A service of

How Moray West’s revenue stack gamble paid off

When the UK government awarded its fourth contracts for difference (CfD) auction in July 2022, the spotlight was firmly placed on a handful of mega offshore wind projects, including the largest among them, Ørsted’s 2.8 GW Hornsea 3.

The mood of the Danish renewable energy giant was upbeat after the award. Duncan Clark, Ørsted’s head of UK, described Hornsea 3’s win as a “landmark for offshore wind” and promised GBP 14bn of investment in the UK to the end of the decade.

"Successive governments deserve credit for providing the regulatory and policy certainty for continued investment in offshore wind,” he said at the time. “This has allowed the cost of offshore wind to fall rapidly and to become the thriving industry it is today.”

Among the offshore behemoths, one project did not seem much of a winner. Ocean Winds, a joint venture of Engie and EDPR, secured CfDs for just 294 MW, a relatively small portion of its 890 MW Moray West wind farm.

The Franco-Portuguese team kept a lower profile, with Ocean Winds COO Grzegorz Gorski not venturing much further than to say he was “pleased” with the outcome of the auction.

Fast forward to today and the tables have turned.

Ocean Winds and its junior partner, Lithuanian utility Ignitis, are set to reach financial close this month on Moray West with a nearly GBP 2.6bn debt package, several sources familiar with the deal told Infralogic.

Meanwhile, last March Ørsted warned that Hornsea 3 could be halted due to the “extraordinary” impact of increased interest rates and supply chain prices, if the government did not offer more support.

“Industry is doing everything it can to manage costs on these projects but there is a real and growing risk of them being put on hold or even handing back their CfDs, with repercussions that could impact across the economy,” said Ørsted’s Clark.

So how did Ocean Winds convince 18 banks from across the world to back its project with 18-year debt while its rival is struggling to make its project work?

The answer lies in the Ocean Winds team’s ability to build a “revenue stack” to make up for the missing CfDs and capture the upside of the current high power prices, according to multiple sources familiar with the project’s financing.

The rise of the CPPA

At least 52% of Moray West’s generation capacity is contracted under a corporate power purchase agreement (CPPA), with the CfD covering about a third of the project’s capacity, and the rest of the output set to be sold on a merchant basis, one of the sources said.

The project has signed CPPAs with several off-takers, including a 12-year contract with Google covering 100 MW, which was signed in November.

In June the sponsors also signed a major CPPA with an unnamed buyer for 350 MW of the project’s total capacity.

A similar model was used by TotalEnergies and SSE Renewables to finance their 1.1 GW Seagreen offshore wind farm in June 2020. The project had CfDs covering 42% of its output, with 30% covered by a PPA and 28% sold on the merchant market.

Offshore wind farms always have a merchant tail as the average 40-year project life will surpass the average length of CfDs, which are usually 15-20- years, but the wholesale market represents almost a third of Seagreen and Moray West's revenue stream throughout their life.

Seagreen, 27km off Scotland, secured a GBP 41.61/MWh strike price covering just 42% of its capacity in the government’s third allocation round in September 2019. It was the only successful offshore wind project not to have received a price for its entire operating capacity.

At the time, many offshore wind lenders were sceptical of the partial subsidy. Regular major lenders to UK offshore wind farms opted out of the project financing, including French banks BNP Paribas, Credit Agricole and Societe Generale, to name a few.

Just a few months later the three banks supported another project by SSE Renewables fully backed by CfD, the 2.4 GW Dogger Bank A&B offshore wind farm.

Three years on from Seagreen’s debt package, appetite to lend against offshore wind projects with lower CfDs and higher CPPAs has shifted.

“The rise in the PPA market has increased lenders’ appetite to finance a project with a lower CfD,” says a senior banker close to the deal.

Many of the banks that financed Seagreen also returned for Moray West, including Allied Irish Bank (AIB), Bank of China, Barclays, Lloyds, MUFG, NatWest and SMBC.

Crucially, several major lenders that stayed away from Seagreen joined the Ocean Winds-backed deal, including the three-largest French banks, BNP Paribas, Societe Generale and Credit Agricole, with the latter also advising the sponsors.

A senior banker involved in Moray West’s financing says a lot has changed between the two deals in the PPA market, which has made it more attractive for lenders.

“CPPAs are a good way for banks to secure strong investment grade counterparties,” he says, “and the average length of CPPAs for offshore wind has doubled in recent years.”

Up until now, the average length of CPPAs has been around three to 10 years, according to the banker, but banks are now looking at the prospect of 25-year offtake agreements, signed for the first time for offshore wind by Ørsted and chemical producer BASF in November 2021.

CPPAs by nature offer lenders a hedge against future volatile power prices by securing a fixed energy price for a fixed period. Lenders increasingly see them as a good alternative to CfDs, even though the counterparty is a private company rather than government.

