Sustainable Offshore Wind Farm Supply Chain Management REPORT

Transcription

1 Sustainable Offshore Wind Farm Supply Chain Management REPORT Final Report Robins, D., Leseure, M., Cooper, D. University of Chichester Bishop Otter Campus College Lane, Chichester West Sussex, PO19 6PE

2 Contents 1. Introduction Project Background Project Objectives... 4 Objective Objective Objective Objective Organisation of Report Database Database structure Total number of entries Key principles when analysing the database... 7 Principle of Representative Search... 7 Principle of Activity Matching Activity Value Supply chain capabilities and gaps Quantitative Analysis Spatial Analysis Qualitative Analysis Data collection Industry Background First Findings Theoretical Background Global or Local Supply Chains? Contractual Nature of Industry Current Opportunities Based on Interviews Findings from events General summary of events Ramsgate event Whitstable event Ramsgate Workshop Findings Whitstable Workshop Findings Conclusion Synthesis and strategic recommendations Contrasting a supply chain with a regional cluster perspective Reasonable Local Impact Targets

3 5.3. Kent and Medway growth and First Tier Suppliers Strategic recommendations Conclusions

4 Sustainable Offshore Wind Farm Supply Chain Management 1. Introduction 1.1. Project Background Kent County Council commissioned the University of Chichester to develop knowledge and understanding of the current wind farm supply chain and gap opportunities in the County of Kent and the Medway area. The project is being driven by the INTERREG IVa Fusion project that aims to support businesses to develop ways to become environmentally sustainable and help the expansion of the low carbon sector. The Kent and Medway local authorities are committed to reducing greenhouse emissions by 34% by 2020 and 60% by In the 2011 report Unlocking Kent s Potential three themes were identified around environmental sustainability and the action point to build on the success of the offshore wind prospectus was identified as a key priority. In April 2012 a report by AECOM on the social and economic benefits of Kent and Medway becoming a renewable energy hub was published 2. The recommended actions included Establish a renewable energy economic hub in Kent and Medway, initiated by development and servicing of offshore wind farms as a high priority. Kent and Medway is well placed to become a leading renewable energy hub due to the location of both current and planned offshore wind farms, its designation as a Centre for Offshore Renewable Engineering (CORE) these are partnerships between central and local government and local enterprise partnerships its commitment to energy reduction, and proximity to mainland Europe and the developing interest in renewable energy that is emerging there Project Objectives The project objectives that were agreed to are: Objective 1 - Create an electronic database of potential tier 2, 3 & 4 product or service suppliers incorporating information from Kent County Council, Crown Estate and district authorities as well as the University of Chichester s own unique data set. The database will include contact details, a short description of current activities, capacity and capability and will be prepared in consideration of the requirements of the Kent Wind Energy Directory (KWED). Objective 2 The identification and mapping of Kent based companies, including those within the Medway area, who could have future capabilities to supply key products or services to the offshore wind industry. 1 KCC. (2011) 21 st Century Kent Unlocking Kent s Potential. Growing the Garden of England: A strategy for environment and economy in Kent, July AECOM (2012) Renewable Energy for Kent, Part I: Overview and Action Plan, April

5 Objective 3 - Carry out a gap analysis of the data collected to identify the specific industry areas and skills that are not currently provided for and which require populating within the database. Objective 4 - In conjunction with data collection, raise awareness and promote the supply opportunities linked to the growth of the offshore wind sector, including the availability of business support programmes in Kent such as Expansion East Kent, TIGER (from April 2013), High Growth Kent and other sustainable business services offered by Kent County Council 1.3. Organisation of Report This report is organised as follows: Section 2 provides information about the structure of the database (supplied as a separate Excel file) and of the key fields that can be used to sort and access data. Section 3 addresses objectives 2 and 3 and uses the database to analyse Kent and Medway-based business sectors that could participate (or already do) in wind supply chains. We also use cost data published in the research literature to highlight which areas of the supply chain contain the most lucrative opportunities. This section also includes important background information about the industry in order to describe constraints and issues that potential suppliers to the industry would face. Section 4 is a summary report about the two events that were held as part of this project and thus, reports on objective 4. It includes the results of the interactive workshops that were conducted within these events. Section 5 provides a synthesis of the different findings of the project, combining the data obtained from the database, results from interviews and workshop conducted as part of this project, and data sources linked to other research activities from the investigators. In this synthesis, the development of a sustainable supply chain is investigated from a strategic perspective and we provide recommendations to Kent County Council in order to strengthen Kent's economic involvement in the wind energy sector. 2. Database 2.1. Database structure The database is based on a 4-tier hierarchical structure of the expenses related to the construction and operations of an offshore wind farm. The tier 1 structure is depicted graphically in figure 1. It shows that the different activities are categorised in three key groups: The construction of the wind farm, coded as CAPEX (capital expenditure). This is further deconstructed into the following key components: cables, wind turbines, balance of plant, project monitoring, construction port, project development, and installation and commissioning. The operations and maintenance (O&M) of the wind farm. This category contains recurring annual expenses once the wind farm is in operations. It is categorised into 15 tiers 2 activities. 5

