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The Edge

Offshore wind’s value proposition

Big Oil’s future dividend machine?

4 minute read

Here’s the existential challenge that oil companies face: building an alternative income stream for the time when oil and gas demand peters out. The new business has to be sustainable, broadly commensurate in scale and ideally a growth market. The big bet being made is renewable power – solar, onshore and offshore wind. That last segment is the one most clearly suited to the Majors’ skill set.

But can they make money from it? Akif Chaudhry from our Corporate Power and Renewable research team has developed a new metric to assess the future cash contribution of offshore wind. I asked him:

How big is the opportunity in offshore wind?

Massive. Growth will be exponential; annual spend on offshore wind will rise from less than US$20 billion in 2020, 6% of global renewables investment, to almost US$120 billion in 2030, 25% of the total. The growth in capacity will be more significant, reflecting falling unit costs as the industry scales up. Growth in offshore wind is practically limitless with the emergence of floating turbines capable of tapping wind resources in remote locations.

Can the Majors achieve the scale they need?

Yes, but it will take time. Utilities, including Ørsted, RWE and Iberdrola, have locked in much of the offshore wind pipeline through 2026. But the UK, Europe, the US and Japan are among a host of governments accelerating lease auctions and centralised tenders in the push for net zero. The Majors are paying up for lease options, often partnering with incumbents and positioning to participate in the next wave of big projects later this decade.

What’s the WoodMac value metric?

We wanted a common metric to benchmark energy companies producing both oil and gas (molecules) and power (electrons). We chose operating cash flow per gigajoule equivalent (GJe). As electrons replace hydrocarbon molecules in Big Energy production portfolios, converting MWh (power) and barrels of oil equivalent (oil and gas) into units of primary energy equivalent allows a direct comparison.

The chart compares pre-generation offshore wind portfolios owned by industry leaders with the Majors’ new field upstream developments. The analysis uses asset data from Wood Mackenzie’s Lens Upstream and Lens Power platforms.

What does the metric tell us about value?

Offshore wind’s operating cash margins are 25% higher than those of future upstream oil and gas developments. They even trump deepwater projects, E&P’s highest margin asset class.

The long life of offshore wind projects also sets them apart from most deepwater and conventional upstream developments. Project lives are typically estimated at 30 years, delivering steady output with little decline in power generation. Only domestic gas and LNG projects come close to having a similar profile.

This combination of higher margins and long life means superior cash flow generation through the project’s life. An offshore wind portfolio will deliver an average operating cash flow margin of US$4 per GJe from 2025 to 2040. For a giant 3.6 GW project such as the UK’s Dogger Bank, that equates to around US$9 billion of cash flow generation in real terms over the 15 years. Deepwater, LNG and conventional projects of comparable scale would generate US$8 billion, US$6 billion and US$5 billion, respectively, over the same period, assuming US$60/bbl.

Are modest returns a problem?

There is scope to double returns, depending on the developer’s risk appetite. Baseline returns are around 5% to 6% (nominal, unlevered), driven down by fierce competition and added pressure in recent months from supply-chain delays and supply-led cost inflation.

To compete for capital against alternative investment options, we think the Majors need to deliver IRRs above 10%. The trick will be to get the balance right between the stability of cash flows and higher risk.

Using leverage and asset rotation, the baseline numbers can be boosted to around 10%. Higher merchant price exposure, building power-to-x projects (such as green hydrogen), power trading and an integrated approach with retail all offer further upsides. TotalEnergies, for example, is guiding for a 70% power purchase agreement (PPA) and 30% merchant exposure in its renewable portfolio going forward. Most legacy contracts have tended to lock in prices for 15 years, leaving only the ‘tail’ – and more recently the nose – exposed to wholesale prices.

Is offshore wind the answer to the Majors’ sustainability goals?

It could be a big part of it and perhaps even become the dividend machine of the future.

Our analysis suggests that if the Majors capture 25% of offshore wind demand, those electrons could replace about a third of the oil and gas molecules they lose by 2050 in the push to net zero. Solar and onshore wind might fill the rest of the gap but the contribution from offshore wind could be even higher in an accelerated energy transition.

As the Majors morph into Big Energy, a well-curated and diversified offshore wind portfolio holds the promise of the full package: scale with double-digit IRRs, long-term and relatively stable cash flows and high operating cash margins.

But they will need to convince investors they can navigate the “pay to play” strategy in offshore wind. That’s often ended badly in upstream, killing returns and destroying value.

Our Corporate Power and Renewables research team provide further analysis in “Why the Majors need to consider margins in weighing up offshore wind”.