The Growing Strategic Importance of Interconnectors: a Look at the North Sea Region

Electricity grids are complex systems comprising multiple elements. Electricity from power generators is fed into the power grid’s high-voltage transmission lines for long-distance transport. Near the point of final consumption, electricity is then transformed into a low-voltage current and delivered to businesses and households. High-voltage transmission lines located within individual countries transfer power between regions. Power cables that connect the grids of at least two countries are referred to as ‘interconnectors.’ Interconnectors can be built on land (underground or via overhead cabling) or at sea.

High-voltage cables use either alternating current (AC) or direct current (DC). Between the two types of transmission lines there are differences in, for instance, costs, technical specifications, power loss, and other performance indicators. In general, high-voltage alternating current (HVAC) cables are used within countries while most subsea cables are high-voltage direct current (HVDC) lines. HVDC is progressively preferred for long-distance transmission from around 600km, where these cables become increasingly cost-competitive.

Recognizing the strategic importance that interconnectors will have for the region, the EU has set a target of a 15% interconnectedness level[1] by 2030, applicable to all EU countries. Currently, the level of interconnectedness varies greatly between different countries (see Figure 1), implying that greater investment will be needed in the coming years. To understand the relevance of interconnector projects within Europe, it is crucial to understand the strategic role they can play in the power system, especially in the future.

[1] The interconnectivity rate is expressed as the ratio of import capacity to total installed capacity in a power market. This way of measuring interconnectivity sufficiency is still open to debate. Some experts also want to take peak load and the share of variable renewable sources into consideration, in addition to the total installed capacity.

Energy Security and Grid Stability

Interconnectors can play a crucial role in Europe’s energy security. They are simply necessary for some countries that produce little to no power and, thus, rely almost fully on imported electricity. An extreme example is Luxembourg, which is dependent on its interconnections to the German and French power grids to cover more than 80% of its electricity consumption.

In a broader context, imports via interconnectors can help avoid blackouts and secure grid stability in case of a drop in local power production. A recent illustration is France, where a substantial part of the nuclear fleet experienced an outage during 2022. This brought French power output to its lowest levels in years. Interconnectors between France and its neighbors partly mitigated the effects of this significantly lower-than-usual domestic electricity supply. Typically, France is a net exporter of electricity through the same interconnectors. In 2018, for example, it was French nuclear power that helped keep the lights on in Belgium when Belgian nuclear power production was temporarily reduced.

Flexibility To Counter Local Price Fluctuations

Interconnectors allow neighboring countries to respond more efficiently to changes in power supply and demand, and thus price fluctuations. If there is a demand spike in one country, power can be transmitted via interconnectors from abroad. Such power imports can therefore reduce pressure on national grids and also help reduce power prices in moments of regular high electricity demand by pushing expensive sources of peak response, like gas, further down the merit order. It goes without saying that this process can work in both directions – countries with excess electricity production can also alleviate pressure on their grids through exports. Consequently, interconnectors can help balance the grid by increasing a system’s flexibility and help lower the cost of electricity in a specific market. The European Network of Transmission System Operators for Electricity, ENTSO-E, estimates that yearly investments in interconnectors of EUR 3.4bn between 2025-2040 would lead to annual savings of EUR 10bn in generation costs.[2]

Inclusion of High(er) Shares of Renewable Energy

Finally, interconnectors are a crucial instrument for the future European grid, which will include much higher shares of energy from renewable sources, like solar and wind. The EU recently set a renewable energy target of 45% by 2030 and has strong ambitions for offshore wind.