6 Support services: Support services comprises of a list of 47 peripheral service activities which are neither solely part of the construction phase nor the operations phase. The full list of activities and their hierarchical relations can be consulted on the 'activities' tab of the Excel spreadsheet. Activity Categories Cables and Array Cables CAPEX Construction Project Balance of Plants Project Monitoring Construction Port Project Development Installation And Commissioning Technicians Equipment Transfer Operations And Maintenance O&M Port Large Component Replacement Vessel Support Services Wind Turbines Figure 1. First Tiers Structure of the Database Skilled Technicians Large Component Replacement 2.2. Total number of entries Entries in the database are organised in regional tabs within the Excel worksheet. An entry contains all the information about a company and can be duplicated across the different sectors of activities that a company is engaged in. Total entries are tabulated across the different regions in the 'activity' tab. This tabulation is shown below in table 1: Kent & Medway E. Sussex W. Sussex Others Total TOTAL entries Activity Totals: Activity Blanks: Filled Activities: TOTAL % FILLED (per region) Table 1: Activity Fill Rate in Database This tabulation is done by looking up in each tab how many entries have been made against the unique identifier of an activity and reads as follows: the database contains 645 Kent & Medway 6

7 entries against the full list of activities (695) in the database. 422 of the activities do not have any entries against them, meaning that the 645 entries are concentrated on 273 activities Key principles when analysing the database The database format was taken from the original database that was designed and developed by 4C Offshore. The original database was designed in Microsoft Access but for ease of updating and for future use this has been exported to Microsoft Excel. When using the database, a few key principles should be borne in mind in order to make sure that valid conclusions and recommendations can be made: Principle of a representative search Principle of activity matching Principle of Representative Search In order to interpret the data provided by the database, it is important to stress that the database should not be assumed to be exhaustive. Records were obtained by: Existing databases, either owned by the University of Chichester or provided by KCC and associated parties Companies details obtained during the events organised as part of the project Data collection performed by a research assistant employed to perform online searches specifically targeting missing activities. Therefore, the existence of a record in the database should be interpreted as follows: for the purchasing officer of a wind farm searching for suppliers in a specific activity sector, it is likely that a search conducted by traditional means (online, use of regional databases, yellow pages, existing contacts, etc.) would match the database content. It is also likely that where activities were left blank, a purchasing officer would conclude that no local supply base exists. Clearly, with a more intensive (and expensive) search, it is likely that additional records could be found. Principle of Activity Matching The inclusion of a company in the database, possibly through multiple entries across a range of activities, is not an indication that this company has experience of working with the wind energy sector but rather that it produces products or services that matches those consumed by the wind energy industry. This means that the database contains both companies that could supply products to wind farms immediately but also companies that may require a substantial investment in product and process design before being able to supply wind farms Activity Value Each activity category in the database contains a percentage value breakdown. These percentages are based on average wind farm costs and are used to identify activity gaps where important business opportunities exist. There are a number of other typical value percentage breakdowns published in the renewable energy literature 3 which are consistent but different in structure than the value percentages that we use in this report. 3 Blanco, M.I. (2009), 'The economics of wind energy', Renewable and Sustainable Energy Reviews, Vol. 13, pp

8 Throughout this report, we will be using the standard value breakdown in the database and values obtained from publicly available sources to estimate what total and local supply chain spending for wind farms are likely to be. As these estimates are based on a series of assumptions (the likelihood that a local company would win a contract, typical ratios between CAPEX and O&M expenses, etc.) it is important to note that all financial figures quoted in this report are for the sake of illustration and to provide a rough benchmark. 8

