Windsea Array Report 2015

Written by Chau Man Yick Patrick

Content

1. Executive Summary P. 3 2. Industry overview P. 4-6 i) Renewable energy globally ii) UK offshore windfarm overview 3. Situation analysis P. 6 4. Our project P. 7-12 i) Description of location ii) Turbine models and foundation iii) Construction process iv) selling price v) Financing of project vi) Operation and maintenance 5. Financial analysis P. 13-18 6. Environmental issues P. 19 7. Conclusion P. 20

1. Executive summary

Renewable energy has always been an issue in the world, when people are starting to realize the consequences of producing energy through the usage of fossil fuels such as pollution and global warming. In light of the situation, it is observed that there is a need to help shape a better world, a greener future so that our ancestors will not be living in a world that is full of pollution. In this report we proudly present our offshore wind farm – Windsea Array. We will first introduce the overview of the entire renewable energy industry, such that people all over the world are gaining stronger attention to the importance of developing renewable energy, due to the fact that our fossil fuels will be running out soon. Then we will narrow down our view specifically to the UK where our wind farm will be built, highlighting the fact that the UK has been the largest offshore wind farm producer since 2008. Next we will give an introduction to the location of our wind farm West of Isle of Wight, addressing factors which influence our decision including the wind speed, distance from shore and cost. Then the construction phases will be highlighted to keep our investors informed when and how the wind farm is constructed. It is estimated that our project is ready to be operated in 2019. Our selling price of electricity, which is also one of the major aspects that our investors concern will be addressed as well. After that financial analyses and estimations of our project’s internal rate of return are highlighted to convince our investors that we are not only financially healthy throughout the project period, but also making impressive profit to pay back our valuable investors. Finally environmental issues during the construction process are addressed to inform our investors that while we are building our project we are not ignoring the potential harm brought about by the construction and how we are going to minimize the damage.

2. Industry overview

i) Renewable energy globally
Renewable energy has always been a global issue since people started to notice the fact that fossil fuels would be used up soon. As we can see from the Figure 1.1, the growth of investment in renewable energy has been increasing throughout the years in general globally, implying that not only developed countries, but developing countries are also putting much effort in the development of renewable energy.

Figure 1.1: Global investment in renewable energy: developed V developing countries, 2004-2013, $BN
Source: UNEP, Bloomberg New Energy Finance

ii) The UK renewable energy situation
Today, the major energy source in the UK still comes from gas, coal and nuclear which are non-renewable energy. From figure 1.2, it is observed that in 2014 gas still supplies 38.6% of the total electricity, whereas renewable supplies around 17.8% of the total electricity only. However seeing that the demand of electricity would be rising in the future and the problem of fossil fuels shortage arising, it is expected that the proportion of which renewable energy supplies the total electricity will gradually increase throughout the years. Today, the major sources of renewable energy are wind energy, solar energy, tidal energy and bio energy.

Figure 1.2: Proportion of energy generation in the UK
Source: The UK government https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/386812/ET_Dec_14.pdf

Wind energy
The UK has always been a nice location for wind power farms due to the geographical factors. As a result wind energy has always been a major source of renewable energy provider to households in the UK as well. With reference to figure 1.3, currently wind energy is the 2nd largest source of renewable energy supplier in the UK, supplying around 7% of the total, just behind bio energy.

Figure 1.3 Renewables’ share of electricity generation
Source: The UK government (https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/406993/Press_Notice_Feb_2015.pdf )
Offshore wind farm
In terms of offshore wind farm, the UK has been the largest offshore wind farm producer since 2008, leading the other countries for almost 7 years. According to renewable UK, currently in the UK there are 24 projects ongoing, 1184 turbines in total and producing 8 terawatt-hours of electricity annually, providing energy to around 2 million homes. In the future, 6GW of capacity will be installed by 2016 and 10GW of capacity will be installed by 2020, and offshore wind farm will be supplying around 8-10% of the total electricity in the UK annually. It is expected that there would be a growing demand for wind energy in the UK.

