The gradual absorption of wind power into the mainstream energy sector is no longer a matter of conjecture, but of fact. As the undisputed leading-edge renewable energy source, wind is increasingly competing for supply contracts alongside the conventional power generation technologies. From politicians to fund managers to energy executives, the wind mantra is surprisingly consistent. All of this ought to be good news for the independent developers of wind farms, who have the skills, track records and now the commercial environment required to succeed -- particularly in the light of lessons learned from the growth of Independent Power Producers (IPPs) in the US over the last 15 years. Early IPP developers grew from uneconomic single projects to large-scale corporations who fundamentally changing the energy landscape, even acquiring a number of mainstream energy companies along the way.
On close inspection, however, the picture is neither as clear nor as promising. The majority of the early IPP project developers were pushed out along the way, victims of insufficient size or unrealistic expectations, particularly as to their ability to replicate the development process. Some of those who succeeded did so by making more money from the fuel or from "Engineering, Procurement & Construction" contracts than from power supply, options which are far less available to wind.
FUTURE FACTORS
Most importantly, the future is clouded by three factors set to decisively impact the direction -- and success -- of wind developers operating in the market today:
o the rise of a new class of large scale, "strategic" wind plant owners and developers (the "investor/developers;")
o the intense competition for prime development sites;
o the lack of independent equity capital for operating wind farms.
These factors are partially, but not completely, interconnected. They provide the context in which investors and industry are making their decisions. Success and survival is becoming a function of how well a developer defines itself in relation to these three factors.
The creation and rise of the investor/developer is perhaps the most significant factor impacting wind's entry into the mainstream. This business model entails the development and ownership of wind farms, with ownership playing an important strategic role for the company and development being the growth engine of the firm. The business model is highly capital intensive and on numerous levels represents a major shift away from the "pure" developers prevalent today. Among these pure developers are Germany's Energiekontor, Umweltkontor, and Plambeck, Seawest, Cielo and Zilkha of the United States, and (to some extent) Britain's Renewable Energy Systems.
The investor/developer today is almost exclusively represented by the major utilities, though this need not necessarily be the case. Companies like SIIF Energies in France (the renewables arm of French national utility Electricité de France), FPL Energy (a division of giant Florida Power & Light in the US), Spain's utility-owned Iberdrola Renovables and ENEL Green Power, the green division of Italy's national utility, typify the investor/developer. For these companies, renewables is a core growth business where the objective is to build a compelling platform across, at least, the main markets of Western Europe and the US.
Ownership of wind farms may help to serve their larger corporate objective of having direct access to green power to market to their utility customers, thereby also fulfilling regulatory requirements. For the business itself, asset ownership means a stability of cash flow that offsets the inherent lack of predictability and visibility of the development business. This business model is much better suited, therefore, for public listing, particularly when they have sufficient scale. Indeed, a number of players plan to go public.
For the investor/developer model to really work, however, the company must have a vital, proven development pipeline, and more importantly, an experienced development team with a successful track record. Without this, there is no growth in the business; and it loses a critical element of its appeal. Herein lies the essential challenge of this group: how to build companies of scale without destroying the entrepreneurial culture and drive that is so central to successful development -- and achieve this in a business critically short of the manpower skills required.
Strength in numbers
Mergers and acquisitions (M&A) is seen as an essential tool in growing wind businesses to respond to the increasingly global market. One notable aspect of such activity is the recent run of "platform-building" deals, such as the acquisition by Dutch green power marketer Nuon of the wind business DESA from Abengoa of Spain, RWE Harpen's acquisition of Aersa in Spain, or the purchase of the Indian Mesa wind farm in Texas by giant American Electric Power. From Denmark, Energie E2's recent acquisition of American Cinergy's Spanish wind and renewables business is also an example of a Northern European player, committed to the sector, looking to find an appropriate platform in southern Europe.
Whether the investor/developers succeed or not, their rise and attempts to do so are radically reshaping the sector. For the first time there is a large scale class of strategic asset owners and there is also a group of well capitalised entities looking to dominate wind power project development. All of this is highly disturbing for the smaller "pure developers," both because they lose a group of potential customers and because they gain a well-capitalised, relatively ruthless new group of competitors.
The development battlefield
The looming battle for the development business is particularly intense due to the growing maturity of the market. If prime development sites were plentiful, then this battle would play out more slowly. Unfortunately for the weaker players, this is not the case. Within Europe, onshore northern Europe is rapidly maturing. The Iberian Peninsula and Italy hold attractions, but they too are finite. Offshore is a potential mitigating factor, but it is not an immediate market and the first generation may be of more marginally attractive economics. The US has vast potential, though US tax paying capacity is a prerequisite for access to wind's federal production tax credit, which has a value this fiscal year of $0.018/kWh. In short, the playing field is small and near term conflict is inevitable.
