By Jones Day’s Elise N. Zoli, Alex Cull, Karthik Kumar, Stephen DeCosse, Marianne Chao, and Jean Kuo
Setting aside the hype, the rising stars of offshore wind and hydrogen are coalescing rapidly, particularly in Asia. The parallel growth and coupling in these twin sectors presents a number of short- and long-term commercial opportunities and challenges for savvy market participants focused on the energy transition (and the associated estimated $16trn in infrastructure spending by 2030 it entails).
In this article, we outline the unique attributes of the Asian offshore wind sector, including by underscoring the implication of its leadership for the global wind sector. In addition to anticipating pressure points in these rapidly evolving twin markets, we anticipate and address directly certain challenges that Asian wind and hydrogen sector pioneers may face, based on our experience at scale in the European Union (EU) and United States (US) wind markets.
In particular, we highlight the importance of addressing the supply chain, novel risk profiles and hydrogen optionality of Asian offshore wind installations. In a year that the upstream oil and gas sector has experienced significant investment cuts, we anticipate committed renewables and hydrogen investment to expand beyond current predictions.
Offshore Wind & Hydrogen’s Precipitous Rise
There is no question that the offshore wind sector is maturing. From 2010 to 2018, the sector saw steady year-over-year growth, and it continues to experience strong growth and expansion.
The reasons are myriad, but two sector-based considerations deserve emphasis. The sector has benefited from levelized cost of energy (LCOE) reductions and successful development experience, with investors moving comfortably into the space.
The sector has been further buoyed by capacity factors (40-50%) at existing installations that compare favorably with traditional baseload energy supply, based on new and larger turbines, improved generators, and foundation-based innovation, e.g., floating structures, allowing access to deeper waters.
In other words, where resource conditions are favorable, offshore wind is becoming the ‘go to’ technology for developed economies seeking de-carbonized baseload profiles and scale, particularly for those regions not advancing or a nuclear asset class.
While the EU has long led offshore wind technology and project development, and will continue to underpin project development for some time, Asia is entering the market with speed and might. As a sign of the future, in 2019, more than 75% of the worldwide offshore turbine order book was with Asia.
Within Asia and to date, China has dominated the market, with Taiwan emerging as a major new player with a nationally funded goal of more than 15GW. Nonetheless, developers predict substantial growth potential in Japan and South Korea, following the announcement of installed capacity targets and promulgation of regulations encouraging offshore wind (including those facilitating the existing pipeline).
Even viewed without the hydrogen overlay, the level and breadth of pan-Asian offshore wind activity, viewed against Trump administration-driven delays and disruption in the US offshore wind market, may prefigure a shift in the epicenter of offshore wind from Europe to these Asian nations.
As it matures, the offshore wind sector is advancing its ability to deliver as a cross-over technology. The drivers beyond wind’s focus on flexibility are multi-faceted. The depth of experience in European offshore wind markets has shifted the focus from pure development (i.e. “can we build it bigger, deeper and faster”) to enabling more versatile, efficient deployment of offshore wind-based electrons (i.e. “can we deploy electrons in new markets”).
Wind developers want an ability to shift production to match resource availability to alternative high-quality markets, optimizing wind power’s usage and project economics without curtailment. That goal has prompted a hard look at wind-produced (or renewable) hydrogen.
It is no surprise that energy experts are keen on a hydrogen economy. Hydrogen has been called the Swiss army knife of energy – an abundant, familiar, non-toxic base element of the periodic table, with an enviable energy density, compressibility and flammability that facilitates transportability and supports a range of applications across the industrial value chain.
In this article, however, we focus on its use as a storage medium for electricity pricing arbitrage and grid services, as well as a transportation fuel for Asian and EU markets with meaningful carbon goals and without domestic hydrocarbon resources. Both are addressed below.
As a storage medium, hydrogen is an emergent choice if certain economic precepts are present. In a nutshell, hydrogen storage works best for wind developers in economies that put a price on carbon and monetize electric system security and reliability (beyond demand response or capacity). In terms of fundamentals, wind-based hydrogen production (separating hydrogen from water), combined with hydrogen-turbine or fuel-cell based generation (called regenerative hydrogen systems), is effectively equivalent to batteries, despite lower round-trip efficiencies, where any of these conditions is present, because the regenerative hydrogen systems optimizes what otherwise would be curtailed or underpriced wind-based electricity production.
The competitiveness of hydrogen-based storage is expected to improve, as the technology costs continue to decline. Nonetheless, while storage should not be written off, the primary differentiator for wind-based hydrogen is the ability of electrolyzers to produce a high purity, zero-carbon transportation fuel, for a range of transport vehicles, including fuel cell electric vehicles (FCEVs). FCEVs are 2-3 times more efficient than internal combustion engines and offer particular value for the marine and long-haul sectors, where battery displacement (mass), weight and range matter.
The use of hydrogen as a transportation fuel is not new. Hydrogen is a long-known non-carbon transportation fuel, and hydrogen-based fuel cells have long powered NASA’s explorations, with well tested experience in complex environments: space.
What is newer, however, is the significant innovation-driven improvements and costs reductions in proton-exchange or polymer electrolyte membrane (either, PEM) fuel cells that underpin the FCEV market, particularly in Asia. While small in total number of vehicles, the FCEV markets are flourishing, catalyzed by groundbreaking investment, development and scaling in Asia, the US (where the shift to a hydrogen economy is enshrined in a 2005 vintage law) and the EU. Japan and South Korea, in particular, have engaged key domestic motor vehicle manufacturers, and advanced infrastructure, with the highest global concentration of fueling stations.
