Financial accounting standards in the offshore wind and the renewable energy targets

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Financial accounting standards in the offshore wind and

the renewable energy targets

Master Thesis Accountancy

By: A.C. de Jong Student number: 1814826

University of Groningen Faculty of Economics and Business

Supervisor: Prof. I.J.J. Burgers

Supervisor PwC: Prof. dr. J.W. Velthuijsen, Drs. H.J. Kruisman RA

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Foreword

While writing this foreword I am finishing my Master Thesis and at the same time completing my Master Accountancy at the University of Groningen. During the last five months, I performed research in the sector offshore wind energy. I discovered that the offshore wind energy sector is a sector with interesting movements. However, it is also a quite difficult sector and there is still a lot to learn.

The realization of this thesis was not able without the help of several people. I would like to thank them in a random order. To start with professor I.I.J. Burgers. She was my supervisor at the University of Groningen. She helped me structuring all my questions. Furthermore, I very much appreciated the support I received from PwC. They provided me the opportunity to write my thesis in their office in Groningen. Professor. Drs. J.W. Velthuijsen, Drs. H.J. Kruisman and E. Koopal helped me formulating my research question. Most of all I would like to thank my parents for the support during my study and everyone who has supported me and encouraged me during my entire study.

Finally, I hope you enjoy reading this thesis.

A.C. de Jong, Groningen

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Executive summary

The goal of this master thesis is to investigate if financial accounting standards for determining the estimated revenue in the offshore wind industry, contribute to achieving the renewable energy targets in the Netherlands. The European Union set up a 10-year strategy to reduce greenhouse emission in 2010. This strategy is called Europe 2020. In respect to energy the targets are that by 2020 greenhouse gas emission should be reduced with 20 percent compared to 1990, 20 percent from the energy supply needs to come out renewable energy and energy waste should be reduced by 20 percent. Offshore wind production should be a key component of the renewable energy strategy and be critical in achieving these goals. Offshore wind is at the time of writing (June 2013) more expensive than traditional energy sources such as coal or natural gas and around 50 percent more expensive than onshore wind. Expected benefits of an offshore wind park are higher wind speeds, the larger turbines and availability of large continuous areas suitable for major projects. The exact value of the revenues of an offshore wind park is hard to predict. During the life cycle of the offshore wind park clear financial accounting standards may assist in making estimates of the revenue of an offshore wind park. Shareholders and potential investors need to be able to estimate the potential return on investment. The return on investment of an offshore wind park is an annual growth percentage rate of revenues minus the costs divided by the costs. At the time of writing, there are no financial accounting standards for calculating the return on investment of offshore wind in a way investors can easily compare different offshore wind parks. The lack of financial accounting standards could contribute to investor dilemmas in offshore wind energy. New financial accounting standards for the revenue might improve this situation. This lead to the research question if financial accounting standards for determining the estimated revenue in the offshore wind industry, contribute to achieving the renewable energy targets in the Netherlands.

To answer the research question, two methods are used. An analysis of the return on investment of an offshore wind park which identify the components that influence the revenue and costs of an offshore wind park. Eight quantitative interviews with auditors and other experts in the offshore wind energy will identify the need of financial accounting standards in the offshore wind energy.

The results of this master thesis are divided in three main conclusions. First the financial accounting standards for offshore wind energy are useful, but not the main factor for achieving the EU targets in the Netherlands. There is a lack of specific offshore wind financial accounting standards. However, this is not the only or most important reason why the renewable energy targets are not achieved. The second main conclusion is that improvements in renewable energy regulation and/or government are seen as the main force for achieving the EU targets in the Netherlands. And the third main conclusion is that there is doubt if other renewable energy sources, especially solar, could structurally provide better ways for the Netherlands to achieve the EU targets. The answer of the research question is that financial accounting standards in the offshore wind energy could help to make investors invest and this way the Netherlands could achieve the renewable energy targets set by the EU. However, regulatory aspect and other renewable energy sources play a bigger role in achieving the renewable energy targets.

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Chapter 1 - Introduction

1.1 Backgroundinformation

In 2010 the European Union (EU) launched the Europe 2020 strategy for a sustainable growth for the coming decade (European Commission (2012)). Short-term challenges linked to the crisis and the need for structural reforms through growth-enhancing measures requires Europe to make changes in its economy. The European Commission sets different directives for employment, innovation, education, social inclusion and climate/energy that must be achieved by 2020. In respect to energy the targets are that:

- Greenhouse gas emission should be reduced with 20 percent compared to 1990; - 20 percent from the energy supply need to come out renewable energy; and - Energy waste should be reduced by 20 percent.

The EU targets must be implemented by each EU member country. According to the Dutch coalition agreement ‘Bruggen slaan’ the Dutch production of energy should consist of 16 percent renewable energy by 2020. Moreover, in 2050 the energy production should completely consist of renewable energy.

The Federal Association of Energy and Water in Germany showed that our neighbour Germany already in 2012 has a 25 percent renewable energy supply compared to its total energy supply (BDWE, 2012). Comparing this to the developments in the Netherlands, Germany’s development is faster. However, not just Germany is developing faster than the Netherlands. The Scandinavian countries are leaders in the renewable energy sector at this time (June, 2013). The 2012 leader is Norway; 67.5 percent of their energy production is from renewable energy (see appendix 1 for details). This is due to the fact that Norway traditionally has hydro power plants.

The European average is over 12 percent and the Netherlands scores a low percentage of 3.8. Some scores are presented in table 1.

Table 1. Shares of renewable energy

Country Norway Sweden Latvia Finland Austria The

Netherlands Shares of

renewable energy*

67.5 47.9 32.6 32.2 30.1 3.8

*In percentage of gross final energy consumption

The European Environment Agency (EEA) confirms that wind energy can play a major role in achieving the European renewable energy targets (EEA, 2009). According to the NWEA, in 2020 till 2030 at least 10 Giga Watt (GW) of offshore wind parks should be built if the Netherlands wants to achieve their renewable energy targets. In the Netherlands sufficient place is available for building offshore wind parks. In appendix 2 a table is presented that the EEA provided regarding the available offshore area (km²) for wind energy parks within national jurisdictions in Europe. It shows that the Netherlands is on a relative high place, 5th place.

