The Australian National Electricity Market is undergoing a rapid transformation as it transitions to net-zero. While it is clear we are heading towards an overwhelming renewable energy-based market, the generation technology mix is more difficult to predict. However, it is likely that offshore wind could play a significant role in Australia. By Dan Brown, co-head of international projects group and projects and real estate partner, Jeff Lynn, projects and real estate partner, and David Wadham, projects and real estate partner, Ashurst.
Fossil-fuelled electricity generation still dominates the National Electricity Market and the scale of the transformation ahead is enormous. The Australian Government has legislated to commit to net-zero emissions by 2050 and aims to achieve an 82% renewable electricity generation target by 2030. While the answer to meeting this enormous future growth in renewable energy demand will invariably have many parts, offshore wind will likely have an important role to play.
Offshore wind regulation
In late 2021, the Australian Parliament enacted the Offshore Electricity Infrastructure Act 2021 (Cth), and after a lengthy process of developing regulations, the act came into force in June 2022. The act is based loosely on Australian legislation governing the offshore petroleum industry and shares a common regulator in the National Offshore Petroleum Safety & Environmental Management Authority (NOPSEMA) and titles registrar in the National Offshore Petroleum Titles Administrator (NOPTA). At its core, the act is a regime for allocating exclusive rights over areas of the ocean and seabed to assess the feasibility of the development, construction, operation and maintenance of an offshore renewable energy project.
After lengthy industry and community consultation, the Australian government declared its first offshore wind development zone, which lies off the coast of Gippsland in Victoria, to the east of Wilsons Promontory. Prospective project proponents had until April 27 2023 to lodge a feasibility licence application. Applicants must have addressed the "merit criteria" specified in the act. The established merit criteria that applicants must have demonstrated are:
* Their technical and financial capability to develop a project;
* The likely viability of their proposed project;
* The suitability of the applicant to hold a licence; and
* Whether the proposed project is in the national interest.
The Australian Government released detailed and prescriptive guidance on the matters that it expected applicants to address in responding to these merit criteria.
The launch of the feasibility licence application process has drawn considerable interest from Australian project developers and global offshore wind project developers. While the Australian government has offered no formal advice, industry speculation suggests it may award up to five feasibility licences. Licence areas may be up to 700km2, which equates to an area large enough to accommodate the 2GW-plus sized projects many proponents have announced an intention to develop if successful.
More than 20 applications for licences are expected to have been lodged. In addition, as feasibility licences are considered to be "interests in land" for the Foreign Acquisitions and Takeovers Act 1975 (Cth), applicants that are foreign persons will need to have considered whether or not they are required to make an application under that legislation for approval to be granted a feasibility licence.
The primary role of the Australian government and its offshore regulatory agencies in developing and administering this regime is explained by the fact that the offshore wind development zone declared under the act is located within marine waters under Commonwealth Government jurisdiction. However, the adjacent territorial state of Victoria has expressed strong policy support for offshore wind and has commenced work on a series of complementary policy initiatives designed to support the development of the industry.
The Victorian government has set offshore wind targets of at least 2GW by 2032, 4GW by 2035 and 9GW by 2040. The state government has also committed to investing in a significant transmission network system upgrade to strengthen the grid in the onshore region of Gippsland, adjacent to the first offshore wind development zone, and is developing a financial support package that may take the form of a contract for difference and complementary contributions for capital and financing.
However, the number and value of the contracts available to project proponents, or the process by which they will be awarded, are not yet known. That said, the Victorian government has indicated that bids will be evaluated against various factors, including, price, demonstrated track record, level of community engagement, project preparedness, workforce and industry development approach, and value for money.
The Australian government has opened up community consultation for the Hunter Region, off the coast of Newcastle in NSW, as the location for the next offshore wind development zone. Other zones, including Northern Tasmania, the Portland region of Western Victoria and the Illawarra region of NSW are among the other regions in line for declaration. If the level of interest in Gippsland provides any indication, feasibility licences for multiple GW scale projects may be issued within the next 12 months, providing a significant potential pipeline of offshore wind projects to be developed over the next five to 10 years.
Even with the strong support for offshore wind in Australia, the successful development of these projects is not straightforward. Many features of these projects are unique and far more complex compared with the development of onshore wind and other renewable projects.
Revenue structures
As with almost all energy development projects, the revenue structure and model are the golden ticket for debt and equity funding. For many years, offshore wind developments outside Australia have enjoyed stable subsidies, tariffs and support from various state-sponsored programmes.
This support has been critical in propelling the offshore wind industry in many countries. However, the competitive bidding for this support has seen a race to the bottom and resulted in increased pressure on project returns, especially in the context of the perceived contractors' market, and including factors such as the increased pressure on supply chains, the Covid-19 hangover, increases in raw material costs and the ongoing erosion of developer-led risk allocation in contracts.
In the Australian context, it is not yet clear what the exact revenue structure or other substantive support will look like for offshore wind projects across various states, particularly in the context of its wholesale market structure. Without meaningful support, there are few counterparties in the National Electricity Market capable of contracting the many gigawatts of green electrons created by a single large-scale offshore wind project in a way that could ultimately underwrite the serious capital cost of developing these projects. This may see large retailers or other players embedding themselves into consortia or joint ventures with offshore wind developers to support those projects and gain complete transparency on development costs to optimise offtake pricing.
While the support mechanisms exist more broadly for the development of certain renewable energy projects, including through the Australian Renewable Energy Agency, the Clean Energy Finance Corporation, or Victoria's Renewable Energy Target auction process, it's arguable that support from these sources will not ultimately be sufficient to underwrite the billions of dollars required to complete construction of a large-scale offshore wind project.
