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SQUEEZING THE LITTLE GUY

Offshore wind parks are the biggest market for workboats in Europe, but the competition is ferocious. Why do the weakest players take all the risk?

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By Erik Kravets 2018-03-09 22:47:00

(Article originally published in Nov/Dec 2017 edition.)

Work it harder, make it better, do it faster. We may remember these lyrics from Daft Punk’s biggest dance hit of 2007, but they could also be today’s motto for workboat charterers. Not included but equally, if not more, relevant: Do it cheaper! Today’s workboat jobs must get done on razor-thin margins despite increasing complexity.

It doesn’t matter how you define “workboat” because, when all is said and done, no charterer will pay extra for semantics. Whether you consider tugboats, pontoons, support vessels or any of many other vessel types as workboats, in Europe they are all competing under similar conditions for similar customers in a tough market.

A racing yacht can be converted into a crew transfer vessel. A tugboat can be used for cargo runs. Definition takes a back seat to function. Ultimately, as the old proverb goes, the proof of the pudding is in the eating.

Workboats today are covering more ground than ever in more varied roles than ever. This puts a premium on expertise and know-how. In the past, tugboat masters may have had their highest value in salvage or the nuances of their local waters.

Today, following the recent consolidation wave, the survivors have become elite project management and logistics providers, flanked by strong technical, service and sales teams.

WIND MARKET CONSOLIDATION

The biggest sector employing workboats in northern Europe is offshore wind. It’s consolidating even faster than the workboat market, and the effects are significant.

The official E.U. goal going forward to 2030 is to add five to six gigawatts of installed wind-generating capacity per year. Five to six gigawatts are equivalent to two to three large-scale offshore wind parks. The government-endorsed buildout is picking up speed, not slowing down. Everybody wants a piece of the action.

The industry’s consolidation is driven, in part, by the struggle to scale up to meet the challenge. For example, early this year E.U. regulators granted unconditional antitrust approval to the merger of Siemens AG and Gamesa SA, whose eight-megawatt turbine product lines had formerly been in direct competition. This is part of the price to build five to six gigawatts per year.

Among the “synergies” anticipated by Siemens Gamesa is €230 million of savings annually from the “integration” of Gamesa’s Adwen subsidiary. This means, inter alia, the shuttering of Adwen’s eight-megawatt rotor blade production site in Bremerhaven, which employs 600 workers.

Look out when big money is playing at the VIP tables! Especially when some of the high-rollers, like Siemens Gamesa Renewable Energy, look poised to go on a multiyear winning streak.

Now imagine if, on top of that, the dice were loaded – even if just a tiny bit?

The story of wind power in Europe is of companies launching, succeeding or failing at obtaining funding, bidding for rights, executing projects and then, in the end, either making a profit or going bust. This process frequently entails collateral damage, which is sometimes politically condoned.

In 2015, Dresden-based Gicon Group developed a prototype floating wind park (“swimming offshore foundation” or SOF). It was awarded a government grant of €5.25 million. By mid-2016, the company reported it was in financial trouble and might not have enough money to bring its product to market. The reason: bureaucracy.

The German Federal Network Agency captures and assesses each newly installed wind generator to ensure that the buildout goals in a geographic zone are not exceeded. Because of a long-winded permitting process, Gicon Group was delayed a year and was only able to obtain €2.7 million of its €5.25 million of funding. The remaining grant money was subject to the wind generator being installed by a certain deadline, which had lapsed.

After a long silence, the SOF briefly made an appearance in an August 2017 interview in which Gicon Group stated that “new investors” were being solicited. The prototype, which had been scheduled for a 2017 launch, would otherwise be delayed indefinitely.

But for every unhappy ending, life nevertheless seems to find a way.

Take the spectacular early 2013 restructuring of North German BARD Engineering GmbH, which left unprecedented legal and financial wreckage in its wake. After writing off €800 million of debt, BARD Engineering GmbH’s site in Cuxhaven was handed off to subsidiary Cuxhaven Steel Construction GmbH, which predictably also ran into financial difficulties. The same site was purchased by Ambau GmbH in 2016, which is using it to build foundation pieces – coincidentally, ones very similar to the pieces that were built there years ago by the original owner.