Expected benefits of an offshore wind park are higher wind speeds, the larger turbines and availability of large continuous areas suitable for major projects, which could help the Netherlands reach its ambitious energy targets with offshore wind energy. However, an offshore wind park needs to be financed. Offshore wind is at the time of writing (June 2013) more expensive than traditional energy sources such as coal and natural gas and around 50 percent more expensive than onshore wind

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(EWEA, 2009). The upfront investment, called the capital expenditure (CAPEX), is at this moment high. To create return on investments the offshore wind park must produce sufficient revenue and utilize subsidies.

Figure 1 provides a rough draft to clarifying this scenario. The green line represents revenues over the years. The decline in the figure represents the upfront investment. After this investment the power production may lead to positive returns. However, many risks and uncertainties could influence the revenue. During the life cycle of the offshore wind park, an auditor assists energy companies in making estimates of the total value an offshore wind park. Shareholders and potential investors need, based on the information provided by the auditor, to be able to estimate if they will get a good return on investment in the future. The return on investment of an offshore wind park can be determined in the following way. The total revenues consist of power production multiplied by the electricity price plus subsidies and taxes, carbon tax and carbon credits.

The total costs consist of investment costs (CAPEX) and operational costs (OPEX). The return on investment will be discussed in detail in chapter 4.

Currently, revenue of offshore wind parks is heavily depending on subsidies. These subsidies provide the financial basis for the investment in individual offshore wind projects. For future investments subsidies should become less dominant in offshore wind energy. Offshore wind energy will become more competitive with other energy sources that currently dominate the market. Using financial accounting standards for the unsubsidized value of an offshore wind park, might give more insight for investors. These investors could, based on this information, be willing to invest in offshore wind companies as opposed to single heavily subsidized projects. Such a standard for offshore wind could be comparable with the fossil fuel industry where companies have to provide estimates of the reserves based on financial accounting standards. For example IFRS 6: Exploration for and Evaluation of Mineral Resources by Oil and Gas companies is used to provide estimates of oil and gas reserves.

This leads to the research question of this master thesis:

‘Can financial accounting standards for determining the estimated revenue in the offshore wind industry, contribute to achieving the renewable energy targets in the Netherlands?’

This research question is divided in the following sub questions:

1. How does the return on investment looks for investors for offshore wind energy? The goal of the question is to identify the components that influence the revenue and costs of an offshore wind park and gives insight information for the second sub question; and

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2. What is the opinion of the auditor and other experts about the need of financial accounting standards for the offshore wind energy?

Based on these results we give suggestions for further research

1.2 State of art

In this section previous research relevant to the renewable energy issues will be discussed. In the past years there has been research regarding investment decisions in the (offshore wind) energy. However, there is no empirical research about the absence of financial accounting standards for revenue in the offshore wind energy and its influence on the process of investing in offshore wind energy.

Some studies (Mormann and Reicher (2012), Jenner et al. (2012), Brunnschweiler (2009)) explain reasons for the lack of investments in the energy world.

Mormann and Reicher (2012) closely looked at the investment options of renewable energy. They introduced an investor-oriented evaluation for financing renewable energy in the United States. They concluded that technological innovation alone will not be enough to make renewable energy fully cost competitive with non-renewable energy and subsidy‐independent. Their proposal is to finance through Master Limited Partnerships (MLPs) and Real Estate Investment Trusts (REITs). Both are structures that issues shares that can be traded like stocks. To be more specific, a MLP is a structure that has the tax advantages of a partnership but whose ownership equity can be traded easily, like public stock. A company that qualifies as REIT can deduct from its corporate taxes the amount of dividends it pays out to shareholders, which must be at least 90 percent of its taxable income in a given year. According to Mormann and Reicher this has a couple of positive effects. Three are mentioned below:

- Give renewable energy projects access to more capital. This way capital markets would be able to better align risk with return;

- Reduce the overall costs of renewable power; and

- Promote United States competitiveness in the global renewable energy.

Jenner et al. (2012) investigate what drives states to support renewable energy. Their paper focused on regulatory levels and looks for explanation of policy adoption in the renewable energy sector. Jenner et al. found three conclusions. First, the existence of a solar energy association increases the probability of a state to adopt regulation. A solar energy association is an association of solar professionals and advocates. Their mission is to inspire an era of energy innovation and speed the transition to a sustainable energy economy. Secondly, the intensity of solar radiation and the unemployment rate also increase the change a state adopts the regulation. Lastly, the market power of utilities on state electricity markets comes with a negative effect on the likelihood of policy adoption. Brunnschweiler (2009) examines the role of the financial sector in the renewable energy market. Financial intermediation has a significant positive effect on the amount of renewable energy produced. The impact is especially large when considering renewable energy such as wind, solar, geothermal, and biomass. Brunnschweiler found also evidence that the adoption of the Kyoto Protocol has had a significant positive impact on the development of the renewable energy sector.

There also has been recent research about investing in the specific sector wind energy (Holburn et al. (2010), Dong (2012), PwC UK (2010)).

Holburn et al. (2010) stated that the ability to encourage the private sector to invest in wind energy in Ontario (Canada) depends on the presence of regulatory governance institutions that provide credible long-term commitments to potential investors. They concluded that utility investors are as concerned about regulatory governance as they are with specific regulatory policies. Moreover, Ontario could stimulate their investors by formalizing its wind energy strategy through legislation in two ways.

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1. Long-term targets for renewable fuel capacity levels or carbon emissions from power generation should be legislated, and the ability of the minister to revise such targets should be restricted; and

2. Energy agencies should have independent authority instead the minister, to set key dimensions of policy such as procurement schedules and rates paid to owners of renewable generation assets. This could reduce the risk that policy development is sensitive to political pressures and will thereby increase the attractiveness of Ontario as a location for wind power investments.

Dong (2012) examines the relative effectiveness of the feed-in tariff and renewable portfolio standard in the wind energy sector. A feed-in tariff is a form of price regulation in which producers of wind power are paid a set rate or premium for their electricity, no matter how much they can generate. A renewable portfolio standard is structured as a quantity regulation. The governments set targets or quotas to ensure that a certain market share of capacity or generation of electricity comes from renewable energy sources. Dong has found no significant difference between the feed-in tariff and renewable portfolio standard. The other conclusion was that wind energy development responds to high electricity demand and high oil dependence.

