OCEAN SPACE CENTRE An evaluation of incentive effects

OCEAN SPACE CENTRE An evaluation of incentive effects February 27, 2014 A report to the Ministry of Trade, Industry and Fisheries and the Ministry of Finance

Ocean Space Centre (OSC) incentive effects Introduction This note presents an ex ante evaluation of the incentive effects of realising the project Ocean Space Centre (OSC) as described by the D FLEX Alternative. A positive incentive effect is defined here as a change in demand for Marintek s services, induced by the industry, in terms of increased level of R&D&I activity, scope, amount spent or speed. The main criteria for incentive effects are both qualitative and quantitative and for the case of OSC can be related to an assessment of the following bullet-points: Expected increase in turnover related to marine technological R&D&I Market risk, economic risk and technological risk Increased quality and scope of marine technological research Contributions to solving congestion/delay in completion of marine technology projects Expected cash flows More specifically, we shall evaluate the incentive effect for the industry, and hence the potential increases in the R&D&I activity at Marintek, induced by implementing the OSC project by comparing it to a probable future should the OSC project not be realised out. This situation is described as the 0+ Alternative. Details are found in references [1]-[4]. Evaluation of incentive effects comparing The D FLEX with the 0+ Alternative In the following we discuss the bullet-points with reference to the D FLEX Alternative comparing the expected development with the 0+ Alternative, the situation without investments in new laboratories. Expected increase in turnover related to marine technological R&D&I The D FLEX alternative describes five target areas of R&D&I, chosen in accordance with market analyses that take into account global challenges and demand in the development of ocean space technology the next 10-20 years. These areas are labelled Smart Maritime, Deepwater, Arctic, Renewables and Seafood. The core of the target areas consists of a number of strategic research topics with associated market segments that will make up the basis for increased knowledge and expertise of OSC. The expected development is based on a strategy to strengthen the cooperation with present R&D&I partners and to establish new alliances both nationally and internationally, including research communities and industrial partners. This strategy also emphasises the recruitment of highly skilled staff and MSc/PhD candidates. The upgraded and new laboratory facilities will be one of the main factors in supporting the planned development. Consequently, Marintek argues that the turnover related to R&D&I activities will grow moderately the first five years after the project has been initiated, while laboratory facilities are under construction, and thereafter, turnover will grow considerably steeper and reach a steady-state after approximately five 1

years. Here, and in the following, we present the numbers representing the first year of new laboratories in operation (2020) and the expected steady-state five years later (2025), c.f. Table 1. 1 Table 1 Expected R&D&I turnover for Marintek in The D FLEX Alternative, given that 2020 is the year when new laboratories, inclusive revision of the existing ocean lab, are in operation (mill. NOK 2012) 319.6 415.2 623.1 Source: OCEAN SPACE CENTRE Gevinstrealiseringsplan for The D FLEX Alternative In comparison, The 0+ Alternative contains no escalation in R&D&I ambitions and only renovation of existing facilities in order to sustain activities in the laboratories up until 2030. Therefore, the relevance of the laboratories for research activities and commercial clients will deteriorate as the equipment grows out-of-date. Consequently, the international expertise, research activities and services that the laboratories support today will be phased out and this is very likely an irreversible process. That is, rebuilding a corresponding research community at a later point will require substantial resources. Nevertheless, the alternative does not exclude R&D&I activities that are not supported by the laboratories today. However, the overall competence in Marintek is extensively built on knowledge gained in the laboratories. A shift toward non-laboratory based projects may accelerate a deterioration of the competence. Besides this a shift in research scope with similar international ambitions will also need additional resources. Anyway, the 0+ Alternative as described in the KS1- Report does not imply a change in behaviour that is likely to increase the level of R&D&I activities at Marintek above today s level either in size, scope, amount spent or speed, rather the opposite. Table 2 presents the development of expected turnover for Marintek in the 0+ Alternative. Table 2 Expected R&D&I turnover for Marintek in The 0+ Alternative (mill. NOK 2012) 312.3 293.6 286.2 Source: OCEAN SPACE CENTRE Gevinstrealiseringsplan for The 0+ Alternative According to Marintek, the area with largest expected growth in R&D&I turnover is Arctic, whereas the areas with the largest expected growth in absolute numbers are Smart Maritime, Deepwater and Renewables. In Table 3 below we present the difference in turnover between The D FLEX Alternative and The 0+ Alternative in the period 2013-2025. The figures illustrate the increasing gap in expected turnover 1 Note: In [2]-[4] it was assumed that the first year of new laboratories in operation would be 2018. As the planning process has been more time consuming than expected, we evaluate it more likely that the first year of operation after investment is finish will be in 2020. 2

