xUtilities moving in as big time players
The prospect that the United States will implement a national renewable energy standard (RES) stipulating a minimum level for the proportion of green electricity in the supply mix and place mandatory limits on greenhouse gas emissions under President Barack Obama's administration will help push utilities to own an increasing proportion of the country's wind power generating fleet. Regulated utilities emerged for the first time as "a significant factor" in project ownership last year with a 12% share of the market, reports Jeffrey Chester of law firm Kaye Scholer. It is a number that is expected to grow -- and Chester is not alone in that belief.
Emil Avram of Dominion Resources, a Virginia utility whose first wind project came online last year, agrees: "We're already starting to see the progression towards more and more utilities owning wind assets. I think maybe in ten or twenty years you could see as much as fifty per cent of the market owned by utilities." Like Chester, Avram was speaking at a recent conference on wind power finance and investment, hosted in San Diego, California, by Infocast. "Certainly if there is a federal renewables portfolio standard I think utilities will want to take a look at their capital allocation and determine, do we want to take control and ownership of more assets in the renewables space?"
Dominion's 27 GW generation portfolio is about 75% nuclear and coal, with another 20% gas. The utility is pursuing wind energy with a threefold aim: to meet the Virginia state target of 12% renewable energy by 2022; to reduce its carbon intensity in the face of expected legislation to cap CO2 emissions; and as a hedge against rising fuel costs. It built the 264 MW NedPower Mount Storm Wind Project in partnership with Shell and has a 50% interest in 650 MW of BP Alternative Energy's two-phase, 750 MW Fowler Ridge Wind Farm in Indiana. It also has an agreement with BP to develop half a dozen projects in Virginia to come to market in 2012 or later.
A national RES of the magnitude Obama envisions, which would see 25% of US electricity come from renewable energy sources by 2025, would require "quite a bit more" wind than Dominion is developing today, says Avram. "We're looking at options to build a development pipeline that we can either expand or contract in the future to meet those requirements."
One thing Dominion does not want to do is simply buy its way into compliance through power purchase agreements (PPAs) with independent wind power producers. "We've taken a position where we'll do a PPA with a wind farm but we will also want to have an equity ownership piece in that asset," Avram explains. "We do that for one reason. The rating agencies view long-term PPAs as a liability. They are essentially an obligation to pay a third party for a long term -- and so we balance out that liability with an asset. We feel that is prudent as far as maintaining our credit rating as a corporation."
There are other motivations for owning rather than buying wind output as well. "Utilities earn returns based on how much they build into their rate base, so there is clearly value in adding assets," says Elias Hinkley of Deloitte Tax LLP.
What Chester calls the wind industry's "extreme need" for project investors with tax liabilities large enough to want to own equity stakes in wind farms in order to utilise the federal $0.021/kWh production tax credit (PTC) for wind generation is also expected to drive more utility investment in the sector. But utilities may not be the tax equity saviours many had hoped they might become after the ranks of tax-motivated investors shrunk dramatically late last year (previous story).
"Even good-sized utilities such as my own only have limited tax shelter appetite. We have a market cap of nearly $4 billion and that allows us enough revenue and taxable income to shelter only 400 MW of 30% capacity factor wind. So even our industry will fairly quickly run out of tax shelter appetite," warns Eric Markell of Puget Sound Energy, a Washington state utility that owns two operating wind farms and signed a joint venture agreement with RES Americas in December to develop another 1250 MW of projects in the state.
Dominion has the tax appetite to utilise the PTC for several thousand MW of wind, says Avram, but that does not mean it will. The utility is developing a nuclear facility in Virginia that would also qualify for tax credits. "That could consume a lot of our tax capacity. So we're looking at it as a total portfolio of opportunities. Right now we are not pursuing tax equity investments from the outside for any of our wind projects, but it doesn't mean we're not open to it."
It is unlikely regulated utilities will ever get involved simply as tax equity investors in projects, says Hinkley. The rules they live under require them to share tax benefits with ratepayers, which means that "there is more challenge than value" in exercising the PTC as an investment proposition. "Their position is much more one of wanting some control over the asset," he says.
A new ownership model
Markell believes that wind developers looking for investors for completed projects may find more value in pursuing outright sales to utilities than the complex "partnership flip" deals that companies without a big tax bill must strike to effectively use the PTC today. Under a partnership flip, the tax equity partner gets most of the economic returns from a project until it reaches a targeted return. At that point, majority ownership flips back to the developer, who also has the option to buy out the remaining interest of the tax equity player. Reaching the flip date can take ten years or more. The PTC is eligible for ten years of generation.
"It isn't clear that hanging out for ten to sixteen years to get your project back to harvest some unknown, immeasurable upside is a particularly attractive way to create cash flow and value," says Markell. "We are somewhat enamoured of a model that says move your development project as far along as you would like, then we buy your rights in exchange for your out-of-pocket expenses, as well as an appropriate return for your risk capital, the payment of an appropriate development fee and the payment of a long-term royalty that is linked to actual production."
This model puts financing responsibility in the hands of the utility. "I think we would argue that the balance sheet capability and access to the capital markets of the utility industry is far more liquid, broad and deep than you all have access to and therefore it is often less costly," explains Markell.
But with the electric industry potentially on the cusp of a national RES, he continues, it is facing issues far more fundamental than who owns the projects. "As we all have discussed, there is $500 billion of wind cost headed into the system. Whether it is coming through power purchase agreements or owning the sources, it is on the way and from our perspective the recovery of those costs in an efficient and prompt way is imperative."
Execution risk
The industry is already facing "an enormous execution risk" with the state renewable energy targets and laws that are now in place, says Markell. Taking the west coast states of Washington, Oregon and California, they will have to construct at least 15 GW of wind capacity in the next decade to meet their combined targets. "That means constructing a 300 MW wind project and placing it in service every 75 days for the next decade. Together with that we are going to be having to build large, new transmission systems to get those projects to load, multiple new gas-fired projects to help manage and integrate all that wind, and interstate pipeline facilities to deliver the gas to those plants. All that requires significant permitting as well as capital activity," he stresses.
Recovering those costs and getting approvals in place through the current mix of state and local regulatory processes is not going to work, Markell argues, and moving that authority into the hands of the Federal Energy Regulatory Commission (FERC), where national priorities can be set, is going to be critical to the growth of the sector. "The siting and rate regulation of renewable energy is much more important in my view for this industry than whether or not we have a national renewables portfolio standard."
Avram shares that view. The regulatory environment is going be an issue in meeting any national RES, he says. "It is probably going to be the biggest obstacle to reaching the goals we've all heard about in the last seven or so months. There is definitely a problem of how to balance regulatory authority between FERC and the states. It has resulted in a lot of lawsuits in the past and slows down transmission construction and permitting in many cases to beyond a decade."
It is also a problem without a simple solution. States have fiercely defended their right to control what happens inside their borders when it comes to electricity. That is unlikely to change. "I think it would be a major fight for the federal government to pre-empt state siting of transmission lines and I just struggle to see it happen," says Eric Blank of Iberdrola USA, the American arm of Spanish utility Iberdrola, the largest wind power investor globally.
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