PwC UK (2010) provided research to provide four solutions for the offshore wind finance gap in the UK. They stated that to attract investors and reduce the finance gap, the balance of risk and returns needs to be sufficient. The risks for the investors that need to be reduced are construction risk, technology risk and price/volume risk. Considering these risks, the first two solutions could reduce the risks:

1. The first solution mentioned to reduce the construction and technology risk, is to share the construction and technology risk between the developer and the consumer. This happens through a consumer levy; and

2. The second solution to reduce all three risks is to share these risks with the developer, the administrator and indirectly with consumers. Here, an offshore wind park is put into a regulated asset regime. This means that the government would control all output from the offshore wind park and sell it primarily through the wholesale market on a bilateral basis and, to some extent, on the spot market. In appendix 4 is a detailed explanation of these markets. The second two solutions involve improving the return on short-term:

1. The first solution is to increase the number of Renewable Obligation Certificates (ROC) in the first couple of years of operation; and

2. The second solution is to finance with renewable Individual Savings Accounts (ISA) bonds. An ISA bond is a tax free bond for the public, this means that on the interest or dividends no tax need to be paid and any profits from investments are free of capital gains tax. Therefore these bonds are more attractive for private investors to invest.

These solutions are provided for the UK market. It is not clear whether these have the same effects in the Dutch market.

Previous literature considering the regulation and standards in the renewable energy market has also been taken into account for this master thesis (Coulon (2008), Nykamp et al. (2012), Słupik (2012), Stahl et al. (2009)).

Coulon (2008) pointed out a discussion around the financial accounting standards considering an offshore wind park. Cited from his research: ‘Not only is there a lack of tried and tested standards, but because this is still a new and changing field, decisions are being made in the absence of established industry best practice.’ He showed a couple of accounting dilemmas. One of the dilemmas is that a decision must be made whether renewable investments are a business combination or an asset acquisition. IFRS 3 requires that an entity distinguishes between the acquisition of a business and a group of assets. A business combination is defined in IFRS 3 as a transaction or other event in which an acquirer obtains control of one or more businesses. According to IAS 38 an asset is a resource:

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- Controlled by an entity as a result of past events; and

- From which future economic benefits are expected to flow to the entity.

As a result, investing in an offshore wind park fits in both definitions. Both options create a different outcome in the company’s financial statements. In a business combination, both the value of intangible assets and goodwill must be determined. Its carrying value must be tested at least once a year and any decrease must be recognized immediately. If a company decides to go for the asset acquisition, a depreciation of a standard amount per year is applied.

The absence of financial accounting standards under IFRS presents a problem, as regards whether the offshore wind park should be recognized a business or an asset and what accounting treatment is most appropriate

Nykamp et al. (2012) did research on the question whether regulation hinders the integration of renewable energy. Their analysis illustrates that incentive regulation creates disincentives to invest in renewable energy. They stated that ‘If a grid operator is forced to invest, it is economically rational to invest in conventional reinforcement, even when the grid operator is indifferent between the investments, because the regulation design fosters conventional investments.’ The most important influence factors are the effects on the efficiency objectives and the time lag between the investment and the consideration of costs in the revenue cap.

In the Polish electricity and gas market Słupik (2012) looked for barriers to develop competition. Słupik pointed out three components with related barriers. The first component concerns the regulatory barriers in the electricity market. Examples are:

- Unstable regulatory environment, which poses a threat to successful execution of investment projects in the generation sector; and

- Independence and discretion of regulator’s decisions.

In the second component, barriers concerning legal forms and ownership of energy companies can been found. An example of a barrier found is the vertical consolidation in the sector. This means that increased market power decreased the number of wholesalers. This way energy will be sold within consolidated groups and an oligopoly may be formed. The vertical consolidation has a negative effect on the transparency of market conditions and prices. The third component tells something about the barriers in the retail energy market. Examples of barriers found are low consumer activity in the energy market and maintaining retail prices for households regulated.

Stahl et al. (2009) provide an overview of salient laws, incentives, and rules relating to wind energy project development in seventeen key wind states across the United States. They observe two effects of increased regulation. The first is that compliance with specific rules could provide a level of regulatory certainty to developers. Second, when the regulatory environment becomes too complex it slows down the development process.

The Big 4 audit firms produced reports considering the wind energy and IFRS. The most recent rapports from Ernst & Young (2012) and PwC (2011) will be discussed below.

Ernst & Young (2012) discussed in their rapport ‘IFRS for the wind industry’ the IFRS accounting issues for manufactures and IFRS accounting issues for plant owners and developers. Examples of IFRS accounting issues for manufactures are:

- Sales arrangements: Bundled arrangements that combine the sale of assets (e.g. wind turbines) with service components related to the assets being sold. In IAS 18 five criteria’s have been given considered recognition of revenue from the sale of goods which could lead to different interpretations; and

- Embedded derivatives: If an embedded derivative is separated, the host contract will be accounted for under IAS 39 as if it is a financial instrument. If it is not a financial instrument, it will be accounted for in accordance with other appropriate standards.

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Examples of IFRS accounting issues for plant owners and developers are:

- The qualification of an acquisition as a business combinations or asset purchase. This could be found in IFRS 3;

- The absence of provisions in IFRS on accounting for green certificates, certified emission rights and similar instruments from the perspective of the producer.

These issues occurred because there is no clear financial accounting standard in IFRS for wind energy. PwC (2011) published their rapport ‘Offshore proof; Turning windpower promise into performance’ in which they discussed the make or break issues for the offshore wind sector. The respondents presented the following make or break issues:

- Cost reduction: scale and smarter technological and engineering solutions are the main routes to reduce costs and thereby become economic without subsidies;

- Construction risk: delays or cost overruns in construction can fundamentally alter the project economics;

- Supply chain management: project experience is relatively low and the learning curve is very steep in the offshore wind power market. With the complexity of offshore wind power projects multi- contracting with three to four suppliers of key work packages is a more common arrangement; - Grid access: projects need to be connected to the grid and different countries take different

approaches to this;

- Investment attractiveness; investment needs to be attracted into the offshore wind sector if expansion plans wants to be realized; and

- Regulatory certainty: they concluded that investors wait for clarity on the exact subsidy environment.

Again, no specific guidance for offshore wind energy has been found in this report.

1.3 Research questions

The research question for this master thesis is:

Can financial accounting standards for determining the estimated revenue in the offshore wind industry, contribute to achieving the renewable energy targets in the Netherlands?

To clarify the research question, a research model has been developed, presented in figure 2.