9 3. Supply chain capabilities and gaps 3.1. Quantitative Analysis For each high level activity, we compute a 'competitive density' index as the ratio of number of Kent and Medway based suppliers to the total number of suppliers in the database. A value of 0 indicates that it is unlikely that a purchasing officer would find a local supplier. A value of 1 is utilised to indicate that a supplier of an activity can only be Kent and Medway-based. We then multiply the standard value percentage of an activity by the competitive density ratio: the resulting figure, 'potential local revenue' is the likely percentage revenue that could be incurred in Kent and Medway (if one assumes that competitive density is an indicator of regional specialisation, and thus of the probability of a local provider to win a bid). Tables 2 and 3 show the results of this analysis for CAPEX and OPEX expenses respectively. CAPEX Activities Value Percentage Competitive Density Potential Local Revenues Balance of Plant Construction Port Project Development Installation and Commissioning Wind Turbines Total 100% 1.76% Table 2: Potential local revenues for CAPEX activities Operations and Maintenance (OPEX) Value Percentage Competitive Density Potential Local Revenues Grid maintenance, lease, and other recurring costs Large component replacement Large component replacement vessel O&M Port Skilled technicians Technicians and equipment transfer Total % Table 3: Potential local revenues for OPEX activities Tables 2 and 3 show that the lack of tier 1 suppliers in Kent and Medway, and for that matter in the rest of the UK, mean that only a minor portion of key first-tier contracts are likely to be won by Kent and Medway-based companies. It is important to remember that table 2 excludes support services and only represents the likely local expenditure on the technical construction of the wind farm and associated project management expenses. Table 2 shows that the percentage of revenues accrued in Kent and Medway could be as low as 1.76% for the construction stage. In practice, this percentage is likely to be larger when one factors into account local orders for technical components placed by tier 1 suppliers. However, table 2 is useful in terms of highlighting that the local impact of the construction of a wind farm (the 'project supply chain') is actually small. The largest 4 Entered as 1 as this activity can only be conducted by local wind farms, i.e. Vattenfall or London Array. 9

10 opportunities lost are down to the turbine and balance of plant, representing 76% of the total CAPEX budget. Table 3 shows a better opportunity in terms of local spending linked to operations and maintenance expenses, with an estimated 43% of the annual budget being spent by local operators into the local economy. Table 4 shows that the competitive density of Kent and Medway for support services tends to be good, meaning that extra revenues will accrue through these. It is worth noting that some of these support services are included in the CAPEX and OPEX standard value percentage whilst others represent more general services consumed. Activity ID Activity Description Competitive Density 649 Building and onshore site maintenance Caterers Cleaners Conference venues Diving Fire and security protection systems Health and safety Access systems Consumables Fall arrest system services (supply and certifying equipment) 659 HSE training providers Lifting gear Safety equipment and work wear Sign makers Helicopter providers Hotels and B&Bs IT service providers Laundry services Marketing/PR agencies Office supplies Recruitment agencies Security personnel Training/skills providers HSE training suppliers Offshore survival Working at height Skills training suppliers Engineering Marine Transport and courier services Vehicle maintenance 1 10

11 684 Waste management services Hazardous waste collection Recycling collection Refuse collection Navigation Oil spill Communication Table 4. Competitive Density for Support Services In order to produce some valuations for the sake of illustration, we considered a number of wind farm in the vicinity of Kent and Medway, as show in the table, and used known CAPEX budget to estimate a typical investment cost per MW of capacity. This is shown in table 5 below: m/mw of Wind Farm Capacity (MW) CAPEX ( b) capacity Thanet Average Cost per MW of Installed Capacity London Array Greater Gabbard Rampion Table 5. Estimating the typical CAPEX cost of investing in the UK in 1 megawatt of capacity in million pounds The table shows that the typical investment cost for a wind farm cost is about 3 million for each Megawatt of installed capacity. Note that this is an approximate figure, with great uncertainty regarding the actual expenditures in some cases. For example, Greater Gabbard is said to have cost between 0.65 and 1.5 billion pounds. Also note that the average is increased by the relatively high cost of the Rampion wind farm, relatively speaking. Table 6 shows a group of regional wind farms with their actual or estimated (estimated on the basis of the 3.02 m /MW ratio, shown in italics) CAPEX budget and per annum operations and maintenance expenses (estimated at 4% of the CAPEX budget per year 5 and assuming an operational life of 25 years for each wind farm). The percentages defined in tables 1 and 2 are used to compute how much each wind farm is likely to bring to their local economy. Wind Farm Capacity (MW) CAPEX ( b) Local Spending ( m) OPEX ( m p.a.) OPEX total CAPEX OPEX p.a. Kentish flat Thanet London Array London Array 1 & This standard value is largely debated. It is a function of the initial investment, i.e. a better upfront investment will typically result in lower O&M charges. This percentage is normally 1 to 3% for onshore wind farms, and is known to be higher for offshore situations. Some authors have also suggested that this percentage could increase with the age of an installation (Blanco, 2007, Ibid). 11

