The UK has one of the most ambitious targets for offshore wind energy generation in Europe, and Denmark's state-controlled DONG Energy (formerly Dansk Olie & Naturgas) is emerging as one of the major project sponsors, building on its track record of developing or operating some of the world's largest offshore wind farms in its domestic market.

Total capital expenditure for 2008 to 2010 at DONG Energy is expected to be DKr40 billion ($7.73 billion) to DKr50 billion – 60% for power generation (including renewables), and another 20% for oil & gas exploration and production.

DONG Energy already has two offshore wind projects in operation in the UK. The wholly owned 90MW wind farm at Burbo Bank near Liverpool went into commercial production in October 2007. And the 90MW wind farm four miles off the coast of Barrow in the north-west of England, which is a 50/50 joint venture with Centrica, started operating in late 2006.

Scheduled to come onstream in 2009 is Gunfleet Sands I, a 108MW offshore wind project, located in the Thames Estuary. And in early December DONG Energy announced that it plans to build and operate two more offshore windfarms in the UK – Walney Island and Gunfleet Sands II, both to be 100% owned by the company.

Gunfleet Sands II will comprise 18 turbines generating 64MW, and will also come onstream in 2010. The expected investment is Eu188 million ($271 million).

The Eu509 million Walney Island project will involve 42 turbines generating 151MW, and will come onstream in 2010. It will be located in the Irish Sea, 15km off the west coast of England, and is only the first phase of a larger project, with the company having the rights to develop, build and operate up to 450MW of generation capacity. The UK government gave its final approval for the project in November 2007.

DONG is also involved as a minority partner in the London Array project, which in late 2007 received its final go ahead from the UK government. At a potential maximum size of 1,000MW it will be the world's largest offshore wind farm. DONG's partners are E.ON and Shell WindEnergy. DONG participates via a joint venture called DONG Energy London Array Ltd (formerly known as CORE Ltd) where its partner is Farm Energy, which was in from the start as the original project developer for London Array.

Each wind farm is put into a separate legal entity, so if DONG were to sell at some point after a minimum of three years it would be tax efficient. But as a general principle, the company develops and hold assets, while preserving the flexibility to sell.

DONG's strategy

DONG Energy's strategy is to increase the proportion of electricity that it generates from renewable sources. It already operates one of the world's largest wind farms – the 158MW Nysted project south of the island of Lolland. And in its home market it successfully bid to develop Horns Rev II in the North Sea off the west cost of Jutland, coming onstream in 2009. The 160MW Horns Rev I is currently the world's largest offshore windfarm, and is owned 60% by Vattenfall and 40% by DONG.
"We are an integrated energy company present in all part of the value chain in both electric power and gas, and if you want to be in all parts of the value chain then you need to keep a sharp geographic focus, and for us that is Northern Europe," says Carsten Krogsgaard, chief financial officer at DONG Energy. "That is why we sold our Spanish renewables activities in 2007."

Carsten Thomsen

 E.ON purchased Energi E2 Renovables Ibericas for Eu722 million, including the assumption of Eu256 million of debt. E2 had 260MW of operating capacity in Spain and Portugal, but also a sizeable 560MW development pipeline.

"Renewables is an important part of our strategy and we want to grow in that area, but for example in Germany there are a lot of old power plants which will need to be replaced, and we believe that there is a need for new or upgraded conventional thermal power plants alongside more renewable capacity," says Krogsgaard.

One possible project is a 1500MW thermal plant in Greifswald in eastern Germany, a final decision on which will be taken within the next two years, and which could involve gas and biofuels as well as coal.

"The majority of our renewable projects are wholly owned by DONG Energy, but we also go into partnerships if we find it interesting, particularly with very large wind projects such as London Array," adds Krogsgaard. "We generally like to be the operator, since we believe we have synergies to offer across different parts of our business as project operator."

With offshore wind farms already up and running in both Denmark and the UK, the company is well positioned to take advantage of a massive increase in offshore wind power licensing in those countries – especially at a time when onshore wind farms are becoming more difficult to obtain planning permission for.

"Denmark has the highest level of wind power generation at around 20% of total output, so there are not so many good sites left to build new windmills, and there is often local resistance to large onshore windmills. So the main focus is now on offshore wind, although the older and smaller existing onshore windmills will be replaced by larger ones."

No recourse to non-recourse

DONG Energy finances all its projects on balance sheet – an advantage for it in the UK (a market favoured by developers for its relatively high ROIs) where the complexities of the UK tariff system make putting non-recourse debt in place, particularly for a relatively new technology such as offshore wind, more challenging than in markets like Germany and Denmark.

"We don't normally go into non-recourse financing, primarily to avoid structural subordination problems at the group level," says Krogsgaard. "In order to protect our senior unsecured credit rating structural subordination should not be too high, so we finance on balance sheet using group debt, which we then lend down to our various subsidiary companies."

