If you want a job done properly, you best do it yourself

Part 2 of this article described how, by self-performing servicing and maintenance (say in place of a turbine supplier) an offshore wind farm can lower operating costs. Even better, they unlock the opportunity to synergise operations across more than one wind farm.

Yet, self-operating is not simple. Part 3 examines what it takes to self-operate, what it means for lenders and how it affects any equity joint-venture set-up.

What do we mean by self-operate?

Arguably, every wind farm self-operates to some extent. Even if every O&M execution job is outsourced, the Owner(s) will always retain the right to make fundamental decisions about its asset’s operations. The Owner will therefore, at the very least, establish a supervisory function that is close enough to operations to support its decision making.

The minute anything unexpected happens within the asset, the Owner needs to call on procurement, contract management, legal, finance and regulatory capabilities. The Owner may either set up its own functions for this or appoint a lead investor to manage the Owner’s interests.

From here, it is a short step to taking on some of the less complicated wrap around services to O&M execution. Facilities management, logistics, offshore co-ordination, vessel management are not simple tasks but are well within the capability of most competent organisations in the energy sector. Complications may arise with how the Owner structures its operating model depending on whether these roles are performed by, or on behalf of the wind farm holding company but this a big topic in itself to be covered in a future insight.

Figure 1 – Self-Operating Models

Nonetheless, in the context of fundamentally changing the O&M cost base, what we are really talking about are repeat Owner operators such as Orsted, RWE, Vattenfall who have built the in-house capability to execute the day-to-day preventive and corrective O&M services. Crucially, they are also prepared to accept performance risk for that service (rather than the role of managing someone else performing them).

How do you even start self-operating?

Leaving aside scenarios in which wind farms such as Nordsee Ost, Nordsee One, Trianel Extension were historically forced into self-operating, most self-operators have the opportunity to develop the capability to self-operate during development of an offshore wind farm.

A common approach is to negotiate for a 2-to-5-year service and maintenance contract (“SMA”) with the turbine supplier before phasing into to full operational responsibility. Transition is facilitated by sharing a significant portion of the labour and vessels during the SMA. The organisation can learn on the job during the turbine equipment warranty period prior to taking 100% custody.

Even then, three major obstacles stand in the way of the self-operator: (i) Capability, (ii) bankability and (iii) the JV Conundrum.

1.      Capability

First the self-operator must create an organisation technically capable of operating an offshore wind farm. Offshore operations can be complex and dangerous. Think of craning heavy objects at sea, thousands of transfers from a moving vessel, working underwater, working at height, working with high voltage. Ideally, the self-operator needs to be already operating energy assets. They have transferable and adaptable systems, processes and people to build that organisation.

Secondly, the self-operator must secure the commercial arrangements that permit them to self-operate. They are negotiating with a (turbine) supplier whose lunch they are effectively stealing. A turbine supplier won’t necessarily agree to a short SMA, especially in a new geography where the set-up costs may be prohibitive. They need reasonable terms for spare parts that only a supplier can manufacture, for instance, blades. Similarly, there could be complications accessing and interpreting key operating data as well as maintaining the core data systems, particularly over the longer-term. This is not an easy negotiation, and it must take place years before actually self-operating.

Thirdly, a quality O&M strategy requires good understanding of wind farm and key component performance. Any self-operator must therefore invest in the engineering as well as intelligence-based tools and systems to understand what is happening within the wind farm, plan and respond accordingly.

2.      Bankability

Even once a wind farm is capable of self-delivering O&M, its investors who are used to SMA fixed pricing and availability warranties as a precedent may not share the enthusiasm for taking on the O&M risks to reduce suppliers’ risk premium.

While the choice to self-operate will be driven by the long-term benefit to equity, lending appetite and terms may be assessed on the wind farm’s ability to consistently repay its debt. This is not exactly the same as operating profit.

This means that if the wind farm (or any co-investor) wants to finance with debt, it must consider any impact that self-operating would have on lenders’ terms. It is no good self-operating to save on the turbine supplier’s risk premium if it costs you the equivalent or more via worse lending terms.

To counter this, a self-operator might need to offer risk protections common to SMAs such as fixed O&M pricing and/or an availability warranty. But this requires a margin commensurate to the risk, which threatens to undermine the rationale to self-operate, just from the opposite flank.

There is much more to say about the bankability relationship and its variables but given that many offshore wind farms are built using 70% or more debt, anyone self-operating must ensure their O&M strategy will be reasonably acceptable to lenders.

3.      The JV Conundrum

The JV conundrum arises when a self-operator seeks efficiency and lower cost by sharing parts of operations across wind farms owned by different parties.

O&M Strategy used to be determined by the sole developer-owners of the 2010s. They could unilaterally decide to share delivery, cost and other project synergies across their 100% owned (at that time) wind farms. Since then, offshore wind farms have grown to a scale that makes it increasingly rare to find sole developer-owners. Instead, development risk is more likely to be syndicated across two or more co-investors.

This means that the O&M Strategy must be agreed by the joint-venture shareholders for each individual wind farm first. Only then, among all the different wind farm entities that will benefit from co-operating. Both steps can be surprisingly difficult and contentious.

(a)   We are all in this together, aren’t we?

Whichever elements a JV decides to self-operate, it must decide who and how they are delivered. Tensions between partners with similar capabilities are relatively easy to apportion out.  The real problem starts when one partner takes on O&M risk for the benefit of all partners including those not taking O&M risk (see above on bankability). On the flipside, an operating partner taking margin through the O&M service contract may erode some of the benefit for the non-operating partners.

This asymmetry opens a world of negotiations across the service contracts and the shareholder agreements to fairly recognise who stands to gain or lose from the commercial arrangements, synergies and the risk allocation. The negotiation must also weigh how benefits change through many future scenarios such as exits, farm-downs, refinancing events, changes in strategy, future synergies.

(b)   The Director’s paradox.

Once one JV is happy, consensus is required to unlock the benefit of shared operations across wind farms owned by different parties. Yet, different Owners can easily have competing interests or simply different opinion about operating decisions, allocations of shared costs, approval processes and procurement. Planning and executing operations across multiple wind farms using the same resources can trigger severe anxieties about fair treatment (whether real or perceived). It takes willing and co-operative partners to accept the commercial implications for all affected. Today my wind farm might win or lose a little, but bigger picture we all win big.

This triggers the director’s paradox because the directors of each wind farm have a duty to act in the best interests of their individual wind farm holding company, not the operating collective. The director’s paradox is not conducive to the give and take required with shared operations. It is easy to stumble into conflict with every major decision affecting more than one wind farm a potential trigger.

Conclusion

Controlling and sharing resources synergistically between wind farms provides the biggest single opportunity for wind farms to reduce their long-term operating costs. However, between the effort needed to build capability, the requirements to achieve bankability, and the challenges of JV asymmetry and consensus it is understandable why so many wind farms instead set up with standalone, subcontracted operations. It just comes at the cost of less control, less knowledge and the lost opportunity cost to scale operations.

Unlocking savings through shared operations is complicated and difficult. But it is doable. The reward potential is high (see Part 2). And perhaps the control, knowledge and reward for those that can provide bankable self-operate solutions will give them the competitive advantage to thrive through these most challenging times in the industry.