Developers in the offshore wind industry and governments do not always agree on the value of the Local Content Requirements (LCRs), which are rules set by governments that stipulate a certain portion of goods or services in a particular industry must be produced or sourced locally. From governments’ perspectives, feed-in tariffs (FITs) facilitate the development of the renewable energy sector while incurring considerable expenditure. Such a mechanism enables the supply chain to strengthen resilience and diversify risks, but gaining public support might be challenging if it fails to create more jobs and opportunities for infant industries like renewable energy. On the other hand, developers believe that when comparative advantages between countries determine the optimal allocation of resources, LCRs can lead to market distortion, resulting in inefficiencies and cost increases, hence the preference for more relaxed LCRs. Under these two distinct perspectives, how do we find a balance?
Short-term benefits and challenges: Job opportunities and resilience vs. costs and monopolies
The Taiwanese government sees the necessity of LCRs for two reasons: firstly, the policy helps create job opportunities and rationalize FITs for potential development sites; secondly, LCRs is believed to help secure supply chain resilience, preventing disruptions in wind farm construction due to external shocks, such as supply chain disruption and soaring freight rates caused by the Russia-Ukraine war. From an energy security standpoint, even though LCRs may lead to cost increases and events like the Russo-Ukrainian War are unforeseen circumstances, it is necessary to trade off some efficiency for supply chain resilience.
While developers understand the government's considerations, they are concerned about the rising costs brought about by LCRs that could ultimately hinder wind farm construction. Despite the cost advantages of some items, the surge in shipping and capital costs necessitates developers to strengthen cost management. Furthermore, Taiwan's market size has led some LCR items to become natural monopolies. Developers are concerned that the monopoly of mandatory LCR items may lead to price gouging or an inability for wind farm construction to be completed as scheduled in the absence of alternatives. Ultimately, electricity consumers in Taiwan will bear the brunt of high electricity prices and delayed wind power supply.
InfoLink believes that it is inevitable that newcomers will not be cost-competitive in the short term. Excluding the issue of oligopoly, newcomers require time to learn and amortize equipment costs. Therefore, it is unfair to attribute the lack of competitiveness to the newcomers, especially considering the high barriers to entry in the offshore wind sector, which extend learning time. It is expected that these manufacturers can facilitate competition and accelerate grid parity as they mature and enter the international market.
However, if a developer is unable to complete the construction of a wind farm in the short term, the supply chain will lose the opportunity to grow. Therefore, the key lies in preventing short-term costs from rising beyond the reach of developers. To achieve this, the government could consider providing low-interest loans or tax subsidies to help stabilize the financial situation of wind farms, while the issue of monopolies among manufacturers must be addressed, as both natural monopolies and oligopolies lead to an uncompetitive industry, thus resulting in the failure of LCRs. Competition across industries can be promoted through the following two approaches:
- Requiring a certain proportion of local capital expenditure1:
This is the practice of localization of offshore wind power in the U.S. as discussed in the article Comparison of local content requirements for offshore wind power: Case studies from Taiwan, Japan, South Korea, and the United States, which requires developers to purchase a certain proportion of locally manufactured equipment. The advantage lies in allowing market mechanisms to determine the most suitable items, while the disadvantage is the challenge for governments to allocate resources to specific items and the increased administrative resources in determining capital expenditure.
- Cancelling mandatory items and providing bonus points based on investment amount:
This approach shares some similarities with the previous one, but is closer to the current regulations. It allows manufacturers that have already made substantial investments to receive protection, ensuring policy continuity. In addition, governments can adjust scoring for industries that are still in the early stages of development. However, defining the level of investment amount can be a major challenge due to varying degrees of asset specificity. For example, blade and nacelle assembly are highly asset-specific, while other assets such as distribution panels and cables are not.
Medium- and long-term benefits and challenges: Success rate and trade barriers
In the medium to long term, LCRs do not only bring negative effects on costs, but can also benefit developers by making them more competitive internationally. One benefit is the elimination of long-distance transportation costs, especially for parts like wheel hubs or blades that incur high transportation costs or are prone to damage during transit, while also significantly shortens the lead time for parts to be shipped. For example, if a typhoon damages the blades of wind turbines, it may take more than a month to transport them from Europe to Taiwan. Another example is the situation where Siemens’ onshore wind turbines needed to be replaced ahead of schedule due to a shorter-than-expected lifespan – something that is worth noting even though offshore wind turbines have yet to encounter the same issue so far. Secondly, if LCRs can successfully create a clustering effect in Taiwan, the resulting spillover effects would also be beneficial in enhancing the overall competitiveness and innovation of the industry. Lastly, developers would have more access to the supply chain and would be able to minimize the premiums they would have to pay for information asymmetry with wind turbine manufacturers during the procurement and maintenance periods. These benefits are contingent upon the successful implementation of LCRs. In the medium to long term, the adoption of LCRs to protect domestic industries may lead to trade barriers in other markets, affecting the progress of international trade, resulting in greater overall benefit losses, and exacerbating market distortions.
For the medium and long term, InfoLink believes that the key lies in ensuring the effective implementation of LCRs and guaranteeing the proper allocation of resources to local supply chains. According to a 2013 study2 by the International Trade Centre under the United Nations Sustainable Development Group, the following factors can increase the likelihood of LCR's value creation: having a stable and adequate market size, selecting potential industries with a "learning by doing" capability, avoiding excessive proportion of requirements3, providing financial support, and establishing exit mechanisms. Taiwan has corresponding policies for the first four points, but lacks clear regulations for the exit mechanism.
Exit mechanisms are crucial for the success of LCRs. The original intention of LCRs is to provide nascent industries with an opportunity to thrive, rather than infinite protection of domestic industries. Establishing an exit mechanism earlier is advantageous for companies' long-term planning. On the other hand, exit mechanisms offer room for development without permanently protecting domestic industries, thus reducing the likelihood of other countries filing complaints with the WTO. Finally, exit mechanisms serve as a stop-loss point for LCRs. If Taiwanese companies lack competitiveness, continued protection means subsidizing manufacturers with profits of green energy purchases by companies.
Overall, the difficulty in reaching a consensus on LCRs arises from different weight placed by the government and developers for the short, medium, and long term, as well as the high level of uncertainty regarding the benefits that LCRs can bring in the medium to long term. It is suggested that the government consider adjusting the bidding system and establishing exit mechanisms to promote competition, thereby reducing the short-term costs and distortions in resource allocation of LCRs, increasing the chances of success, and expediting the arrival of medium to long-term benefits. Developers can also reassess the external and medium to long-term benefits generated by LCRs.
1 The editorial in Commercial Times provides a more comprehensive discussion of the advantages of this approach.
2 Kuntze, J. C., & Moerenhout, T. (2012). Local Content Requirements and the Renewable Energy Industry-A Good Match?
3 According to the study by Francisco Veloso titled "Local content requirements and industrial development: Economic analysis and cost modeling of the automotive supply chain" (2001), the appropriate level of localization is related to the opportunity cost of capital and the market size.