trend of declining renewable costs, but it may lead to postponement of investments to preserve credit quality. After the peak in wind turbine prices signaled by orders made in the past two to three years, we expect the LCOE to start reducing again from 2027 or 2028. This may not bring a definite improvement in projects' profitability metrics however, since power prices are also reducing (see "Europe's Power Producers Continue Their Balancing Act As Electricity Prices Stay Low," July 10, 2024). In addition, there are material differences in LCOE across projects, among other things depending on load factors.

Chart 15

While lacking maturity at this stage, floating offshore wind projects may allow for accelerated growth and capture more wind resources.   But we don't foresee this fairly new approach taking off until the next decade. The technology still has some way to go to become economically viable, although it promises a reduced need for building foundations on the seabed, quicker installation and decommissioning, as well as wind power generation at greater water depths. The current LCOE exceeds €150/MWh, which isn't as competitive as other technologies (see chart 16).

Chart 16

This technology, which features an offshore wind turbine mounted on a floating structure, allows for electricity generation in deeper water where fixed-bottom structures are not feasible. According to WindEurope, floating installations can unlock 60% of Europe's offshore wind resources. They will allow the decarbonization of energy systems for the region's islands and coastal regions in waters deeper than 60 meters, including the Mediterranean, the Atlantic coast, and the coasts of Scotland and Norway. Recently, France has awarded what is said to be the first commercial-scale floating offshore wind power auction, with 250 MW of capacity off the south of Brittany (AO5). The winning bid was awarded at €86/MWh (excluding the grid), and the contract for difference is indexed to inflation. These conditions are unlikely to be representative for future floating offshore wind auctions, however. At the same time, we understand that Norway, Portugal, and Spain have postponed their first floating offshore wind auctions (source: WindEurope).

Unmitigated Merchant Risk Still Weighs On Credit Quality

Generally, wind power projects applicable for our project finance criteria, and with unmitigated merchant risk, don't display investment-grade quality ('BBB-' or higher).

One of the most credit-dilutive features of such projects is that power prices are extremely volatile and increasingly difficult to forecast.   Electricity prices may also change quickly over a short period and are ultimately strongly influenced by gas prices, which are still relatively unstable. Projects are also becoming larger (see chart 17). In view of the envisioned structural change in Europe's energy market, historical correlations may not be indicative of future performance.

Chart 17

Another constraint is the rising share of low marginal-cost renewables, which could imply a long-term decline of power prices in real terms.   In addition, price cannibalization could weaken projects' creditworthiness as the share of zero-marginal-cost renewables rises, since hourly electricity prices will probably drop to below €10/MW more frequently. This risk arises due to excess power supply from strongly correlated generation sources, notably solar, but also offshore wind in certain regions.

Appendix

Related Research

• Power Sector Update: China Will Keep Its Lead In Global Offshore Wind Additions, Aug. 29, 2024
• Power Sector Update: U.S. Offshore Wind Projects Have Not Harnessed Their Full Potential Yet, Aug. 2, 2024
• EMEA Utilities Industry Credit Outlook, July 18, 2024
• European Electricity Producers' Credit Quality And Revenue-Support Contracts: It's Complicated, July 10, 2024
• Europe's Power Producers Continue Their Balancing Act As Electricity Prices Stay Low, July 10, 2024
• European Utilities: The Rating Relevance Of Net-Zero Commitments, May 2, 2024
• European Utilities' Net-Zero Ambitions Face Myriad Hurdles, May 2, 2024
• WindMW GmbH's Senior Secured Debt Outlook Revised To Negative; Affirmed At 'BBB-', May 1, 2024
• Europe's Power Push: Can Project Finance Help Fund Interconnections?, Nov. 16, 2023
• Germany's Green Energy Ambitions Spark A Transformative Decade For Utilities, Sept. 14, 2023

External Research

• https://energy.ec.europa.eu/topics/renewable-energy/renewable-energy-directive-targets-and-rules/renewable-energy-targets_en