Figure 2. Research model

Investors Offshore wind energy

Financial accounting standards for determining the

estimated revenue in the offshore wind industry

Achieve EU energy targets

The research model shows that financial accounting standards for determining the estimated revenue in the offshore wind industry could have an influence on the process of investing in offshore wind energy. By increased investments in offshore wind energy, the targets set by the EU are more likely to be achieved.

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To answer the research question of this master thesis, the thesis is divided in two sub questions. The first sub question is:

1. How does the return on investment looks for investors in offshore wind energy?

This question is more an exploratory question. The goal of the question is to identify the components of the return on investment of an offshore wind park and to gain a better understanding of offshore wind energy which provides a basis for the kind of information that is needed to give insight in the revenue potential of an offshore wind park. This answer will be given in chapter 4.

The second sub question is:

2. What is the opinion of the auditor and other experts about the need of financial accounting standards for the offshore wind energy?

This sub question is to investigate what the opinion is of the auditors and other experts, who work in the offshore wind energy sector. By identify the opinion of the auditors and other experts, the need of financial accounting standards in the offshore wind energy could be found. The revenue side is the starting point for this sub question. The revenue of an offshore park exists of production multiplied with the price of electricity, subsidies and taxes. This means that the questions in the interview with the offshore wind auditors are based on those four categories.

1.4 Limitations

Since this is a master thesis, there is only limited time for research and writing. The start was in February 2013 and the master thesis should be completed by the end of June 2013. Hence, only 20 weeks were available. A consequence of the time restriction is the number of interviews held is limited to eight interviews. More interviews could have led to different results.

The interviews consist of five questions, in appendix 3 is the interview guideline presented. Production, price, subsidies and taxes are the subjects were the interviews are focused on. A consequence could be that there will be too much focus on these subjects and other possible factors could get less attention. However, this is a choice made on forehand and further research could investigate possible other subjects.

Another limitation is that offshore wind energy is a relative new subject. This could mean that not all wanted data is available and limit the investigation for this master thesis. Statistical research for example is not really realistic.

1.5 Structure

The structure of this master thesis is as follows. The theoretical framework of this master thesis is described in chapter 2. In this chapter the trust theory of Limperg, the agency theory, the stakeholder theory and the transaction cost theory will be linked to offshore wind energy. Chapter 3 describes the research design for this master thesis. In chapter 4 an analysis of the return on investment of an offshore wind park is set out. Chapter 5 gives a short review of the financial accounting standards and the fiscal standards for valuation of offshore wind park. The complexity of the returns and the cost of an offshore wind park will be explained. The results and conclusions are described in respectively chapter 6 and 7.

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Chapter 2 - Theoretical framework

The goal of this chapter is to provide an overview of theories that explain the need of investors for financial accounting standards in the offshore wind energy sector. This chapter begins with familiar accountancy theories, the Limperg’s trust theory and the agency theory developed by Jensen and Meckling. The stakeholder theory is also taken into consideration. This chapter ends with the Transaction Cost Economics theory based on the publication of Coase.

This does not mean that no other theories have been considered. The modern portfolio theory and the prospect theory are typical investment theories. These theories are not included in this master thesis. A brief explanation of both theories would help to understand why. The modern portfolio theory is a model that describes how an investor composes his own portfolio. The efficient portfolio is a combination of its expected return, standard deviation and its correlation with other stocks in the portfolio. This theory searches for a group of stocks that has the highest expected return given the amount of risk assumed or the lowest possible risk for a given expected return (Markowitz, 1952, 1959). By diversification an investor can lower their risk. The prospect theory is a behaviour theory. The theory describes how investors assess and calculate the possibility of a profit or loss in comparison to the perceptible risk of the stock or mutual fund (Ricciardi and Simon, 2000). If investors are faced with a possibility of losing money, they often take a riskier decision. The fact is that we are experiencing a financial crisis at this moment (2013). This financial crisis could have an overshadowing impact on the investment decisions made by investors. Effects of the financial accounting standards on investments could be relative low compared to the financial crisis. This is why these two investing theories are excluded.

2.1 Trust theory of Limperg

A classic accountancy theory is the ‘Theory of Inspired Confidence’. This is a translation of the Dutch ‘Leer van het gewekte vertrouwen’. In this paper referred as the trust theory of Limperg. The theory explains the function of an accountant. According to Limperg (1935), the function of an accountant is as follows:

‘The function of the accountant is split up into the auditing (and advisory) body of management and the auditing (and advisory) body of the community (consisting of investors, bankers, suppliers, workers, etc. = the public interest)’

Considering this definition, the accountant has two functions. In his or her first function the accountant is the auditing body of the management of the company and in the second function the accountant is the auditing body the community.

The accountant as the auditing body of the community is called the external accountant or auditor. According to Limperg, the auditor has two obligations towards the community:

1. The auditor should realize and meet the responsibilities the community expects of an accountant; and

2. The auditor should not raise certain expectations by the community that he or she is not able to realize.

When the auditor raises more trust than he should, the community could create an incorrect perception. Due to this incorrect perception, the community could make a decision they would not have made if they would have had a correct perception. An expectation gap exists. The American Institute of Certified Public Accountants (1993) defines the expectation gap as:

‘The difference between (1) what the public and financial statement users believe the responsibilities of auditors to be and (2) what auditors believe their responsibilities are’

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From a trust theory perspective, the investor (as part of the community) expects from the auditor to give the right values of the revenue of an offshore wind park to make proper investment decisions. The auditor tries to meet these expectations but also has to follow, if there are any, the financial accounting standards. If these financial accounting standards are not extensive enough, the accountant will estimate the revenue. This can result in an expectation gap between the auditor and the investor, which implies that the financial statements of an offshore wind park look too attractive or not look attractive at all for investors. Financial accounting standards could help the auditor to decrease the expectation gap between the auditor and the investor. Therefore, both parties know where they are up to.