between the OSC concept and the status quo concept, represented by The D FLEX and The 0+ Alternative, respectively. Table 3 Expected additional R&D&I turnover for Marintek in The D FLEX Alternative compared to The 0+ Alternative, given that 2020 is the year when new laboratories, inclusive revision of the existing ocean lab, are in operation (mill. NOK 2012) 7.3 121.6 336.9 Source: MFM and OCEAN SPACE CENTRE Gevinstrealiseringsplan for The 0+ and The D FLEX Alternatives The stipulated growth in turnover corresponding to The D FLEX Alternative implies a larger share of the European market for marine technology R&D&I than Marintek, Sintef and NTNU jointly have today. Today s joint share is 2 percent of NOK 24 billion. The said market is expected to grow to NOK 26 billion in 2025, but the joint share requires an increase to approximately 3 percent to match the turnover growth reflected in Table 1. In other words, the expected growth in turnover associated with OSC suggests a 50 percent rise in Marintek s present share of the European market for marine technology R&D&I. We deem this target to be realistic, in view of the present position, market analyses of future R&D&I demand and the strategies for increased knowledge developed for The D FLEX alternative. Marintek s present turnover related to R&D&I can approximately be classified either as applied research (80 percent) or basic/strategic research (20 percent). Applied research is typically funded by industrial partners, whereas basic research is typically funded by The Research Council of Norway and The European Union. As illustrated in Table 1 and Table 3, total turnover related to R&D&I associated with The D FLEX Alternative is expected to grow both in absolute numbers and relative to The 0+ Alternative. Moreover, due to the planned strengthening of international research cooperation and new laboratory facilities, we anticipate that the share of basic research will increase compared to the present level. One can argue that a certain share of industrial projects are testing of concepts and therefore should not be included in R&D&I turnover. Evaluated outside the context this may be a correct approach, but as these projects are undertaken in a research environment and are important to build knowledge and competence, one would expect that data collections and corresponding results from testing will benefit research projects at a later point. Anyway, it is a difficult task to decide which project has a research potential and which project has not, as long as the academic staff involved is the same. Market risk, economic risk and technological risk There are a number of challenges to the realisation of the planned increase in R&D&I turnover associated with The D FLEX Alternative described in the previous subsection. In the following we address potential market risk, economic risk and technological risk. Regarding market risk, we do not fear that the national and international demand and need for competent research milieus specialised in marine technology will decrease. Global research 3

challenges within the target areas Smart Maritime, Deepwater, Arctic, Renewables and Seafood are hardly difficult to envisage, and a growth in demand seems justified. However, the stipulated growth in R&D&I turnover is dependent on a substantial increase of Marintek s present share of the marine technology market, and it is here we acknowledge market risk. Being successful in establishing new laboratory facilities, increasing cooperation with research institutions home and abroad, strengthening the cooperation with industrial partners, increasing the academic staff, and developing a research hub with international attractiveness are all factors that will influence the outcome. In the documents describing The D FLEX alternative, Marintek addresses all these factors and presents a detailed plan for how the challenges will be met in order to be successful. Anyway, one challenge will always exist being able to transform reasonable plans into appropriate actions, which in this case puts a substantial responsibility on the organisation and interplay of future research activities at Marintek, Sintef and NTNU. Since we included income (turnover) risk in the market risk paragraph above, economic risk will mainly constitute increased costs associated with new investments and renovation of the laboratory facilities. The largest economic risk identified with The D FLEX Alternative is owner control, which is related to investment planning, implementation and risk handling. A substantial risk of increased investment costs is also due to contractors and their corresponding planning and implementation abilities. We associate the term technological risk with utilisation of the laboratory facilities at Marintek. If The 0+ Alternative is realised, the facilities will gradually be unfit for advanced research projects and the share of projects aiming at simpler, low end testing of concepts is likely to grow at the expense of competence driven research projects. Clients of Marintek have expressed that their willingness to pay for research projects increases with the knowledge content and the level of expertise involved in a project. Therefore, the technology risk is reduced if The D FLEX Alternative is realised, as the new laboratory facilities will enable Marintek to engage in projects that reflect the forefront of international research. However, the laboratory facilities that are included in The D FLEX Alternative will last for decades. Thus establishing multi-functional and flexible solutions are important risk reducing factors. Creating such options may involve higher investment costs up front, but will yield flexibility and leeway when facing unforeseen shifts in the demand for marine technology R&D&I. We acknowledge the work put down by Marintek to address this risk, but emphasise the importance of continuous focus on real options. Increased quality and scope of marine technological research The scope of marine technological research differs between The D FLEX Alternative and The 0+ Alternative. Whereas The 0+ Alternative implies continuing the present conduct, The D FLEX Alternative implies a new objective to become an international knowledge hub for ocean space technology. The plan for The D FLEX Alternative includes a larger staff, a higher level of activity and a stronger emphasis on scientific quality. Moreover, The D FLEX Alternative includes the development of new research areas, such as the Arctic area. If an international knowledge hub is established successfully, including the upgraded and new laboratory facilities planned in The D FLEX Alternative, OSC will be able to offer new services with a stronger international reach. Also, international research cooperation will be strengthened. The increased level of scientific ambition included in The D FLEX Alternative enables OSC to initiate and 4

