In this second in a series of articles looking at Financing the Quest for Net Zero, Michael Stoneham (Banking Partner in Brodies LLP's Energy and Infrastructure team) looks at the opportunities and challenges appearing for the financing of the supply chain now or in the near future.
Financing is needed for the nascent local supply chain
In the first of this series the hopes for an expansion of onshore wind farm development were highlighted. There has been an increasing clamour in England and Wales for the "ban" on such development to be lifted. The UK Government and the Labour opposition have begun to engage on this, and Scotland remains steadfast in promoting ambitious onshore wind targets, albeit with requests to the UK for greater Contract for Difference (CfD) support and for levelling-up changes to the unfair transmission charges regime.
The two major barriers to delivering those onshore quick wins are the forward availability of grid connection slots and the entirety of the planning process (which we discussed here). These still persist but in both cases governments are coming under pressure to ensure that the pace of change is accelerated.
These barriers also indirectly affect another key aspect of the quest for net zero, namely the development of a UK supply chain for these projects. A large proportion of the new activity to be engaged for delivering net zero can be serviced by the UK supply chain.
Offshore wind: the pathway for supply chain growth
Whilst onshore wind development may or may not progress through extensions, repowering and subsidised or subsidy-free new projects, it's in the offshore wind sector that a pathway for supply chain growth is mapped out.
England has an offshore wind programme of large-scale development that is proceeding apace. Scotland has started out with its first round of offshore wind developments which is now nearing completion, but it's mainly in the follow-up plans for future development that greater opportunities will arise for new or expanding service industry businesses.
The ScotWind programme
Scotland's ScotWind offshore wind programme has granted options for 17 projects which, if all are licensed, completed and financed, would bring in a potential £28bn of supply chain commitments. Realistically, only a small proportion of these projects can be completed by 2030, but the aim is to have achieved up to 8GW of new Scottish offshore capacity by that date, including 5GW of floating offshore.
Network reinforcements for the grid are being approved and there is talk of some planning constraints being lifted. Delivery of ScotWind projects is expected to start in the late 2020s with first generation of power by 2030.The thinking is that the resultant scaling-up of power can increase exports to England and Northern Ireland, and also be available for use in creating green hydrogen, assuming green, rather than white or natural, hydrogen has a role to play in relation to achieving net zero.
The reason for caution on timescales may be because at least 10 of the ScotWind projects are specified to have floating turbines, anchored onto moorings, rather than turbines fixed to the seabed. To an extent, this is new technology and so the financing of the construction processes itself may be more difficult to put in place before technological maturity is achieved.
Floating offshore wind sites are considered to be environmentally better for the seabed Floating wind sites can also be in deeper waters (the English programme sits largely in shallow beds) which means they can be located in areas of greater wind speed. These aspects also present challenges connected with more extremes of weather, the ease of servicing and risk of degradation of the installations.. There are a couple of small floating projects already in operation in Scottish waters, which is a promising start.
The INTOG programme
A further Scottish programme, called INTOG (Innovation and Targeted Oil and Gas), has followed ScotWind and has two elements. The first (TOG) is aimed at supplying power directly to North Sea oil and gas installations and so reduce their emissions and help to decarbonise the North Sea. The second (IN) is an innovation element, which runs in parallel, but is separate in scope and scale. The innovation part of the programme consists of small-scale projects to supply offshore private networks of up to 100MW to benefit local communities. Grid connections may therefore not be needed, but onshore connections will still be relevant.
Exclusivity agreements have been issued for 13 INTOG projects, and those qualifying will be granted options and move on to the planning and financing stage. Interfaces with carbon capture and storage projects designed to utilise sub-sea storage caverns are expected and so may lead to a need for pipelines, monitoring equipment and wells. A Supply Chain Development Statement is expected soon.
The need for supply chain financing
Stepping back from all these expansion plans, its apparent that a need for offshore project financing will largely not arise for a few years. Apart from grid or planning issues, and financing support through CfDs or other mechanisms, there are those higher technology risks of floating wind to take into account.
Yet a crucial part of the picture over the next few years will be the strengthening of a resilient local supply chain across the UK which can enable these developments to be advanced. And that will require not long-term project finance, but traditional business growth development financing to enable existing businesses to upscale and new entrants to get established.
Some businesses will already have assets that can support new debt but others will need equity investment. It is in this latter category that the role of development banks and governmental entities such as Scottish Enterprise will be crucial. There may be an investment need in advance of bidding for, and winning, contracts which somehow needs to be supported. But pre-award work is already well underway by the successful bidders, and the 30 plus holders of options or exclusivity agreements will be gearing up to do their various surveys and engage with local communities.
We are presently seeing a significant uptick in finance facilities being made available to support corporate expansion plans in this sector of the economy. There also appears to be greater visibility of UK Export Finance in transactions, bringing with them some ESG covenants that are conditions of the financing.
One area of immediate investment will be the extension of port facilities across the UK. In many ports quayside arrangements and loading gear will need to be upgraded. The offshore services supply industry will be looking for new and better vessels that can service the new installations. Manufacturers and fabricators of parts will be looking for ground space and construction facilities near to relevant ports. And all supply chain participants will be looking for skilled and unskilled labour.
The selection of two Green Freeport areas in Scotland, the equivalent batch of freeports across England, and the imminent announcements on enterprise zones across the UK may well result in increased business investment. This will depend on if the incentives offered are meaningful and if, in Scotland's case, its additional requirements such as payment of the living wage, don't deter investment. There are examples of businesses that have already invested heavily and been able to raise finance (Aberdeen Harbour, for example) or are waiting for confirmation of UK Government support (such as the Acorn CCS project). All are likely be looking out for suppliers to assist them as they pick up the net zero challenges.
Final comments
The accumulation of this activity over the next few years, along with transitioning from North Sea oil and gas activity will likely result in a regenerated and expanded UK supply chain, hopefully encouraged by appropriate subsidy support (noting however that post-Brexit UK remains subject to WTO rules). Bodies such as both UK and Scottish National Investment Banks, and the British Business Bank, have roles to play here.
The debate has already begun in advance of the CfD Allocation Round 6 (AR 6) as to how or whether the local supply chain should be an integral part of a subsidy award. This month has seen UK Government's response on comments received in the consultation on the future content of Supply Chain Questionnaires, including specific references to floating offshore wind., and guidance has been publicised. The application window for AR6 will open in December for 55 days.
The financing opportunity presented by a wide range of large and small businesses that are expected to engage in this process looks like it is real and imminent. Genuine green loans or bonds, and in many cases, equity investment and patient capital, can form a part of the picture. The likelihood is that whether progress towards net zero continues, or succumbs to the headwinds of economic or geopolitical pressures, we are on the cusp of a genuine expansion of sustainable business activity.
