A law amending the German Renewable Energy Sources Act (EEG) came into force on 1 August 2004 with a particular focus on offshore wind. The UK government has increased its commitment to support wind by extending Renewables Obligations Certificates (ROCs) to 15 years from 10, which gives developers more reason to look at the more risky offshore market for opportunities. And bidding in France's three-coast offshore wind licence auction also closed last month.

Currently the largest offshore wind park in Europe is the 160MW Horns Rev off the coast of Denmark. European offshore development is moving forward – but slowly and to date always on balance sheet.

In the UK, offshore wind projects such as Blyth and North Hoyle are operational and after Crown Estate's offer of Round 2 sites last year, there are now 33 potential offshore development sites, with varying estimates of total capacity of around 7-8 GW for offshore alone. The most recent to get of the ground is North Barrow.

In Germany there are around 60 applications in the works and a number of German offshore farms are already underway. In February, German wind developer Plambeck and Danish power company ENERGI E2 got the licence for a Eu1 billion ($1.2 million) 500MW farm in the North Sea – Germany's biggest farm to date. And the Eu500 million 240MW Butendiek project has recently been given the environmental go-ahead for cable works.

In the Irish Sea, Ireland's first offshore farm – the first 25MW stage in the 500MW Arklow Bank project – is operational.

And in France, winners for the 500MWs in total recently tendered by the government – which will be split equally among developments on the Mediterranean, Atlantic and English Channel – will be announced by March 2005.

But the figures speak for themselves – developers talk in terms of 500MW parks (equivalent to the total French licences just tendered) while the biggest offshore park built to date is 160MW. And in the UK alone it is estimated that 15000 turbines will need to be installed at a capital cost of £12 billion to meet government targets by 2020.

Legislation and licencing approaches vary

Part of the problem has been legislation and licencing, and although change is afoot, governments vary in their efforts to boost offshore wind.

The UK ROC system has been pushed to 2015, but wind farm life expectancy is 20 years leaving a tail on projects for developers to worry about. Furthermore ROCs pricing fluctuates, unlike the previous NFFO UK system where prices were fixed.

The recent French tender features offtake contracts that end in 2021, but with farms expected to be online by 2007 and also with no fixed tariff.

Conversely, the new German offshore regime appears very generous. Germany is keen to curb onshore wind development, which is in danger of environmental overbuild. The German onshore market has been sustained by a renewables regime that guarantees offtake for 20 years at various rates depending on the frequency of wind at any given plant – the higher the wind expectancy the lower the rate. Consequently banks and KG funds have been eager to invest in what seem very safe bets given average claw-back on investment of 10 years.

The latest German EEG amendment is a serious boost to offshore wind farm development, both in terms of the amount of the tariff payable to the generator by the regional electricity companies and the period of the payment.

Wind farm electricity will attract the new tariffs for 20 years, split into an initial and a final period. During the initial period, if a plant meets certain criteria higher tariffs will be payable.

For offshore wind farms located within 12 nautical miles of the German shore and in the German exclusive economic zone, and up to a water depth of 20 metres, the initial period is 12 years. For each additional nautical mile, this is increased by 0.5 months and, for each additional metre of water depth, it is increased by 1.7 months.

Electricity can attract a tariff of 9.1 cents per kWh in the initial period, provided that the relevant plant is commissioned before 31 December 2010 (extended from 2006). This tariff is subject to annual reductions from the beginning of the second year after commissioning of 2% of the previous year's tariff, other than for new sites that are commissioned before 2008, where the annual reduction is 1.5% of the tariff for the previous year.

After the initial period, or if the requirements for the higher tariff available in the initial period are not met, a lower tariff of 6.19 cents per kWh will be payable for the remainder of the 20-year term. Again, at the beginning of the second year of the final period, the same annual reduction mechanism applies.

Is there a non-recourse solution?

Although governments are backing offshore development – albeit with different degrees of enthusiasm – the costs offshore are high, around Eu2 million per MW. And as the potential development volume on the market grows, finance is becoming a critical part of the equation.

The funding requirement for offshore wind alone could run into billions, even with a substantial falloff of delivered projects. Banks and, more recently, private equity houses and venture capitalists are waking up to the market's potential, but are still cautious about planning, counterparty and regulatory risks. And building on-balance sheet – which to date all offshore deals have been – is restricting the pace of offshore development.

The Beaufort Wind deal last year did take one offshore farm – North Hoyle – off balance sheet for sponsor RWE Innogy (for more details see www.projectfinancemagazine.com). But the farm was part of a wider onshore portfolio deal and was already built.

The Arklow Bank project will likely be the next to refinance with project debt once GE Wind, which has built the farm on its own balance sheet, transfers to sponsors Airtricity and EHN.

What is really needed is pre-construction money. And the search for a non-recourse solution to offshore wind risk is on. But the majority of bankers agree a buoyant market is a long way off.

Project finance solutions will emerge as the technology emerges to make offshore wind a more quantifiable risk. Current offshore wind developments draw upon a range of disparate models, measurements and surveys in order to identify sites for development and to secure both planning consents and subsequent finance.

This includes information on the metocean climate, bathymetry, geology, sediment transport and most importantly, wind energy yield. Much of this information is often based on short term data capture which introduces increased levels of risk when forecasting environmental impacts and commercial revenues over a typical 20 year life of a development.

But initiatives are already in place to improve forecasting. BMT Renewables is leading an international 12-month project trial of a range of Earth Observation (EO) based decision support systems for the offshore wind industry commissioned by the European Space Agency. The trial will end in 2005

EO data has the potential for improving wind field mapping based on long term observations over many years. But it also presents opportunities to map other parameters including wave climate, bathymetry and features governing coastal change.

But science aside, bankers and institutional investors are going to have to take a leap of faith if the market is to pick up in the short term.

An alternative to post-construction take-outs is securitization of existing onshore assets to fund offshore development – at least for the larger developers.

Hypovereinsbank introduced the asset class to market with Europe's first structured basket bond (SBB) (partial wind securitization, partial project bond) for developer Energiekontor in June. Entitled BreezeOne, the deal comprises Eu100 million of 20-year notes due in 2024.

The deal is designed to refinance Eu40 million of existing project debt and equity from five wind farms in Germany and finance Eu46 million of greenfield construction of three farms in Portugal. Construction of the new farms – the 13MW Penedo Ruivo, 10.4MW Montemuro, and 10.4MW Marao – is expected to begin this year.

Although the ultimate sponsor was Energiekontor, the company is an operations and maintenance specialist and retains very little equity in any of the farms it manages. In effect, the majority of the equity was from KG investors, a system that has dictated the way German development has gone – lots of small farms developed independently. The deal creates a portfolio effect for the KG system with the consequent economies of scale.

But surprisingly the structure did not cross-collateralize existing farms with those to be developed. As a consequence wind risk on each farm was not mitigated by the strength of the others and thus the deal only pulled in a BBB- rating from Standard & Poor's.

Beaufort and BreezeOne are essentially bond and project debt solutions to the same problem – development funding. The difference is that all Beaufort future developments will require on-balance sheet funding followed by post-construction debt from the Beaufort vehicle once the operational plants are transferred to it.

If, and it is a very big but realistic if according to some bankers, bond investors could be persuaded to take BreezeOne-type portfolio deals but featuring a majority mix of cross-collateralised existing onshore farms and offshore greenfield, the pace of development funding into offshore could pick up substantially.