The scarcity element will be compounded by the investor/developers starting to shift to "developer/investors," and focusing the majority of their efforts on building large scale, diversified development pipelines. Their ability to outspend, not always wisely, and to outlast the competition will make it all the more challenging to the independents -- the smaller "pure developers" who in some instances may be far better suited to the actual development process.
Outspending will also feature in the M&A market, which is increasingly focusing on development properties rather than operating assets. Players recognise that there is an onshore land grab at work and are currently more focused on securing development positions than operating positions. This is not inconsistent with the investor/developer model and is a function of timing rather than strategy. SIIF Energie's acquisition of veteran Danish/American developer enXco is an example of this focus on development, though it has a strong platform building element to it as well. But corporate M&A, such as the enXco transaction, is likely to be less common in the development sector than asset, and particularly development asset, M&A going forward.
Brag-a-watts
A final element of the development pressure cooker is quality. In the IPP business, amassing a large portfolio of development and operating assets was referred to as building "brag-a-watts." The wind sector today is still at the stage of bragging about its watts, with most companies claiming hundreds or thousands of megawatts in their portfolio. As with the IPP sector, the upcoming shift will be towards the real quality of these pipelines, with investors only giving companies credit for the truly visible end of their pipeline, often those that are likely to reach financial close within the next 18-24 months.
The net impact of these factors is the increased competition for development. Independents will have to recapitalise if they want to compete directly with the large players, or they will have to find areas of true comparative advantage, be it regional, offshore, early-stage prospecting or any other niche.
Another visible aspect of the wind sector is the current lack of equity capital for operating wind farms. As with all other factors, as the wind sector is not yet truly a single market, there are many exceptions to this rule. Nonetheless, currently there is less equity than there are operating wind farms in which to invest. For two reasons, this is largely an issue of timing.
First, investor/developers (largely those who already have a platform of operating assets) would rather spend, for example, $30 million on either their own development efforts or on acquiring promising development sites than on a single operating wind farm. As development sites are scarce and as these companies need to demonstrate their ability to develop and close new wind farms, this preference makes sense, today, for the investor/developers. More interestingly, some larger investor/developers might jump at the opportunity to monetise some of their existing wind farms to free up cash for development. While not exactly an investor/developer, Gamesa Energie's efforts to sell down its operating portfolio exemplifies the concept of recycling capital.
But as the investor/developers players get larger and the sector and development mature, they will need to continue to find growth. A return to acquiring operating wind farms is likely.
Second, outside of Germany, specialist funds focused on operating wind farms have been slow to develop. There is a strong argument that the best, risk-adjusted returns in the wind sector today are in operating wind farms. Investors must be able to view the operating farms as relatively stable from a risk perspective and relatively cheap from a return perspective.
There are a number of efforts to put together specialist private-equity funds with this focus, some of which also may dabble in development. London-based corporate finance house Augusta Finance is looking to launch such a vehicle. Other players, primarily financial institutions, are simply planning to invest their own capital in this area, without building a fund structure. Still more players, such as the Black Emerald Group, are approaching the market from a leasing fund perspective.
For savvy investors, operating wind farms offer an attractive investment case, provided the investment vehicle is solid. Once these large, institutional funds begin to emerge, the equity gap will narrow significantly.
Small funds too
Retail investors also have an important role to play, as the success of Germany's equity funds for wind projects has demonstrated (“uåX˜äŠÊ˜·³Ç, September 2001). The German wind funds are perhaps too quickly written off as a country-specific, tax-driven phenomenon. Other jurisdictions, such as the US, make it highly challenging to replicate such a structure, precisely because the wind project tax credits and benefits are not fully available for individuals. But while the US may prove one of the more difficult venues for retail wind funds, the mixture of relatively stable, attractive-yielding wind assets, falling stock markets and a sufficiently large market opportunity, ought to combine to produce individual wind investment vehicles across Europe. Some of the German fund companies are already advancing quickly down this route (“uåX˜äŠÊ˜·³Ç, April 2002).
Regardless of reason, the current equity gap further puts pressure on all developers, independent and integrated. Development without a clear financing "exit" is all the more challenging, and will widen the gap between those who have access to capital and those who do not.
A dynamic future
All of this discussion does not by any stretch mean the end of the "pure developer," just as it does not mean the inevitable rise and success of the investor/developer. It does, however, provide the setting in which the players, and certainly the investors, are viewing the prospects for these companies.
It is also the context for the strategic development of the wind sector and the M&A and equity capital raising transactions that accompany it. Above all is else, it is clear that the wind sector will continue to be highly dynamic, increasingly competitive and increasingly remunerative for those who succeed.
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