Recently SiemensGamesa announced a large contract in Finland with a particularity that did not go unnoticed in the sector: the maintenance contract was of the full service type with a duration of 35 years!!!!
As Sergio Fernández Munguía points out in his highly recommended latest newsletter, this was not the first case of such long contracts, as Vestas also announced a 35-year contract in Finland a few months ago. In fact, WindEurope, in its report on digitization, included a very illustrative graph on the topic
As can be seen, according to WindEurope data, more than half of the contracts for which data is available are signed for periods of more than 20 years. This coincides with data from other sources such as BNEF, which puts the number of published contracts with agreements of more than 20 years at 40%, with countries such as Poland, Finland and Sweden being the markets where they are clearly in the majority.
And why are these types of contracts so striking?
The first and most obvious reason is that they are for terms longer than the theoretical design life of the turbines. If we take as an example the aforementioned SiemenGamesa contract, the SG 5.X platform is designed for 20 or 25 years depending on the type of wind, as can be seen in its type certificate available at IECRE.
Although it is not clarified in the press release, it is most likely that the contract already includes some life extension package which basically involves renewing some key components of the turbine such as blades and gearbox in order to extend the lifetime by 10 or more years.
In fact, just over a year ago we published a post in this blog about the barriers in the industry to longer theoretical life turbine designs and how it was likely that life extension packages and very long term O&M contracts would be enough to lengthen the business cases.
Why do customers choose these contracts?
This is a very interesting point because it is not really to save money but to reduce the perceived risk. Simplifying a lot, there are 2 types of wind farm developers:
1) the very expert ones whose business is to operate the wind farms (utilities like Iberdrola or IPPs like Acciona). These companies optimize their O&M as much as possible and therefore split contracts and work with mixed schemes of external suppliers and internal personnel, trying to close agreements that are not very long in order to promote competition.
2) companies with a more investment profile that try to design the best business case to obtain financing and subsequently sell the project to other investors. And it is in these cases where it is key to extend the life of the project to the maximum and also reduce risks by closing from the beginning a service contract with the OEM for the entire life of the project.
A question of trust
Not so long ago, the majority of O&M contracts were for 5 years, but as we have seen, we are now in periods of more than 20 years. And this means that trust between the different parties has to be high:
1) Customers in OEM: 35 years is a long time and the customer who signs such a contract trusts that the OEM will survive and have operational capacity all that time.
2) OEM in its technology: we do not know what kind of price review clauses (so fashionable nowadays) may be included in such long term contracts but regardless of that, the manufacturer that agrees an almost closed price for 35 years has to be very confident in the reliability of its machines as well as in the potential cost improvement of its services to even improve profitability.
Both aspects are clearly a consequence of the maturity of the sector, which is reflected in stronger and more experienced companies and more reliable technology.
As we have commented many times, currently the most profitable business for OEMs is O&M as can be seen in the following graph
It is clear that OEMs are interested in securing this business for very long periods and thus have captive customers and a larger fleet in order to reduce costs by applying economies of scale. And as we have seen, there are certain customers who need these contracts to reduce risk in their business case, so we are likely to see more and more of these types of agreements.
But such a long duration has its risks and therefore OEMs should avoid starting a trade war by lowering prices and increasing scopes because in case of future unexpected cost increases due to reliability problems as we have seen with the Vestas blades, it could be catastrophic.