These same synergies between offshore wind and FCEV growth will also help South Korea and China meet their respective goals of just under a million fuel-cell vehicles on the road by 2030. Beyond FCEVs, Asian nations are also actively investigating the use of hydrogen as a zero-emission fuel for international shipping, as discussed in a recent Jones Day Commentary.
See Singapore Encourages Investment Toward Decarbonizing Shipping.
The focus on renewable hydrogen in Europe and Asia is grounded in national security and de-carbonization goals, and the trade game that results. China and Japan are the largest net importers of fossil fuels, with the EU, China and Japan’s economies reflecting the highest global gasoline prices per liter to the consumer (i.e. each at or above $1/liter or $4/gallon in 2020), with a substantial consumer tolerance for gas taxation.
Current hydrogen transportation fuel production costs equate to less than $5/kilogram (the 4 liter or gallon equivalent), with off-site wind hydrolysis production. In other words, hydrogen fuel is already cost competitive in certain markets, e.g. Germany, Japan and California, a calculation that assumes none of the avoided externalities of renewable hydrogen are valued.
The effect of the FCEV and hydrogen fuel markets on wind-based hydrogen development is already being seen. Installed electrolyzer capacity is projected to increase more than 1,500 times in the near term, bolstered by the growth in project numbers and sizes, with wind-based hydrogen production likely dominating.
Given this evolution, industry participants should consider having operative development and operational agreements reflect, preserve, and facilitate hydrogen optionality, as well as consider the appropriate distribution of the related economic benefits, with specific allocation of future credits and subsidies, that are likely to materialize over the next several years, and certainly within the next decade.
The Asian growth in offshore wind, particularly in parallel with hydrogen sector development, will stretch our current experience profile in new and diverse marine systems and complex economies. The following considerations are of particular relevance to Asian offshore wind development, including as it works to engage the associated hydrogen market.
These challenges may be exacerbated by Covid-19, and the associated trade positioning between and among nations and regions. We highlight them, as well as potential ways to address them, with the goal of advancing long term wind sector stability:
As is well documented, the offshore wind sector has relied on larger turbines specifically designed to meet offshore wind dynamics (so-called ‘strong winds’), combined with increasing use of specialized magnet-based generators (permanent magnet synchronous generators or PMSGs) correlated to lower weights, higher efficiencies, and lower maintenance costs (particularly important in offshore installations). This technology evolution has precipitated a near-term focus on specialized manufacturing and delivery mandates, and a long-term focus on metallurgy of critical components and materials.
Of concern, for instance, is a dependence on certain rare earth metals used in the permanent magnets for PMSGs. The dynamic is exacerbated as a function of a lack of production diversity for such metals, geopolitical risk associated with their supply chains, and recent COVID-19-driven supply chain interruptions and trade barriers, all of which can contribute to high price variability.
Despite mitigation strategies premised on substitution of alternative metals, it is all too easy to foresee bottlenecks to turbine optimization, PMSG deployment and wind-project development, particularly given the scale of Asian growth and the limited number of specialist manufacturers, installers, and equipment. Therefore, when awarding contract mandates, particular attention should be given to due diligence of the sourcing of these materials and the supply chain realities, including those provisions implicating component-substitution rights and remedies.
As mentioned above, the offshore wind sector is in part driven by chasing the ‘strong winds’ that deeper offshore installations afford (typified by the shift to floating installations).
Historic EU leadership in the wind sector means that the industry has yet to fully engage and experience wind and wave profiles in Asian waters. These include hurricanes, cyclones, typhoons, and tsunamis – the last two in particular being extreme weather events that are not present or are rarer and less severe in European offshore waters. Indeed, models of the tropical-storm-related (50-year event threshold) wind project losses in Asia (excluding China) are $2.7bn through 2030, compared to negligible risk profiles in Europe.
Accordingly, attention should be given to new risk-mitigation strategies, from technological innovation to insurance products. We specifically highlight new forms of indexed construction products, designed to keep pace with global risk at a reduced cost burden, compared to traditional products.
The synergies between offshore wind and hydrogen development require planning, and industry participants should consider having operative transactional, finance, development and operational agreements preserve, reflect, and facilitate hydrogen optionality, as well as consider the appropriate distribution of the related economic benefits, that are likely to materialize over the next decade.
We emphasize this because preserving hydrogen sector integration has not been a priority in wind transaction, finance and development documents that we have reviewed, and the costs are significant. By way of example, the allocation of attributes, including in off-take agreements, is not well suited to preserving hydrogen optionality, and in many cases requires a ground-up review.
Typical market language gives away fuel incentives, the values of which counterparties either have not considered or simply do not understand. We suggest developers, and their equity investors, parse and retain attribute allocations to reserve rights to fuel attributes that can drive valuations and long term project profitability. Likewise, leasehold interests and planning documents should project forward to account for and authorize not only electric, but also fuel infrastructure, interconnections.
Just as US wind-project forms required material modification from EU-origin forms, careful attention should be paid to Asian forms to avoid similar paper trail errors.
In sum, the Asian offshore wind market is a critical and important one, likely to reflect key hydrogen-based synergies. At the same time, it raises a number of novel considerations that are worth attention and proactive management.