3. Situation Analysis

Development rounds of the UK offshore wind farm
The UK government has been providing a lot of support to renewable energy suppliers in constructing and operating the power plants in the past decade. In the UK, offshore wind farms are leased in rounds. Since 2000, there have been 3 rounds of construction of wind farms. Round 1 was launched in 2001, involves 18 sites and has a potential capacity of 1.5GW. Round 2 was launched in 2003, in which the offshore wind farms are located even further offshore and built in deeper water, added another 7GW of capacity. Round 3, in which our company got the approval of constructing an offshore wind power plant, was launched in 2010 and has been allowed to enter construction in since 2014. In round 3, our wind farm can only be constructed in the highlighted zones as shown in figure 2.1:

Figure 2.1: Offshore wind farm locations for round 3 in the UK
Source: www.thecrownestate.co.uk

4. Our project

i) Location
Windsea Array will be constructed in West of Isle of Wight, one of the areas which is issued by the UK government in Round 3. The exact location is shown in figure 3.1:

Figure 3.1: Offshore wind farm locations for round 3 in the UK
Source: www.thecrownestate.co.uk

The location is selected based on the following 2 factors: a) High wind speed
West of Isle of Wight on average has a wind speed of 8-9 m/s as seen from figure 3.3 and can reach even 22m/s at maximum. As seen from figure 3.2, this wind speed generates wind power from 700-900 W/m2, which is comparably strong in the UK offshore region. This location will utilize our wind farm’s potential and reach the maximum efficiency to produce the most electricity.

Figure 3.2: wind power in the UK offshore Figure 3.3: wind speed in the UK offshore
Source: Adapted from the UK government Source: www.publications.parliament.uk

b) Short distance from shore
West of Isle Wight is just approximately 20km from the shore, which lowers the transportation cost a lot especially during and after construction. Moreover, the lower sea level because of such close distance to shore lowers our cost of constructing the wind turbine foundations.

ii) Turbine models and foundations
Turbine models
Windsea Array introduces 80 Siemens 3.6 MW wind turbines with a total capacity of 288MW, producing around 2.2m MW annually. The turbines will be arranged and aligned according to the west English Channel wind direction. This model’s hub is 120m above the sea level, has a blade length of 58.5m and swept area of 11,300m2. This model is selected because it will operate normally in the conditions of 3-6m/s cut in wind speed and 25 m/s cut-out wind speed, which fits in our circumstances.

Foundations
Monopile foundation will be selected as it fits all the requirements that our turbines would need. This type of foundation is able to stand a weight up to 700 tons, which is almost 500 tons heavier than our turbines. It is also suitable for locations which have a water depth of 20m.

iii) Construction process
The following timetable schedules the expected completion date for each step. The installation company that we are hiring is A2SEA, a company specializes in building turbines, foundations and cables.

July 2016 offshore construction base built in Port of Portsmouth

Dec 2016 Foundation construction commences

May 2017 Offshore substations constructed

Jan 2018 Cable installation starts

Aug 2018 Turbine installation starts

Aug 2019 Project handed over to operation and maintenance team

iv) selling price a) Contract for difference CFD
In order to encourage companies to actively develop renewable technologies and construct renewable energy plants, the UK government introduced a policy – Electricity Market Reform Program (EMR). One of the elements of this program is contract for difference CFD. CFD is a contract between the developers and the government-owned counterparty which provides developers with clear contractual rights and increase investor’s certainty. In the contract, strike price is introduced. Strike price implies the minimum price that renewable companies are able to sell, and the contract will last for 15 years after the inauguration of the project. In other words, if the wholesale price is lower than the strike price, companies will be able to earn the wholesale price plus the difference between this price and the strike price. Currently, the average strike price for offshore wind farm is £117 per megawatt hour.

b) Current selling price
Today, the wholesale price is £45 per megawatt hour. As the wholesale price is lower than the strike price introduced by the government, we would be able to sell at the wholesale price £117 per megawatt hour.