2.2 Agency theory

Jensen and Meckling (1976) developed the agency theory. They define the agency theory as:

‘A relationship where both parties (agent and the principal) are utility maximizing and believe that the agent will not always act in the best interest of the principal’

An agent is someone who takes assignments and the principal is someone who gives assignments. In other words, an agent is someone who acts on behalf of the principal. The agent not always acts in the best interest of the principal, which results in three asymmetries. These asymmetries are information asymmetry, different risk preferences and goal conflicts. Saam (2007) briefly explained them:

1. Information asymmetry: the agent has more information because the principal cannot monitor the ‘hidden’ characteristics, intention and knowledge of the agent due to the fact that the agent works in the organization. This is in favor of the agent;

2. Different risk preferences: the agent and the principal differ in risk preferences. In general, the agent is risk averse and the principal is risk neutral;

3. Goal conflicts: the agent and principal have different preferences. The agent goes out to maximize his own income. The principal goes out to maximize his profit.

These asymmetries explain the need for financial accounting guidance concerning the revenues and costs in the offshore wind energy sector.

Placing an offshore wind investment in an agency framework, the agent could be someone who is building an offshore wind park and the investor could be seen as a principal. As said above an agent is someone who takes assignments, in this case someone who builds an offshore wind park. He or she gets the assignment to build the offshore wind park from the investor. The principal is someone who gives assignments, which is here the investor. He or she gives the assignment to build an offshore wind park to the agent. For the principal is it essential to know if it is profitable to invest in an offshore wind park. According to the information asymmetry principle, the investor is already one step behind because of his or her lack of knowledge compared to someone who builds the offshore wind park. In this case different risk preferences are not really in place. The investor is not risk neutral because it is a large investment and first needs to know if it is profitable to invest this large amount of money. Goal conflicts exist in an offshore wind investment between the principal and the agent occur the agent presents figures in his benefit. The agent wants to get as much as possible for the wind park to maximize his or her own income. The principal only wants to invest in an offshore wind park if this will maximize its profit. Due to these conflicts the agent and the principal may attach different values to the offshore wind park. The auditor could play a role in solving these information asymmetries, by following financial accounting standards that is the same for the investor and someone who builds an offshore wind park.

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2.3 Stakeholder theory

Ansoff (1965) introduced the term ‘stakeholder’ for the first time and defined this as follows:

‘A stakeholder is any group or individual who can affect, or is affected by, the achievement of a corporation’s purpose. Stakeholders include employees, customers, suppliers, stockholders, banks, environmentalists, government and other groups who can help or hurt the corporation’

The stakeholder theory is more a philosophical theory than an economical theory and puts focus on all groups that are interested in a firm. Freeman and Reed (1983) said stakeholders are all identifiable groups who could influence the organisation goals or may be influenced by the organisational goals. In this theory an organisation must take into account a variety of relationships with stakeholders. Investors belong to this stakeholder group. If a firm wants to attract an investor it needs to focus on the right information for the right investor. If there is a lack of investment, this could according to the stakeholder theory be explained by the fact that information that is relevant for the investor (stakeholder). The auditor could play a role in this situation by helping the firm in providing the right information to the investors.

2.4 Transaction Cost Economics theory

This theory finds its origin in the publication ‘The Nature of the Firm’ by Coase (1937) and is further developed by Williamson. Coase studied why a firm occurs. For every transaction a contract is necessary and Coase came to the conclusion that firms can coordinate a transaction cheaper if they lowering transaction costs. Transaction costs are the costs for contracting and costs involved searching for the right price.

Williamson developed this thought of Coase which lead to the Transaction Cost Economics (TCE) theory. In this scenario transaction costs consist of: costs involved with searching, information costs, negotiation costs, organization costs and monitoring costs. A firm derived its right to exist from the fact that it can minimize these transaction costs. The hypothesis of TCE (Williamson, 1991) is:

‘Align transactions, which differ in their attributes, with governance structures, which differ in their costs and competencies, in a discriminating (mainly, transaction cost economizing) way’

The goal of TCE theory is to minimize the transaction costs by aligning transactions. In other words, trading partners choosetransactions that offer protection for their relationship-specific investments at the lowest total cost. Two behavioral assumptions influence the aligning process. These are bounded rationality and opportunism.

Bounded rationality describes the ability of humans to access, store, and process information. This means that contracts are incomplete because everybody accesses, stores and processes contracts in their own way. The second point, opportunism, is that people tend to have opportunistic behavior which occurs by self-interest. This means that people just want to favor their own benefits of the transaction. One example of opportunism is agency costs, such as when the actions of an agent are not in the best interest of the principal due to misaligned incentives (section 2.2). By bounded rationality and opportunistic behavior the transaction costs are getting higher. A governance structure could according to the TCE theory reduce transaction costs. Governance structure is according TCE theory an enterprise with structured regulation. Placing this in an offshore wind perspective, transaction costs could be reduced by new financial accounting standards introduced by the government focusing offshore wind industry. This guidance can contribute to minimize the transactions costs by giving one guideline for all companies to follow.

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2.5 Conclusion theoretical framework

According to Limperg the auditor tries to meet the expectations from community. However, at the time Limperg formulated his theory no financial accounting standards, such as IFRS, for offshore wind parks were available. This could mean that the financial statements of offshore wind parks do not look attractive enough for investors. The agency theory by Jensen and Meckling would consider information asymmetry, different risk preferences and goal conflicts as possible risks for auditors to value offshore wind parks using different assumptions than other auditors. Ansoff tells that we should look at all groups, including investors. According to this stakeholder theory, the lack of investment is explained by wrong information being displayed by the auditor. The TCE tells us that bounded rationality and opportunism makes the transaction costs of an offshore wind park more expensive. Financial accounting standards for the offshore wind energy could minimize the transactions costs by giving a guideline that everybody can follow.

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Chapter 3 - Research method

Within this chapter, the research methodology will be described. The goal of this chapter is to explain which methods are used and how they are used. The methodology in the master thesis consists of an analysis and qualitative interviews.

3.1 Research methodology

The goal of this master thesis is to investigate the contribution of financial accounting standards for determining the estimated revenue in the offshore wind energy to the investment decisions. Therefore, qualitative interviews with energy auditors are the dominating research method. Instead of quantitative research, which tries do draw conclusions based on a large sample, qualitative research tries to capture the individual’s opinion and allows for more descriptions and explanations. This section starts with an explanation of the analysis of the return on investments of an offshore wind park. Thereafter, the qualitative interviews will be explained.

3.1.1 Analysis

An analysis of the return on investment of offshore wind energy is given in chapter 4. The goal of the analysis is to identify the components that influence the return on investment of an offshore wind park and to gain a better understanding of offshore wind energy which provides a basis for the kind of information that is needed to give insight in the revenue potential of an offshore wind park. This analysis is the answer of sub question 1 and provides background information for sub question 2. Any comments made by experts in the interviews were added to the analysis. The analysis has several times been reviewed by an expert who teaches in offshore wind energy. This way the analysis will be provided with more reliability.