12 (complete) Greater Gabbard Rampion Greater Galloper Table 6. Estimated spending per wind farm with their local economy Table 6 shows that the local economic impact during construction is actually little compared to the spending for operations and maintenance expenses over the lifecycle of a wind farm. For reasons explained later in the report, there are reasons why CAPEX spending is so low, and scenarios under which this share could be increased are discussed later in the report. Comparatively speaking, operations and maintenance expenses could become more localised, and could even reach, under certain conditions, 100%. As the revenues that be accrued in this fashion are an annuity of 25 years, there is, cumulatively speaking, as much of an opportunity in O&M as in the construction of a wind farm, and this for a, relatively speaking, more focused area of specialisation (technical inspection, maintenance, and spare parts). Tables 2, 3, 5 and 6 make up our base case scenario, which is our best estimate of the situation/potential today. Several others scenarios will be considered in this report and compared to the base case scenario Spatial Analysis In order to maximise on the opportunities provided by the Marine Renewable Energy (MRE) sector the demography and geography of the area need to be considered to ensure potential infrastructure and other spatial issues are accounted for. Kent is the closest county to mainland Europe with Dover the UK s busiest port for passenger and road freight traffic across the Channel. The development of the Channel Tunnel and high speed rail services from London, Ebbsfleet and Ashford has further increased connectivity between Kent and Europe. Kent has recently developed an international airport and flights leave from just outside Ramsgate via Amsterdam to a host of European connections. Kent has a long coastline to the south, west and north and includes the Channel, edging towards the North Sea and also the Thames Estuary in its geography. There are currently 3 wind farms serviced from Kent Thanet, Kentish Flats, and London Array. London Array and Thanet are maintained from Ramsgate Port by London Array and Vattenfall operations and maintenance centres. There is an operation and maintenance base for Kentish Flats at Whitstable run by Vattenfall. All the current wind farms are located to the north and north east of the county and future sites (apart from the Rampion wind farm off the coast of Sussex) are within the same area. The project called for an understanding of the industry support structure for the MRE sector in Kent and the potential for cluster activities to be facilitated. By identifying each company location within the database a graphic picture could be developed of each sector, activity or sub tier group. The following maps identify the database companies and describe the findings. 12

13 Figure 2 All Kent and Peripheral Area Data The location of the industry is fairly well spread across the southeast of England but the concentration does increase in the North Kent and Medway region. In some respects this can be explained by the fact that the data search concentrated on the Kent region and not East or West Sussex but it does also point to the main motorways, towns and wind farm locations. In all counties the increase in density of industry is around the coastline. 13

14 Figure 3 Businesses who can supply to the Balance of Plant category Balance of Plant features many of the infrastructure support necessary for a wind farm. This includes cableing and the substations. Industry that can support this sector is fairly well spread out across the souteast and does not appear to offer any cluster opportunities based on location alone. 14

15 Figure 4 Industry within the Construction of Port category Although this category is mainly port based the supporting structures may come from further afield. Dover, Ramsgate, Sheerness and Whitstable are identified as being port regions that can support a wind farm but there is nothing to suggest that any of the supporting industries are locating closer to the ports. If anything, the locations suggest a clear line along the motorway route providing easy access by road to any of the ports. 15

16 Figure 5 Businesses in the Installation and Commissioning sector There is no evidence of cluster activities or opportunities within this sector of the industry. This, apart from the actual turbines themselves is probably the most immature sector due to the nature of the work and the lack of call for historical work in this area. Some of the companies may have adapted from similar sectors to take on work in the MRE sector but the majority are not working within the sector but have the capability of doing so. 16

17 Figure 6 Businesses in the Operations and Maintenance sector This is not the largest sector within the database and mainly deals with technicians and personnel and logistics. This is a sector that is well utilised although not necessarily with an abundance of opportunities. Most of the categories are transferable from other industry sectors therefore location for clustering is not apparent, nor will it be all the time the primary sectors are flourishing. 17

18 Figure 7 Businesses in the Supply of Project Development Another small sector for developing the wind farm and mainly centred around surveying, This sector is planned in advance of the wind farm being developed and is a difficult sector to break into due to the professional nature and the early onset of the requirements. 18

19 Figure 8 Support companies that can service a wind farm operations and development phase The support sector is quite well established and probably the most diverse sector as it includes everything from toilet and accommodation facilities to IT and stationary support. There is clear evidence that the majority of companies are situated within the main towns and along the motorway infrastructure but due to the diversity of the work requirements it is unlikely that this sector could be targeted for cluster facilitation. 19

20 Figure 9 Businesses able to supply to the Turbine Supply Chain This sector has definite possibilities to be developed as it is mainly engineering by nature and can support the ongoing maintenance of a wind farm or support an incoming tier one turbine manufacturer in the future. There are definite pockets of activity but this is probably due to the need for the companies to locate on industrial sites and near transport infrastructure. It is apparent that should a tier one company decide to base itself in Kent, the region would be capable of supporting it. 20

21 There is very little evidence to suggest that there has been a move towards any cluster activities in the MRE sector. The could be due to a number of reasons 1. The sector is relatively new and has not had time to establish any natural leanings towards clustering 2. There has been no support offered to cluster activities from either central or local government therefore due to a natural fear of losing competitive advantage through associated activities, such as knowledge transfer, there will be little incentive to cluster. Business support, funding or advice can increase the potential for clustering to occur but without a clear identified objective this is not a suitable or stable method of increasing business growth 3. The lack of any tier one company to draw in business means there is no clear and defined focal point for businesses to be drawn to 4. the nature of the business the Maritime sector is micro by nature and identifying cluster activities is difficult with such a fragmented industry such as the MRE sector It is both plausible and probable that each of these points play a part in determining the lack of natural cluster activity in the Kent region. It is sensible to identify a sector, industry type, or growth objective before any support or facilitation is considered. 21