Weather-dependent electricity sources with unpredictable output represent one of the main energy transition challenges. Due to the inherent intermittent nature of such energy sources, a larger share of renewables in the electricity supply will lead to fluctuations in power generation. These can occur both during the course of a day (e.g. solar output only when the sun is shining) and throughout seasons (e.g. higher solar output during summer, higher wind in the winter). And, in principle, it is not always possible to ramp up renewable energy production when needed, as gas turbines can do. Interconnectors are expected to play a role in smoothing out those power fluctuations by allowing transmission of energy from locations with favorable renewable power production conditions to neighboring areas. Interconnectors can only help to a certain extent though. Weather conditions are often similar across entire regions, meaning that windy weather enabling high wind energy production in Belgium, for example, also likely results in similar favorable conditions in the Netherlands.

In summary, interconnectors can potentially reduce power costs and improve local energy security. Moreover, interconnectors are expected to play a vital role in the future of the renewables-led power grid in Europe.

[2] ENTSO-E. “Completing the map: Power System needs in 2030 and 2040.” November 2020. https://eepublicdownloads.azureedge.net/tyndp-documents/IoSN2020/200810_IoSN2020mainreport_beforeconsultation.pdf.

Until recently, most interconnectors in Europe were built on land. Land-based cables are, in theory, easier to construct, although such projects have sometimes met local resistance from residents objecting to overhead power cables. As the need for stronger interlinkage of the EU’s power system has grown and the offshore wind sector is expanding, we have also seen a growing trend of project proposals for subsea power transmission cables.

Around 2015, the number of interconnectors really started taking off. Figure 2 shows the cumulative number of all HVDC projects across Europe from 2000 till today, plus those expected by 2030. ‘Internal’ HVDC projects refer to domestic cables connecting, for example, the northern and southern parts of Germany. The number of domestic connections shows relatively modest growth while the number of land-based and ocean-based connections between countries – that is, interconnectors – and those linking countries to an offshore wind park (‘offshore’) have grown strongly. As a result, BloombergNEF expects the number of interconnectors (including the offshore category) to grow from 56 in 2022 to 98 in 2031.

According to our estimates, there are currently more than ten subsea interconnector projects in the North Sea and English Channel in the planning or construction phase, in addition to the 17 major subsea cables already in operation.

It’s also worth noting that the capacity of each interconnector in the pipeline tends to be much bigger than that of existing interconnectors. In the last six to seven years, the typical capacity of an interconnector increased to beyond 1GW (up to 2GW) while only a handful of projects installed earlier had such a large capacity.

If interconnectors are so useful, why don’t we build a lot more of them everywhere – and much faster? There are a number of reasons: mainly, the significant (upfront) investment costs, the prolonged time horizon of projects and asset lifespans, and de-risking challenges in various business models.

Significant Investment Costs

Let’s start with the costs. Interconnector projects represent a sizable investment (see Figure 3). This applies particularly to the several-hundred-kilometer-long underwater cables that are also becoming increasingly large in size and capacity. The Neuconnect interconnector planned between the UK and Germany, for example, is a 1.4GW, 725km-long cable with a construction budget of EUR 2.4bn. The Viking Link between the UK and Denmark planned to be commissioned in December 2023, has roughly the same dimensions (1.4GW, 760km, costs about EUR 2.4bn). Proxy costs of interconnector projects sometimes exclude expenses related to, for example, planning and permitting processes, which can be both costly and time consuming. On top of that, capital investments might also be required to improve the infrastructure at the point of connection and transmission within a country.

Prolonged Time Horizons Can Affect Bankability

The time horizon is another important inhibiting factor. Every part of an interconnector project, including planning, permitting, obtaining subsidies, and construction – not to mention the lifespan of the final asset – takes a long time. For example, it took 12 years for the full development and construction process of the North Sea Link interconnector between Norway and the UK, which was finally commissioned in 2021. The feasibility study was conducted back in 2009 and construction started in 2015.

Following delivery, interconnectors are expected to be in service for at least a couple of decades. Neuconnect, for example, is expected to operate for at least 30 years from the planned delivery in 2028.

These long time horizons are linked to many uncertainties that affect investment decisions and the bankability of a project, for example, because of very long payback times.