3.1.2 Interviews

The main research method is a series of qualitative interviews with a number of auditors in the Netherlands. The energy auditors must have an offshore wind park as their client. The energy auditors are all registered auditors. This experience guarantees that information is more reliable. The advisory department plays an important role in an offshore wind audit. This is why they are interviewed as well. The analysis in chapter 4 is a couple of times reviewed by someone who teaches in offshore wind energy. He had a clear view on offshore wind energy and the future. That is why we included him in our interviews.

The experts where contacted by phone and asked whether they were willing to participate in this research. The interviews were held at a place chosen by the experts. During this conversation, the purpose of the interview was explained. To give the experts some more insight information, before the face-to-face interviews, an information review was send to them. This review consists of the background information out of the introduction. This way the validity and reliability will be increased because the expert can prepare his answers and if necessary look up needed documents.

The interviews are held in Dutch. The writer of this master thesis and the experts are people from the Netherlands. Moreover, the native language of both parties is Dutch. Doing the interviews in the native language helps to understand each other better and therefore improve the quality.

The intention was to do face-to-face interviews only. However, the tight time schedules of four experts led to four phone interviews. In total seven interviews were held, three face-to-face and four by phone. The duration of the interviews was from 45 minutes until 1 hour.

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In appendix 3 the guideline for the interviews is given. To reduce the bias, all interviews where audio recorded. The results of the interviews were processed as quickly as possible. This means that at latest one day after the interview the recorded interviews were transcribed to a word document. Thereafter this document was send to the experts for verification. After their approval of this document via email, the results of the interview were included in the research results. This way permission of the experts was asked twice, once during the phone conversation regarding a possible appointment and once by email. All the experts agreed with the documents summarizing the interview results.

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Chapter 4 - The return on investment of offshore wind energy

In this chapter the main factors determining the return on investment (ROI) in offshore wind energy are described. Nowadays offshore wind energy is subsidized. In this chapter will be described what the return on investment could be for an offshore wind park. By doing so, a better understanding of offshore wind energy is gained and this provides a basis for the kind of information an auditor needs to give insight in the revenue potential of an offshore wind park.

The ROI in general is defined in section 4.1. An explanation of the electricity market mechanism which determines the electricity price of offshore wind energy is given in section 4.2. In section 4.3 the production of offshore wind energy is explained. Subsidies and taxes for offshore wind energy are described in section 4.4. The CAPEX and OPEX of offshore wind are discussed in section 4.5. A summary of this chapter will be given in section 4.6.

4.1 The return on investment of offshore wind energy

Shareholders and potential investors in off shore wind want to be able to estimate if they will get a proper ROI. If the ROI is not clear, it makes it hard to decide whether to invest in offshore wind or not. ROI provides a ratio that gives insight in the returns received on the investment an investor makes. When the revenue is higher than the costs, a positive ROI occurs. The objective in all investments is to have a high reward to risk and ROI is the standard calculation of reward (Kirkpatrick and Dahlquist, 2011). Investors tend to be looking for a ROI which is higher that the interest on bank accounts to get the lowest risk possible.

Manion (2012) gives the following equation of the ROI:

ROI is expressed in an annual growth percentage rate. The ROI is the difference between the financial gain, in this thesis named the total revenues, and the costs of investment divided by the costs of investment. Whereas the total revenues consist of:

.

The costs of investments are:

Each of the components of the return on investment will be discussed.

4.2 Electricity price for offshore wind energy

The electricity price (of offshore wind energy) is determined on the electricity market. The electricity market can be split up in two markets:

1. The wholesale market; and 2. The retail market.

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Figure 3 gives a simplified overview of the split-up in the electricity market. The producer generates electricity and sells this for a wholesale price in wholesale market to a distributor. On the wholesale market different energy sources (wind, solar, coal or gas) are traded. An example of a wholesale market is the Amsterdam’s Power Exchange (APX). In appendix 4 can be found how the wholesale market price is determined. The distributor can trade the electricity with other players on the wholesale market or sell it for a retail price to the consumer.

Figure 3. Simplified overview of the split-up in the electricity market

The electricity produced by offshore wind park is sold at the wholesale market. From the investor point of view in this master thesis, therefore only the development of the wholesale price is of interest.

On the wholesale market a difference can be made between the short-term wholesale market price and the term wholesale market price. An explanation of the short–term wholesale market and long-term wholesale market will be given in the next two sections.

4.2.1 Short-term wholesale market price

On term, the price of electricity is determined by matching the term demand and short-term supply.

The short-term demand for electricity has a cyclical daily pattern. This is displayed in figure 4. The time is displayed at the horizontal axis and the power in MWh on the vertical axis. People tend to simply switch on for example the lights or turn on their electrical equipment, which results in variations in the short-term demand. Also companies and factories are closed during the night and in weekends.

Figure 4. Electricity demand over a 7 day period

Producer Wholesale

market Distributor

Retail

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These variations in short-term demand have to be matched by changes in the amount of electricity generated. Most of these variations can be predicted based on previous patterns, weather forecasts and information about major events that might change how the country is using electricity (Hauk, 2013). At the wholesale market, the electricity price is set for every time period by classification in merit order along with matching short-term demand and short-term supply (APX, 2013) The merit order is ranking of all different types of electricity supplies (EWEA, 2010) from the least expensive marginal costs to the most expensive marginal costs. The ranking of the different types of electricity suppliers is given in figure 5. The short-term demand curve is a straight line because time is not given in this figure. Wind energy is at the beginning of the merit order, given that the wind turbine already is built and wind is for free. This indicates that wind energy has the lowest marginal costs and will produce for any given market price.

The pricing mechanism of the wholesale markets is that the price is set for every energy suppliers to the price of the most expensive supplier. So, if all supplied electricity production is needed by the distributors and for example gas turbines are the most expensive supplied energy source. All other energy sources, including offshore wind, get paid the price set by gas turbines.

