Fitch Ratings has revised the Outlook on Dudgeon Offshore Wind Limited's (Dudgeon) senior secured debt rating to Stable from Negative and affirmed the rating at 'A-'.
The revision of the Outlook reflects the increase in expected debt service coverage ratios (DSCR) following increased revenues under Dudgeon's Contract for Difference (CfD) as its strike price is inflated annually with UK CPI. The rating action also reflects a revision of Fitch's Rating Case (FRC) operating cost stress to 10% from 30%.
The FRC projects an average DSCR of 1.60x, consistently above the 'A-' threshold of 1.51x.
The rating continues to reflect favourable remuneration under the UK CfD regime, sound operational agreements, as well as a strong debt structure. However, high electricity prices pose a downside risk over the short to medium term as the project receives revenues under its power purchase agreement (PPA) at a discount to the market price but is reimbursed by the Low Carbon Contracts Company (LCCC) under the CfD at the market price.
KEY RATING DRIVERS
Remuneration from CfD - Revenue Risk, Price: 'Stronger'
The CfD regime ensures high revenue visibility with a fixed strike price of GBP150/MWh (2012 real terms, indexed by inflation). Generated electricity is sold under long-term PPAs at market prices with a discount. Government-owned LCCC pays the difference between the strike price and market prices from levy payments received from UK electricity suppliers.
Fitch considers the payment mechanism a system risk, given the obligation of the electricity suppliers to pay the CfD, their ability to pass the cost to end-consumers and the different regulatory mechanisms in case of supplier default, such as the supplier of last resort, LCCC's ability to mutualise defaulted amounts and the administration regime.
Exposure to Increased Costs - Operation Risk: 'Midrange'
Dudgeon uses 6MW direct drive technology wind turbines from Siemens Gamesa, based on proven technology and incorporating only incremental change. Equinor ASA operates the wind farm with some support from Siemens Gamesa in the initial years. Equinor is an experienced operator and operates the project under a no-gain-no-loss basis, whereby it covers its costs, but does not receive any margin, bonuses or incur penalties. The detailed cost analysis by the technical advisor and Equinor's incentive to perform well as a shareholder mitigates the 'Weaker' feature of the cost-based operation and Dudgeon's maintenance (O&M) agreement with Equinor.
Equinor could divest its equity stake as the lock-in period expired in 2021. Fitch assumes a 10% cost stress to reflect alternative arrangements, down from 30% previously, in line with the technical advisor's indication that the services provided by Equinor and costs are aligned with the market.
Dudgeon is exposed to transmission risk, which is a 'Weaker' feature but common in many offshore wind projects. Dudgeon provides O&M services to the offshore transmission owner (OFTO) under a comprehensive agreement, which should support the OFTO's high availability levels. However, this further exposes Dudgeon to potential cost increases.
Favourably, the opex budget includes a contingency of about 5% of total technical opex (technical opex excludes grid fees and government charges). Dudgeon also has a revolving working capital facility of GBP50 million.
Adequate Resource Assessment - Revenue Risk, Volume: 'Midrange'
The original production forecast is well-supported, based on 2.5 years of data from an offshore met mast 40km from Dudgeon. Fitch believes that this approach and distance is common in the sector. In 2020, the technical advisor provided a revised wind study based on operational data, which reduces the uncertainty of the assessment. The difference of 10% between 1yP90 and P50 production forecasts of the revised wind study reflects moderate resource volatility.
Fully-amortising Fixed-Rate Debt - Debt Structure: 'Stronger'
The rated notes are senior secured, fixed-rate and amortise fully until maturity in June 2032. They rank pari-passu with Dudgeon's senior term loans, which are fully hedged against floating interest-rate risk. The notes' amortisation profile is more back-ended, as the senior term loan amortises fully by June 2026. The lock-up DSCR is 1.20x, and it is calculated both on a backward- and a forward-looking basis. A six-month debt service reserve facility is in place.