Business Models: De-risking Uncertainties

In general, there are two main business models for interconnectors. The regulated model, where interconnectors are sponsored by Transmission System Operators (TSOs) or utilities, is the most common. These players will usually finance interconnectors through their balance sheets as part of their ongoing business. The prime responsibility of a TSO is to ensure proper functioning of the power grid, so this group doesn’t necessarily need to make a profit on the interconnector. There is some room to make a profit though, for example, through congestion rents. These are basically the difference in power price between two connected markets.

This arbitrage option via congestion rents is one of the revenue streams that is driving increasing interest from privately sponsored interconnector projects. For the sake of illustration, we call this the ‘merchant’ model. The caveat is that the more interconnectors are added to the system, the more congestion rents will shrink due to increasing price convergence between power markets.[3] In essence: the interconnectors will cannibalize one another in the long(er) run. This will apply to all interconnectors, whether financed by TSOs or independent investors. In addition to potential bankability challenges, this is one of the reasons for the low number of merchant model interconnectors in place. These investments typically require subsidies or other forms of support to reduce or even eliminate the associated long-term risks of such projects.

Neuconnect is a good example to illustrate how such de-risking could work. This interconnector project was set up as a special purpose vehicle (SPV) by a group of institutional investors: Meridiam, Allianz Capital Partners, Kansai Electric Power, and TEPCO. The investors applied for all available permitting revenue guarantees (which can be seen as a kind of subsidy) with authorities in Germany and the UK. In Germany, the TSO will in effect pay Neuconnect a fixed tariff per megawatt hour transmitted. In the UK, the project’s revenues are subject to a cap and floor mechanism guaranteed for 25 years by Ofgem (the Office of Gas and Electricity Markets, the UK regulator). This model assures the SPV a steady income interval for the 25-year period. In essence, revenues from this project are guaranteed by the two states through the local regulators and TSOs. The result is a highly de-risked business model with a higher chance of bankability. But it also means that the merchant risk is thus taken by the TSOs or, in the end, the tax payers.

[3] There are also other factors that can influence the revenue streams of interconnectors, for example, changes in the power mix or structural changes in demand in one of the connected markets. Moreover, the revenue streams of interconnectors can also include utilization fees or capacity market payments.

In recent years, subsea interconnector investment activity has taken off in the North Sea region[4] as a tool to increase energy security, stability and flexibility. Some countries, like the UK, also see interconnectors as a way to access green electricity to reach their net-zero emissions ambitions. Interconnectors can effectively help maximise the use of the (renewable) electricity production across the region. Figure 4 shows the existing and currently planned subsea interconnectors in the North Sea region.

[4] In this analysis, we also include interconnector projects in the adjacent Irish Sea, Baltic Sea, and the English Channel, as trends are interrelated in this entire area. For simplicity reasons, we refer to the area as the North Sea region in this article.

Great Britain’s Growing Reliance on Interconnectors

Subsea power cables represent the only option for Great Britain, given the geography of the island, to connect to electricity grids in other countries. Therefore, the country has the highest number of (future) interconnectors in the North Sea region. Great Britain has eight existing interconnectors with Norway, Ireland, Northern Ireland, Belgium, and the Netherlands, and ten additional ones in the planning, including to new countries (Denmark, Germany). The latest subsea interconnector announcement (in April 2023) was the LionLink project between Great Britain and the Netherlands. (This project is a rebranding of the previously announced EuroLink project.)

Some of the most important connections go via the English Channel to France. In addition to three existing interconnectors, there are plans to commission at least three more interconnectors to connect Great Britain (via England) with France. In that way, Great Britain can continue to benefit in the long run from the relatively cheap electricity generated by France’s nuclear power plants. In the North Sea region France only has existing subsea interconnections with England, and one planned with Ireland.

