ØRsted: Energy Won’t Just Mean Oil & Gas (OTCMKTS:DNNGY)

Fractals are interesting structures that are built up from a myriad of identical smaller structures. Call me strange but I can’t help but think of fractals when I think of Ørsted (OTCPK:DNNGY), the world’s biggest offshore wind developer. The thing is that DONG ENERGY’s (Danish Oil and Natural Gas) historic transition to become Ørsted, meant a shift from the old world view that energy = oil & gas (plus coal), towards a new view that energy can = wind and solar. The oil & gas industry is roughly split between those who can’t conceive of energy other than through an oil & gas lens (Exxon Mobil (XOM), Chevron (CVX)), and those (eg BP (BP), Shell (SHEL), TotalEnergies (TTE)), who see the future as everything electrified through renewable energy captured via solar PV and wind turbines. The fractal view comes from seeing the oil & gas industry focus down to Ørsted and then focus out again to a new view of the world of energy.

Here I explore Ørsted and an emerging decarbonized energy industry. Ørsted represents one of the first oil & gas companies that has successfully made the transition. BP, Shell and TotalEnergies are on a similar path. Because renewable energy involves construction of energy capture devices and then the energy comes essentially free, the nature of an energy business in the future is going to move away from discovery and development followed by long term mining of the fossil fuel resources, which is a capital intensive business. The common theme between the traditional fossil fuel industry (coal, oil, gas) and renewables is that both involve major engineering and capital intensive exploration and development phases. However, once the capital equipment is built in a renewables business, there is a 20-year period where energy capture comes at minimal cost and effort. The price of oil is not going to be the sole metric for energy price for much longer. I think long term investors need to have this stuff on their investment horizon and Ørsted is definitely worth having on your watch list.

Major offshore wind developers

Ørsted’s business is primarily as an offshore wind developer, which accounts for more than 70% of its business. It has a small onshore wind business and also some solar PV investments. It is also interested in the development of green hydrogen. Here I focus on the offshore wind business.

A recent McKinsey and Company report on offshore wind capacity, and that planned by 2030, for major offshore wind developers gives the following summary:

Ørsted: 4.4GW (2020), planned 13.4GW addition to 2030

Iberdrola (OTCPK:IBDSF): 1.3GW (2020), planned 10.7GW addition to 2030

Equinor (EQNR): 0.4GW (2020), planned 7.5-10GW addition to 2030

RWE Aktiengesellschaft (OTCPK:RWEOY): 2.4GW (2020), planned 5.6GW addition to 2030

The above figures give the prorated contribution by each company in shared projects. The actual build is substantially more than these figures as most projects have a 50% or less stake by the developer. The McKinsey offshore wind report predicts 630GW of offshore wind capacity by 2050, but with a 1000GW goal if climate action to limit temperature rise to 1.5C is included.

While offshore wind has been started in Europe, it is rapidly becoming a global business, with major projects everywhere. From another report, the global offshore wind pipeline is now 846GW (dramatically up from 429GW 12 months ago). This includes 98GW in China, 91 GW UK, 80GW US and 57GW Germany. Many other countries (including India, Japan, South Korea, Taiwan, Brazil, Sweden, Ireland, Vietnam, The Philippines, Australia) have substantial offshore wind pipelines. Until recently offshore wind was limited to waters less than 50 meters deep. Today floating turbines are enabling big expansion of offshore wind opportunities. Major floating offshore wind pipeline opportunities include UK (32GW), Sweden (25GW), Taiwan (21GW), Ireland and South Korea (both with 16GW floating pipelines).

Ørsted’s Q1 2022 earnings transcript

I’m a fan of quarterly earnings call transcripts as they often give a sense of how the senior management of a company views the current situation. The Q1 2022 call with CEO Mads Nipper was helpful to get a sense of the current challenges that Ørsted is encountering, and also a huge potential upside for the company.

Proposed response to energy shortfall resulting from Russian invasion

The call started with a summary of the challenging Russian situation and management’s efforts to exit interaction with Russia. CEO Mads Nipper made clear that the solution to two key problems facing Europe currently, energy dependency and climate change, have the same solution. Nipper stated “We need to replace fossil fuels with renewables, directly and indirectly electrify energy use, improve interconnection and mitigate the use of intermittency and use energy as efficiently as possible.” He made clear that this is already a work in progress for Ørsted, but Ukraine means everything has to speed up. He claimed that 30GW of additional European offshore wind capacity can realistically be in place by 2030 and 60 GW by 2035 (on top of current buildout targets)! Nipper indicates that it won’t be easy and it will require a change of focus from cost reductions to an accelerated build-out, with a new focus on societal value and scale. Projects need to be fast-tracked and permitting processes need to be streamlined. At the same time space needs to be allocated to enable large-scale build-out in the second half of this decade and beyond. Of course, such a radical plan would be controversial in some areas such as the accelerated approvals, but the big facilities end up offshore, which makes it easier than on land.

Nipper’s vision is to deliver a win for society with the socioeconomic benefits of a rapid build-out. There are some gnarly problems to address, but the societal benefits (including achieving climate goals) are significant. Of course, there are downstream issues to solve too to ensure that large offtakers can manage the substantially increased renewable power. Nipper also makes a pitch to sort out a role for hydrogen and e-fuels, two areas that I have some difficulty understanding the rationale for (but that would make a long diversion, so we’ll leave that here).