WindMW GmbH (BBB-/Stable for 2027 Long notes), an offshore wind project in Germany, displays similar exposure to volume risk and also benefits from a fixed regulated strike price (not indexed). In addition, WindMW is protected through regulation against transmission cable outages. However, its debt metrics are much lower than Dudgeon, with an average DSCR of 1.33x under the FRC.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
DSCRs consistently below 1.5x under Fitch's rating case
Deterioration of the overall credit profile of the liquidity facility and hedge providers below initial rating requirements of 'A-'.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Positive operating history and DSCRs consistently above 1.6x under the FRC.
Best/Worst Case Rating Scenario
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Dudgeon is a 402MW offshore wind farm comprising 67 6MW Siemens Gamesa wind turbines. It is located 32km off the Norfolk coast in the UK. Construction activities began at end-2014 and the project entered full commercial operation in October 2017. Its O&M base is in the port of Great Yarmouth.
In 2018, Dudgeon issued senior secured financing to refinance the debt raised to finance construction and to distribute a dividend to its shareholders.
Equinor is now providing all O&M services to Dudgeon, with some limited support from Siemens-Gamesa for condition monitoring and remote diagnostics.
An independent technical advisor recently conducted a revised benchmarking exercise and highlighted that Dudgeon's annual technical opex is in line with other comparable projects in the market with recently re-negotiated O&M contracts. In line with this view, we now apply a 0% cost stress in the Fitch base case (FBC) compared with the sponsor case. For the FRC, we apply a 10% stress, in line with the renewable energy criteria approach for projects with Midrange Operation Risk.
In April 2022, a fleet-wide turbine inspection found heat damaged generator cables, which resulted in some turbines being stopped or curtailed. Most of the turbines have been repaired and returned to operation. However, some are still undergoing repairs, which are expected to be completed by the end of 2022.
Dudgeon's availability has been significantly affected by the generator cable outages. This is reflected in the availability of 92.57% in 1H22, which is below the FRC forecast (96.75%). However, Equinor expects availability to return to more normal levels in 2023 once the curtailed turbines return to operation.
In line with Ofgem's recent announcement, balancing services use of system (BSUoS) charges will be completely removed from CfD contracts from 1 April 2023. BSUoS will also be removed as an operating cost for the project. The overall impact on Dudgeon will be broadly cost neutral.
Both 2021 and 1H22 operating costs were above budget. This was primarily due to higher BSUoS charges than budgeted and fees paid to Siemens-Gamesa.
Wholesale electricity prices have been very high over 1H22, exceeding the strike price. As a result, Dudgeon has had to repay the difference between the given market price and strike price. Given the discount to the market price under Dudgeon's PPA, this has had a slightly negative effect on the project cash flow. Additionally, Dudgeon was required to draw on its working capital facility due to the timing difference between debt service and the receipt of its revenues under the PPA. Consequently, actual DSCRs have been weaker than expected at 1.51x in 2H21 and 1.53x in 1H22.
The FRC reflects the 1y-P90 resource assessment and a 3% haircut on production to reflect uncertainty related to production, as well as Fitch's view that availability may be lower than the level indicated by the technical advisor. Fitch assumes availability of 96.75%.
Fitch stresses the costs corresponding to activities performed by Equinor by 10% in the FRC. Fitch also reflects a cost increase based on a new crew transfer vessel contract and insurance contract.
Market prices reflect the average of the reference and high cases from Baringa for the FRC. Inflation assumptions are in line with Fitch's sovereign assumptions for the UK and the interest rates reflect a higher stress under the FRC than the FBC.
Under the FRC, the average annual DSCR is 1.60x compared with 1.52x at the last review with a profile that is consistently above the 'A-' threshold of 1.51x throughout the life of the debt. The minimum DSCR is 1.58x.
Fitch ran a sensitivity to reflect the near-term expected continued high electricity prices and found that the DSCR metrics weakened, mainly due to the structure of Dudgeon's revenue agreement.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
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