“CPPAs used to be an alien concept just a few years ago, but banks are now more comfortable,” the lender says.

CfDs falling out of favour

The rise of the CPPA market crucially comes alongside the fall in CfD strike prices, which have decreased year on year since the government’s first allocation round in 2015. The banker close to Moray West said the reduced attractiveness of CfDs was in fact the key factor that pushed Ocean Winds to find a different solution for its project.

The offshore wind strike price of round four, the latest CfD auction, was GBP 37.35/MWh in 2012 prices, or GBP 49.26/MWh adjusted for inflation. This is only a third of the GBP 119.89/MWh price secured by Scottish Power Renewables for its East Anglia I project as part of the government’s inaugural allocation round in 2015.

The CfD price creates certainty for all parties by allowing sponsors to take in returns, while lenders can bank a base case with the locked-in pricing. However, it also limit project revenues by stealing the upside. 

“The CfD has done an amazing job at making UK offshore wind the most desired market for liquidity, but as the CfD gets lower and lower sponsors will find more imaginative ways to make revenue,” another source involved in the Moray West deal told Infralogic.

 “The market can expect to see far larger rises in CPPAs.” 

A senior energy lawyer agreed, telling Infralogic that the current CfD strike price is not sufficient and the risk reward is not right for sponsors and lenders. Although CfDs are indexed to inflation, profit margins are so compressed that higher-than-expected cost increases can hit a project’s profitability significantly.

Selling some of the electricity through a CPPA or on a merchant basis, however, allows sponsors to capture higher revenues, now that power prices are high, and reduces some of the pressure.

 “Now is a good time to hedge as we can lock in this high inflation rate and hope costs will be lower,” a senior banker involved in the Moray West financing said.

 However, leaving the safety net of a CfD behind could be hard.

 “Despite the low strike prices in the UK, offshore wind projects will still bid for CfDs as there is no market currently to replace the government subsidies with CPPAs,” the energy lawyer said. “This is why Moray West is doing a balanced split.”

Research firm Cornwall Insight counted only about 890 MW of subsidy-free renewables CPPAs signed for new projects in the UK in the period between August 2019 and March 2021.

 This compares with 10.8 GW of capacity awarded in the last CfD auction alone, almost double the 5.7 GW awarded in round 3 in 2019.

 There are signs the market has expanded since then. WindEurope, a trade association, said last year that CPPAs have taken off since 2018, with more than 2.5 GW of offshore wind contracted through PPAs across Europe. This is still a fraction of the projects backed by CfDs, however.

 The vast majority of CPPA offtakers have been information and communications technology groups and heavy industry companies, WindEurope’s research shows, while companies in other sectors are lagging behind.

 Also, UK renewables projects with a CfD are exempt from paying a generation levy, which is another point of attraction.

 The levy was introduced by the government last year as a temporary 45% charge on generators producing over 50 GWh of wholesale electricity annually, in effect from January 2023 to March 2028.

Looking forward to round five

Large offshore wind developers have also been used to financing their projects through a CfD, and changing established habits can be hard.

 “I think you’ll find that the major players would ideally like to secure 100% of the revenue with a suitably priced CfD,” a senior offshore wind developer told Infralogic. “CfDs are usually very good for industry if priced correctly.”

All of the other winners of the UK’s CfD round four apart from Moray West in fact secured CfDs for 100% of their projects’ capacity.

ESB and RedRock Power’s Inch Cape offshore wind project is one of them, and its project financing process is tipped to launch as soon as Moray West’s debt raise closes.

In addition to Ørsted’s Hornsea 3, Scottish Power also secured full CfDs for its 1.37 GW East Anglia Three phase 1 and Vattenfall did the same for the 1.4 GW Norfolk Boreas Phase 1.

The main problem was the high competitive pressure in CfD tenders, which drove down prices, the developer argues, and the other projects may also face similar issues to Ørsted’s Hornsea 3

“There is an argument here that Ørsted and Vattenfall priced their bids incorrectly and now shouldn’t be complaining,” the source said.

Scottish Power and Vattenfall have made some progress on their projects, although neither has reached a final investment decision.

Scottish Power, a subsidiary of Spain’s Iberdrola, agreed in March a GBP 1.3bn contract with Siemens Gamesa for 95 wind turbines for East Anglia Three, while Vattenfall said in January it will start building Norfolk Boreas Phase 1 this year.

The next big test of whether the CPPA market is indeed becoming a solid alternative to CfDs will be the UK’s allocation round five, which kicked off last month and will culminate with bids in summer.

Until then, expect plenty of discussions between sponsors and lenders on what’s the best way to finance the next wave of offshore wind projects.