There are indications of moves in the right direction in some European countries, with Germany’s Easter package increasing its offshore wind target for 2030 by 10GW to 30GW. The UK has similar plans for dramatic acceleration of offshore wind (eg additional 10GW by 2030 for a 50GW target) to those being pitched for Europe. The Netherlands, Belgium, and Denmark are all planning to ramp up offshore wind. All of the above is aligned with the recent REPowerEU policy. Ørsted has clearly thought this through and is ready to engage (see slide 4 of Q1 2022 Ørsted Investor Presentation). When asked about timing, Nipper indicated that these opportunities will have much higher visibility within the next 18 months. The major issue seems to focus on affordable seabed and predictable and rapid consenting.

Ørsted’s current construction program and pipeline

The Ørsted offshore wind business in the Investor presentation (slide 5) indicated 7.55GW installed capacity, rising to 11.07GW of installed and under construction, and finally Firm capacity (installed, under construction and awarded) of 19.37GW. In addition, 18 offshore wind auctions and tenders are indicated in 2022/2023. These global opportunities include five projects in the US, two each in UK, Holland, Taiwan and Germany, and one in Ireland, Portugal, Japan, Denmark and Lithuania. Other non-core markets are beginning to be looked at (eg France and Greece).

The challenges

The offshore wind business operates in challenging global environments all around the world. Keeping staff safe and moving them around, along with supply chain challenges have been severe during the COVID pandemic and these have not gone away yet. Add to that inflationary pressures on top of sourcing materials, finding transport, etc., have all made doing business difficult with rising costs. On top of that the standard way of doing business has involved competitive quotes with the lowest price the winner. This has led to an unprofitable environment as companies have sought to keep their operations alive through a difficult time. There was some discussion in the Q1 2022 earnings call transcript about unnamed oil majors stepping into the industry in an aggressive way. These companies undoubtedly have huge experience of offshore operations, but not necessarily a lot of knowledge about offshore wind, which is pretty specialised and immature. The point is that it seems some players have become less aggressive, perhaps understanding that losing money isn’t a great way to do business.

The environment that wind companies are operating is not viable in the longer term, yet growing pipelines and urgency to expand the renewables industry (especially, but not only, in Europe) all indicate that things need to change fast; see above for the commentary about the challenges of reliance on Russian oil and gas. Note that there are similar issues arising, especially in Asia as emerging countries become aware of the dangers of locking into reliance on expensive oil and gas. The opportunity to become self reliant with renewable energy is not being lost in Asia and, as well as in China and India, many Asian countries are exploring opportunities to grow offshore wind industries (notably Taiwan, South Korea, Japan, Vietnam, The Philippines).

In the Q1 2022 earnings call transcript it was made clear that the situation is not what Ørsted had planned, but the projects are still NPV positive. The solution is regulation and Ørsted clearly supports clean energy legislation. Of course, the company continues to seek efficiencies and business synergies. The company has significant inflation protection as 55% of total revenue from operating assets, assets under construction and awarded projects have an inflation indexation. With other mitigation total net inflation risks sit at 20%, which is useful in today’s environment.

Ørsted’s lumpy business model

Readers who follow me will be aware that my focus is on qualitative analysis, especially in the energy and transport sector, which is undergoing a once-in-a-century revolution. Investors also need to pay attention to the details and a recent article from the Wolf Report concerning Ørsted is really helpful on that score. Dividend investors will find the business unattractive as Ørsted pays a small 1-1.5% dividend that gets taxed for foreign investors (it is a Danish company that has a 50.1% ownership by the Danish Government). The interest for Ørsted is that it is a growth company in an industry that is going to be huge.

Conclusion

This article is my second concerning the wind industry’s schizophrenia, with leading companies like turbine maker Vestas Wind Systems, and here offshore wind project developer Ørsted, struggling at a time when the wind industry seems set to really take off. A report just out by RenewableUK indicates that the global pipeline for offshore wind almost doubled over the past year from 429GW to 896GW. That is a lot of business and the leading companies seem certain to benefit from this burgeoning interest in offshore wind power. On the other hand, as many commenters have noted, the big wind companies are struggling to be profitable at the moment. The business model for Vestas is pretty straightforward; it is the leading turbine maker and also has a huge business servicing and maintaining a massive global wind turbine fleet. Here I’ve considered the offshore wind business of Ørsted, the biggest offshore wind project developer. The business case is more complicated for the developers than for turbine manufacturers, especially when large projects are sold off to give lumpy earnings.

For the wind industry it is important to understand where it fits in the overall energy transition landscape. This is about addressing climate change and energy independence. The Russian invasion has focused Europe’s attention on the downside of fossil fuel dependence. The wind industry has been challenged by operating on a business model of the cheapest bid winning business, but it is now becoming acknowledged that there are other critical elements to be considered. Europe is facing a crisis, but the rest of the world has the same problem of relying on fossil fuel that means cyclic pricing which creates crises when the prices (like now) are high. My take is that renewables will at least halt exacerbating the climate emergency and also help countries all over the world become energy independent. This is revolutionary stuff, but it is coming. If you are an energy investor it is a good time to pay attention. Ørsted is worth having on your energy watch list. I’ve mistimed my entry point for Ørsted but I’m not concerned as I’m confident that my investment will be successful in the longer term. Now may not be the time to buy, but I’m not convinced that Ørsted’s share price will keep falling; it is down 28.6% year on year. As is the case for the largest wind turbine maker Vestas, the Seeking Alpha world is looking the other way with just one buy rating for Ørsted from a Seeking Alpha contributor, and only one Wall Street Analyst “hold” rating in the past 90 days. I think that companies beginning the end of the fossil fuel era deserve more investor attention. The contrast with Tesla (TSLA), which started the electrification of transport, is stark. I’m puzzled as to why renewable energy is so uninteresting to investors. It has been good for me as an investor.

I am not a financial advisor but I am very focused on the end of the fossil fuel era as a major investment opportunity. I hope my perspective helps you and your financial advisor when thinking about your energy investments.