Investing in Nordic wind energy

Every MWh of electricity generated from wind in Sweden is worth 18% more than its counterpart in Germany[1]. Though the capacity mix of the Nordic power system has traditionally been dominated by hydro, wind is catching up. Compared to 2015, wind capacity is expected to increase by 83% to reach 22 GW in 2020, while hydro capacity will only increase by 3%. This increased investment in wind is being driven by a continued decline in levelised costs of electricity (LCOE) for Nordic wind projects, supported by, larger production per plant mainly due to longer rotor blades increasing the swept area, falling capex and lower land costs than those faced by European and UK counterparts. For example, according to Vestas, the LCOE in the region are projected to decrease by 47% by 2021 compared to 2014[2].

Other important factors making Nordic countries a favourable geography for investments in wind are strong wind yields, coupled with low population densities. Denmark and Norway enjoy some of the highest annual average wind speeds compared with other European countries^[3]. The low population density in the region results in low land costs and the resulting large projects have lower investment and operation costs due to economies of scale, and efficient development timelines. The regulatory environment is stable and wind farm operators have access to several revenue streams like wholesale and balancing markets. For all these reasons, Nordic wind markets have natural advantages in the now imminent subsidy-free wind world.

The cannibalisation effect in an increasingly merchant wind world

However there’s a cloud hanging over this otherwise bright horizon. As an intermittent low marginal cost generator, the increased proliferation of wind projects has the effect of decreasing the very electricity prices on which they depend. The reason for that lies within the merit order effect of renewables. In competitive wholesale power markets such as in the Nordics, power plants place bids to supply electricity at a price that covers their short-run marginal cost (SRMC). The bids are ranked from the least to most expensive – the merit order, representing the supply curve of electricity. Since the market price is set at the intersection of the supply and demand curves, the marginal plant that sets the price will depend on how much wind precedes it along the merit curve. Bids which are less expensive than the market price are said to be in-merit and the ones which are more expensive are said to be out-of-merit. Under normal circumstances, the marginal unit is a conventional thermal power plant which has higher SRMC due to the cost of fuel it uses to produce electricity. By providing electricity with a close to zero SRMC, renewables push conventional plants into the outof- merit zone and as a consequence exercise a downward pressure on the market price.

The decrease in wholesale prices due to the widespread deployment of renewables is already happening across Europe. It’s estimated that the average price decreases by 0.5 EUR/MWh with every 1% increase in renewable capacity^[4]. Our own econometric analysis of the Nordic power market, examining trends in the market over the past 20 years, confirms this effect is statistically significant.

The effect can be further exacerbated since wind projects generate their highest volumes at times when power prices will be most influenced by them. As a result, the wind-volume-based average price may be lower than the average price over the day. In the Nordic markets however, hydropower reserves provide a natural mitigation to this threat. For installed wind capacities up to 30%, it’s estimated that hydropower mitigates the drop in power prices by a third^[1]. So we can expect that, for power markets where hydroelectric stations with large reservoirs prevail, as in Sweden and Norway, there’s significant protection against the cannibalisation effect, even as wind power takes on a greater share of the total capacity.

The fundamental reason for the synergy between wind and hydro is that, thanks to their dispatch flexibility, hydro plants compensate for wind power output variability by stopping generation when the price is low and ramping up generation when the price is high. That mitigates the impact of wind power by smoothing out the wholesale power price. There’s a further compensating effect from the expected increase in CO2 prices providing additional uplift in wholesale power prices in times when thermal generators remain those that set prices.

Efficient asset management in combination with robust forecasting are vital for accurate pricing and return uplift over time

Capitalising on the strong returns from investments in Nordic wind assets will be increasingly driven by three core factors:

1) statistically consistent assessment of forecast price and wind yield, placed in the context of the relevant risk-bearing slice of the capital stack,

2) efficient and well-benchmarked management of the asset life cycle costs, especially attuned to revenue (vs volume) optimisation, and

3) articulation of terminal values embracing new revenue streams, and evolving technological solutions.

These factors have the combined effect of assuring investors pay under the odds for expected revenues, whilst ensuring that operational and exit upsides remain achievable through informed cost tension and evolving best practice.

Statistically consistent price and yield forecasting means assessing power price on a “PX” basis, as with wind yield, a practice naturally facilitated by econometric forecasting, such as that we’ve developed. The results are unambiguous P90, P75, and P50 (for debt, mezzanine and equity respectively, for example) revenue forecasts that combine price and energy yield statistics into one consistent picture. That means less ambiguity and more consistent risk-based pricing and debt sizing, for all financiers within the capital stack.

Efficient asset pricing leaves room for upside discovery through operational excellence. Benchmarking techniques can be applied along the asset life cycle to ensure the operation is at the forefront of efficiency measures. Alongside technological improvements, for example more efficient turbine solutions, predictive analytics for asset failure or unscheduled maintenance can result in increased availability above base case assumptions. These benefits could increase significantly if the asset owner is able to use analytics to avoid or dramatically reduce the impact of unscheduled outages.

Over a number of years, we’ve worked with numerous renewable players (hydro and wind) to support improvements in operational excellence spanning from the ongoing focus on improving current practice to larger turn-arounds. A well-designed (and executed) initiative often delivers gains in the 30-40 percent savings range. These initiatives have typically been supported by use of our proprietary renewable benchmarking model (hydro and wind) that provides a baseline then measures the benefits of particular actions.

What’s more, long term contracts (PPAs) are a valuable tool to mitigate price risk and ensure consistency of revenue streams. Bilateral agreements allow very locational and site-specific services to be developed which again will increase the potential for providing bespoke flexible services which both eliminate third party costs and generate further revenue streams.

In the longer term, and in the course of an effective asset management programme, new business models should be embraced as power markets move beyond energy-only markets. Relying on synergies between different technologies to provide flexibility is the key to exploiting and diversifying simultaneous revenue streams that would otherwise have a higher risk/return frontier. For example, with the eventual deployment of wind power plants and batteries, demand side response and heat storage can be operated simultaneously, creating an aggregate value greater than the sum of their parts. Besides network services which differ significantly in different geographic regions, higher power quality and flexibility as a service can be offered on the balancing market, as well as opportunities on the intraday market to generate additional revenues by exploiting temporal arbitrage.

Read more PA perspectives on Nordic energy markets

1. Hirth, Lion (2016): “The benefits of flexibility: The value of wind energy with hydropower”, Applied Energy 181, 210-223

2. Anne, Vedel Head of Technical Sales Vestas Northern Europe (2017): ”Innovating to lower the cost of energy”

3. World Wind Energy Association (WWEA) (2014): “World Wind Resource Assessment Report”

4. Report from the Commission to the European parliament, the council, the European Economic and Social Committee and the Committee of the Regions (2016): “Energy prices and costs in Europe”