It’s hard to imagine similar sectors of the economy that are simultaneously worth so much yet subject to so much constant volatility. The combination of pioneering technology, a vast influx of speculative money, political gamesmanship and stormy seas must be intoxicating.

IMPACT ON THE WORKBOAT MARKET

So how does all this influence workboat owners?

Politics – and the lowest bid – decide who wins the exclusive rights to a particular wind park. Big power and network companies like EnBW, EWE, Vattenfall, TenneT and E.ON end up with exclusivity to develop an offshore zone up to a certain number of gigawatts.

These companies, who may be referred to as “employers” in industry parlance when they find themselves at the top of a “back-to- back” contract hierarchy, buy turbines and other equipment. They are direct (or, at times, indirect) customers of Siemens Gamesa, Vestas, General Electric, and other wind park parts suppliers. As “employers,” they also charter workboats to build wind parks. Banks and insurance companies, who finance the construction of the wind parks, complete this triangle.

When a bid is placed, e.g., for four cents per kilowatt hour, it means the bidder will accept a government subsidy of four cents per kilowatt hour for every kilowatt of electricity delivered to the network. A bid of two cents per kilowatt hour is more competitive because it means the bidder will accept half the subsidy of the company that bid four cents per kilowatt hour.

Just a few years ago, subsidies of 19.4 cents per kilowatt hour were de rigueur in Germany. By early 2017, the situation hit rock bottom: EnBW and Dong Energy recently won bids for wind parks at zero cents per kilowatt hour. While this is no doubt incredibly competitive, the resulting cost pressure is passed both up and (much more likely, and much more often) down the line.

Big players like Siemens Gamesa can typically defend their prices since wind park developers cannot easily find alternative turbine or production capacity. But the small players, namely workboat operators, do not have that kind of market power. Hence, the cost pressure really only flows downstream as reflected in the proliferation of “back-to-back” contracts, i.e., contracts that pass on liability to the lowest subcontractor in the project chain.

This is, after all, a market with few employers owning exclusive rights to certain wind park projects. The employers don’t need to value their relationships with workboat owners. A workboat can be swapped out or negotiated down in price.

For workboat operators, however, it’s inconceivable to swap out an employer. Remember: Employers have exclusivity in a particular wind park. They have an unassailable negotiating position. They are at leisure to invite multiple tenders from multiple workboat operators and make their choice from among these, even changing terms and conditions at the last minute. It’s rational for the employer to give the award to the offer that is both lowest in price and accepts the greatest liability.

It seems unfair that those who are exposed to the highest risk, namely workboat operators, have the lowest return and/or profit, while those who are exposed to the lowest risk, namely the employers, have the highest return and/or profit. But this inversion of the risk-reward spectrum is, itself, a result of well-known and well-understood market principles. There’s a lot of competition at the subcontractor level and much less competition at the project (or, employer) level. In a concentrated industry with only a few employers, oligopoly pricing rules.

A common pricing mechanism in an oligopolistic market is “cost-plus.” This means the production cost is averaged out and a margin of profit added on, whatever that may be, as a return on capital. This is, incidentally, how wind park developers calculate their bids for wind park rights: They conduct a cost calculation and then add a margin. Bids for wind park rights have become more competitive because the costs involved in developing and building out a wind park have been declining, allowing the “cost” part of “cost-plus” to bottom out.

Upstream costs are coming down due to mergers like Siemens Gamesa. Downstream costs are, unfortunately, coming down because workboat operators are struggling to find their footing in the face of the overwhelming negotiating power of a few big players.

THE BIGGER PICTURE

Since wind energy, for a long time, had the reputation of being extremely expensive relative to other modes, we should be happy to see zero-subsidy wind farms emerging. But while we celebrate that industrial achievement, we should pause and understand the negative consequences that come from monolithically pushing cost as the only factor in the bidding process for wind park development rights.

There is, as always, a bigger picture. The only sustainable solution is one in which all the stakeholders take home enough that they can live to die another day.  MarEx

The opinions expressed herein are the author's and not necessarily those of The Maritime Executive.