Offshore Wind’s Not Dead Yet

But the hype of its future dominance is, as projects stall.

Not since 1999 have utilities and essential services stocks lagged market averages by so wide a margin. Aversion to dividend stocks in an era of 5 percent CD rates and atrocious market momentum are two reasons, as investors great and small chase big technology stock winners in hopes they still have further to run.

At the core of underperformance are the highest benchmark interest rates in 22 years. The Federal Reserve’s war on inflation is clearly crushing investment, by making the cost of borrowing prohibitive for even the more financially secure. And there’s no sign the central bank is second-guessing anything it’s done so far, with New York Fed President John Williams quoted last week stating “we’ve gotten monetary policy in a very good place.”

Reduced investment now means less supply and higher prices down the road for everything from housing to commodities, including food and energy. One sector feeling the pain more than most: US offshore wind.

Onshore wind accounted for 10.2 percent of US power generation in 2022, according to US Energy Information Administration data. And that share continues to grow, with wind accounting for 22 percent of new power plant construction last year.

In contrast, despite being already widely adopted in Europe, offshore wind is new to this country. By early next year, 800-megawatt capacity Vineyard 1 should be delivering electricity to New England, as the country’s first commercial scale facility.

That’s a testament to the persistence of developer Avangrid Inc (NYSE: AGR) and its 81.61 percent-owner Iberdrola SA (Spain: IBE, OTC: IBDRY), who at one time had to overcome outright opposition from then-President Trump’s Bureau of Ocean Energy Management (BOEM). And by 2026, Dominion Energy (NYSE: D) should be opening the country’s first offshore wind facility in regulated utility rate base, the 2.6-gigawatt Coastal Virginia Offshore Wind Project (CVOW).

Beyond those facilities, however, prospects have dimmed considerably for President Biden’s target of 30 GW by 2030. The reason: A sharp spike in construction costs from initial estimates, particularly financing.

We’ve seen a version of this movie before in the US with nuclear energy. Back in the ‘00s, excitement was building for a new generation of plants built on models such as Toshiba-Westinghouse’s AP-1000. But so far, only one new reactor has entered service—Southern Company’s (NYSE: SO) Vogtle Unit 3, with Unit 4 set to start up by early next year.

The rest of the proposed projects fell prey to the spike in costs that followed the Fukushima accident in Japan, including two AP-1000 reactors well under construction at the Summer site in South Carolina. Only Southern’s deep pockets and the consistent support of Georgia regulators brought Vogtle over the finish line.

Avangrid’s Vineyard project locked in construction and financing costs before last year’s burst of inflation and soaring interest rates. As a result, contracts previously negotiated for output still make economic sense. Similarly, “more than 90 percent” of CVOW costs are locked in, including a construction ship being built in Texas that Dominion should be able to profitably lease in future.

That’s a stark contrast to the rest of the 30 GW envisioned just months ago. In fact, according to data from Bloomberg Intelligence, the levelized cost of energy (LCOE) for new US offshore wind facilities has risen by 48 percent since 2021 to $114.20 per megawatt hour.

That’s now some of the most expensive power in the country. And despite aggressive renewable energy mandates in New England and other offshore wind states, regulators and politicians are understandably reluctant to pass those costs onto customers.

In a call with analysts in late August, leading global offshore wind developer ORSTED A/S (Denmark: ORSTED, OTC: DNNGY) announced a projected non-cash impairment charge of $860 million for its ownership interests in three US projects: Ocean Wind 1 in New Jersey, Sunrise Wind in New York and Revolution Wind off the coast of Rhode Island.

Orsted cited supplier delays as the primary reason for the writedown, as key components and materials essentially must be imported and global demand is high. It also noted concerns it would not qualify for full Inflation Reduction Act tax credits, since certain provisions of the IRA require use of as yet unavailable domestically produced materials.

The biggest reason, however, is almost surely borrowing costs. Interest rates on short-term debt and credit lines typically used to fund projects under construction are now several times what they were just a few year ago. And coupled with delays and doubts about tax credits, that shifts project economics from quite profitable to possibly not making sense.

Orsted management remains outwardly optimistic the projects will eventually be completed. But its CEO has also made clear consumers and regulators are going to have to be willing to pay more for output or else face an indefinite delay.

Iberdrola and Avangrid have indicated they won’t be writing anything off. But Avangrid is paying utilities $49 million to exit previously negotiated contracts for its facilities still in early stages of development. That was the result of protracted negotiations with New England regulators, in which the company had initially sought higher rates to compensate for rising costs. And regulators’ reluctance to take that step means these projects are effectively on hold for the foreseeable future

Another key data point for US offshore wind’s demise: The almost complete lack of interest in a federal auction of Gulf of Mexico offshore wind leases.

The only lease awarded was to a $5.6 million bid from RWE AG (Germany: RWE, OTC: RWEOY). That’s a stark contrast to the $700 million fetched last year for a parcel off the coast of New York. RWE and partner Entergy Corp (NYSE: ETR) now have perhaps the best offshore wind economics in North America. But even they are talking mid-2030s for a prospective project.

Offshore wind projects are moving ahead elsewhere in the world with Iberdrola, ORSTED and Northland Power (TSX: NPI, OTC: NPIFF) leading the way. RWE, for example, still expects to increase its global generation from the current 5.9 GW to 8 GW by 2030.

And it’s quite possible the Biden Administration will try to jump start offshore wind in coming months, possibly by easing rules on claiming tax credits and/or pursuing permitting reform. Atlantic Coast states may negotiate an amicable compromise on rates, since the only feasible alternative is using more natural gas indefinitely to generate electricity.

The Fed will eventually take the pressure off borrowing costs by declaring victory over inflation. And new manufacturing capacity in the US fueled by IRA tax credits should ultimately make supply chains less problematic.

But at least for now, there’s a big winner from US offshore wind’s pause. That’s America’s leading developer and operator of onshore wind, solar and energy storage: NextEra Energy (NYSE: NEE).

The Florida-based company studiously avoided offshore wind investment during its days of greatest hype. Management cited the length of time and cost uncertainty completing multi-year projects as reasons, as well as greater wear and tear on equipment from exposure to the elements.

Now NextEra’s “non-bet” is paying off, as renewable energy consumers double down on projects that can be completed relatively quickly with highly predictable costs—quite simply its stock in trade.