At round five of the contract-for-difference auctions on September 8, 3.7 gigawatts of renewable capacity were awarded, one third of the amount awarded last year; 1.9 GW was solar and 1.5 GW was onshore wind. No offshore wind capacity was cleared. This a blow to the UK goal to grow offshore wind capacity to 50 GW by 2030 from 14 GW currently. Still, no surprise here as many developers had warned that the ceiling strike price of £44/MWh in 2012 prices of these auctions was way too low given the 40% increase in construction costs over the last year. Overall, the absence of awarded capacity reflects price discipline from developers.
Last year, a record of 6.9 GW of offshore wind capacity was awarded at a record low price of £37.5/MWh in 2012 prices. Due to the latter and soaring costs ever since, none of the projects has been sanctioned yet. In July, Vattenfall scrapped the Norfolk Boreas project and booked a £0.4 billion impairment. Now, we see two options. Either the government maintains its austere stance ahead of the 2024 general elections and endures the burden of being labeled as a climate villain or it grants tax breaks in the form of capital allowances at the next autumn budget for offshore wind projects awarded last year so they can be sanctioned.
This includes narrow-moat Orsted’s giant 2.8 GW Hornsea 3 project. Given the price inflation, we expect the project to be value-neutral. Should it be scrapped, we calculate that Orsted could have to write off up to £1 billion driving a 21 Danish krone negative valuation impact per share. Still, this is largely priced in after the 34% share price fall since the announcement of the US impairments on August 30. We confirm our DKK 670 fair value estimate.
Orsted's woes have entailed an unjustified read-across for RWE and SSE, offering good entry points in those two quality names for which we confirm our fair value estimates of £22 and €55, respectively.
RWE (RWE) and SSE (SSE) have no awarded offshore wind projects in the US or projects awarded before the inflation wave that have yet to be sanctioned. Still, it is possible that rising interest rates drive an impairment of some of their offshore wind projects, but this is excessively priced into current share prices.
SSE and RWE were the biggest winners of round five of the renewables auctions. SSE was awarded 605 megawatts of onshore wind capacity at a 2012 price of £52.3/MWh. Based on our estimates, this points to a high-single-digit internal rate of return and even above for the Viking farm located in the Shetland islands that benefits from offshore wind conditions. RWE was awarded 450 MW of onshore wind and solar capacity at 2012 prices of £52.3/MWh for onshore and £47/MWh for solar.
Based on our estimates, this points to an internal rate of return (IRR) of around 7% for solar plants and high-single-digit rate for onshore wind, in line with SSE excluding Viking. Overall, these awarded projects will be comfortably value-accretive given our 6% weighted average cost of capital (WACC) estimate. Our fair value estimates are unchanged for SSE and RWE as these projects are part of the yearly capacity additions targeted by the groups that we include in our forecasts.
Pessimism is excessive on Orsted (ORSTED). To justify the current share price, we would have to strip out of our valuation all future offshore wind projects and value the onshore business at almost zero, assuming we keep our valuation of the thermal business unchanged. In other words, at the current share price, the market grants almost no value to the future offshore wind projects and to the onshore business.
