EXPERT: How Dong achieved a landmark strike price

NETHERLANDS: The announcement of the Borselle auction results was greeted by the offshore wind industry with a mixture of astonishment, delight, and (from competitors) a little concern. Dong Energy had beaten the €100/MWh levelised cost of energy (LCOE) barrier well ahead of schedule.

Dong Energy CEO Henrik Poulsen

Dong’s bid secured 15 years of SDE+ (the Dutch equivalent of CfD) funding for the project followed by the ability to sell energy at market price for the rest of the project’s life.

Obviously, LCOE and bid prices are two distinct measures that cannot be directly compared. Dong’s bid was actually at €72.7/MWh, which implies an LCOE of about €68/MWh excluding transmission.

The Dutch government has already paid for key elements of project development activity and is taking the risk on transmission connection for which it will add a (fairly modest) €14/MWh to the costs, giving a total project LCOE of about €82/MWh. That is a dramatic decrease from current levels.

So what is behind this headline figure, and how has Dong managed to leap ahead in the race to be "subsidy free"?

There are six main levers of LCOE: energy production, annual operating cost, total capital cost, project lifespan, cost of finance, and timing of capital expenditure. Assuming a "normal" expected life of the project and timing of capital expendure, our analysis suggests that Dong’s bid is likely to have pulled hard at the other four levers.

The chart below shows how Dong may have been able to make this leap.

click to enlarge

We start with an estimated range of LCOE for 2020 FID 500MW self-developed sites across different locations in European water.

Firstly, the natural advantages of the Borssele sites put them closer to the lower end of this range for LCOE. The sites are close to shore, have a water depth suitable for monopiles, and have good wind conditions.

Transmission costs will be paid separately by the Dutch government. These would normally add around €14-16/MWh for a self-developer (though the Dutch government is charging only €14/MWh for this). The government is also paying for some development activities.

Project size is a factor, and by bidding and being successful for both sites, totalling up to 760MW, Dong should be able to achieve economies of scale, further reducing LCOE.

Our estimate for LCOE at Borssele, using only the advantages of site conditions and the Dutch government’s approach to transmission and development costs is €84/MWh.

At a weighted average cost of capital (WACC) of 8.5%, this would have implied SDE+/CfD bids at €92/MWh. Of course, this is very much the starting point for all bidders, with an expectation that competition (from the reported 36 bidders) would drive bids lower.

Combining the additional 760MW with existing supplier orders can give Dong an advantage in enabling it and its supply chain to industrialise to lower LCOE.

Through its deep knowledge of the sector, Dong probably has higher buying power (even in a pipeline situation) than other bidders. When combined with Dong’s ability to learn lessons and reduce cost faster than the industry average, this will deliver further benefit.

Dong and its turbine supplier may have come up with ways to increase annual energy production (AEP), especially rotor size, but also reliability, availability, overrating in some conditions and reduced losses.

Its finance providers may view that any investments are relatively low risk due to the financial attractiveness of the Dong organisation, as demonstrated by the recently successful IPO. If so, a lower WACC would be available on the project, even after allowing for pipeline WACC reduction.

As shown, by pulling hard on most of the available levers, Dong has been able to offer the Dutch government a stunningly low price at the Borssele sites. That should be welcomed by electricity consumers, governments and, ultimately, the industry as a whole.

Now that Dong has set this new benchmark, they and other developers will have to examine their supply chain, procurement strategy, finance structures, site characteristics, and technology to ensure they match (or beat) this price level for future projcts.

Governments will also need to examine policies that encourage equal levels of competitiveness, offer project clarity, and enable the benefits of industrialisation and the other approaches used to be delivered by multiple players.

Giles Hundleby is associate director of BVG Associates