22 3.3. Qualitative Analysis Data collection As part of the project, we have interviewed a number of key persons working either for local wind farms operators, contractors, or policy makers. The objective of the interviews was to assess how Kent and Medway-based wind farms were perceived in terms of local economic impact and importance. For this reason, the interviews were not structured and interviewees were left to develop their views freely. A total of 4 interviews with key persons were conducted but another 6 shorter interviews were also used to inform this section of the report Industry Background The UK is characterised by a strong policy push for the building of wind farms as a source of electricity supply. The portion of UK electricity generated by wind power was reported to be 5.3% in When considering this number, it is important to distinguish installed capacity from usage. The 5.3% represents usage, which requires that there is wind and demand for electricity simultaneously. Published estimates are that by 2050, this percentage could rise to as much as 50%. This policy push is confirmed by the Crown Estates' extensive list of planned consent for offshore farms around the UK. Denmark is adopting a similar strategy, but with a target of 100%. The move towards using renewable energy as sources of electricity is justified by the rising interest and motivation towards sustainability. However, although using wind farms does an excellent job of addressing the environmental dimension of sustainability performance, its impact along the economic dimension is rather controversial. Wind energy is not the cheapest source of electricity production today and there is much R&D activity concentrating on improving its cost performance. There is a consensus that significant cost reduction will be experienced in the future, but not commonly agreed-upon cost targets that could be reached. The economic challenge posed by the operations of wind farms has two important implications in terms of understanding the industry sector: (1) a policy push towards supply chain economic benefits and (2) high technological uncertainty. Sustainability is commonly defined as the adoption of practices with good performance levels in the present and the future across the three 'pillars' of sustainability: economic, environment, and social. As discussed above, investments in wind energy are excellent from the standpoint of the environmental dimension but rather controversial from the economic standpoint. It may be for this reason that much marketing literature has been published by a variety of bodies advertising the widespread 'spillover' effects that this new industrial sector will have on the UK economy. Many talk of significant impacts in tourism 7, rural communities 8 and other spillover in 6 DECC Energy trends statistics section 6: renewables 7 Riddington, G. McArthur, D. Harrison, T. & Gibson, H. (2009) Assessing the economic impact of wind farms on tourism in Scotland: GIS, surveys and policy outcomes. International Journal of Tourism Research Vol 12, Issue 3, pp Munday, M. Bristow, G, & Cowell, R. Wind farms in rural areas: How far do community benefits from wind farms represent a local economic development opportunity? Journal of Rural Studies, Volume 27, Issue 1, January 2011, Pages

23 social and economic situations but trying to ascertain the actual impacts of a wind farm on the local economy has proven difficult. An example of how the issues of capitalising on the economic spillovers have been achieved is given by the BEEMS project founded by the Interreg European Regional Development Fund. Based on the fact that the UK is planning to increase its renewable energy supply by 15% by 2020 and France by 23%, RenewableUK has estimated that 29,700 direct jobs and 17,500 indirect jobs will be created between now and 2030, creating a large scale skills shortage that the BEEMS project is planning to address through training. The main issue has been identifying where these jobs will fall region, or sector and how to provide training to the right people in the right place. Thus, although the policy literature remains evasive regarding the economic performance of wind farm technology, it promises vast spillover economic and social benefits. One of these is the emergence of offshore wind farm supply chains, a concept introduced in the Centres for Offshore Renewable Energy (CORE) brochure. COREs aim to to generate a process for strong two-way communication between the offshore wind supply chain and UK Government, providing support where necessary through the Local Enterprise Partnerships and Central Government Departments 9. In terms of what has been discussed so far in the report, it is important to note specific points from the CORE brochure: The supply chain opportunity includes construction and O&M activities. The stimulation for investment and governance for growth is organised regionally, with for example explicit references made to the concept of local ports serving local wind farms. Kent and Medway are listed in the CORE brochure as the Kent CORE along with 5 other such centres. Another important centre in the context of this report is the Humber CORE: it is close enough to Kent that it could be considered a competitor, and it is, like Kent and Medway, involved in applied research about offshore wind farm supply chains. Through the design of COREs, many regions are asking themselves how to stimulate industrial activity around wind farms. Whilst France has opted for setting local content requirements for its planned wind farms, the UK has followed its free trade tradition by deciding not to allow such requirements to be set. This means that the UK trusts that the private sector will take up the advertised business opportunities to become a supplier to the wind energy industry and that competitive mechanisms will ensure that UK wind farms are equipped with the best equipment. The second consequence of the sustainability challenge posed by wind farms operations is that manufacturers of wind turbines and operators are well aware of the fragility of their industry. As with any new technology, one would expect significant learning curve effects to be experienced. One would also expect that as the scale of production of wind turbines increases, significant economies of scale will lower unit production cost. However, nobody today is able to forecast the magnitude of these learning curves and economies of scale effect and whether or not these would be sufficient to make wind energy a competitive source of energy remains a much debated question