c) Future selling price
It is expected that the future selling price and the strike price will increase in the future. First, the population will increase and thus the demand for electricity increases. Second, fossil fuels will be used up soon resulting in relying more upon the renewable energy. We make an assumption that the price will be adjusted according to inflation 2.2%, which is captured from the CPI of the UK market.

d) Contract
We have signed a contract with EDF Energy, the UK’s largest producer of low-carbon electricity with contract term of 20 years. The selling price would be the strike price offered by the UK government, which will be adjusted according to inflation each year.

v) Financing of project

a) Total investment cost
The estimated total investment cost of the project is approximately £727m. As mentioned our wind farm’s capacity is 288MW, therefore the average cost would be £2.5m / MW. The breakdown of the total investment is shown below:

Figure 4.1: Total investment cost of project
Source: Group Work

As we can see from the pie chart, the cost of wind turbines constitutes over half of the total investment costs. Second comes foundations, constitutes 20% of the total cost. Other costs include mostly administration and management costs such as legal cost, construction management, bank fees, development fee and auditing fees. Auditing firm KPMG will be hired as the auditor of this project. Boston Consulting Group will also be hired to consult the construction and development of our project.

b) Debt and equity financing
The total investment cost of this project is supported by two forms of funding, debt and equity. Upon calculation, it is estimated that 70% of debt and 30% of equity enables us to maximize our internal rate of return.

Debt
We will borrow from HSBC, one of the largest bank in the world with a good reputation in providing finance support to companies at a loan rate of 7%, and a payback period of 20 years.

Equity
We will be partnering with 3 companies which have years of experience in constructing offshore wind farms. They are EON, Dong Energy and Masdar. Each company will be holding 33.3% of shares in this project. These 3 companies are also partners in another offshore wind project London Array.

vi) Operation and maintenance

Maintenance team
Our turbines are designed to operate 24 hours a day, 7 days a week for over 20 years. Therefore having a professional maintenance team is extremely essential to ensure that the turbines, grids and cables are in good conditions to operate. Our maintenance team will be travelling from Portsmouth Port to the operation and maintenance centre by speed boat regularly. Working in the marine environment has always been harsh, as there might be extreme weathers such as strong winds and tides. To ensure the safety of our team members, the weather and sea conditions will be checked every time before the team travels to the centre. We will be working closely with the coast guard in Portsmouth Port as well so that any unexpected accidents can be handled immediately.

Estimated operation and maintenance cost
After consulting with BCG and KPMG, it is estimated that the operation cost for year 1 would be approximately £49m. Throughout the years, it is expected that the cost will increase due to inflation and the fact that the facilities such as turbines, grids and cables requires more maintenance because of depreciation. The breakdown of the O&M cost is shown below:

Figure 4.2: Estimated total O&M cost
Source: Group work

As seen from figure 4.2, O&M cost constitutes almost 55% of the total operation cost annually, costing approximately £27m, which is equal to £27/ MWh. As mentioned before, it is of paramount importance to ensure the safety of our maintenance crews, thus the expected O&M cost is relatively high.

5. Financial Analysis

Financial analysis is always the section that most stakeholders are interested in because it implies whether the project is profitable. To get a better understanding about how much our project is going to earn, detailed analyses is provided below including internal rate of return, net present value and more.

i) Discounted rate - weighted cost of capital (wacc) – 6.25%
In this project we are calculating our discounted rate from wacc. To get the wacc, several elements is needed, including the risk free rate, tax rate, project beta, expected market return, and debt equity composition. Upon calculation, the wacc is 6.25%.

Risk free rate
The risk free rate is captured from the UK gilt 20 year bond of which the yield is 2.2%.

Project Beta
The project’s beta is calculated by referring to 5 other similar companies that are building offshore wind farms and listed in the London Stock Exchange. After calculating the unlevered average beta of the other 5 companies, we have come up with our own project’s beta equal to 0.93, slightly negatively correlated to the UK’s market return.

Tax Rate
According to the UK government’s tax policy, for companies which have profits of £300,000 or above, the tax rate would be 21%, otherwise 20%. Therefore 21% will be the rates that we are paying on our profits.