Effect of offshore wind on the short-term wholesale price

The availability of offshore wind influences the wholesale price in the short-term wholesale market. This is called the merit order effect. The marginal costs of offshore wind are relatively low. In case in there is a lot of wind in combination with the low marginal costs for offshore wind, the supply curve will shift to the right and the wholesale price of electricity gets lower. See the dotted green line in figure 5. Concluding, on the short-term wholesale market the price of electricity will be lower in periods of high wind than in periods of less wind

4.2.2 Long-term wholesale market price

On long-term, the wholesale price of electricity is determined by matching the long-term demand and long-term supply. This view reflects that both producers and consumers can anticipate their behavior in the long run.

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On the wholesale market, electricity can be traded in several periods in the future. How electricity companies can secure their future cash flow (hedging) by selling energy in the coming years, quarters, months or weeks on the electricity wholesale market is not taken into account in this master thesis.

The long-term demand curve represents how energy consumers change their energy consumption given the price. The consumers can:

- Reduce demand by energy savings when prices are high. Examples are isolate their building or use more energy efficient equipment; and

- Increase demand when prices are low by investing in more energy consuming equipment and installations.

The long-term, suppliers do not look at the marginal costs but include all costs. This is why the energy suppliers are willing to prolong production if the average long-term electricity prices are higher that the average costs of power production. The average price is determined by the total cost of power production by a given power plant, divided by the amount of time a power plant is actually producing power. As will be seen in figure 6 are the costs for an offshore wind park relative to other energy sources high. This means that without subsidies it is not profitable for an offshore wind park to generate electricity.

Figure 6. Direct and external costs of electricity generation

Effect of offshore wind on the long-term wholesale price

Offshore wind will have effect on the long-term supply in the wholesale market. Wind energy can influences the long-term supply curve if wind energy gets cheaper compared to other energy sources. This could happen by improved technologies. If the technology of wind energy gets improved, the long-term supply curve will shift to right. Shifting of the supply curve to the right means that the wholesale price gets lower.

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4.3 Production of offshore wind energy

The crucial factor in offshore wind production is the wind turbine. Therefor a short introduction over a wind turbine is given, which shows that wind production is very volatile and hard to predict. Furthermore the wind can be produced at hours when there is no demand for power and, the other way round, the wind may not blow when the demand for power is high.

4.3.1 A wind turbine

A wind turbine is a device that converts kinetic (wind) energy in into electric energy. Wind turbines come in different shapes and types. The two main types of wind turbines are the horizontal-axis and the vertical-horizontal-axis wind turbines. The horizontal horizontal-axis turbines blades rotate in a vertical plane about a horizontal axis and the turbine is dynamically rotated on its tower to face the wind. Vertical axis turbines do not need orientation into the wind and require a power source to start rotating because of their high torque. In figure 7 the different parts of a horizontal-axis wind turbine are summed up. It has typically two or three rotor blades. The wind turns the rotor blades, which spins the low-speed shaft or the high-speed shaft depending on the amount of wind. The rotation feeds into a generator which rotates a magnet. That magnet produces electric energy. Electricity will be transported by cables (over the bottom of the sea) to a battery bank or electricity grid.

Wind turbines have a capacity. The capacity tells the amount of electricity a turbine will produce at optimal wind speeds. For example, a 2 KW wind turbine will produce 2 kWh of electricity for every hour it is exposed to his optimal wind.

4.3.2 Power production

The amount of electricity a wind turbine can produce depends on different variables: - The design of the turbine;

- The height;

- The length of the rotor blades; - The location of the turbine; and - The wind speed.

Two main variables determine how much production a wind turbine will make are the size and the wind speed.

Size

A bigger wind turbine generates more energy than a smaller wind turbine. The size of a turbine depends mostly on its tower and on their blade radius. The fastest and most consistent winds are high above ground level, so turbines are raised on a tower of 40-100 meters in order to generate more electricity. When the blade radius is bigger, the more energy the wind turbine can catch and the more electricity it can produce. If the blade is twice as big, the production will be increased till fourfold.

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Today’s offshore machines are ranging from 3.0 MW to 6.0 MW, employing rotors in excess of 120 meters in diameter, and standing with hub heights of 70 to 100 meters. The expected growth of wind turbines is given in figure 8 provided by National Renewable Energy Laboratory (NREL, 2012).

Figure 8. Expected growth wind turbine

Wind speed

For a wind turbine the wind speed has to be between 4 and 25 meters per second. In figure 9 the production curve of wind energy is shown. Wind speed in meters per second is displayed at the horizontal axis and the output in KW of a wind turbine at the vertical axis. The graph shows that the production starts around 3 meters per second and increases until 12 meters per second. From that point the production is stable until it reaches a maximum wind speed of 25 meters per second. At this point the turbine is switched off and the amount of energy produced drops till 0. Otherwise the turbine could be damaged or even break down. To prevent wind turbines have influence on each other’s production, distance between the wind turbines is built in of six times of the radius from the blades.

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Edwards (2009) compares the distribution of wind speeds with the total energy production. The typical distribution of wind speeds can be seen in figure 10 and the percent of total energy can be seen in figure 11.

In figure 10 is 25 percent of the distribution of wind speeds shaded. This means that only 25 percent of the time the wind speeds are between 10 and 20 m/s. In figure 11 is displayed that 75 percent of the total energy produced comes from the samples in the shaded area on the left. Relatively rare high wind gusts will provide a disproportionately large amount of energy. From a trading perspective, the practical implication of this that it is hard to predict what the value of wind energy is. The energy will be produced in relatively random spurts that may or may not coincide with a period when people want to use power. This refers to the short-term demand in the wholesale market (section 4.2.1).

4.4 Subsides and Taxes for offshore wind energy

Given the high average cost on long-term, offshore wind needs subsidies and/or tax cuts. Based on the average price, offshore wind is not yet competitive with other energy sources. This section covers the subsidies and taxes involved with wind energy.

4.4.1 Subsidies

The long-term costs for offshore wind are high and it is not possible to make a profit with offshore wind parks without subsidies. The wholesale price for the long-term of offshore wind is much higher than the long-term wholesale price of coal or gas fire power plants.

In July 2003 introduced the Dutch government the MEP-subsidy, a feed-in premium on top of the market price for power. This MEP policy program stands for Environmental Quality of Power Generation and is fixed for ten years. Under the MEP-subsidy, Dutch producers of renewable electricity feeding into the electricity grid receive a fixed fee per kWh for a guaranteed period of ten years. These tariffs where are adjusted annually. This subsidy had no limit and the Dutch government stopped in August 2006 due to budgetary constraints (EWEA, 2009).

