Wind turbines: Not something that will blow over
Commitments to deliver ‘net zero’ emissions by 2050 gained significant momentum in 2020, and now cover roughly 60% of global CO2 emissions. On top of this, China is targeting net zero by 2060.
A meaningful ramp up in renewables is required to meet these goals, with the EU alone targeting an increase in offshore wind capacity from circa 12GW to at least 60GW by 2030 and 300GW by 2050. Similarly, the UK aims to boost offshore wind from around 10GW to 40GW by 2030.
Beyond renewables simply replacing existing coal and gas-fired capacity, there is ongoing electrification of the wider economy, starting with transport and heating. The International Renewable Energy Agency expects electricity to grow from an approximate 20% share of final consumption to almost 50% by 2050. Wind accounts for only around 6% of global electricity generation at present,1 which highlights the significant runway for growth.
The development of green hydrogen to replace tricky-to-electrify industries (i.e. steel, oil refining, fertiliser production, etc.) and to offer a potential energy storage solution should help to overcome the intermittency issue with renewables. Surplus energy generated by renewables during low-demand periods can be used to power electrolysis for green hydrogen production. The EU is targeting an installed electrolyser base of 6GW by 2024 and 40GW by 2030, compared with less than 0.5GW currently. Estimates suggest it would take at least 2.5GW of renewables to power 1GW of electrolyser capacity.
There are clearly multiple ways an investor could gain exposure to the energy transition theme: renewable original equipment manufacturers (OEMs), independent power producers, integrated utilities, or even through commodities, given the high copper content required in solar projects (4.5t/MW) and offshore wind (15t/MW) versus conventional power generation (1t/MW).
In my view, though, wind-turbine manufacturers hold some distinctly attractive characteristics.
First, this is a consolidating industry: the top three players (Vestas*, Siemens Gamesa* and GE*) accounted for circa 78% of new onshore wind installation outside China in 2019, compared with closer to 60% in 2015. This has helped to stabilise turbine prices and the margin outlook. In contrast, the generation market is becoming more fragmented with a host of newer entrants – pension funds, private equity, and oil and gas companies to name a few.
Second, wind OEMs can benefit from attaching service agreements to their turbine sales. Servicing turbines has become increasingly important for operators, as any downtime on wind projects can prove costly. The opportunity cost of not generating electricity is high when project return rates are already low. Servicing is also an important source of recurring, high-margin, asset-light revenue for wind OEMs. For instance, Vestas is increasingly signing 15-year or even lifetime turbine service agreements (for 20-25 years). Currently, 117GW of Vestas’s installed base – around 91% – is under a service agreement.
Third, there is a longer-term replacement cycle opportunity in onshore wind. This will prove important as new onshore order intake inevitably slows. Repowering involves swapping out older turbines for new, more powerful ones. In 2020, 10GW of the global onshore installed base was between 20 and 25 years old. In 2025 and 2030, this is expected to reach 37GW and 118GW, respectively2. Repowered sites obviously retain the existing transmission infrastructure, which reduces the levelised cost of electricity (LCOE) over the lifetime of the wind farm’s site.
Finally, offshore wind can offer the next growth leg for the sector, with new installations expected to grow at a 20-25% compounded annual growth rate over the next five years3. Turbine sizes have increased from 3MW to 14-15MW over the past 10 years, which has supported steady falls in the LCOE of offshore wind.
Fewer land and height constraints, less ‘NIMBYism’, and healthy wind speeds should also support offshore growth. There is debate over which OEM will win out with the best offshore turbine, but we see plenty of scope for the three largest players to co-exist in an industry still very much in its infancy.
We therefore believe wind OEMs offer exposure to a long-term growth theme, not easily reflected in shorter-term valuation multiples – and not something that will blow over.
1 International Energy Agency: IEA World Energy Outlook 2020, October 2020.
2 Repowering statistic: Wood Mackenzie Q4 Global Wind Power Market Outlook Update, December 2020.
3 Offshore growth 2020E-2025E: Wood Mackenzie Q4 Global Wind Power Market Outlook Update. December 2020.
*For illustrative purposes only. Reference to a particular security is on a historical basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.
Forward-looking statements are, by their nature, subject to significant risks and uncertainties and are based on internal forecasts and assumptions and should not be relied upon. There is no guarantee that any forecasts made will come to pass.