Expected market return
The expected market return is captured by referring to the average market return of FTSE 100 Index. The average return is 8.37%.

Debt equity composition
As mentioned in the Financing of project part, the debt equity composition is that debt 70% and equity 30% as this optimizes our internal rate of return upon calculation.

Cost of equity
Through applying the CAPM equation, the cost of equity calculated is 7.94%.

After tax cost of debt
Applying the tax rate 21% and the loan rate 7% in the equation, the after tax cost of debt is calculated to be 5.53%.

Weighted average cost of capital
Applying the cost of equity and after tax cost of debt in the equation, the wacc is calculated to be 6.25%. This would be the discounted rate used in calculating the net present value of our project.

ii) Internal rate of return
Optimal case scenario with IRR 12%
In the optimal scenario, we assume that the selling price of electricity will continue to rise after the contract for difference CFD ends in year 15. We estimate that the demand for wind energy will increase due to a rise in population and shortage of fossil fuels. Applying these assumptions and having the price adjusted to inflation 2.2%, it is estimated that the selling price starting from year 15 would be £162 / MWh. Upon calculation, it is estimated that the internal rate of return will be 12%.

Worst case scenario with IRR 10%
In the worst case scenario, we assume that the wholesale price will remain stable after the CFD ends. In other words, after adjustment to inflation, the wholesale price is estimated to be £65 / MWh. Despite the low selling price, upon calculation it is still possible to get an internal rate of return of 10%/.

iii) Net present value of project
Optimal case scenario with NPV £313m
In the optimal case scenario we apply the same factors same as the ones used in estimating the optimal IRR above. The net present value is estimated to be £313m.

Worst case scenario with NPV £188m
We apply the same factors used in estimating the worst case IRR. Even at the worst case the net present value of the project is estimated to be £188m.

iv) Levelized cost of electricity LCOE - £110 / MWh
Levelized cost of electricity LCOE is a valuable financial tool to measure a company’s cost of producing electricity. A lower LCOE implies lower cost to produce electricity and higher return for investors. According to research, the average LCOE of offshore wind farm in the UK is £140 / MWh. Upon calculation our LCOE is estimated to be £110 / MWh, implying that we are able to produce electricity at a lower cost comparably.

v) Debt equity ratio
Our project has a quite high debt equity ratio of around 2 at the beginning due to the fact 70% of the capital investment cost is financed by debt. However throughout the years we are expecting to have a lower debt equity ratio when we start to pay back our loan, while our equity is increasing as well because of the expected increase in net income. The decreasing debt equity ratio is good news for investors, as this implies lower additional interest expense, less volatile earnings and a lower risk of facing bankruptcy. Figure 5.1 illustrates the expected trend of our debt equity ratio:

Figure 5.1: Debt equity ratio
Source: Group work

vi) Profit margin
Due to the fact that our income is expected to increase throughout the years because of the expected increase in selling price, our profit margin will be having an increasing trend throughout the years as shown in figure 5.2:

Figure 5.2: Profit margin
Source: Group work

It is seen from the figure that there is a sudden drastic decrease in profit margin from 40% to -10% during year 1 and 2. The reason is attributed to the fact that we would be starting to pay back our loan in year 2, thus resulting in a negative income from year 2 to 7. However, starting from year 8, we are going to break even and start to earn a positive net income.

vii) Return on investment
Our return on investment is expected to increase throughout the years due to the fact that our net income is expected to increase because of the anticipated rise in selling price. Figure 5.3 illustrates the trend of our project’s return on investment:

Figure 5.3: Return on investment
Source: Group work

The drastic decrease in ROI during year 1 and 2 is explained by the fact that we would start to pay back our loan in year 2, thus resulting in a great decrease in net income. However, it is expected that net income will turn positive starting from year 8 and our return on investment will gradually increase.

viii) Asset turnover ratio
Throughout the years our asset turnover ratio is expected to increase. This implies that our project is generating more revenues per pounds of assets. In other words, the efficiency of our assets generating revenues increases, and this is beneficial to our investors. Figure 5.4 illustrates the trend of our project’s asset turnover ratio:

Figure 5.4: Asset turnover ratio
Source: Group work

ix) Net income growth
In general, it is expected that our net income will be facing a positive growth rate throughout the years due to the expected increase in selling price in the future. Figure 5.5 illustrates the trend of net income growth:

Figure 5.5: Net income growth
Source: Group work

As seen from the figure, there is a drastic decrease in net income during year 1 and 2. The reason is attributed to the fact that we are starting to pay back our loan starting from year 2, thus there is a drop in net income in year 2. However it is anticipated that our net income will turn positive after year 7.

x) Expected cash flow
To ensure that we will have a stabilized cash flow to circulate, we require our management team to closely monitor and control the outflow of cash so that our company will always have enough cash in case of sudden accidents. Investment decisions will be made carefully and consulted wisely with our consulting and auditing partners BCG and KPMG to ensure a stable cash flow within the company. Our expected cash flow is illustrated in figure 5.6:

Figure 5.6: Expected future cash flow
Source: Group work

As seen from the figure our cash flow is expected to increase throughout the years. Although the operation and maintenance cost will be increasing due to inflation, the expected increase in our net income is anticipated to cover the cost, bringing in more revenues to the company and investors.

6. Environmental issues
The entire project’s mission is to make a greener world through producing electricity in a low-carbon way. However it is also of paramount importance that we should not deny the fact that constructing an offshore wind farm in the central of the sea will possibly bring harmful consequences to the marine environment. These issues have to be addressed prior to the commencement of the construction to ensure that the project is on the right direction.

i) Legal surveys
To avoid being convicted of any environmental restrictions, it is essential to communicate with Natural England about the actions that should not be taken. For instance, we have to conform to the Countryside and Rights of Way Act 2000, in which it is an offense such as to intentionally kill, injure or take any wild bird and intentionally damage any wild bird nest while it is in use or being built.

ii) Pre-construction marine environment monitoring plan
To ensure that the construction of the wind farm is going to cause the least harm the environment, an environmental monitoring plan following the advice from Natural England and CEFAS has to be implemented. For cables installation, we will have ecological specialists to walk along the cable routes to see how much vegetation area will be affected, thus making the clearance of the area reasonable and not affecting much of the original areas. For foundations construction, we will have experts dive under the water to do a survey of the marine environment in which the foundations will be constructed. The purpose is to ensure that least harm is done to the habitat of marine organisms. In short, the plan is to monitor the area affected and we will try out best to create the least disturbance.

iii) Shipping navigation and fishing
In order to minimize the impact on shipping and fishing activities affected by the construction, regular updates will be issued to Port of London Authority, Maritime and Coastguard Agency and local fisheries in case of any incidents. Details of the notices include the locations where we will be working at each stage, the transportations required and the transportation route that is going to be used to transfer materials.

7. Conclusion

Windsea Array will be a renewable energy plant that does not only make money, but also build a greener environment and a better world. After detailed analyses, it is believed that building our wind farm in the UK will be the most profitable because of the favorable government policies which includes the guaranteed strike price offered. The location West of Isle of Wight is also carefully selected based on several geographical factors including the wind speed and water depth level. Our construction plan is scheduled in detail as well, which includes the expected work days in completing each stage. Safety measures and contingency plans is prepared to ensure our worker’s safety meanwhile running the project efficiently. The cooperation with consulting firm BCG and auditing firm KPMG provides us with a reasonable estimate of the investment cost and yearly operation figures. Upon analyses our IRR in the optimal condition can reach up to 12% and having a NPV of £313m. A worst case scenario is also prepared and upon calculation our IRR can still maintain 10% and a NPV of £188m. In terms of financial analyses our financing team will frequently monitored the cash flow of company to ensure that our company is always financially healthy. Finally a number of environmental issues have been addressed to guarantee that the entire construction process will be meeting the standards set up by the UK government, such as avoid causing great disturbance to the marine environment. To conclude, Windsea array is going to shape a better and a greener world and would play an important role in protecting the environment.

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