Successful project delivery
Notwithstanding Australia's abundant renewable resources and the explosion of renewable developments over the past ten years, few credible, well-established local stakeholders are capable of delivering offshore wind. In recent years, a rush of reputable global players into the market has been seen. Yet none have understood Australia's legislative framework, construction and labour markets, or its complex and unique National Electricity Market. This has prompted some joint ventures and consortia between local and international players to corral the deep expertise, experience and financial backing to maximise success in this growing market opportunity.
Unlike conventional renewable energy developments, few construction counterparties can truly wrap the delivery of the whole of offshore wind development. While we are seeing a slow march away from project-financed, EPC-wrapped onshore wind, solar and battery storage projects in Australia, the EPC-wrap is generally not a viable approach for large-scale offshore wind projects.
Broadly, the multi-contracting model is in vogue for offshore wind in Europe and recently, Taiwan, with the project vehicle entering many contracts for the delivery of offshore wind, including the supply and installation of turbine, array cable, foundation, export cable, as well as onshore works, vessel and charter contracts. Ultimately, the project vehicle assumes the interface risk arising from the coordination, cooperation and interoperability of the various project contracts. In the past, Australian banks have resisted favourably funding more straightforward renewable energy projects, where the borrower assumed certain interface risks given the inherent uncertainty this creates regarding the time and cost impact of the project.
Underpinning the interface risk are a series of other fundamental project development risks that the project vehicle will need to address, including:
* Design risks, especially weather phenomena in the emerging offshore market;
* Site risks, including unforeseen ground and other conditions;
* Cable failure risks, particularly in offshore cabling;
* Supply chain risks, such as inadequate port facilities;
* Vessel procurement risks, along with supply constraints and cabotage issues; and
* Grid risks, among connection and curtailment issues, prevalent in conventional renewables developments
The following factors may prove helpful in navigating the inherently complicated and risk-laden development pathway for offshore wind in Australia:
* Establishing a consortium or joint venture of well-resourced, well-connected and deeply experienced parties;
* A clear definition of project interfaces and management of those interfaces, including parties undertaking operations and maintenance;
* Consistency and integration of legal terms across the entire suite of project contracts, including back-to-backing of key terms;
* Deep understanding and appreciation of local content and best practice procurement practices, which are usually a condition of government support;
* A robust installation management and vessel support strategy;
* Engaging with project lenders early as well as investing in bringing them and their advisers up to speed;
* Ensuring the appropriate insurance programme is in place; and
* Receiving the support from well-credentialed and experienced advisers.
Understanding financing structures
Various financing structures have been used to fund offshore wind projects to-date, for example, power producer or EPC contractor equity, project finance, third-party equity and project bonds. However, in Europe, where there is a developed market for offshore wind projects, limited recourse project finance has been the most common financing structure over the past decade, with a smaller portion of projects funded through corporate finance. It is interesting to note that the limited recourse financing structures that have been developed over the past decade in Europe have been quickly replicated in other markets such as Japan and Taiwan, which have been opened up to large-scale offshore wind development.
The size in megawatts of potential offshore wind projects in Australia is very significant. If a limited recourse financing approach is taken, this will entail raising amounts of debt that far exceed the amounts needed even for the most significant onshore renewables projects. The larger financings in Europe easily require bank groups of 20+ institutions. Therefore, it will be imperative to ensure that deals are structured to attract sufficient interest from local and international financial institutions.
As with any new market, funders will look to ensure that projects have the robust fundamentals needed to support limited recourse financing. Critically, they will be looking to see that the projects have adequate revenue certainty over the debt tenor, be it in the form of a feed-in tariff, contract for difference or corporate PPA with fixed pricing. The revenue stack on European offshore wind projects is becoming increasingly complex, but whatever the form of offtake, there will be limited appetite for exposure to merchant (variable) pricing.
Potential funders will also look closely at the contracting strategy. As noted, multi-sourced procurement has become the norm in Europe, particularly in the UK. Still, it is by no means the rule, and several projects have been developed in Asia with slightly more simplified contracting structures to address local funder expectations.
In a new market, funders will also look very closely at the experience of developer consortia, both in terms of offshore wind know-how and local market understanding. The technical due diligence will also be significant regarding supply chain constraints. Funders will also want to understand how the environment and other conditions may differ in Australia from different geographies.
While limited recourse offshore wind financings may be similar to other renewable financings save in terms of scale, they typically have a number of features that aim to address the specific challenges of offshore wind. For example:
* Contingency and impact on equity structures – Contingency levels in offshore wind projects are higher than in onshore projects, with around 10%–15% of project costs split between funded and unfunded contingency. Banks require a robust level of contingency to deal not only with the risks that may arise from a multi-contract procurement strategy, but also to reflect the higher risk profile of construction in the marine environment. This leads developers to want to ensure there is some form of equity true-up to rebalance the project and to take account of unspent contingency.
* Deferral and reprofiling – Depending on how it sits with the requirements of any agreed offtake structure, it is usual for offshore wind financings to incorporate a degree of flexibility to address any construction delays. This can take the form of an ability to defer the initial debt repayments and/or reprofile the debt with associated mandatory prepayments (cash sweeps) to protect base case economics. While not exclusive to offshore wind, including equity cure rights is also widespread.
We expect the features of recent offshore wind financings in Europe and Asia to rapidly find their way into the Australian market. However, suitable adaptations must be made to address market and geographic specifics.
Australia has vast opportunities and enormous potential for offshore wind projects. While it is difficult to predict what the generation technology mix will look like, it will be exciting to watch what the future holds for offshore wind.
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