Given the UK’s low rate of interconnection (see Figure 1) and its net-zero ambitions, one would expect more subsea interconnector announcements in the future.[5]

Germany and the Nordics Strongly Interlinked

Denmark is probably the most (subsea) interconnected country in the North Sea region, which is clearly illustrated in Figure 4. Despite its small size, Denmark has six existing subsea connections (with Great Britain, Norway, Sweden, Germany, and the Netherlands) and three in the planning (with Great Britain, Belgium, and Germany). This is likely due to a combination of factors. Denmark is a strong producer of wind energy and in periods exports a lot of electricity. Due to its geographical position, the country also plays a role as a gateway for green electricity produced in Sweden or Norway flowing to Germany. Germany also has direct links with Norway and Sweden, mainly to take advantage of cheap hydropower.

Currently, Germany has three planned subsea interconnectors, including the earlier mentioned Neuconnect cable, which will be its first direct link with the UK market. Germany will most likely be in strong need of these additional interconnectors (in addition to its many land-based interconnectors) in order to assure a reliable and sufficient supply of (green) electricity at affordable prices. This is linked to the country’s current phaseout of nuclear and coal-powered electricity production and its high renewable energy ambitions. Gaining additional access to neighboring electricity markets will also potentially allow Germany to burn less gas during peak demand periods and give the country the option to export renewable power during moments of excess supply.

Interconnectors and Significant Offshore Wind Ambitions

Interconnectors are particularly important for the successful integration of wind energy in the electricity grids in this region. The North Sea region countries have got strong ambitions for offshore wind projects (see box below). Denmark (two projects) and Belgium (one project) also have far-reaching plans to build offshore energy islands. All of these projects will need power cables to connect them with mainland grids, often connecting more than one country to an offshore project. One example is the aforementioned 2GW LionLink multipurpose interconnector (MPI) between the Netherlands and the UK, due to be operational in 2031. The term MPI refers to the fact that this interconnector will link the two countries via a Dutch offshore wind farm. According to the two TSOs developing this project, this is “the first step towards an integrated North Sea grid.” In the future, we could therefore expect more MPIs in the region in order to connect the planned future offshore wind farms efficiently with electricity grids across northern Europe.

[5] On a side note, investors also plan to access green electricity imports via the first interconnector project that will link Great Britain with a country outside of the North Sea region. UK-based company Xlinks is planning to construct the longest interconnector in the world, linking Devon in England with a wind and solar farm in Morocco’s Guelmim-Oued Noun region, whose output would be dedicated to the UK market. This interconnector will consist of four cables, each 3,800km long, and is due to be delivered in 2030. This project is also linked with investments in battery storage. There are still many uncertainties about whether this project will be built. It is currently in the initial phases of planning and feasibility, and sponsors are seeking ways of making the project bankable. In addition to solving financing challenges, project developers will have to deal with France, Portugal, and Spain, as the cable will cross their waters. And finally, there are substantial technical challenges involved with such an unprecedentedly long cable.

It is hard to overestimate the strategic importance of the role of interconnectors in the future of the European power grid. This is reflected, for example, in the 15% minimum interconnection target that the EU has set for all countries in the region by 2030. Interconnectors are crucial for both net power importers and exporters as a way to balance power markets and bring electricity prices down. In addition, interconnectors can provide energy security and much needed flexibility required for the higher uptake of renewable energy production in the future. Europe’s substantial plans for offshore wind, in particular, and to some extent for energy islands, will be driving the need for interconnectors in the North Sea and adjacent seas.

As a result, we believe that the current elevated activity related to interconnector development in Europe – in particular in the North Sea region and surrounding areas – will continue. We might, however, see some projects being delayed, postponed, or even canceled entirely as a result of the challenges associated with undertaking these massive infrastructure projects. And, while interconnectors are one part of the puzzle to speed up the energy transition, they will not fix all the challenges we face in our race toward a carbon-free power grid.

This article was written in collaboration with Cristian Stet, previously part of RaboResearch, and Igor Stepanov from Rabobank’s Project Finance Department.

Cover image: © National Grid