carry out more projects with stronger scientific content leading to competence building of existing staff. Increased scientific quality in the projects and more competent staff will help recruiting the presupposed addition to the present number of staff. Increased competence may in turn improve teaching and supervision at NTNU, which will benefit both national and international students. More competent staff may also strengthen the industry, due to turnover (spill-over) and new products (spin-offs), including speeding up the pace of innovation. A potential long-term effect is global economic growth. New services facilitated by new and upgraded laboratories will support the development of new research areas. For example, several of the research topics planned under target area Arctic are dependent on the High-sea laboratory that will replace the present towing tank. As noted above, Arctic is the area with largest potential growth in R&D&I turnover for Marintek. Contributions to solving congestion/delay in completion of marine technological projects Today, the demand for using the Ocean Laboratory and the Marine Structures Laboratory at Marintek exceeds the capacity, and no capacity expansion is planned in The 0+ Alternative. In The D FLEX Alternative the capacity and the operation time of these laboratories will be increased. The Marine Structures Laboratory already runs more on a 24-hours operation and market analyses confirm that the increased capacity will be easily absorbed, implying an amplification of research activities. The operation of the new Ocean Laboratory in The D FLEX Alternative is also planned with more shifts (more round-the-clock operation) and, additionally, the new laboratories will be more time efficient. The potential capacity increase of the Ocean Laboratory enables a higher level of research activities compared to the present level, which supports the ambition of The D FLEX Alternative, including more and larger projects performed at a higher speed with stronger scientific content. Expected cash flows The time profile of incurred costs starts out similarly in The 0 + and The D FLEX Alternative, due to the laboratory investments and renovations, except that the level is higher in The D FLEX Alternative. In both Alternatives refurbishment, construction and building mainly take place during the first five years of the project. This period also involves costs associated with recruiting additional staff in The D FLEX Alternative. When the investment period is over, and new laboratory facilities have come into full operation in The D FLEX Alternative, incurred costs basically imply operating costs. We present the estimated operating cost for Marintek in Table 4 and Table 5, for The D FLEX and The 0+ Alternative, respectively. Table 4 Expected operating costs for Marintek in The D FLEX Alternative, given that 2020 is the year when new laboratories, inclusive revision of the existing ocean lab, are in operation (mill. NOK 2012) 296.6 393.3 578.4 Source: OCEAN SPACE CENTRE Gevinstrealiseringsplan for The D FLEX Alternative 5

As is seen in Table 4, operating costs in case of The D FLEX Alternative are expected to increase gradually until the new laboratory facilities are in operation, followed by a steeper increase up until the assumed steady-state. In contrast, operating costs are expected to decrease the corresponding years if the The 0+ Alternative is realised, due to a reduction in the activities caused by a degradation of the infrastructure, c.f. Table 5. Table 5 Expected operating costs for Marintek in The 0+ Alternative (mill. NOK 2012) 289.4 276.7 274.8 Source: OCEAN SPACE CENTRE Gevinstrealiseringsplan for The 0+ Alternative Similarly, the income level is expected to be relatively constant or growing moderately during the investment phase in The D FLEX Alternative, whereas in The 0+ Alternative income is expected to decrease. A further decrease is expected in The 0+ Alternative, while a steeper growth of income is assumed for The D FLEX Alternative after laboratories are in full operation. The income levels are already presented in Tables 1 and 2, for The D FLEX Alternative and The 0+ Alternative respectively. These tables show expected R&D&I turnover in the first year after refurbishment of the 0+ Alternative, and five years later, i.e. the assumed steady-state of operations. Similarly, for the last year of construction and building work of the new infrastructure in the D FLEX Alternative, but before the refurbishment of the existing ocean lab is completed, and five years later. Operational expenditure may however increase in The 0+ Alternative, due to lost functionality and lack of flexibility in the laboratories. Conclusion Investment in R&D infrastructure at Marintek implies higher capacity, upgraded and new laboratory facilities, as well as an escalation in R&D&I ambitions. With new R&D infrastructure, as described in The D FLEX Alternative, it is estimated that the activity will double by 2025, the year when turnover reaches its new steady state level. In this note it is argued that the activity growth, caused by The D FLEX Alternative, will lead to the required incentive effect for the industry. First, it is expected that the industry will face new global challenges which will increase the demand in the development of ocean space technology the next 10-20 years. The D FLEX alternative will aim at five different target areas of R&D&I (Smart Maritime, Deepwater, Arctic, Renewables and Seafood) to meet these new challenges. Second, market analyses reveals that the industry will increase the demand for developing projects with higher research content. Without the investment in infrastructure, the research activities and services that the laboratories support today will be phased out, and hence will not face the industry s future need. Third, the demand for using the Ocean Laboratory and the Marine Structures Laboratory exceeds the capacity at Marintek today. With The D FLEX Alternative the capacity and the operation time of these laboratories will be increased sufficiently to meet future demand. 6

References [1] Kvalitetssikring fase 1 (KS2- Konseptvalg) av Ocean Space Centre» Metier AS og Møreforsking Molde AS, 2012 [2] «OCEAN SPACE CENTRE gevinstrealiseringsplan alternativ 0+» Marintek, 2013 [3] «OCEAN SPACE CENTRE gevinstrealiseringsplan alternativ D FLEX» Marintek, 2013 [4] «Tilleggsoppdrag om kvalitetssikring av gevinstrealiseringsplaner for Ocean Space Centre» Metier AS and Møreforsking Molde AS, 2013 7