24 Practically, the consequence of this state of affairs is that the wind energy industry works in a context of high technology ambiguity. In 2009, Blanco 10 reported that the cost of constructing a wind farm had been rising, a fact that demonstrates that the industry is far from experiencing its first learning curve effects. There seems to be a trend away from small wind turbines to large and more powerful wind turbines. The most likely scenario is this trend will intensify, but alternative scenarios are possible. Aside from the issue of electricity production cost, the size of wind turbines have an important impact on regional economies and supply chain, as a number of logistical and regulatory considerations should be taken into account. These will be discussed later in the report in section 5. For now, it is important to note that the industry is new, based on a rapidly evolving technology for which it is sometimes difficult to make a business case First Findings After conducting the interviews, it became clear that there exists considerable ambiguity around two notions central to the project: (1) the very notion of supply chain, and (2) the scale of the local impact of Kent and Medway-based wind farms. The notion of supply chain and how it should be interpreted in the context of the wind industry is discussed in the next section (3.3.4). Regarding the ambiguity about the local economic impact of wind farms, some respondents considered that Kent and Medway-based wind farms (operated by Vattenfall and London Array) have had an important and widespread impact on the local economy, especially around Ramsgate. Other interviewees believed that this impact was in fact limited, and this for a variety of reasons: some felt that the impact was limited for the time being and that more opportunities would arise in the near future, whilst others expressed concerns over the fact that opportunities are 'well-guarded' and benefit large scale experienced first tier contractors only. When interviewing wind farms operators, they mention that they are under permanent pressure to demonstrate their good will and ability to contract with local firms. Overall, the diversity of answers and perspectives that we have collected point to an issue of objective setting. There has been so much promotion of the supply chain benefits of the wind farm sector (see section 3.3.2) that expectations from most parties could be said to be insatiable. Clearly, there is only so much money and jobs that one should expect a competitive wind farm to bring to a local economy. Our impression was that the policy literature on wind farms supply chain made an impression on readers, with one interviewee describing the common perception that a wind farm is perceived as a goose laying golden eggs. That qualitative impression though has never been translated into a quantitative target. In order to work towards helping defining what such a target could reasonably be, we turn in the next section to theoretical considerations in order to better understand the nature of work and contracting in this industry Theoretical Background As supply chain management is a relatively new field of business practice it is not surprising that its meaning entails a variety of management activities. Historically, supply chain management was best described as a multiple echelons inventory management. The typical context of application would be a retailer needing to stock a certain amount of products for consumers and managing purchasing and logistical activities so that items of stock arrived when and where needed. 10 Ibid, p

25 For this reason, it is customary to refer to supply chain management in steady state production contexts as for example the flow of groceries and supplies to a supermarket or the flow of raw materials and components to an automotive assembly factory and into a dealership network. Note that in both these examples purchases represent a very high percentage of the cost of goods sold of businesses. It is because the vast majority of these businesses costs are purchases that the discipline of purchasing management was extended to the more modern concept of supply chain management. This means that when one talks about the construction of a supermarket or the construction of an automotive assembly factory, one would refer to a project management problem rather than a supply chain management problem. It is possible indeed to talk of a 'project supply chain ' but typically supply chain management is referring to a different, routine-based, context of operations. As supply chain management is typically concerned with the management of a large number of repeat transactions between multiple parties, collaboration has become a key concept within the body of supply chain management theory. The ability to trust in order to build collaborative arrangements should indeed be able to develop over a long period of time. One of the major issues faced by supply chains is uncertainty regarding market demand. The ability to collaborate or design better inventory management system would be useless if market demand is completely unknown. Within a supply chain the exposure to demand information of different parties is very different. Retailers typically know a lot about actual market demand and receive feedback from the market on a real-time basis. One of the great challenges of supply chain management is that this knowledge was typically not passed down to suppliers who were left to prepare very approximate forecasts by themselves. A lot of modern supply chain research concentrates on this problem, commonly referred to as demand chain management, and proposes technological and collaborative solutions whereby all supply chain parties can exchange market demand information on a real-time basis for the benefits of all. This much summarised presentation of modern supply chain management is enough to question what supply chain management means in the context of a wind farm? A typical supply chain is characterised by the core 'pipeline' whereby the product is being manufactured or distributed. Supply chain management should normally refer to the activity related to this pipeline and not to peripheral support activities. In the case of a wind farm the core pipeline is about transforming wind into electricity and then injecting this electricity into the national grid. As electricity cannot be stored, there are no inventory management issues associated with the main pipeline. There are indeed inventory management issues associated with construction and support activities: a substantial amount of equipment is to be sourced during the construction of the wind farm and operations and maintenance activities will require the consumption of many parts and supplies. These two inventory management problems are however relatively traditional ones that can be treated with standard project and purchasing management knowledge respectively. Wind farm 'supply chains' also can benefit from collaboration initiatives that are typically used in supply chain management (as most forms of economic activity would). It is only during the operations and maintenance phase that standard routine and repetitive transaction systems will be 25