In October 2007, the Dutch government published a new regulation for renewable energy which resembles the old MEP premium system. This feed-in tariff is called SDE subsidy, in Dutch ‘Stichting Duurzame Energy (SDE)’. SDE stimulates the production of renewable energy and their focus is on companies and non-financial companies with a time period of 15 years. For 2013 the SDE has a budget of 3 milliard euros available to support projects (Agentschap, 2013). In contrast to the old scheme, the SDE subsidy comprises an upper limit. In the first year, the premiums will be distributed on a ‘first come, first go’ basis.

Figure 11. Percent of total energy production Figure 10. Typical distribution of wind speeds

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Besides the SDE subsidy, the Netherlands provides for an Energy and Innovation subsidy. This subsidy is established by law in the regulation of minister of Economic affairs, Agriculture and Innovation (25 June 2012, nr. WJZ/12068812). Paragraph 3.7 of this regulation reviews the offshore wind and is called Wind on sea-project. With wind on sea-project they intend a ‘fundamental or industrial offshore wind project’ or an ‘experimental and demonstration offshore wind project’. Fundamental or industrial offshore wind project is a project that exists of fundamental or industrial research and experimental and demonstration offshore wind project exists of experimental developments or demonstration projects. The minister divides the subsidies ordered by ranking of the applications. In table 2 the maximum amount of subsidies is given.

Table 2. Subsidy limits

Sea-project Time Maximal amount

Fundamental or industrial offshore wind project

t/m 6 June 2013 € 5.050.000 Experimental and demonstration

offshore wind project

1 July t/m 12 September 2013 € 5.300.000

4.4.2 Taxes

Investors who invest in the Netherlands in wind energy can make under certain conditions use of the Energy Investment Allowance, the Energie Investering Aftrek (EIA). The EIA is provided in the Dutch Income Tax Act 2001. Through the EIA 41.5 percent of the investment costs can be deducted from the earnings before interest and taxes. In the event that the EIA results in a fiscal loss the auditor should evaluate this loss and decide if a deferred tax asset can be recorded for this tax loss. This way, investors are able to pay less income tax and/or corporate tax.

The European Wind Energy Association (2009) include in their rapport an overview of the main renewable energy support schemes for wind energy in the EU member states as implemented in 2007. At the same time, this is a disadvantage because we are writing this master thesis in 2013. However, the intention is to point out the different kind of schemes for renewable energy support. Appendix 5 provides an overview of support schemes in 24 EU members provided in 2007. Investors have to choose between different schemes while they want to build an offshore wind park in just one area. For example take the area the North Sea. The Netherlands, Belgium, United Kingdom (UK), Denmark and Norway are all countries bordering at the North Sea. Therefore, every investor can build a wind park in the North Sea and all countries have their own support system. The different schemes are displayed in table 3. Information on the subsidy system provided in Norway was not provided in the report of the European Wind Energy Association (2009) and the Netherlands is already explained.

Table 3. Renewable energy support schemes in Belgium, Denmark and UK

Country Main support instrument

for wind

Setting the main support instrument for wind in detail

Belgium Quota obligation system with tradable green certificates; combined with minimum price for wind

Flanders, Wallonia and Brussels have introduced a quota obligation system. Wind offshore is supported at the federal level, with a minimum price of 90 €/mWh (the first 216MW installed: 107 €/mWh minimum).

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Denmark Tendering System for Wind Offshore

Wind offshore: 66-70 €/mWh (i.e. Market price plus a premium of 13 €/mWh); a tendering system is applied for future offshore wind parks, balancing costs are borne by the owners.

UK Quota obligation system with tradable green certificates

Obligation (based on tradable green certificates) on electricity suppliers. Obligation target increases to 2015 (15.4 per cent RES-E; 5.5 per cent in 2005) and guaranteed to stay at least at that level until 2027. Electricity companies which do not comply with the obligation have to pay a buy-out penalty (65.3 €/mWh in 2005). Tax exemption for electricity generated from renewable energy is available.

Different support schemes could be used even if the investor builds in just one area, the North Sea. This is quite a notable point to keep in mind for inter alia investors.

Carbon tax and carbon credits

Carbon tax is an environmental tax given by governments on carbon (pollution). This is during the production, distribution or use of fossil fuels. The amount of the tax depends on how much carbon dioxide each type of fuel emits. However, an offshore wind park does not have any carbon. It could save carbon. The EWEA (2009) provided an overview, shown in appendix 6, of how much total CO2 costs and fuel costs can be avoided during the lifetime of the wind energy capacity installed for each of the years 2008-2030. They assume that a technical lifetime for onshore wind turbines of 20 years and for offshore wind turbines of 25 years. Between 2008 and 2020 wind energy will avoid €135 billion worth of CO2 and €328 billion in fuel cost under the assumptions that the average CO2 price €25/t is and the average fuel prices (gas, coal and oil) is based on $90/barrel of oil (EWEA, 2009). However this is just an indication to show how much carbon can be saved.

4.5 CAPEX and OPEX for offshore wind energy

The total costs of an offshore wind park consist of capital expenditures (CAPEX) and operational expenditures (OPEX). Key elements that determine the CAPEX of a wind turbine are upfront investment costs, installation costs of a wind turbine, cost of capital, other project development and planning costs (EWEA, 2009). Operation and maintenance costs are the OPEX.

To give an indication of the high costs involved, some examples will be given. The average costs of a turbine installed in Europe is € 1.23 million/MW. In the Netherlands the average investment cost is around € 1.1 million/MW. For offshore wind energy the capital costs are higher than for onshore, this is due by the larger structures and complex logistics of installing the turbines. The majority of the CAPEX (around 50 percent) by an offshore wind turbine consist of the turbine itself. Concluding, a wind turbine is a capital-intensive asset. The second most important upfront cost is the grid connection. For more details over the costs of an offshore wind turbine, look at appendix 7. Cost specific for offshore wind turbine are: transformer station and main cable to coast, internal grid between turbines, design and project management environmental analysis and miscellaneous.

The supply chain of an (offshore) wind turbine is showed in figure 12. The orange square represents the CAPEX and the purple square represents the OPEX. The supply chain starts with development and consenting. This includes environmental survey, seabed survey, human impact studies and development services (license). The rotor, nacelle and tower are components who are made in the

Financial accounting standards in the offshore wind and the renewable energy targets