"The last bank facility that we signed was negotiated early in summer 2007, so we haven't been out doing any new funding since the disruption on the global credit markets. But everyone is going to experience higher margins in both the bank debt and bond markets during 2008," he adds. "If you look at senior bonds that were trading at a 25bp margin before the crisis, you may now be looking at more like 50bp-75bp."

To take one example, in Spring 2007 DONG Energy tapped the capital markets for fixed and floating Euro denominated rate debt via an offering led by Barclays Capital, Morgan Stanley and Danske Bank. The Eu310 million floating tranche paid 25bp over Euribor, while the Eu670 million of fixed rate bonds paid 4.63%.

The company is also a sizeable issuers of bonds denominated in Danish Krone, issuing DKr9.933 billion of bonds in 2006, and DKr7.925 billion for the first nine months of 2007. It also took out DKr8.261 billion of bank loans in 2006, and DKr7.131 billion for the first nine months of 2007. The full year outlook for 2007 EBITDA was around the DKr8.5 billion, and estimated profits after tax stood at DKr2.6 billion.

The long term capital structure target is to keep net interest bearing debt plus hybrid capital equal to approximately three times EBITDA after the special hydrocarbon tax. The goal is also to stay comfortably within investment grade territory, with a minimum rating of BBB+ from Standard & Poor's, Baa1 from Moody's, and BBB+ from Fitch.

Upcoming IPO

The Danish state currently has a 72.98% stake, with the other main shareholders being SEASA-NVE Holding A/S and ESS Net A/S. The government stake will be reduced to 51.2% after an IPO next year.

An IPO was expected in late 2007, but got delayed because of the snap election called for 13 November by Prime Minister Anders Fogh Rasmussen. He won and secured a third term in office. The state will retain majority ownership until at least 2015. What happens after that will depend on the political climate, and especially on concerns about energy security and the growing dependence across Europe upon Russian.

The current company was formed in 2006 following the merger of six Danish energy companies, DONG, Elsam, ENERGI E2, Nesa, the power activities of Copenhagen Energy, and Frederiksberg Forsyning.

Each company was active in a different sector, ranging from oil & gas exploration and production, traditional power generation, renewable power generation, and electricity and gas distribution.

DONG itself has been involved in oil and gas exploration and production since the 1980s, and as a state owned company established the natural gas infrastructure in Denmark. Subsequently DONG has owned and operated the natural gas distribution grids in Southern Jutland, West Zealand, and South Zealand.

Elsam and ENERGI E2 operate oil and gas fired power stations, and have also introduced efficient coal fired processes (also recycling residual products from the process) and have developed waste energy processes.

DONG Energy is also a major energy trader within Northern Europe, and access to long term energy supplies ensures a convenient, flexible supply of energy. Nesa, Copenhagen Energy and Frederiksberg Forsyning are old established power utilities that include grids serving Greater Copenhagen.

In 2006 around 10% of DONG Energy's total energy output was generated by wind. This figure will rise rapidly, with the bulk of this growth to occur abroad. The group's projects include the construction of the Nysted Offshore Wind Farm south of the island of Lolland, where 72 turbines generating 166MW make it the largest offshore windfarm in the world to date.

DONG is also active in hydropower sector in Sweden and Norway. Its holdings include 33.3% of Narvik Energy in Norway, which in 2006 generated 886GWh. In the geothermal sector DONG runs facilities in Thisted and Amagar that supply heat to the local district heating grid, extracting 7MW and 14MW respectively.

A unique business model

"DONG Energy has quite a unique business model when compared to its competitors, most of whom are either vertically integrated utilities or oil & gas players," comments Erwin van Lumich, Credit Analyst at Fitch Ratings, which currently rates the company BBB+ with a stable outlook.

"In the case of DONG Energy, as part of the Danish government's effort to create a national energy champion, there is a structure with all the different elements in one group," he says. "That can make a lot of sense at a time when we are seeing the gas and electricity sectors converge, with many generating companies needing gas supplies for their combined cycle generation, but the risk profiles of the different parts of the group vary quite a lot."

DONG Energy derives an estimated 25% of its EBITDA from regulated operations such as distribution, gas pipelines and district heat generation.

"The utility portion has very stable earnings, and can support relatively a high level of debt for a given rating, while offshore wind is still in its initial phase and represents a larger degree of implementation risk," says van Lumich. "The oil & gas sector is doing very well at the moment, but we are seeing a high level of cost inflation in this sector which is increasing capex spending levels. And since the oil & gas sector is traditionally highly cyclical, we are not upgrading many oil & gas players at the moment, since we know that at a different part of the cycle their financial profiles can change very quickly."