26 observed and that traditional lessons from supply chain management would be the most applicable. The domain of application remains rather different than supply chain management though: the challenge is not to source turbine blades on a daily basis but rather to source them when and as needed. Again, this class of problem is well known to maintenance managers and many tested management frameworks can be used (e.g. spare parts management in the aerospace industry). The marketing literature that has promoted extensively the economic opportunity behind wind farm supply chains may have created some confusion around the exact nature of this opportunity. It is clear, and beyond debate, that the intended size of investment in the wind energy sector will result in the creation of an entirely new industry and therefore in the creation of many opportunities for technology savvy entrepreneurs and in many job creations. These new activities however do not fit nicely under the traditional supply chain management umbrella terminology and instead, from the perspective of the required management knowledge, are better described as requiring experience in project management, construction management, maintenance management, and purchasing management. Although there is nothing wrong in principle with using supply chain in the broadest possible sense of the terminology (i.e. as meaning that one party is supplying products to another), it could be said that it has generated some confusion by suggesting that supply chain management expertise is what is needed to take the industry forward. A basic comparison of the modern meaning of supply chain management and of the typical activities of wind farms suggest that it is not the case. In order to illustrate this point quantitatively, table 7 compares the investment in London Array to Toyota's investment in the UK, which comprises two factories (Wales and Derbyshire): Investment ( b) Employees O&M budget p.a. ( m) London Array Toyota Manufacturing UK Table 7. Industry Comparison 11 Table 7 shows how drastically different these two industries are, both in terms of local jobs generated but also in terms of the total volume of purchases of parts and services required Global or Local Supply Chains? Further confusion is potentially created when this literature refers in particular to regional or local supply chain. The promise of generating local job and local economic activity is often used at the consent stage of a wind farm project in order to buy in regional decision-makers. The construction and the operations of an industrial entity such as a wind farm will always bring out some sort of positive impact on a local economy. One should however clearly differentiate this notion of local economic impact from the notion of a local supply chain. Supply chain theory does not predict nor advise that a local supply chain is a desirable feature of an industrial system. Although many strategy models (as for example Porter's diamond shown in figure 12) make an explicit reference to the importance of a local supply base, these models make a 11 Toyota UK sold 110,000 cars p.a. before the recession. The average weighted average sale's price is assumed to be 17000, CGS is 80% of sales, and purchases are 70% of CGS. 26

27 reference to the traditional meaning of a 'pipeline' supply chain. For example, in the context of the automotive industry, the application of Porter's diamond suggests that a car factory is best located in a region where plenty of parts suppliers are located. Such a 'locational advantage' is derived from the industrial dynamics resulting from the proximity of the supplier which can deliver parts more economically or interact in a collaborative fashion more frequently. In the case of an industry where purchases and the need for collaboration during routine operations are infrequent, it is likely that a cost advantage would typically offset locational advantage. Cost advantages are typically derived from global supply chains arrangements. Supply chain theory expands the argument of the international division of labour and suggests that a cost advantage can be derived if one supplier can specialise in one activity and supply its products on an international scale. When a global supplier serves a large market, it benefits from learning curves and economies of scales. The application of this principle to the wind farm industry is that when one considers the supply of expensive and complex components, such as turbines, typically only 2 to 3 suppliers should exist at the scale of Europe. Supply chain theory would conclude that each European country producing their own turbines is an ineffective form of economic organisation, as none of the manufacturers would experience sufficient economies of scale to make them competitive. By the same token, the reduced competitiveness of European manufacturers if the industry is too fragmented would make them less competitive than foreign manufacturers benefiting from access to larger markets (e.g. the US). Figure 12 Porter s Diamond Cluster Porter, M. E. (1998). "Clusters and the New Economics of Competitiveness." Harvard Business Review December:

28 This is not to say that location is not an important decision variable in this industry. The size and weight of the required equipment is such that transportation costs will be high, and thus geographical proximity will always give an advantage to a supplier. Optimal purchasing decisions are likely to take into account both cost and transportation considerations. As there are at present no suppliers of turbines in the UK, it so happens that wind farms only have the option to buy turbines made in continental Europe. There has been currently much pressure put on wind farm operators to spend more than they do in their local economy. When interviewed, wind farm operator representatives were actually keen to do so and had no objection in principle to increasing their local purchasing portfolio. These operators, however, accept that there are a number of hurdles in the way of doing so. In order to understand these hurdles it is important to describe in more detail the contractual nature of work in this industry Contractual Nature of Industry Wind farm projects are benefiting from the lessons learned about project financing and project organisation in the electricity supply industry. The previous sections mentioned that a wind farm requires a very high upfront investment and relatively low yearly operations and maintenance expenditure. These two expenditures are related through a whole life-cycle costing relationship: an upfront investment in higher quality equipment will typically reduce the operating cost of the wind farm whereas an upfront investment 'on the cheap' would typically result in increased operations and maintenance expenses. The electricity supply industry, like many of the industries requiring very large infrastructure investments, has always suffered from the fact that the initial investment is so high and that possibilities to postpone expenses are rather limited. When a high upfront investment is combined with the relatively risky nature of the industry, infrastructure industries have often found themselves to be considered too risky to be worthy of financing. This difficulty is addressed by the project finance approach whereby finance is raised specifically for the project by setting in place systems of contract mitigating all, or at least most, of the operational risk away. This approach is illustrated in figure

29 Figure 13. Typical organisational and contractual set up for an independent power producer (IPP). Figure 13 shows that an independent company (in blue) is created for a specific infrastructure project. Electricity supply companies are typically one of many sponsors that would take an equity stake in this company. The rest of the financing of the infrastructure is through debt instruments in order to lower the overall cost of capital. Figure 13 shows operational risk has been accounted for in order to convince investors that their investment is safe. Market risk is eliminated by signing a long-term power output purchase contract (typically with the sponsors). The input risk is handled by signing a long-term gas supply contract. Figure 13 shows that any element of risk that may result in the independent power producer not being a profitable company is covered by a contractual arrangement. This means that the company is a relatively safe and secure business model and that financing is desirable. It is important to note that it is unlikely that wind farms would have been built in UK if it were not for project finance. Indeed, the risk associated with selling electricity with a cost of production three times higher than competing sources would normally be so high that the investment would be regarded as unworthy. All wind farms projects will use such a contractual structure and any new supplier will have to either be able to enter such contracts or to enter into the contract with the party currently in business with a wind farm. There is a significant transaction cost associated with this approach. 29

30 It is common to tie the design and build contract for at least the first five years of operations of the wind farm. In other words, the turbine manufacturer is typically responsible for the uptime of the turbines for the first five years of operations. This means that key maintenance and purchasing decision of spare parts and key components will rest with the turbine manufacturer, or another contractor, rather than with the wind farm operator. It is important to note that both the amount of wind but also access condition (i.e. weather systems) has an impact on the uptime and efficiency of the turbines. This puts considerable pressure in this relatively new industry in terms of managing input risk. As a result it is very important that wind farm operators manage their assets as efficiently as possible and therefore they cannot afford to subcontract services or purchases locally if local provision comes at a cost or quality/reliability disadvantage Current Opportunities Based on Interviews Based on the above presentation of the industry and on the interviews, we were able to confirm the existence of the following opportunities in Kent and Medway. There are some opportunities during the construction phase of a wind farm, many of which have already been or are being exploited (specialist fleet, labour, associated port services). Some further opportunities could be exploited, as for example involving local parts during the wind farm construction (the assembly of the turbine in key subsets for the transportation and final assembly on-site). A Kent-based company interested in being more involved in the construction phase of a wind farm would however have to tender directly to an international first-tier supplier. This first-tier supplier is likely to have entered informal discussions with some of its legacy suppliers prior to the inception of the project. It would therefore require a very specific experience or a significant cost advantage for such a contract to be obtained. It is likely that legacy suppliers will have extensive knowledge of the industry and that Kent-based firm may struggle to win the contract if demonstrating experience of the wind energy sector is required. As winning such a contract would be a one-off order, the cost of acquiring more knowledge and preparing to bid may be prohibitive. Once the construction phase is finished and the wind farm enters phase 2 (operations and maintenance), further opportunities arise. This is the situation of London Array currently. Opportunities are mostly in the domain of office supplies and administrative services (legal, secretarial, accounting) at the handover stage between phase 1 and phase 2. Opportunities in the technical domain are very limited due to contractual ties with the first-tier supplier. London Array is estimating that in the technical domain only 5% of the total purchases can be contracted out to local suppliers. It is only after the expiration of the initial contract period (Vattenfall currently) that a significant increase in contracting opportunity related to operations and maintenance takes place. After the first five years of operations, the responsibility for the operations of the turbine is moved from the builder to the operator. Turbine manufacturers have a relationship and legacy advantage but their parts and services typically come at a cost. According to an internal investigation by Vattenfall, up to 80% of parts needed are not specific to the wind energy industry and could be purchased from non- 30